UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



FORM 10-KSB



(Mark One)



ý

Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934For fiscal year ended December 31, 2006

o

Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period   from __________ to ___________





Commission File Number 000-28333



| |                                | 
| | ------------------------------ | 
| | COASTAL BANKING COMPANY, INC.  | 
| | (A South Carolina Corporation) | 



IRS Employer Identification Number:  58-2455445



| |                                                       | 
| | ----------------------------------------------------- | 
| | 36 Sea Island Parkway, Beaufort, South Carolina 29907 | 
| | Telephone Number:  (843) 522-1228                     | 





Securities registered pursuant to Section 12(b) of the Act:  None.



Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value.



Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. [  ]

Check whether the issuer:  (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that registrant was required to file such reports) and (2) has been subject to such filing requirements for past 90 days.    Yes [X]   No [  ]



Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B in this form, and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.  [  ]



Check whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  Yes [  ] No [X]



State issuers revenue for its most recent fiscal year: $28,771,878



The aggregate number of shares of the Companys common stock held by non-affiliates as of March 16, 2007 was 2,052,028. The aggregate market value of these shares as of March 16, 2007 was $46,786,238 based upon the estimated fair market value of the common stock of $22.80 per share, which is the average bid and ask price on the Over the Counter Bulletin Board on March 16, 2007.  This price reflects inter-dealer prices without retail mark up, mark down, or commissions, and may not represent actual transactions.



2,402,594 shares of common stock were outstanding as of March 16, 2007.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the registrants Proxy Statement for the 2007 Annual Meeting of Shareholders, scheduled to be held on May 18, 2007, are incorporated by reference into Part III.



Transitional Small Business Disclosure format (check one):                        Yes [  ] No [X]



---







Table of Contents





Page



PART 1.



1.

Description of Business

1

2.

Description of Property

16

3.

Legal Proceedings

16

4.

Submission of Matters to a Vote of Security Holders

16



PART II.



5.

Market for Common Equity, Related Stockholder Matters and Small Business Issuer

Purchases of Equity Securities

17

6.

Managements Discussion and Analysis or Plan of Operation

17

7.

Financial Statements

31

8.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

60

8A.

Controls and Procedures

60

8B.

Other Information

60



PART III.



9.

Directors, Executive Officers, Promoters, Control Persons and Corporate Governance;

Compliance With Section 16(a) of the Exchange Act

61

10.

Executive Compensation

61

11.

Security Ownership of Certain Beneficial Owners and Management and Related

Stockholder Matters

62

12.

Certain Relationships, Related Transactions and Director Independence

63

13.

Exhibits

63

14.

Principal Accountant Fees and Services

63







i



---



PART I.



Item 1.

Description of Business



This Report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and the Securities Exchange Act of 1934. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those projected in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words may,  would, could, will, expect, anticipate, believe, intend, plan, and estimate, as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties include, but are not limited to those described below under Risk Factors.



General



Coastal Banking Company, Inc. was incorporated in June, 1999 to operate as a bank holding company pursuant to the Federal Bank Holding Company Act of 1956 and the South Carolina Banking and Branching Efficiency Act, and to purchase 100% of the issued and outstanding stock of Lowcountry National Bank, an association organized under the laws of the United States. The bank opened for business on May 10, 2000. On October 1, 2005, we merged with First Capital Bank Holding Corporation, and, by virtue of the merger, acquired 100% of the issued and outstanding capital stock of First National Bank of Nassau County (First National Bank). On October 27, 2006, Coastal acquired the Meigs, Georgia office of Cairo Banking Company, a Georgia state bank, from Ameris Bancorp. The acquisition allows Coastal to establish full service banking operations in Georgia. First National currently operates the Meigs office as a branch office under the name of the First National Bank of Nassau County, doing business as The Georgia Bank. Through our subsidiaries, we conduct a general commercial and retail banking business principally in the markets of Beaufort County, South Carolina, Nassau County, Florida and Thomas County, Georgia. First National also operates loan production offices in Jacksonville, Florida and Savannah, Georgia.



Location and Service Area



Our primary service areas consist of the areas within a 20 mile radius of the main offices of Lowcountry National Bank in Beaufort County, South Carolina, First National Bank in Nassau County, Florida, and First National Bank d/b/a The Georgia Bank in Thomas County, Georgia. The primary service area of Lowcountry National Bank covers a large portion of Beaufort County, including Beaufort, Bluffton, Burton, Callawassie Island, Coosaw, Dataw Island, Harbor Island, Hilton Head Island, Hunting Island, Fripp Island, Ladys Island, Port Royal, Spring Island, St. Helena Island, and the rapidly growing Sun City. The primary service area of First National Bank includes the communities of Amelia Island, Fernandina Beach, ONeil and Yulee, Florida. The borders of the primary service area of First National Bank are the St. Marys River and the Georgia border to the north, the Atlantic Ocean to the east, Duval County to the south and Baker County to the west. First National Bank also serves the Savannah, Georgia and Jacksonville, Florida market areas through loan production offices.



Lending Activities



General: We emphasize a range of lending services, including real estate, commercial, and consumer loans to individuals and small- to medium-sized businesses and professional firms that are located in or conduct a substantial portion of their business in the banks market areas.



Loan Approval and Review: The banks loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds an individual officers lending authority, the loan request will be considered and approved by an officers loan committee with a higher lending limit or the directors loan committee, which has the authority to approve loans up to the legal lending limit of the bank. Neither bank may make any loans to any director, officer, or employee of the bank that, in the aggregate, exceeds $500,000 unless approved by the board of directors of the bank and is made on terms not more favorable to such person than would be available to a person not affiliated with the bank. The banks currently adhere to Federal National Mortgage Association and Federal Home Loan Mortgage Corporation guidelines in its mortgage loan review process, but may choose to alter this policy in the future. The banks currently sell their mortgage loans on the secondary market, but may choose to hold them in the portfolio in the future.





1



---



Lending Limits: The banks lending activities are subject to a variety of lending limits imposed by federal law. In general, the banks are subject to a legal limit on loans to a single borrower equal to 15% of each banks capital and unimpaired surplus. Different limits may apply in certain circumstances based on the type of loan or the nature of the borrower, including the borrowers relationship to the banks. These limits will increase or decrease as each banks capital increases or decreases. Based upon Lowcountry National Banks capitalization of $16,144,000 as of December 31, 2006, the bank has a self-imposed loan limit of $2,373,000, which represents 98% of our regulatory legal lending limit of $2,422,000. Based upon First National Bank's capitalization of $19,761,000 as of December 31, 2006, it had a self imposed legal lending limit of $2,500,000, which represents approximately 84% of its regulatory legal lending limit. Unless the banks are able to sell participations in its loans to other financial institutions, the banks will not be able to meet all of the lending needs of loan customers requiring aggregate extensions of credit above these limits.



Real Estate and Mortgage Loans:Loans secured by first or second mortgages on real estate make up approximately 93% of Lowcountry Nationals loan portfolio, 95% of First National Banks portfolio, and 94% of the consolidated loan portfolio. These loans generally fall into one of three categories: commercial real estate loans, construction and development loans, or residential real estate loans. Each of these categories is discussed in more detail below, including their specific risks. Home equity loans are not included because they are classified as consumer loans, which are discussed below. Interest rates for all categories may be fixed or adjustable, and will more likely be fixed for shorter-term loans. The banks generally charge origination fees for each loan.



Real estate loans are subject to the same general risks as other loans. They are particularly sensitive to fluctuations in the value of real estate. Fluctuations in the value of real estate, as well as other factors arising after a loan has been made, could negatively affect a borrowers cash flow, creditworthiness, and ability to repay the loan.



We have the ability to originate real estate loans for sale into the secondary market. We can limit our interest rate and credit risk on these loans by locking the interest rate for each loan with the secondary investor and receiving the investors underwriting approval prior to originating the loan.



Commercial Real Estate Loans: Commercial real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine its business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 80%. We generally require that debtor cash flow exceed 115% of monthly debt service obligations. We typically review all of the personal financial statements of the principal owners and require their personal guarantees. These reviews generally reveal secondary sources of payment and liquidity to support a loan request.



Construction and Development Real Estate Loans:We offer adjustable and fixed rate residential and commercial construction loans to builders and developers and to consumers who wish to build their own home. The term of construction and development loans generally is limited to eighteen months, although payments may be structured on a longer amortization basis. Most loans will mature and require payment in full upon the sale of the property. Construction and development loans generally carry a higher degree of risk than long term financing of existing properties. Repayment depends on the ultimate completion of the project and usually on the sale of the property. Specific risks include cost overruns, mismanaged construction, inferior or improper construction techniques, economic changes or downturns during construction, a downturn in the real estate market, rising interest rates which may prevent sale of the property, and failure to sell completed projects in a timely manner.



We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages. We may also reduce risk by selling participations in larger loans to other institutions when possible.



Residential Real Estate Loans: Residential real estate loans generally have longer terms up to 30 years. We offer fixed and adjustable rate mortgages. We have limited credit risk on these loans as most are sold to third parties soon after closing.



Commercial Loans: Our banks make loans for commercial purposes in various lines of businesses. Commercial loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or if they are secured, the value of the security may be difficult to assess and more likely to decrease than real estate.





2





---

Equipment loans typically are made for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment and with a loan-to-value ratio of 80% or less. We focus our efforts on commercial loans less than $500,000. Working capital loans typically have terms not exceeding one year and usually are secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal typically is repaid as the assets securing the loan are converted into cash, and in other cases principal typically will be due at maturity. Asset based lending, leasing, and factoring are offered through third party vendors who can handle the paper work and servicing and generally assume most of the credit risk. Trade letters of credit, standby letters of credit, and foreign exchange are handled through a correspondent bank as agent for the bank.



We offer small business loans utilizing government enhancements such as the Small Business Administrations 7(a) program and SBAs 504 programs. These loans typically are partially guaranteed by the government, which may help to reduce the banks risk. Government guarantees of SBA loans generally will not exceed 80% of the loan value and will generally be less, although it will guarantee up to 85% on loans of $150,000 or less.



The well established banks in the Beaufort County and Nassau County areas make proportionately more loans to medium to large-sized businesses than we do. Many of the banks commercial loans are made to small- to medium-sized businesses which may be less able to withstand competitive, economic, and financial conditions than larger borrowers.



Consumer Loans: Our banks make a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit. Installment loans typically carry balances of less than $50,000 and are amortized over periods up to 60 months. Consumer loans may be offered on a single maturity basis where a specific source of repayment is available. Revolving loan products typically require monthly payments of interest and a portion of the principal. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or if they are secured, the value of the security may be difficult to assess and more likely to decrease than real estate.



We also offer home equity loans. Our underwriting criteria for and the risks associated with home equity loans and lines of credit generally are the same as those for first mortgage loans. Home equity lines of credit will typically have terms of 15 years or less, will typically carry balances less than $125,000, and may extend up to 90% of the available equity of each property.



Deposits:The banks offer a wide range of commercial and consumer deposit accounts, including checking accounts, money market accounts, a variety of certificates of deposit, and individual retirement accounts.  The primary sources of deposits are residents of, and businesses and their employees located in, our primary market areas.  Deposits are obtained through personal solicitation by officers and directors, direct mail solicitations and advertisements published in the local media.  To attract deposits, the subsidiary banks offer a broad line of competitively priced deposit products and services.



3





---



Risk Factors



Our recent operating results may not be indicative of our future operating results.



We may not be able to sustain our historical rate of organic growth and may not even be able to grow our business at all. Because of our relatively small size and short operating history, it will be difficult for us to generate similar earnings growth as we continue to expand, and consequently our historical results of operations will not be indicative necessarily of our future operations. Various factors, such as economic conditions, regulatory and legislative considerations, and competition, may also impede our ability to expand our market presence. If we experience a significant decrease in our historical rate of organic growth, our results of operations and financial condition may be adversely affected because a high percentage of our operating costs are fixed expenses.



Our decisions regarding credit risk and reserves for loan losses may materially and adversely affect our business.



Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:





the duration of the credit;





credit risks of a particular customer;





changes in economic and industry conditions; and





in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.



We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors, including:





an ongoing review of the quality, mix, and size of our overall loan portfolio;





our historical loan loss experience;





evaluation of economic conditions;





regular reviews of loan delinquencies and loan portfolio quality; and





the amount and quality of collateral, including guarantees, securing the loans.



There is no precise method of predicting credit losses; therefore, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required. Additions to the allowance for loan losses would result in a decrease of our net income, and possibly our capital.



An economic downturn, especially one affecting the primary market areas of our banks, could reduce our customer base, our level of deposits, and demand for financial products such as loans.



Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets, especially in the primary market areas of our banks, which are Beaufort County, South Carolina and Nassau County, Florida. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. An economic downturn would likely contribute to the deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business. Interest received on loans represented approximately 85% of our interest income for the year ended December 31, 2006. If an economic downturn occurs in the economy as a whole, or especially in our banks primary market areas, borrowers may be less likely to repay their loans as scheduled. Moreover, the value of real estate or other collateral that may secure our loans could be adversely affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. An economic downturn could, therefore, result in losses that materially and adversely affect our business.



4





---



Changes in prevailing interest rates may reduce our profitability.



Our results of operations depend in large part upon the level of our net interest income, which is the difference between interest income from interest-earning assets, such as loans and mortgage-backed securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Depending on the terms and maturities of our assets and liabilities, a significant change in interest rates could have a material adverse effect on our profitability. Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions. While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective and our financial condition and results of operations could suffer. After a series of rate increases beginning in the second quarter of 2004, the Federal Reserve has stopped increasing interest rates, which has slowed the increase in marginal cost of new deposits and borrowings. However, no assurance can be given that the Federal Reserve will not raise interest rates in the future or that the results we anticipate will actually occur.



We are dependent on key individuals and the loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.



The success of our banks depends largely on the services of their respective chief executive officers. Randolph C. Kohn, the president and chief executive officer of Lowcountry National Bank, and Michael G. Sanchez, the president and chief executive officer of First National Bank, have extensive and long-standing ties within our industry. If we lose the services of either Mr. Kohn or Mr. Sanchez, our business and development could be materially and adversely affected.



Our success also depends, in part, on our continued ability to attract and retain experienced loan originators, as well as other management personnel. The loss of the services of several of such key personnel could adversely affect our growth strategy and prospects to the extent we are unable to replace such personnel.



We are subject to extensive regulation that could limit or restrict our activities.



We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth.



The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.



The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission that are now applicable to us, have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices. We have experienced, and we expect to continue to experience, greater compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act.



Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.



We are required by regulatory authorities to maintain adequate levels of capital to support our operations. To support our continued growth, we may need to raise additional capital. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity capital, your interest could be diluted.



5





---



We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher interest rates to attract customers.



The banking business is highly competitive, and we experience competition in our market from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and elsewhere. In addition, we compete with new entrants to our markets, both established and de novo institutions which have aggressively sought after market share. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. These institutions offer some services, such as extensive and established branch networks, that we do not provide. There is a risk that we will not be able to compete successfully with other financial institutions in our market, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us.



We will face risks with respect to future expansion and acquisitions or mergers.



We may seek to acquire other financial institutions or parts of those institutions. We may also expand into new markets or lines of business or offer new products or services. These activities would involve a number of risks, including:





the potential inaccuracy of the estimates and judgments used to evaluate credit, operations, management, and market risks with respect to a target institution;





the time and costs of evaluating new markets, hiring or retaining experienced local management, and opening new offices and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;





the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse effects on our results of operations; and





the risk of loss of key employees and customers.



In addition, we merged with First Capital Bank Holding Corporation on October 1, 2005. Through the merger, we acquired First National Bank of Nassau County. Even though we have not encountered difficulties in integrating the two companies to this point, there is a risk that we would lose key employees and customers from both Lowcountry National Bank and First National Bank.



Supervision And Regulation



Coastal Banking Company, Inc., Lowcountry National Bank and First National Bank are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws generally are intended to protect depositors and not shareholders. The following discussion describes the material elements of the regulatory framework that applies to us.



Coastal Banking Company, Inc.



Because it owns all of the capital stock of Lowcountry National Bank and First National Bank, Coastal Banking Company, Inc. is a bank holding company under the federal Bank Holding Company Act of 1956 (the Bank Holding Company Act). As a result, we are primarily subject to the supervision, examination and reporting requirements of the Bank Holding Company Act and the regulations of the Federal Reserve. As a bank holding company located in South Carolina, the South Carolina State Board of Financial Institutions also regulates and monitors all significant aspects of our operations.





6





---



Acquisitions of Banks:The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserves prior approval before:





acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the banks voting shares;





acquiring all or substantially all of the assets of any bank; or





merging or consolidating with any other bank holding company.



Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned. The Federal Reserves consideration of financial resources generally focuses on capital adequacy, which is discussed below.



Under the Bank Holding Company Act, if we are adequately capitalized and adequately managed, we may purchase a bank located outside of South Carolina or Florida. However, the laws of the other state may impose restrictions on the acquisition of a bank that has only been in existence for a limited amount of time or that would result in specified concentrations of deposits. For example, South Carolina law prohibits a bank holding company from acquiring control of a bank until the target bank has been incorporated for five years. Because Lowcountry National Bank and First National Bank have each been chartered for a sufficient amount of time, this restriction would not limit our ability to sell.



Change in Bank Control:Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring control of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:





the bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934; or





no other person owns a greater percentage of that class of voting securities immediately after the transaction.



The regulations provide a procedure for challenging rebuttable presumptions of control.



Permitted Activities: A bank holding company is generally permitted under the Bank Holding Company Act, to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in, the following activities:





banking or managing or controlling banks; and





any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.





7





---



Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:





factoring accounts receivable;



making, acquiring, brokering or servicing loans and usual related activities;



leasing personal or real property;



operating a non-bank depository institution, such as a savings association;



trust company functions;



financial and investment advisory activities;



conducting discount securities brokerage activities;



underwriting and dealing in government obligations and money market instruments;



providing specified management consulting and counseling activities;



performing selected data processing services and support services;



acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and



performing selected insurance underwriting activities.



Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding companys continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.



In addition to the permissible bank holding company activities listed above, the Financial Services Modernization Act of 1999, or the Gramm-Leach-Bliley Act, revised and expanded the provisions of the Bank Holding Company Act by permitting a bank holding company to qualify and elect to become a financial holding company.  Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity.  The following activities are considered financial in nature:





lending, trust and other banking activities;



insuring, guaranteeing or indemnifying against loss or harm, or providing and issuing annuities and acting as principal, agent or broker for these purposes, in any state;



providing financial, investment or advisory services;



issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;



underwriting, dealing in or making a market in securities;



other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks;



foreign activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking operations abroad;



merchant banking through securities or insurance affiliates; and



insurance company portfolio investments.



To qualify to become a financial holding company, Lowcountry National Bank, First National Bank and any other depository institution subsidiary of Coastal Banking Company, Inc. are required to be well capitalized and well managed and have a Community Reinvestment Act rating of at least satisfactory.  Additionally, we would be required to file an election with the Federal Reserve to become a financial holding company and provide the Federal Reserve with 30 days written notice prior to engaging in a permitted financial activity. While we meet the qualification standards applicable to financial holding companies, we have not elected to become a financial holding company at this time.



On December 18, 2006, the SEC and the Federal Reserve issued joint proposed rules, which would implement the broker exception for banks under Section 3(a)(4) of the Exchange Act of 1934 and would be adopted as part of the Gramm-Leach-Bliley Act.  The proposed rules would implement the statutory exceptions that allow a bank, subject to certain conditions, to continue to conduct securities transactions for the Banks customers as part of its trust and fiduciary, custodial and deposit sweep functions, and to refer customers to a securities broker-dealer pursuant to a networking arrangement with the broker-dealer.



8





---



To qualify to become a financial holding company, the banks and any other depository institution subsidiary of the Coastal Banking Company, Inc. must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least satisfactory.  Additionally, Coastal Banking Company, Inc. must file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days written notice prior to engaging in a permitted financial activity. While Coastal Banking Company, Inc. meets the qualification standards applicable to financial holding companies, we have not elected to become a financial holding company at this time.



Support of Subsidiary Institution:Under Federal Reserve policy, we are expected to act as a source of financial strength for the banks and to commit resources to support them. This support may be required at times when, without this Federal Reserve policy, we might not be inclined to provide it. In addition, any capital loans made by us to the banks will be repaid only after their deposits and various other obligations are repaid in full. In the unlikely event of our bankruptcy, any commitment by us to a federal bank regulatory agency to maintain the capital of the banks will be assumed by the bankruptcy trustee and entitled to a priority of payment.



Lowcountry National Bank and First National Bank of Nassau County



Because Lowcountry National Bank and First National Bank are chartered as national banks, they are primarily subject to the supervision, examination and reporting requirements of the National Bank Act and the regulations of the OCC. The OCC regularly examines the banks operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The OCC also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Because the banks deposits are insured by the FDIC to the maximum extent provided by law, they are also subject to certain FDIC regulations. The banks are also subject to numerous state and federal statutes and regulations that affect its business, activities and operations.



Branching:National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which their main office is located. Under both South Carolina and Florida law, the banks may open branch offices throughout their respective home states with the prior approval of the OCC. In addition, with prior regulatory approval, both banks may acquire branches of existing banks located in their respective home states. The banks and any other national or state-chartered bank generally may branch across state lines by merging with banks in other states if allowed by the target states laws. South Carolina and Florida law, with limited exceptions, currently permit branching across state lines only through interstate mergers.



Under the Federal Deposit Insurance Act, states may opt-in and allow out-of-state banks to branch into their state by establishing a new start-up branch in the state. Currently, neither South Carolina nor Florida has opted-in to this provision. Therefore, interstate merger is the only method through which a bank located outside of these states may branch into them. This provides a limited barrier of entry into the South Carolina and Florida banking markets, which protects us from an important segment of potential competition. However, because neither South Carolina nor Florida has elected not to opt-in, our ability to establish a new start-up branch of either bank in another state is limited. Many states that have elected to opt-in have done so on a reciprocal basis, meaning that an out-of-state bank may establish a new start-up branch only if their home state has also elected to opt-in. Consequently, until either South Carolina or Florida changes its election, the only way we will be able to branch into states that have elected to opt-in on a reciprocal basis will be through interstate merger.



Prompt Corrective Action:The Federal Deposit Insurance Corporation Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) into which all institutions are placed. The federal banking agencies have specified by regulation the relevant capital level for each category. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.





9





---

An institution that is categorized as undercapitalized, significantly undercapitalized or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal regulator. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding companys obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiarys assets at the time it became undercapitalized or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.



FDIC Insurance Assessments: The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities.  The system assesses higher rates on those institutions that pose greater risks to the Deposit Insurance Fund (the DIF).  The FDIC places each institution in one of four risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory group assignment).  Within the lower risk category, Risk Category I, rates will vary based on each institutions CAMELS component ratings, certain financial ratios, and long-term debt issuer ratings.

Capital group assignments are made quarterly and an institution is assigned to one of three capital categories: (1) well capitalized; (2) adequately capitalized; and (3) undercapitalized.  These three categories are substantially similar to the prompt corrective action categories described above, with the undercapitalized category including institutions that are undercapitalized, significantly undercapitalized and critically undercapitalized for prompt corrective action purposes.  The FDIC also assigns an institution to one of three supervisory subgroups based on a supervisory evaluation that the institutions primary federal banking regulator provides to the FDIC and information that the FDIC determines to be relevant to the institutions financial condition and the risk posed to the deposit insurance funds.  Assessments range from 5 to 43 cents per $100 of deposits, depending on the institutions capital group and supervisory subgroup.  Institutions that are well capitalized will be charged a rate between 5 and 7 cents per $100 of deposits.

In addition, the FDIC imposes assessments to help pay off the $780 million in annual interest payments on the $8 billion Financing Corporation bonds issued in the late 1980s as part of the government rescue of the thrift industry.  This assessment rate is adjusted quarterly and is set at 1.22 cents per $100 of deposits for the first quarter of 2007.

The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.



Community Reinvestment Act:The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve, the FDIC or the OCC shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods.  These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on Lowcountry National Bank or First National Bank.  Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.



Allowance for Loan and Lease Losses:The Allowance for Loan and Lease Losses (the ALLL) represents one of the most significant estimates in the banks financial statements and regulatory reports.  Because of its significance, the each bank has developed a system by which it develops, maintains and documents a comprehensive, systematic and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses.  The Interagency Policy Statement on the Allowance for Loan and Lease Losses, issued on December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the banks stated policies and procedures, managements best judgment and relevant supervisory guidance.  Consistent with supervisory guidance, the each bank maintains a prudent and conservative, but not excessive, ALLL, that is at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio.  The banks estimate of credit losses reflects consideration of all significant factors that affect the collectibility of the portfolio as of the evaluation date.  See Managements Discussion and Analysis  Critical Accounting Policies.



10





---

Commercial Real Estate Lending:  The banks lending operations may be subject to enhanced scrutiny by federal banking regulators based on its concentration of commercial real estate loans.  On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (CRE) lending concentrations.  CRE loans generally include land development, construction loans and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property.  The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:

·

total reported loans for construction, land development and other land represent 100% or more of the institutions total capital, or

·

total commercial real estate loans represent 300% or more of the institutions total capital, and the outstanding balance of the institutions commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.

Other Regulations: Interest and other charges collected or contracted for by the each bank are subject to state usury laws and federal laws concerning interest rates.  Each banks loan operations are also subject to federal laws applicable to credit transactions, such as the

·

Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

·

Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

·

Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

·

Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identify theft protections, and certain credit and other disclosures;

·

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

·

Soldiers and Sailors Civil Relief Act of 1940, as amended by the Servicemembers Civil Relief Act, governing the repayment terms of, and property rights underlying, secured obligations of persons currently on active duty with the United States military;

·

Talent Amendment in the 2007 Defense Authorization Act, establishing a 36% annual percentage rate ceiling, which includes a variety of charges including late fees, for consumer loans to military service members and their dependents; and

·

rules and regulations of the various federal banking regulators charged with the responsibility of implementing these federal laws.



Each Banks deposit operations are subject to federal laws applicable to depository accounts, such as the:

·

Truth-In-Savings Act, requiring certain disclosures for consumer deposit accounts;

·

Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

·

Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers rights and liabilities arising from the use of automated teller machines and other electronic banking services; and

·

rules and regulations of the various federal banking regulators charged with the responsibility of implementing these federal laws.



11





---



Capital Adequacy



Coastal Banking Company, Inc., Lowcountry National Bank and First National Bank are required to comply with the capital adequacy standards established by the Federal Reserve, in the case of Coastal Banking Company, Inc., and the OCC, in the case of the banks. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. Lowcountry National Bank and First National Bank are subject to risk-based and leverage capital requirements adopted by the OCC, which are substantially similar to those adopted by the Federal Reserve for bank holding companies.



The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.



The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common stock, minority interests in the equity accounts of consolidated depository institution subsidiaries, noncumulative perpetual preferred stock in consolidated non-depository subsidiaries and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. At December 31, 2006 our ratio of total capital to risk-weighted assets was 13.06% and our ratio of Tier 1 Capital to risk-weighted assets was 11.95%.



In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserves risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2006, our leverage ratio was 10.44%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.



Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.



Payment of Dividends



Coastal Banking Company, Inc. is a legal entity separate and distinct from both Lowcountry National Bank and First National Bank. The principal sources of Coastal Banking Company, Inc.s cash flow, including cash flow to pay dividends to its shareholders, are dividends that Lowcountry National Bank and First National Bank to Coastal Banking Company, Inc. as its sole shareholder. Statutory and regulatory limitations apply to the banks payment of dividends to Coastal Banking Company, Inc. as well as to Coastal Banking Company, Inc.s payment of dividends to its shareholders.



Each bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by each banks Board of Directors in any year will exceed (1) the total of the banks net profits for that year, plus (2) the banks retained net profits of the preceding two years, less any required transfers to surplus. The payment of dividends by Coastal Banking Company, Inc., Lowcountry National Bank and First National Bank may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines.





12





---



In addition, the OCC may require, after notice and a hearing, that Lowcountry National Bank or First National Bank stop or refrain from engaging any practice it considers unsafe or unsound. The federal banking agencies have indicated that paying dividends that deplete a depository institutions capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.



Restrictions on Transactions with Affiliates



Coastal Banking Company, Inc., Lowcountry National Bank and First National Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:





a banks loans or extensions of credit to affiliates;





a banks investment in affiliates;





assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;





loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and





a banks guarantee, acceptance or letter of credit issued on behalf of an affiliate.



The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a banks capital and surplus and, as to all affiliates combined, to 20% of a banks capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. Lowcountry National Bank and First National Bank must also comply with other provisions designed to avoid the taking of low-quality assets.



Coastal Banking Company, Inc., Lowcountry National Bank and First National Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.



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



Privacy



Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.



Anti-Terrorism and Money Laundering Legislation



Lowcountry National Bank and First National Bank are subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the USA PATRIOT Act) as it amended the Bank Secrecy Act and the rules and regulations of the Office of Foreign Assets Control (OFAC). These statutes and related rules and regulations impose requirements and limitations on specific financial transactions and account relationships, intended to guard against money laundering and terrorism financing. Both Lowcountry National Bank and First National Bank have established a customer identification program pursuant to Section 326 of the USA PATRIOT Act and the Bank Secrecy Act, and otherwise has implemented policies and procedures to comply with the foregoing rules.



13





---



Federal Deposit Insurance Reform

On February 8, 2006, President Bush signed the Federal Deposit Insurance Reform Act of 2005 (the FDIRA). Among other things, FDIRA changes the federal deposit insurance system by:

·

raising the coverage level for qualifying retirement accounts to $250,000, subject to future indexing;

·

the FDIC and the National Credit Union Administration are authorized to index deposit insurance coverage for inflation, for standard accounts and qualifying retirement accounts, every five years beginning April 1, 2007;

·

prohibiting undercapitalized financial institutions from accepting employee benefit plan deposits;

·

merging the Bank Insurance Fund and Savings Association Insurance Fund into a new Deposit Insurance Fund (the DIF); and

·

providing credits to financial institutions that capitalized the FDIC prior to 1996 to offset future assessment premiums.

FDIRA also authorizes the FDIC to revise the current risk-based assessment system, subject to notice and comment and caps the amount of the DIF at 1.50% of domestic deposits.  The FDIC must issue cash dividends, awarded on a historical basis, for the amount of the DIF over the 1.50% ratio.  Additionally, if the DIF exceeds 1.35% of domestic deposits at year-end, the FDIC must issue cash dividends, awarded on a historical basis, for half of the amount of the excess.

Financial Services Regulatory Relief Act

President Bush signed the Financial Services Regulatory Relief Act of 2006 (Regulatory Relief Act) into law on October 13, 2006.  The Regulatory Relief Act repeals certain reporting requirements regarding loans to bank executive officers and principal shareholders. These changes have eliminated the statutory requirements for (1) the report to the Board of Directors when an executive officer becomes indebted to another institution in an aggregate amount that is greater than the officer would receive from his or her own institution; (2) the report filed by the institution that listed all credits made to executive officers since the previous report of condition; and (3) the report to the Board of Directors that is required when an executive officer or a principal shareholder become indebted to a correspondent bank.

The Regulatory Relief Act increased the size of a bank eligible for 18-month (rather than annual) examinations from $250 million to $500 million.  The Regulatory Relief Act amends the privacy rules of Gramm-Leach-Bliley to clarify that CPAs are not required to notify their customers of privacy and disclosure policies as long as they are subject to state law restraints on disclosure of non-public personal information without customer approval.  Finally, the Regulatory Relief Act requires that the federal banking regulators develop model privacy notice forms, and banks adopting the model forms will be afforded a regulatory safe harbor under the disclosure requirements of Gramm-Leach-Bliley.

Proposed Legislation and Regulatory Action



New regulations and statutes are regularly proposed that contain wide-ranging potential changes to the structures, regulations and competitive relationships of financial institutions operating and doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.



Effect of Governmental Monetary Polices



Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve has, and is likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The Federal Reserve affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.





14





---

Deposit Services



Through our subsidiary banks, we offer a full range of deposit services that are typically available in most banks and savings and loan associations, including checking accounts, commercial accounts, savings accounts, and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to our primary market areas at rates competitive in the market area. In addition, we offer certain retirement account services, such as IRAs. We solicit these accounts from individuals, businesses, associations, organizations, and governmental authorities.



Other Banking Services



Our banks also offer other bank services including drive up ATMs, safe deposit boxes, travelers checks, direct deposit, U.S. Savings Bonds, banking by mail, and internet banking. The bank is associated with the Plus and Star ATM networks, which may be used by its customers throughout the banks primary market areas and other regions. We believe that by being associated with a shared network of ATMs, we are better able to serve our customers and attract customers who are accustomed to the convenience of using ATMs. Neither bank currently exercises trust powers, and we do not expect the banks to offer trust services in the near future.



Employees



As of February 28, 2007, Lowcountry National Bank had 33 full-time employees and 1 part-time employee, and First National Bank had 37 full-time employees and 3 part-time employees. Our company had no employees other than its officers, who are also employees of Lowcountry National Bank or First National Bank.



Item 2.

Description of Property



Lowcountry National Bank is located at 36 Sea Island Parkway in Beaufort, South Carolina. Lowcountry National Bank owns its 5,800 square foot main office building located on 2.33 acres of land.



In 2006, Coastal sold a lot it had held in Okatee, South Carolina and used the proceeds to purchase a new branch which will be leased to Lowcountry National Bank. The branch is located in Port Royal, South Carolina which adjoins the city of Beaufort. The branch was completed in March 2007. The branch is located in the new Port Royal Center which is a multi-unit office complex. Lowcountry National Bank will also occupy leased space in the upstairs offices above the branch. The lease is for a term of five years that will expire in 2012 with options to renew for subsequent five year periods.



During 2002, Lowcountry National Bank established a loan production office to service the Bluffton area and in 2003 consolidated the office into a new, full-service branch at Moss Creek Village, Bluffton, South Carolina.  Lowcountry National Bank leases the Moss Creek office, which will expire in 2009.



First National Bank is located at 1891 South 14th Street in Fernandina Beach, Florida. First National Bank owns its 6,500 square foot main office, which is located on 1.28 acres of land. In addition, First National has acquired the office buildings on property adjacent to its main office to accommodate expansion.



The Meigs, Georgia branch, operated under the name The Georgia Bank, occupies a storefront office in Meigs, Georgia. The branch building was acquired as part of the acquisition of the Meigs office on October 27, 2006.



In 2004, First National Bank also purchased 1.16 acres of land at the corner of Lofton Square Boulevard and State Road 200 in Yulee for a future branch location. The bank will be required to obtain regulatory approval before establishing a branch at this location. First National Bank also has loan production offices in Jacksonville, Florida and Savannah, Georgia. The property for the Savannah loan production office was leased for a three year term, which will expire in 2008.



Item 3.

Legal Proceedings



None.





15





---



Item 4.

Submission of Matters to a Vote of Security Holders



No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.





16





---

PART II.



Item 5.

Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities



The Common Stock of Coastal Banking Company, Inc. is not listed on any exchange. However, the stock is quoted on the NASDAQ OTC Bulletin Board under the symbol CBCO.OB. There were approximately 1,500 shareholders of record on December 31, 2006. The following table sets forth the high and low bid prices as quoted on the OTC Bulletin Board during the periods indicated. The quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not represent actual transactions. All prices are adjusted for the stock dividends paid to shareholders of record on December 1, 2006.



|               |  |                          |       |      |   |       |  |     |       |  |   |       | 
|-------------- |  | ------------------------ | ----- | ---- | - | ----- |  | --- | ----- |  | - | ----- | 
|               |  | Years Ended December 31, |      
|               |  | 2006                     |       | 2005 |  
|               |  | High                     |       | Low  |   | High  |  | Low |      
|First quarter  |  | $                        | 20.05 |      | $ | 19.01 |  | $   | 18.10 |  | $ | 16.90 | 
|Second quarter |  | $                        | 19.50 |      | $ | 18.95 |  | $   | 18.57 |  | $ | 17.14 | 
|Third quarter  |  | $                        | 21.80 |      | $ | 18.95 |  | $   | 20.95 |  | $ | 18.10 | 
|Fourth quarter |  | $                        | 23.91 |      | $ | 21.05 |  | $   | 22.71 |  | $ | 19.52 | 



The Company has never declared or paid a cash dividend and does not expect to do so in the foreseeable future. The ability of the Company to pay cash dividends is dependent upon receiving cash dividends from the Banks. However, federal banking regulations restrict the amount of cash dividends that can be paid to the Company from the Banks. All of our outstanding shares of common stock are entitled to share equally in dividends from funds legally available when, and if, declared by the board of directors.



Coastal Banking Company issued no unregistered equity securities during the fiscal year ended December 31, 2006 and did not repurchase any shares of its common stock during the fourth quarter of 2006.



Item 6.

Managements Discussion and Analysis of Plan of Operation



General



Coastal Banking Company, Inc. (in this Item 6, the Company) is a bank holding company headquartered in Beaufort, South Carolina organized to own all of the common stock of its subsidiaries, Lowcountry National Bank (in this Item 6, Lowcountry) and First National Bank of Nassau County, Florida (in this Item 6, First National). The principal activity of the Banks is to provide banking services for their domestic markets. Lowcountrys primary market is Beaufort County, South Carolina. First Nationals primary market is Nassau County, Florida. The Banks are primarily regulated by the Office of the Comptroller of the Currency (OCC) and undergo periodic examinations by this regulatory agency. The holding company is regulated by the Federal Reserve Board of Governors and also is subject to periodic examinations. Lowcountry opened for business on May 10, 2000 at 36 Sea Island Parkway, Beaufort, South Carolina 29907. First National opened for business July 26, 1999 and was acquired by Coastal through the merger with its holding company, First Capital Bank Holding Corporation (First Capital) on October 1, 2005. On October 27, 2006 Coastal acquired the Meigs, Georgia office of Cairo Banking Company, a Georgia state bank, from Ameris Bancorp. The Company also has an investment in Coastal Banking Company Statutory Trust I (Trust I) and Coastal Banking Company Trust II (Trust II). Both trusts are special purpose subsidiaries organized for the sole purpose of issuing trust preferred securities.



In the merger with First Capital, each outstanding share of First Capital common stock was converted into 1.054 shares of Coastal stock at the time of the merger. Each outstanding share of Coastal common stock prior to the merger remained outstanding as a share of common stock after the merger.



The following discussion describes our results of operations for 2006 as compared to 2005 and also analyzes our financial condition as of December 31, 2006 as compared to December 31, 2005. Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.



17





---



We have included a number of tables to assist in our description of these measures.  For example, the Average Balances table shows the average balance during 2006 and 2005 of each category of our assets and liabilities, as well as the yield we earned or the rate we paid with respect to each category. A review of this table shows that our loans typically provide higher interest yields than do other types of interest earning assets, which is why we intend to continue to direct a substantial percentage of our earning assets into our loan portfolio.  Similarly, the Rate/Volume Analysis table helps demonstrate the impact of changing interest rates and changing volume of assets and liabilities during the years shown.  We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included a Sensitivity Analysis Table to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our loans, and our deposits.



Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb possible losses on existing loans that may become uncollectible.  We establish and maintain this allowance by charging a provision for loan losses against our operating earnings.  In the following section we have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses. See comments in the section entitled Provision and Allowance for Loan Losses.



In addition to earning interest on our loans and investments, we earn income through fees, cash surrender value of life insurance and other service charges to our customers.  We describe the various components of this non-interest income, as well as our non-interest expense, in the following discussion.



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



Forward-Looking Statements



This report contains forward-looking statements relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management.  The words may, will, anticipate, should, would, believe, contemplate, expect, estimate, continue, may, and intend, as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Potential risks and uncertainties include, but are not limited to those described under the heading Risk Factors in our Form 10-KSB for the year ended December 31, 2006.



Critical Accounting Policies



We have adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements.  Our significant accounting policies are described in Note 1 in the footnotes to the consolidated financial statements at December 31, 2006 included elsewhere in this annual report.



We believe that the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements.  Please refer to the portion of managements discussion and analysis of financial condition and results of operations that addresses the allowance for loan losses for a description of our processes and methodology for determining the allowance for loan losses.



18





---



Intangible assets, included in Other Assets on the Consolidated Balance Sheets, include goodwill and other identifiable assets, such as core deposits, resulting from acquisitions. Goodwill, in this context, is the excess of the purchase price in an acquisition transaction over the fair market value of the net assets acquired. Core deposit intangibles are amortized on a straight-line basis over such assets estimated expected life. In accordance with SFAS No. 142, Goodwill and Other Intangible Asset, goodwill is not amortized but is tested annually for impairment or at any time an event occurs, or circumstances change, that may trigger a decline in the value of the reporting unit. Such impairment testing calculations include estimates. Furthermore, the determination of which intangible assets have finite lives is subjective as is the determination of the amortization period for such intangible assets. The Company tests for goodwill impairment by determining the fair market value for each reporting unit and comparing the fair market value to the carrying amount of the applicable reporting unit. If the carrying amount exceeds fair market value the potential for the impairment exists, and a second step of impairment testing is performed. In the second step, the fair market value of the reporting units goodwill is determined by allocating the reporting units fair market value to all of its assets (recognized and unrecognized) and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. If the implied fair market value of reporting unit goodwill is less than its carrying amount, goodwill is impaired and is written-down to its fair market value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair market value will not result in the reversal of previously recognized losses. The Company performed its annual test of impairment in the fourth quarter and determined that there was no impairment in the carrying value of goodwill as of October 1, 2006.



Results of Operations



Overview



Net income for 2006 was $3,359,537 or $1.41 per basic common share compared to $1,509,370 or $1.09 per basic common share, in 2005. Our operational results were impacted in part by our merger with First Capital on October 1, 2005, which resulted in the inclusion of net income from that operation for the fourth quarter of 2005 and the entire year of 2006. In total, our operational results depend to a large degree on net interest income, which is the difference between the interest income received from our investments, such as loans, investment securities, and federal funds sold, and interest expense, paid on deposit liabilities and other borrowings. Net interest income was $13,271,277 for the year ended December 31, 2006 compared to net interest income of $6,777,223 for the year ended December 31, 2005.



The provision for loan losses in 2006 was $726,700 compared to $380,000 in 2005. The increase in the provision for loan losses was attributable to our loan growth during 2006 and the inclusion of a provision for loan losses for the entire year during 2006 for First National compared to one quarter in 2005 following the merger. The provision for loan losses continues to reflect our estimate of potential losses inherent in the loan portfolio and the creation of an allowance for loan losses adequate to absorb such losses.



Noninterest income for the year ended December 31, 2006 totaled $2,039,795, representing a $942,234 increase from December 31, 2005. This increase was primarily associated with the additional income contributed by First National, which added $1,059,678 during 2006 compared to $326,912 in the fourth quarter of 2005. Non-interest expenses in 2006 were $9,577,803; a $4,388,449 increase compared to the 2005 amounts, primarily due to the inclusion of First National expenses for the entire year of 2006 totaling $4,982,508 compared to the inclusion of one quarter of expenses in 2005 totaling $1,197,713 following the merger.  The companys efficiency ratio, which is a measure of total non-interest expenses as a percentage of net interest income and non-interest income, was 62.55% in 2006 compared to 65.90% in 2005.



In 2006, we recognized $1,647,032 of income tax expense compared to an income tax expense of $796,060 in 2005. Our effective tax rate was 32.9% in 2006 and 34.5% in 2005.



19





---



Net Interest Income



For the year ended December 31, 2006, net interest income totaled approximately $13,271,000, as compared to approximately $6,777,000 for the same period in 2005. Interest income from loans, including fees, increased approximately $12,523,000 to $22,629,000 for the year ended December 31, 2006. This increase in income was partially offset by increased interest expense, which totaled approximately $13,461,000 for the year ended December 31, 2006, compared to $5,185,000 in 2005. The increase in net interest income is due to the overall growth in the volume of interest earning assets and by increases in overall weighted average interest rates. The net interest margin realized on earning assets and the interest rate spread were 3.73% and 3.29%, respectively, for the year ended December 31, 2006. For the year ended December 31, 2005, the net interest margin was 3.66% and the interest rate spread was 3.35%. Yields on interest earning assets increased during the year by 1.05% compared to an increase in rates on interest bearing liabilities of 1.11% during the prior year.



Average Balances and Interest Rates



The table below shows the average balance outstanding for each category of interest-earning assets and interest-bearing liabilities for 2006 and 2005, and the average rate of interest earned or paid thereon. Average balances have been derived from the daily balances throughout the period indicated.



|                                                                    |  |                                  |   |              |  |             |   |                 |            |          |               |             |      |   |  |  |  |  |  |  |  |  |  |  |  |  |  | 
|------------------------------------------------------------------- |  | -------------------------------- | - | ------------ |  | ----------- | - | --------------- | ---------- | -------- | ------------- | ----------- | ---- | - |  |  |  |  |  |  |  |  |  |  |  |  |  | 
|                                                                    |  | For the Years Ended December 31, |  
|                                                                    |  | 2006                             |   | 2005         | 
|                                                                    |  | Average
Balance                  |   | Interest     |  | Yield/
Rate |   | Average
Balance |            | Interest |               | Yield/
Rate |     
|(In Thousands)                                                      |  |                                  |  
|Assets:                                                             |  |                                  |   |              |  |             |   |                 |            |          |               |             |      |  
|Interest-earning assets:                                            |  |                                  |   |              |  |             |   |                 |            |          |               |             |      |  
|Loans (including loan fees)                                         |  | $    273,022                     |   | $     22,629 |  | 8.29        | % |                 | $ 141,989  |          | $    10,106   |             | 7.12 | %
|Taxable investments                                                 |  | 65,924                           |   | 3,054        |  | 4.63        | % |                 | 34,377     |          | 1,400         |             | 4.07 | %
|Tax-free investments                                                |  | 9,386                            |   | 636          |  | 6.78        | % |                 | 6,735      |          | 369           |             | 5.48 | %
|Interest-bearing deposits in
other banks                            |  | 1,755                            |   | 92           |  | 5.24        | % |                 | 125        |          | 3             |             | 2.40 | %
|Federal funds sold                                                  |  | 11,333                           |   | 537          |  | 4.74        | % |                 | 5,313      |          | 209           |             | 3.93 | %
|Total interest-earning assets                                       |  | 361,420                          |   | 26,948       |  | 7.46        | % |                 | 188,539    |          | 12,087        |             | 6.41 | %
|Other non-interest earning assets                                   |  | 30,692                           |   |              |  |             |   |                 | 14,748     |          |               |             |      |  
|Total assets                                                        |  | $    392,112                     |   |              |  |             |   |                 | $ 203,287  |          |               |             |      |  
|Liabilities and shareholders equity:                               |  |                                  |   |              |  |             |   |                 |            |          |               |             |      |  
|Interest-bearing liabilities:                                       |  |                                  |   |              |  |             |   |                 |            |          |               |             |      |  
|Deposits:                                                           |  |                                  |   |              |  |             |   |                 |            |          |               |             |      |  
|Interest-bearing demand and savings                                 |  | $ 122,167                        |   | 4,204        |  | 3.44        | % |                 | $ 69,958   |          | 1,876         |             | 2.68 | %
|Time                                                                |  | 167,451                          |   | 7,641        |  | 4.56        | % |                 | 86,736     |          | 2,757         |             | 3.18 | %
|Other                                                               |  | 33,217                           |   | 1,616        |  | 4.86        | % |                 | 12,814     |          | 552           |             | 4.31 | %
|Total interest-bearing liabilities                                  |  | 322,835                          |   | 13,461       |  | 4.17        | % |                 | 169,508    |          | 5,185         |             | 3.06 | %
|Other non-interest bearing liabilities                              |  | 28,914                           |   |              |  |             |   |                 | 16,533     |          |               |             |      |  
|Shareholders equity                                                |  | 40,363                           |   |              |  |             |   |                 | 17,246     |          |               |             |      |  
|Total liabilities and shareholders
equity                          |  | $    392,112                     |   |              |  |             |   |                 | $ 203,287  |          |               |             |      |  
|Excess of interest-earning assets over
interest bearing liabilities |  | $      38,585                    |   |              |  |             |   |                 | $   19,031 |          |               |             |      |  
|Ratio of interest-earning assets to
interest-bearing liabilities    |  | 112                              | % |              |  |             |   |                 | 111        | %        |               |             |      |  
|Tax equivalent adjustment                                           |  |                                  |   | (216)        |  |             |   |                 |            |          | (125)         |             |      |  
|Net interest income                                                 |  |                                  |   | $     13,271 |  |             |   |                 |            |          | $       6,777 |             |      |  
|Net interest spread                                                 |  |                                  |   |              |  | 3.29        | % |                 |            |          |               |             | 3.35 | %
|Net interest margin                                                 |  |                                  |   |              |  | 3.73        | % |                 |            |          |               |             | 3.66 | %



20





---



Non-accrual loans and the interest income which was recorded on these loans, if any, are included in the yield calculation for loans in all periods reported.



Amounts are presented on a tax equivalent basis.



Volume/Rate Analysis



Net interest income can also be analyzed in terms of the impact of changing rates and changing volume. The following table describes the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. The effect of a change in average balance has been determined by applying the average rate in the earlier year to the change in average balance in the later year, as compared with the earlier year. The effect of a change in the average rate has been determined by applying the average balance in the earlier year to the change in the average rate in the later year, as compared with the earlier year.



|                                             |  |                                                             |        |       |   |            |        |  |   |        |  | 
|-------------------------------------------- |  | ----------------------------------------------------------- | ------ | ----- | - | ---------- | ------ |  | - | ------ |  | 
|                                             |  | 2006 Compared to 2005
Increase (decrease) due to changes in |       
|(In Thousands)                               |  | Volume                                                      |        | Rate  |   | Net Change |       
|Interest income on:                          |  |                                                             |        |       |   |            |        |  |  
|Loans (including loan fees)                  |  | $                                                           | 10,628 |       | $ | 1,895      |        |  | $ | 12,523 |  | 
|Taxable investments                          |  | 1,438                                                       |        | 216   |   |            | 1,654  |  |  
|Non-taxable investments                      |  | 167                                                         |        | 100   |   |            | 267    |  |  
|Interest bearing deposits in other banks     |  | 82                                                          |        | 7     |   |            | 89     |  |  
|Federal funds sold                           |  | 278                                                         |        | 50    |   |            | 328    |  |  
|Total interest income (tax equivalent basis) |  | 12,593                                                      |        | 2,268 |   |            | 14,861 |  |  
|Interest expense on:                         |  |                                                             |        |       |   |            |        |  |  
|Interest-bearing demand and savings          |  | 1,688                                                       |        | 640   |   |            | 2,328  |  |  
|Time                                         |  | 3,327                                                       |        | 1,557 |   |            | 4,884  |  |  
|Other                                        |  | 984                                                         |        | 80    |   |            | 1,064  |  |  
|Total interest expense                       |  | 5,999                                                       |        | 2,277 |   |            | 8,276  |  |  
|Net interest income (tax equivalent basis)   |  | $                                                           | 6,594  |       | $ | (9         | )      |  | $ | 6,585  |  | 



Interest Rate Sensitivity and Asset Liability Management



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



Net interest income is the primary component of net income for financial institutions. The timing and magnitude of repricing as well as the mix of interest sensitive and non-interest sensitive assets and liabilities affect net interest income. Gap is a static measurement of the difference between the contractual maturities or repricing dates of interest sensitive assets and interest sensitive liabilities within the following twelve months. Gap is an attempt to predict the behavior of the Banks net interest income in general terms during periods of movement in interest rates. In general, if the bank is asset sensitive, more of its interest sensitive assets are expected to reprice within twelve months than its interest sensitive liabilities over the same period. In a rising interest rate environment, assets repricing more quickly are expected to enhance net interest income. Alternatively, decreasing interest rates would be expected to have the opposite effect on net interest income since assets would theoretically be repricing at lower interest rates more quickly than interest sensitive liabilities. Although it can be used as a general predictor, gap as a predictor of movements in net interest income has limitations due to the static nature of its definition and due to its inherent assumption that all assets will reprice immediately and fully at the contractually designated time. At December 31, 2006, the Company, as measured by gap, is asset sensitive at three months or less and liability sensitive cumulatively at one year. Management has several tools available to it to evaluate and affect interest rate risk, including deposit pricing policies and changes in the mix of various types of assets and liabilities.



21





---



The following table summarizes the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2006, that are expected to mature, prepay, or reprice in each of the future time periods shown. Except as stated below, the amount of assets or liabilities that mature or reprice during a particular period was determined in accordance with the contractual terms of the asset or liability. Adjustable rate loans are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due, and fixed-rate loans and mortgage-backed securities are included in the periods in which they are anticipated to be repaid based on scheduled maturities. The Banks savings accounts and interest-bearing demand accounts (NOW and money market deposit accounts) that are not contractually tied to an adjusting index are grouped into categories based on the companys historical repricing practices.  Money market accounts which are contractually tied too repricing indexes, reprice monthly and are grouped in the three month or less category. Many of these money market accounts are tied to a Treasury index.



At December 31, 2006

Maturing or Repricing in



|                                                       |  |                  |        |                       |         |              |  |              |          |        |             |         |          | 
|------------------------------------------------------ |  | ---------------- | ------ | --------------------- | ------- | ------------ |  | ------------ | -------- | ------ | ----------- | ------- | -------- | 
|(In Thousands)                                         |  | 3 Months
or Less |        | 4 Months to
12 Months |         | 1 to 5
Years |  | Over 5
Years |          | Total  |            
|Interest-earning assets:                               |  |                  |        |                       |         |              |  |              |          |        |             |         |         
|Federal funds sold                                     |  | $                | 18,968 |                       | $       |             |  | $            |         |        | $          |         | $ 18,968 | 
|Deposits in other banks                                |  | 1,429            |        |                       | 500     |              |  |             |          |       |             | 1,929   |         
|Investment securities                                  |  | 1,012            |        |                       | 1,327   |              |  | 21,939       |          | 56,803 |             | 81,081  |         
|Loans held for sale                                    |  | 1,040            |        |                       |        |              |  |             |          |       |             | 1,040   |         
|Loans                                                  |  | 172,717          |        |                       | 26,266  |              |  | 80,617       |          | 12,220 |             | 291,820 |         
|Total interest-earning assets                          |  | 196,166          |        |                       | 28,093  |              |  | 102,556      |          | 69,023 |             | 394,838 |         
|Interest-bearing liabilities:                          |  |                  |        |                       |         |              |  |              |          |        |             |         |         
|Deposits:                                              |  |                  |        |                       |         |              |  |              |          |        |             |         |         
|Savings and demand                                     |  | 68,243           |        |                       | 27,228  |              |  | 26,901       |          |       |             | 122,372 |         
|Time deposits                                          |  | 51,777           |        |                       | 108,212 |              |  | 33,331       |          |       |             | 193,320 |         
|Securities sold under
agreements to repurchase         |  | 2,000            |        |                       |        |              |  |             |          |       |             | 2,000   |         
|FHLB advances                                          |  | 5,000            |        |                       | 5,000   |              |  | 19,973       |          |       |             | 29,973  |         
|Junior subordinated debentures                         |  | 3,093            |        |                       |        |              |  | 4,124        |          |       |             | 7,217   |         
|Total interest-bearing liabilities                     |  | 130,113          |        |                       | 140,440 |              |  | 84,329       |          |       |             | 354,882 |         
|Interest sensitive difference per
period               |  | $                | 65,053 |                       | $       | (112,347)    |  | $            | 18,227   |        | $  69,023   |         | $ 39,956 | 
|Cumulative interest sensitivity
difference             |  | $                | 65,053 |                       | $       | (47,294)     |  | $            | (29,067) |        | $  39,956   |         |          | 
|Cumulative difference to total
interest-earning assets |  | 16.9             | %      |                       | (12.0)  | %            |  | (7.4)        | %        | 10.1   | %           |         |         



At December 31, 2006, the difference between the Banks liabilities and assets repricing or maturing within one year was $18,106,000 or (12.0)% of total interest-earning assets.



Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may reflect changes in market interest rates differently. Additionally, certain assets, such as adjustable-rate mortgages, have features that restrict changes in interest rates, both on a short-term basis and over the life of the asset. Other factors which may affect the assumptions made in the table, include options to call a security or borrowing, pre-payment rates, early withdrawal levels, and the ability of borrowers to service their debt. Management uses modeling techniques which attempt to quantify the impacts of interest rates on margin changes. These modeling techniques reflect the effects of these cited shortcomings including the effects of maturity changes that occur as a result of changes in interest rates. These modeling tools indicate that net interest margin would be slightly negatively impacted at twelve months given a 1% decrease in interest rates.





22





---

Impaired Loans



A loan is considered to be impaired when, in managements judgment based on current information and events, it is probable that the loans principal or interest is not collectible in accordance with the terms of the original loan agreement. Impaired loans, when not material, will be carried in the balance sheet at a value not to exceed their observable market price or the fair value of the collateral if the repayment of the loan is expected to be provided solely by the underlying collateral. The carrying values of any material impaired loans are measured based on the present value of expected future cash flows discounted at the loans effective interest rate, which is the contractual interest rate adjusted for any deferred loan fees or costs, premium or discount existing at the inception or acquisition of the loan.



Loans which management identifies as impaired generally will be non-performing loans. Non-performing loans include non-accrual loans or loans which are 90 days or more delinquent as to principal or interest payments. At December 31, 2006, Lowcountry National Bank had $85,519 of loans that were impaired and non-performing, and First National had no impaired or non-performing loans. At December 31, 2005, First National Bank had $130,189 of impaired and non-performing loans and Lowcountry National Bank had no impaired and non-performing loans.



The accrual of interest is discontinued on non-accrual loans and any previously accrued interest on such loans will be reversed against current income. Any subsequent interest income is recognized on a cash basis when received unless collectibility of a significant amount of principal is in serious doubt. In such cases, collections are credited first to the remaining principal balance on a cost recovery basis. An impaired loan is not returned to accrual status unless principal and interest are current and the borrower has demonstrated the ability to continue making payments as agreed.



Potential Problem Loans



Management identifies and maintains a list of potential problem loans. These are loans that are not included in non-accrual status, or loans that are past due 90 days or more and still accruing interest. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of borrowers that causes serious doubts as to the ability of such borrowers to comply with the current loan repayment terms. These loans are designated as such in order to be monitored more closely than other credits in the Banks portfolios.



Provision and Allowance for Loan Losses



The provision for loan losses is the charge to operating earnings that management believes is necessary to maintain the allowance for loan losses at an adequate level. The provision charged to expense was approximately $727,000 for the year ended December 31, 2006 as compared to $380,000 for the year ended December 31, 2005. The increase in the provision was the result of our loan portfolio, which included the additions to the portfolio from First National for the entire year of 2006, growing faster in 2006 than in 2005. The loan portfolio increased by approximately $49,451,000 during the year ended December 31, 2006 as compared to growth of $25.4 million in 2005, which included First National for only the fourth quarter. The allowance for loan losses was 1.19% of gross loans at December 31, 2006 as compared to 1.18% at December 31, 2005. There are risks inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.



We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of earnings.  Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based on managements analysis of the potential risk in the loan portfolio.  The allowance for loan losses represents an amount, which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible.  Our judgment as to the adequacy of the allowance for loan losses is based upon a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate.  Our losses will undoubtedly vary from our estimates, and there is a possibility that charge-offs can reduce this allowance.  Our determination of the allowance for loan losses is based on evaluations of the collectibility of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrowers ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans.  We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.



23





---



We allocate the allowance for loan losses to specific categories of loans in our portfolio. See the table below for the allocation of loan losses and for a history of charge-offs by loan category, which may or may not be indicative of future charge-offs by category.



Allocation of the Allowance for Loan Losses



|                                       |  |              |       |        |  |                        |      |        |  |                        |       |  |  |  |      |  |  |  | 
|-------------------------------------- |  | ------------ | ----- | ------ |  | ---------------------- | ---- | ------ |  | ---------------------- | ----- |  |  |  | ---- |  |  |  | 
|                                       |  | December 31, |      
|                                       |  | 2006         |       | 2005   | 
|(In Thousands)                         |  |              |       | Amount |  | % of Loans in
Category |      | Amount |  | % of Loans in
Category |      
|Commercial, Financial and Agricultural |  | $            | 107   |        |  |                        | 4%   |        |  | $                      | 226   |  |  |  | 5%   |  | 
|Real EstateConstruction               |  |              | 1,864 |        |  |                        | 47   |        |  |                        | 760   |  |  |  | 39   |  | 
|Real EstateMortgage                   |  |              | 1,350 |        |  |                        | 47   |        |  |                        | 342   |  |  |  | 54   |  | 
|Consumer                               |  |              | 62    |        |  |                        | 2    |        |  |                        | 50    |  |  |  | 2    |  | 
|Unallocated                            |  |              | 92    |        |  |                        |     |        |  |                        | 1,485 |  |  |  |     |  | 
|Total                                  |  | $            | 3,475 |        |  |                        | 100% |        |  | $                      | 2,863 |  |  |  | 100% |  | 



Our policy has been to review the allowance for loan losses using a reserve factor based on risk-rated categories of loans because there has been relatively little charge-off activity since the Banks respective inceptions. The overall objective is to apply percentages to the loans based on the relative inherent risk for that loan type and grade. Reserve factors are based on peer group data, information from regulatory agencies, and on the experience of the Banks lenders. The reserve factors will change depending on trends in national and local economic conditions, the depth of experience of the Banks lenders, delinquency trends, and other factors. Our general strategy is to maintain a minimum coverage of a certain percentage of gross loans until we have sufficient historical data and trends available. Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period. Thus, there is a risk that substantial additional increases in the allowance for loan losses could be required. Additions to the allowance for loan losses would result in a decrease of our net income and, possibly, our capital.



The following table summarizes information concerning the allowance for loan losses:



|                                                                                          |  |                                  |         |       |   |         | 
|----------------------------------------------------------------------------------------- |  | -------------------------------- | ------- | ----- | - | ------- | 
|                                                                                          |  | For the Years Ended December 31, |        
|                                                                                          |  | 2006                             |         | 2005  |  
|(In Thousands)                                                                            |  |                                  |        
|Loans outstanding, end of year                                                            |  | $                                | 291,820 |       | $ | 242,369 | 
|Average loans outstanding                                                                 |  | $                                | 271,414 |       | $ | 141,989 | 
|Allowance, beginning of year                                                              |  | 2,863                            |         | 1,137 |  
|Charge-offs:                                                                              |  |                                  |         |       |  
|Commercial, financial and industrial                                                      |  | 95                               |         |      |  
|Real estateconstruction                                                                  |  |                                 |         |      |  
|Real estatemortgage                                                                      |  |                                 |         |      |  
|Consumer                                                                                  |  | 27                               |         | 56    |  
|Total charge-offs                                                                         |  | 122                              |         | 56    |  
|Recoveries:                                                                               |  |                                  |         |       |  
|Commercial, financial and industrial                                                      |  |                                 |         | 6     |  
|Real estateconstruction                                                                  |  |                                 |         |      |  
|Real estatemortgage                                                                      |  |                                 |         |      |  
|Consumer                                                                                  |  | 7                                |         |      |  
|Total recoveries                                                                          |  | 7                                |         | 6     |  
|Net charge-offs                                                                           |  | 115                              |         | 50    |  
|Allowance brought forward in merger                                                       |  |                                 |         | 1,396 |  
|Additions charged to operations                                                           |  | 727                              |         | 380   |  
|Allowance, end of year                                                                    |  | $                                | 3,475   |       | $ | 2,863   | 
|Ratio of net charge-offs during the period to average loans
outstanding during the period |  | 0.04                             | %       | 0.04  | %
|Allowance for loan losses to loans, end of year                                           |  | 1.19                             | %       | 1.18  | %





24





---



The following table summarizes past due and non-accrual loans, other real estate and repossessions, and income that would have been reported on non-accrual loans as of December 31, 2006 and 2005 (amounts are presented in thousands):



|                                                             |  |              |   |      |   |   | 
|------------------------------------------------------------ |  | ------------ | - | ---- | - | - | 
|                                                             |  | December 31, |  
|(In Thousands)                                               |  | 2006         |   | 2005 |  
|Other real estate and repossessions                          |  | $            |  |      | $ |  | 
|Accruing loans 90 days or more past due                      |  | 10           |   |     |  
|Non-accrual loans                                            |  | 86           |   | 130  |  
|Interest on non-accrual loans which would have been reported |  | 13           |   | 6    |  
|                                                             |  |              |   |      |   |   | 



Noninterest Income and Expense



Noninterest income for the year ended December 31, 2006 totaled $2,040,000 as compared to $1,098,000 for the year ended December 31, 2005.  Mortgage origination fees totaled $911,000 and $676,000 in 2006 and 2005, respectively. The increase resulted from the addition of First National for four quarters of 2006 which added $416,000 over 2005 loan fee income.  This was partially offset by $181,000 less fee income at Lowcountry National Bank in 2006 as a result of a smaller loan production staff.  Both Banks own bank-owned life insurance policies covering certain of our executives and directors.  The cash value of these policies increases over time and, accordingly, we recognized $240,000 in income related to these policies in 2006.  We recognized losses on the sale of certain investment securities available for sale totaling $13,000 during the year ended December 31, 2006 as compared to losses of $8,000 in 2005.



Total noninterest expense for the year ended December 31, 2006 was $9,578,000 as compared to $5,189,000 for 2005. Salaries and benefits, the largest component of non-interest expense, totaled $5,400,000 for the year ended December 31, 2006, compared to $2,934,000 for the same period a year ago for an increase of $2,466,000.  First National salaries and benefits for four quarters in 2006 compared to one quarter in 2005 represented $2,292,000 of the total.  Salary expense at Lowcountry increased by only $143,000 as a result of lower staffing, particularly  in mortgage loan production staff.  The Companys total number of employees at December 31, 2006 was 70 compared to 66 employees at December 31, 2005.  Other operating expenses, excluding salaries and benefits, were $4,178,000 for the year ended December 31, 2006 as compared to $2,256,000 for the year ended December 31, 2005.  Of the total increase in other operating expenses of $1,922,000, $1,493,000 is attributable to four quarters of income from First National for 2006 compared to one quarter in 2005.  These other operating expenses included increases in audit and professional fees, from $233,000 in 2005 to $462,000 in 2006 related to costs associated with the merger.  Advertising expenses increased from $193,000 in 2005 to $271,000 in 2006, and data processing expenses increased from $435,000 in 2005 to $661,000 in 2006.



Financial Condition



Total assets increased from $355,168,000 at December 31, 2005 to $426,210,000 in 2006.  The primary source of growth in assets was net loans, which increased $49,451,000 during 2006. Total deposits increased $53,663,000 from the December 31, 2005 amount of $286,396,000 to $340,059,000 at December 31, 2006.



Interest-Earning Assets



Loans



Gross loans totaled $291,820,000 at December 31, 2006, an increase of $49,451,000 or 20.4%, since December 31, 2005.  At year-end 2006 the mix of the loan portfolio remained approximately consistent with the mix at the end of 2005.  In absolute dollars, the largest increase in loans was in real estateconstruction loans, which increased $42,583,000, or 45%, to $138,041,000 at December 31, 2006.  Real estatemortgage loans increased $6,689,000 or 11%, during 2006.  Both South Carolina and Florida coastal markets have experienced strong residential loan demand.  Balances and percentages within the major loans receivable categories are as follows:



|                                     |  |              |         |      |    |         |   |         |   |    |  
|------------------------------------ |  | ------------ | ------- | ---- | -- | ------- | - | ------- | - | -- | -
|                                     |  | December 31, |        
|(In Thousands)                       |  | 2006         |         | 2005 |   
|Real estateconstruction             |  | $            | 138,041 |      | 47 | %       | $ | 95,458  |   | 39 | %
|Real estatemortgage                 |  | 136,335      |         | 47   | %  | 129,645 |   | 54      | %
|Commercial, financial and industrial |  | 13,053       |         | 4    | %  | 11,459  |   | 5       | %
|Consumer and other                   |  | 4,391        |         | 2    | %  | 5,807   |   | 2       | %
|                                     |  | $            | 291,820 |      |    |         | $ | 242,369 |   |    |  



25





---



As of December 31, 2006, maturities of loans in the indicated classifications were as follows:



|               |  |            |       |                          |  |       |        |   |         |        |  |   |         |  |  | 
|-------------- |  | ---------- | ----- | ------------------------ |  | ----- | ------ | - | ------- | ------ |  | - | ------- |  |  | 
|(In Thousands) |  | Commercial |       | Real Estate
Construction |  | Total |       
|Maturity       |  |            |       |                          |  |       |        |   |         |        | 
|Within 1 year  |  |            | $     | 8,543                    |  |       |        | $ | 122,123 |        |  | $ | 130,666 | 
|1 to 5 years   |  |            | 3,661 |                          |  |       | 14,645 |   |         | 18,306 | 
|Over 5 years   |  |            | 849   |                          |  |       | 1,273  |   |         | 2,122  | 
|Totals         |  |            | $     | 13,053                   |  |       |        | $ | 138,041 |        |  | $ | 151,094 | 



As of December 31, 2006, the interest terms of loans in the indicated classification for the indicated maturity ranges are as follows:



|                         |  |                      |        |                         |   |         |  |       |         |   |  |       |  |  |  |  |  |  | 
|------------------------ |  | -------------------- | ------ | ----------------------- | - | ------- |  | ----- | ------- | - |  | ----- |  |  |  |  |  |  | 
|(In Thousands)           |  | Fixed
Interest
Rates |        | Variable
Interest
Rates |   | Total   | 
|Commercial               |  |                      |        |                         |   |         | 
|Within 1 year            |  | $                    |        | 969                     |   | $       |  | 7,574 |         | $ |  | 8,543 | 
|1 to 5 years             |  |                      | 3,530  |                         |   | 132     |  |       | 3,662   |  
|Over 5 years             |  | 849                  |        |                        |   | 849     | 
|Real estateconstruction |  |                      |        |                         |   |         | 
|Within 1 year            |  | 12,356               |        | 109,767                 |   | 122,123 | 
|1 to 5 years             |  | 12,289               |        | 2,355                   |   | 14,644  | 
|Over 5 years             |  | 1,273                |        |                        |   | 1,273   | 
|                         |  | $                    | 31,266 |                         | $ | 119,828 |  | $     | 151,094 |  



Investment Securities



Investment securities available for sale increased to $60,373,000 at December 31, 2006 from $46,151,000 at December 31, 2005. Investment securities held to maturity decreased from $18,221,000 at December 31, 2005 to $16,998,000 at December 31, 2006.



The following table presents the investments by category:



|                                     |  |                |        |                      |  |                |        |                      |        |  |        |   |  |        |        |  |  |   |        |  |  |  |  |  |  |  | 
|------------------------------------ |  | -------------- | ------ | -------------------- |  | -------------- | ------ | -------------------- | ------ |  | ------ | - |  | ------ | ------ |  |  | - | ------ |  |  |  |  |  |  |  | 
|                                     |  | December 31,   |       
|                                     |  | 2006           |        | 2005                 | 
|                                     |  | Amortized Cost |        | Estimated
Fair Value |  | Amortized Cost |        | Estimated
Fair Value |       
|(In Thousands)                       |  |                |       
|Available for sale                   |  |                |        |                      |  |                |        |                      |        |  |        |   |  |        |        |  | 
|U.S. Government and federal agencies |  |                | $      | 5,483                |  |                |        | $                    | 5,396  |  |        | $ |  | 4,930  |        |  |  | $ | 4,817  |  | 
|Government sponsored enterprises     |  |                | 17,275 |                      |  |                | 17,143 |                      |        |  | 18,117 |   |  |        | 17,875 |  | 
|State and municipal securities       |  |                | 3,302  |                      |  |                | 3,274  |                      |        |  | 1,409  |   |  |        | 1,385  |  | 
|Mortgage-backed securities           |  |                | 34,844 |                      |  |                | 34,560 |                      |        |  | 22,463 |   |  |        | 22,074 |  | 
|                                     |  |                | $      | 60,904               |  |                |        | $                    | 60,373 |  |        | $ |  | 46,919 |        |  |  | $ | 46,151 |  | 
|Held to Maturity                     |  |                |        |                      |  |                |        |                      |        |  |        |   |  |        |        |  | 
|State and municipal securities       |  | $              |        | 8,825                |  |                |        | $                    | 8,773  |  |        | $ |  | 8,468  |        |  |  | $ | 8,292  |  | 
|Mortgage-backed securities           |  |                |        | 8,173                |  |                |        |                      | 8,085  |  |        |   |  | 9,753  |        |  |  |   | 9,594  |  | 
|Totals                               |  |                | $      | 16,998               |  |                |        | $                    | 16,858 |  |        | $ |  | 18,221 |        |  |  | $ | 17,886 |  | 





26





---



The following table presents the maturities of investment securities at carrying value and the weighted average yields for each range of maturities presented. Yields are based on amortized cost of securities. (Amounts are presented in thousands)



|                                |  |   |                                                       |  |                         |  |   |                                |  |                         |  |   |                            |  |                        
|------------------------------- |  | - | ----------------------------------------------------- |  | ----------------------- |  | - | ------------------------------ |  | ----------------------- |  | - | -------------------------- |  | -----------------------
|Maturities at
December 31, 2006 |  |   | Federal Agencies and Government Sponsored Enterprises |  | Weighted Average Yields |  |   | State and Municipal Securities |  | Weighted Average Yields |  |   | Mortgage-backed Securities |  | Weighted Average Yields
|Within 1 year                   |  | $ | 2,021,874                                             |  | 3.74%                   |  | $ | 305,382                        |  | 4.31%                   |  | $ |                           |  |                       
|After 1 through 5 years         |  |   | 14,312,859                                            |  | 4.39%                   |  |   | 2,616,304                      |  | 4.69%                   |  |   | 4,442,766                  |  | 4.22%                  
|After 5 through 10 years        |  |   | 6,203,626                                             |  | 5.05%                   |  |   | 5,683,919                      |  | 5.44%                   |  |   | 1,405,055                  |  | 4.14%                  
|After 10 years                  |  |   |                                                      |  |                        |  |   | 3,493,266                      |  | 6.16%                   |  |   | 36,885,898                 |  | 5.21%                  
|Totals                          |  | $ | 22,538,359                                            |  | 4.51%                   |  | $ | 12,098,871                     |  | 5.46%                   |  | $ | 42,733,719                 |  | 5.07%                  



Mortgage-backed securities are included in the maturities categories in which they are anticipated to be repaid based on scheduled maturities.



Deposits



At December 31, 2006, total deposits increased by $53,663,000, or 18.74%, to a total of $340,059,000 at December 31, 2006 from $286,396,000 at December 31, 2005. Non-interest-bearing demand deposits increased $1,893,000, or 8.42%, while interest-bearing deposits increased $263,922,000, or 19.62%.



Balances and percentages within the major deposit categories are as follows:



|                           |  |              |         |      |   |         |   |         |   |   |  
|-------------------------- |  | ------------ | ------- | ---- | - | ------- | - | ------- | - | - | -
|                           |  | December 31, |        
|(In Thousands)             |  | 2006         |         | 2005 |  
|Noninterest-bearing demand |  | $            | 24,367  |      | 7 | %       | $ | 22,474  |   | 8 | %
|Interest-bearing demand    |  | 119,394      |         | 35   | % | 105,142 |   | 37      | %
|Savings                    |  | 2,977        |         | 1    | % | 2,534   |   | 1       | %
|Time over $100,000         |  | 119,007      |         | 35   | % | 91,330  |   | 31      | %
|Time                       |  | 74,314       |         | 22   | % | 64,916  |   | 23      | %
|                           |  | $            | 340,059 |      |   |         | $ | 286,396 |   |   |  



The average balance of deposits and the average rates paid on such deposits are summarized as follows:



|                            |  |              |         |      |   |        |   |         |   |   |  
|--------------------------- |  | ------------ | ------- | ---- | - | ------ | - | ------- | - | - | -
|                            |  | December 31, |        
|                            |  | 2006         |         | 2005 |  
|                            |  | Amount       |         | Rate |   | Amount |   | Rate    |  
|(In Thousands)              |  |              |        
|Non-interest-bearing demand |  | $            | 25,219  |      |  | %      | $ | 14,288  |   |  | %
|Interest-bearing demand     |  | 119,589      |         | 3.50 | % | 68,497 |   | 2.73    | %
|Savings                     |  | 2,578        |         | 0.71 | % | 1,462  |   | 0.68    | %
|Time                        |  | 167,451      |         | 4.56 | % | 86,736 |   | 3.18    | %
|Total                       |  | $            | 314,837 |      |   |        | $ | 170,983 |   |   |  



Maturities of time certificates of deposit of $100,000 or more outstanding at December 31, 2006 are summarized as follows:



|                          |  |        |         | 
|------------------------- |  | ------ | ------- | 
|(In Thousands)            |  |        |         | 
|Within 3 months           |  | $      | 33,600  | 
|After 3 through 12 months |  | 63,665 |        
|1 through 3 years         |  | 19,256 |        
|After 3 years             |  | 2,486  |        
|Total                     |  | $      | 119,007 | 





27





---



Junior Subordinated Debentures



In May 2004, Coastal Banking Company Statutory Trust I issued $3.0 million of trust preferred securities with a maturity of May 18, 2034.  In accordance with FASB Interpretation Number (FIN) 46(R), the Trust has not been consolidated in the Companys financial statements.  The proceeds from the issuance of the trust preferred securities were used by the Trust to purchase $3.0 million of the Companys junior subordinated debentures, which pay interest at a floating rate equal to 3 month LIBOR plus 275 basis points.  The Company used the proceeds from the sale of the junior subordinated debentures for general purposes, primarily to provide capital to the Bank.  The debentures represent the sole asset of the Trust.



In June 2006, Coastal Banking Company Statutory Trust II issued $4.0 million of trust preferred securities with a maturity of September 30, 2036.  In accordance with FASB Interpretation Number (FIN) 46(R), the Trust has not been consolidated in the Companys financial statements.  The proceeds from the issuance of the trust preferred securities were used by the Trust to purchase $4.0 million of the Companys junior subordinated debentures, which pay interest at a fixed rate of 7.18% until September 31, 2011 and a variable rate thereafter equal to 3 month LIBOR plus 160 basis points.  The Company used the proceeds from the sale of the junior subordinated debentures for general purposes, primarily to provide capital to the Banks.  The debentures represent the sole asset of the Trust.



Capital Resources



Total shareholders equity increased from $39,315,000 at December 31, 2005 to $43,171,000 in 2006. Net income for the period added $3,360,000. Comprehensive income of $152,000 resulted from an increase in fair market value of investment securities available for sale during 2006, net of tax.



Bank holding companies, such as ours, and their banking subsidiaries are required by banking regulators to meet particular minimum levels of capital adequacy, which are expressed in the form of certain ratios.  Capital is separated into Tier 1 capital (essentially common shareholders equity less intangible assets) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets).  The first two ratios, which are based on the degree of credit risk in our assets, provide the weighting of assets based on assigned risk factors and include off-balance sheet items such as loan commitments and stand-by letters of credit.  The ratio of Tier 1 capital to risk-weighted assets must be at least 4.0% and the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8.0%.  The capital leverage ratio supplements the risk-based capital guidelines.



Banks and bank holding companies are required to maintain a minimum ratio of Tier 1 capital to adjusted quarterly average total assets of 3.0%.



The following table summarizes the Companys risk-based capital ratios at December 31, 2006:



|                                         |  |       |  
|---------------------------------------- |  | ----- | -
|Tier 1 capital (to risk-weighted assets) |  | 11.95 | %
|Total capital (to risk-weighted assets)  |  | 13.06 | %
|Tier 1 capital (to total average assets) |  | 10.44 | %



See note 17 of notes to consolidated financial statements for a detail of the Banks and Company.



Liquidity



The Banks must maintain, on a daily basis, sufficient funds to cover the withdrawals from depositors accounts and to supply new borrowers with funds. To meet these obligations, the Banks keep cash on hand, maintain account balances with their correspondent banks, and purchase and sell federal funds and other short-term investments. Asset and liability maturities are monitored in an attempt to match the maturities to meet liquidity needs. It is the policy of the Banks to monitor their liquidity to meet regulatory requirements and their local funding requirements.



We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments consist of commitments to extend credit, standby letters of credit and loans sold with limited recourse. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are written conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. A commitment involves, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. Our exposure to credit loss in the event of non-performance by the other party to the instrument is represented by the contractual notional amount of the instrument.



28





---



Since certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  We use the same credit policies in making commitments to extend credit as we do for on-balance sheet instruments.  Collateral held for commitments to extend credit varies but may include accounts receivable, inventory, property, plant, equipment, and income-producing commercial properties.



Loans sold with limited recourse are one-to-four family residential mortgages originated by us and sold to various other financial institutions.  These loans are sold with the agreement that a loan may be returned to us within 90 days of any one of the loans first four payments being missed.  Our exposure to credit loss in the event of non-performance by the other party to the loan is represented by the contractual notional amount of the loan.  Since none of the loans sold have ever been returned to us, the total loans sold with limited recourse amount do not represent future cash requirements.  We use the same credit policies in making loans held for sale as we do for on-balance sheet instruments. First National, prior to merger, operated a mortgage wholesale operation, which it sold prior to merger. It held a reserve of $213,000 at December 31, 2006 to cover against potential losses.  Management considers the reserve to be adequate.



The following table summarizes our off-balance sheet financial instruments whose contract amounts represent credit risk as of December 31, 2006:



| |                                  |  |   |            | 
| | -------------------------------- |  | - | ---------- | 
| | Commitments to extend credit     |  | $ | 64,381,000 | 
| | Standby letters of credit        |  | $ | 800,000    | 
| | Loans sold with limited recourse |  | $ | 21,796,000 | 



Management is not aware of any significant concentrations of loans to classes of borrowers or industries that would be affected similarly by economic conditions. Although the Banks loan portfolios are diversified, a substantial portion of their borrowers ability to honor the terms of their loans is dependent on the economic conditions in Beaufort County, South Carolina; Nassau County, Florida; and Thomas County, Georgia as well as the surrounding areas. In addition, a substantial portion of our loan portfolio is collateralized by improved and unimproved real estate and is therefore dependent on the local real estate markets.



The Banks maintain relationships with correspondent banks that can provide funds on short notice, if needed. Presently, the Banks have arrangements with commercial banks for short term unsecured advances up to $16,600,000.



Cash and due from banks as of December 31, 2006 totaled $4,775,000, a slight decrease of $71,000 from December 31, 2005. Cash provided by operating activities totaled $4,575,000 in 2006, while inflows from financing activities totaled $59,893,000, which was attributable to an increase in deposits of $46,451,000, excluding deposits acquired with acquisition of The Georgia Bank in Meigs, Georgia, a net increase in FHLB advances of $7,000,000, a net increase in securities sold under agreements to repurchase of $2,000,000, and an increase in junior subordinated debentures of $4,124,000.



During 2006, we had a net cash outflow of $64,538,000 from investing activities.  Investing activities included net loans made to customers of approximately $48,754,000 partially offset by cash inflows from the merger with The Georgia Bank of $5,385,000.



Inflation



Inflation impacts the growth in total assets in the banking industry and causes a need to increase equity capital at higher than normal rates to meet capital adequacy requirements.  We cope with the effects of inflation through the management of interest rate sensitivity, by periodically reviewing and adjusting our pricing of services to consider current costs.



Selected Ratios



The following table sets out certain ratios:



|                                            |                                  |   |  |      |  
|------------------------------------------- | -------------------------------- | - |  | ---- | -
|                                            | For the Years Ended December 31, |  
|                                            | 2006                             |   |  | 2005 |  
|Net income to:                              |                                  |   |  |      |  
|Average shareholders equity (tangible)     | 11.51                            | % |  | 8.75 | %
|Average assets (tangible)                   | 0.88                             | % |  | 0.75 | %
|Dividends to net income                     |                                 | % |  |     | %
|Average equity to average assets (tangible) | 7.66                             | % |  | 8.61 | %



29





---



Item 7.

Financial Statements







REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors

Coastal Banking Company, Inc.
and Subsidiaries

Beaufort, South Carolina





We have audited the consolidated balance sheet of Coastal Banking Company, Inc. and Subsidiariesas of December 31, 2006, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for the year ended December 31, 2006.  These financial statements are the responsibility of the Companys management.  Our responsibility is to express an opinion on these financial statements based on our audit.  The financial statements of Coastal Banking Company, Inc. and Subsidiaries for the year ended December 31, 2005 were audited by other auditors; whose report dated March 24, 2006 expressed an unqualified opinion on those statements.





We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides a reasonable basis for our opinion.





In our opinion, the 2006 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Coastal Banking Company, Inc. and Subsidiaries as of December 31, 2006, and the results of their operations and their cash flows for the year ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.





/s/ Mauldin & Jenkins, LLC







Albany, Georgia

March 26, 2007



30





---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM









Board of Directors

Coastal Banking Company, Inc.

Beaufort, South Carolina





We have audited the accompanying consolidated balance sheet of Coastal Banking Company, Inc. and Subsidiaries (the Company) as of December 31, 2005 and the related consolidated statements of income, comprehensive income, changes in shareholders equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Companys management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audit.



We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Coastal Banking Company, Inc. and Subsidiariesat December 31, 2005 and the results of their operations and cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.













Elliott Davis, LLC

Greenville, South Carolina

March 24, 2006



31





---



COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Balance Sheets



|                                                                                                                                                 |  |              |             |             |             |             |  |  |  | 
|------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | ----------- | ----------- | ----------- | ----------- |  |  |  | 
|                                                                                                                                                 |  | December 31, |            
|                                                                                                                                                 |  | 2006         |             |             | 2005        |            
|Assets                                                                                                                                           |  |              |             |             |             |            
|Cash and due from banks                                                                                                                          |  | $            | 4,774,561   |             | $           | 4,845,305   | 
|Interest-bearing deposits in banks                                                                                                               |  | 1,928,601    |             | 1,587,139   |            
|Federal funds sold                                                                                                                               |  | 18,967,745   |             | 13,598,435  |            
|Securities available for sale, at fair value                                                                                                     |  | 60,372,740   |             | 46,150,641  |            
|Securities held to maturity, at cost                                                                                                             |  | 16,998,209   |             | 18,220,867  |            
|Restricted equity securities, at cost                                                                                                            |  | 3,710,217    |             | 2,734,567   |            
|Loans held for sale                                                                                                                              |  | 1,039,976    |             | 2,449,651   |            
|                                                                                                                                                 |  |              |             |             |            
|Loans, net of unearned income                                                                                                                    |  | 291,819,946  |             | 242,368,770 |            
|Less allowance for loan losses                                                                                                                   |  | 3,474,640    |             | 2,862,992   |            
|Loans, net                                                                                                                                       |  | 288,345,306  |             | 239,505,778 |            
|                                                                                                                                                 |  |              |             |             |            
|Premises and equipment, net                                                                                                                      |  | 7,383,595    |             | 6,620,652   |            
|Cash surrender value of life insurance                                                                                                           |  | 6,553,009    |             | 5,322,247   |            
|Intangible assets                                                                                                                                |  | 740,073      |             | 1,113,198   |            
|Goodwill                                                                                                                                         |  | 10,215,607   |             | 9,722,772   |            
|Other assets                                                                                                                                     |  | 5,180,430    |             |             | 3,296,885   |            
|Total assets                                                                                                                                     |  | $            | 426,210,069 |             | $           | 355,168,137 | 
|Liabilities and Shareholders Equity                                                                                                             |  |              |             |             |             |            
|Deposits:                                                                                                                                        |  |              |             |             |            
|Noninterest-bearing                                                                                                                              |  | $            | 24,366,771  |             | $           | 22,473,524  | 
|Interest-bearing                                                                                                                                 |  | 315,691,850  |             |             | 263,922,456 |            
|Total deposits                                                                                                                                   |  | 340,058,621  |             |             | 286,395,980 |            
|                                                                                                                                                 |  |              |             |             |             |            
|Securities sold under agreements to repurchase                                                                                                   |  | 2,000,000    |             |            |            
|Other borrowings                                                                                                                                 |  | 29,973,051   |             | 22,962,934  |            
|Junior subordinated debentures                                                                                                                   |  | 7,217,000    |             | 3,093,000   |            
|Other liabilities                                                                                                                                |  | 3,789,911    |             |             | 3,401,055   |            
|Total liabilities                                                                                                                                |  | 383,038,583  |             |             | 315,852,969 |            
|                                                                                                                                                 |  |              |             |             |             |            
|Commitments and contingencies                                                                                                                    |  |              |             |             |            
|                                                                                                                                                 |  |              |             |             |            
|Shareholders Equity:                                                                                                                            |  |              |             |             |            
|Preferred stock, $.01 par value; 10,000,000 shares authorized;
no shares issued and outstanding                                                  |  |             |             |            |            
|Common stock, par value $.01; 10,000,000 shares authorized;
2,402,594 and 2,369,263 shares issued and outstanding in
2006 and 2005, respectively |  | 24,026       |             | 23,693      |            
|Additional paid-in capital                                                                                                                       |  | 39,661,823   |             | 39,317,286  |            
|Retained earnings                                                                                                                                |  | 3,836,130    |             | 476,593     |            
|Accumulated other comprehensive loss                                                                                                             |  | (350,493)    |             |             | (502,404)   |            
|Total shareholders equity                                                                                                                       |  | 43,171,486   |             |             | 39,315,168  |            
|Total liabilities and shareholders equity                                                                                                       |  | $            | 426,210,069 |             | $           | 355,168,137 | 



See accompanying notes to consolidated financial statements.











32





---



COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Statements of Income



|                                                    |  |                                  |            |           |            |            | 
|--------------------------------------------------- |  | -------------------------------- | ---------- | --------- | ---------- | ---------- | 
|                                                    |  | For the years ended December 31, |           
|                                                    |  | 2006                             |            |           | 2005       |           
|Interest income:                                    |  |                                  |            |           |            |           
|Interest and fees on loans                          |  | $                                | 22,629,425 |           | $          | 10,106,654 | 
|Interest on taxable securities                      |  | 3,053,776                        |            | 1,399,547 |           
|Interest on nontaxable securities                   |  | 420,027                          |            | 243,594   |           
|Interest on deposits in other banks                 |  | 91,647                           |            | 8,570     |           
|Interest on federal funds sold                      |  | 537,208                          |            |           | 203,508    |           
|Total interest income                               |  | 26,732,083                       |            |           | 11,961,873 |           
|                                                    |  |                                  |            |           |           
|Interest expense:                                   |  |                                  |            |           |           
|Interest on deposits                                |  | 11,845,450                       |            | 4,632,264 |           
|Interest on junior subordinated debentures          |  | 391,932                          |            | 188,660   |           
|Interest on other borrowings                        |  | 1,223,424                        |            |           | 363,726    |           
|Total interest expense                              |  | 13,460,806                       |            |           | 5,184,650  |           
|                                                    |  |                                  |            |           |            |           
|Net interest income                                 |  | 13,271,277                       |            | 6,777,223 |           
|Provision for loan losses                           |  | 726,700                          |            |           | 380,000    |           
|Net interest income after provision for loan losses |  | 12,544,577                       |            |           | 6,397,223  |           
|                                                    |  |                                  |            |           |           
|Non-interest income:                                |  |                                  |            |           |           
|Service charges on deposit accounts                 |  | 381,098                          |            | 233,547   |           
|Other service charges, commissions and fees         |  | 190,450                          |            | 49,445    |           
|Mortgage origination fees                           |  | 910,558                          |            | 676,248   |           
|Gain on sale of real estate                         |  | 321,038                          |            |          |           
|Loss on sale of securities available for sale       |  | (13,460)                         |            | (7,503)   |           
|Income from investment in life insurance contracts  |  | 239,944                          |            | 124,086   |           
|Other income                                        |  | 10,167                           |            |           | 21,738     |           
|Total other income                                  |  | 2,039,795                        |            |           | 1,097,561  |           
|                                                    |  |                                  |            |           |           
|Non-interest expenses:                              |  |                                  |            |           |           
|Salaries and employee benefits                      |  | 5,400,276                        |            | 2,933,592 |           
|Occupancy and equipment expense                     |  | 821,727                          |            | 491,913   |           
|Advertising fees                                    |  | 270,773                          |            | 193,185   |           
|Amortization of intangible assets                   |  | 373,125                          |            | 99,237    |           
|Audit fees                                          |  | 280,424                          |            | 151,525   |           
|Data processing fees                                |  | 661,301                          |            | 434,987   |           
|Director fees                                       |  | 269,812                          |            | 138,244   |           
|Legal and other professional fees                   |  | 181,715                          |            | 81,332    |           
|Other operating                                     |  | 1,318,650                        |            |           | 665,339    |           
|Total other expenses                                |  | 9,577,803                        |            |           | 5,189,354  |           
|                                                    |  |                                  |            |           |           
|Income before income taxes                          |  | 5,006,569                        |            | 2,305,430 |           
|Income tax expense                                  |  | 1,647,032                        |            |           | 796,060    |           
|Net income                                          |  | $                                | 3,359,537  |           | $          | 1,509,370  | 
|                                                    |  |                                  |            |           |            |            | 
|Basic earnings per share                            |  | $                                | 1.41       |           | $          | 1.09       | 
|Diluted earnings per share                          |  | $                                | 1.30       |           | $          | 0.97       | 





See accompanying notes to consolidated financial statements.











33





---



COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income







|                                                                                                  |  |                                  |           |           |           |           | 
|------------------------------------------------------------------------------------------------- |  | -------------------------------- | --------- | --------- | --------- | --------- | 
|                                                                                                  |  | For the years ended December 31, |          
|                                                                                                  |  | 2006                             |           |           | 2005      |          
|Net income                                                                                        |  | $                                | 3,359,537 |           | $         | 1,509,370 | 
|Other comprehensive income (loss), net of tax:                                                    |  |                                  |           |           |          
|Net unrealized holding gains (losses) arising during period,
net of tax of ($73,681) and $198,058 |  | 143,027                          |           | (374,599) |          
|Reclassification adjustment for losses included in net income,
net of tax of $4,576 and $2,551    |  | 8,884                            |           |           | 4,952     |          
|Total other comprehensive income (loss)                                                           |  | 151,911                          |           |           | (369,647) |          
|Comprehensive income                                                                              |  | $                                | 3,511,448 |           | $         | 1,139,723 | 







See accompanying notes to consolidated financial statements.











34





---



COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders Equity

For the Years Ended December 31, 2006 and 2005



|                                        |  |              |  |                    |        |            |              |                                 |             |      |           |           |  |            |             |  | 
|--------------------------------------- |  | ------------ |  | ------------------ | ------ | ---------- | ------------ | ------------------------------- | ----------- | ---- | --------- | --------- |  | ---------- | ----------- |  | 
|                                        |  | Common Stock |  | Additional
Paid-in |        | Retained   |              | Accumulated
Other
Comprehensive |             |      |          
|                                        |  | Shares       |  | Amount             |        | Capital    |              | Earnings                        |             | Loss |           | Total     | 
|Balance, December 31, 2004              |  | 1,010,379    |  | $                  | 10,104 |            | $  9,626,976 |                                 | $ 1,287,727 |      | $         | (132,757) |  |            | $10,792,050 | 
|Net income                              |  |             |  |                   |        |           |              | 1,509,370                       |             |      |          |           |  | 1,509,370  |            
|Stock issued in acquisition             |  | 1,246,402    |  | 12,464             |        | 27,370,931 |              |                                |             |      |          |           |  | 27,383,395 |            
|Stock dividend                          |  | 112,482      |  | 1,125              |        | 2,319,379  |              | (2,320,504)                     |             |      |          |           |  |           |            
|Other comprehensive loss                |  |             |  |                   |        |           |              |                                |             |      | (369,647) |           |  | (369,647)  |            
|Balance, December 31, 2005              |  | 2,369,263    |  |                    | 23,693 |            | 39,317,286   |                                 | 476,593     |      |           | (502,404) |  |            | 39,315,168  | 
|Net income                              |  |             |  |                   |        |           |              | 3,359,537                       |             |      |          |           |  | 3,359,537  |            
|Proceeds from exercise of
stock options |  | 33,331       |  | 333                |        | 317,466    |              |                                |             |      |          |           |  | 317,799    |            
|Stock-based compensation
expense        |  |             |  |                   |        | 27,071     |              |                                |             |      |          |           |  | 27,071     |            
|Other comprehensive income              |  |             |  |                    |       |            |             |                                 |            |      |           | 151,911   |  |            | 151,911     | 
|Balance, December 31, 2006              |  | 2,402,594    |  | $                  | 24,026 |            | $39,661,823  |                                 | $ 3,836,130 |      | $         | (350,493) |  |            | $43,171,486 | 







See accompanying notes to consolidated financial statements.











35





---



COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows



|                                                                                  |  |                                  |            |              |   |           |  |  |  | 
|--------------------------------------------------------------------------------- |  | -------------------------------- | ---------- | ------------ | - | --------- |  |  |  | 
|                                                                                  |  | For the years ended
December 31, |           
|                                                                                  |  | 2006                             |            | 2005         |  
|Cash flows from operating activities:                                             |  |                                  |            |              |  
|Net income                                                                        |  | $                                | 3,359,537  |              | $ | 1,509,370 | 
|Adjustments to reconcile net income to net cash provided
by operating activities: |  |                                  |            |              |  
|Depreciation, amortization and accretion                                          |  | 332,168                          |            | 318,345      |  
|Amortization of intangible assets                                                 |  | 373,125                          |            | 99,237       |  
|Stock-based compensation expense                                                  |  | 27,071                           |            |             |  
|Provision for loan losses                                                         |  | 726,700                          |            | 380,000      |  
|Provision for deferred income taxes                                               |  | (534,262)                        |            | (107,605)    |  
|Loss on sale of securities available for sale                                     |  | 13,460                           |            | 7,503        |  
|Gain on sale of real estate                                                       |  | (321,038)                        |            |             |  
|Increase in cash value of life insurance                                          |  | (239,944)                        |            | (124,086)    |  
|Net change in loans held for sale                                                 |  | 1,409,675                        |            | 8,217        |  
|Net increase in interest receivable                                               |  | (792,124)                        |            | (977,033)    |  
|Net increase in interest payable                                                  |  | 257,126                          |            | 493,234      |  
|Net other operating activities                                                    |  | (36,737)                         |            | 304,363      |  
|Net cash provided by operating activities                                         |  | 4,574,757                        |            | 1,911,545    |  
|                                                                                  |  |                                  |            |              |  
|Cash flows from investing activities:                                             |  |                                  |            |              |  
|Net (increase) decrease in interest-bearing deposits in banks                     |  | (341,462)                        |            | 426,587      |  
|Net increase in federal funds sold                                                |  | (5,369,310)                      |            | (11,015,435) |  
|Proceeds from maturities of securities available for sale                         |  | 6,595,285                        |            | 6,199,475    |  
|Proceeds from sale of securities available for sale                               |  | 2,992,260                        |            |             |  
|Purchases of securities available for sale                                        |  | (23,582,247)                     |            | (5,389,918)  |  
|Proceeds from maturities of securities held to maturity                           |  | 1,584,993                        |            | 552,625      |  
|Purchases of securities held to maturity                                          |  | (400,000)                        |            | (498,617)    |  
|Net change in restricted equity securities                                        |  | (975,650)                        |            | (363,817)    |  
|Net increase in loans                                                             |  | (48,753,932)                     |            | (25,365,665) |  
|Purchase of life insurance contracts                                              |  | (1,000,000)                      |            |             |  
|Proceeds from sale of real estate                                                 |  | 735,942                          |            |             |  
|Net cash acquired in merger                                                       |  | 5,384,781                        |            | 16,490,497   |  
|Purchase of premises and equipment                                                |  | (1,408,517)                      |            | (116,222)    |  
|Net cash used by investing activities                                             |  | (64,537,857)                     |            | (19,080,490) |  
|                                                                                  |  |                                  |            |              |  
|Cash flows from financing activities:                                             |  |                                  |            |              |  
|Net increase in deposits                                                          |  | 46,450,557                       |            | 19,014,250   |  
|Increase in securities purchased under agreements to repurchase                   |  | 2,000,000                        |            |             |  
|Proceeds from other borrowings                                                    |  | 19,000,000                       |            | 23,900,000   |  
|Repayment of other borrowings                                                     |  | (12,000,000)                     |            | (20,900,000) |  
|Proceeds from junior subordinated debt                                            |  | 4,124,000                        |            |             |  
|Proceeds from exercise of stock options                                           |  | 317,799                          |            |             |  
|Net cash provided by financing activities                                         |  | 59,892,536                       |            | 22,014,250   |  
|                                                                                  |  |                                  |            |              |  
|Net change in cash and due from banks                                             |  | (70,744)                         |            | 3,508,793    |  
|Cash and due from banks at beginning of year                                      |  | 4,845,305                        |            | 1,336,512    |  
|Cash and due from banks at end of year                                            |  | $                                | 4,774,561  |              | $ | 4,845,305 | 
|                                                                                  |  |                                  |            |              |  
|Supplemental disclosures of cash flow information:                                |  |                                  |            |              |  
|Cash paid during the year for interest                                            |  | $                                | 13,203,680 |              | $ | 4,744,209 | 
|Cash paid during the year for income taxes                                        |  | $                                | 2,255,903  |              | $ | 605,780   | 



See accompanying notes to consolidated financial statements.









36





---



COASTAL BANKING COMPANY, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements



Note 1.

Summary of Significant Accounting Policies



Basis of Presentation and Nature of Operations



Coastal Banking Company, Inc. (the Company) is organized under the laws of the State of South Carolina for the purpose of operating as a bank holding company for Lowcountry National Bank and First National Bank of Nassau County (the Banks). Lowcountry National Bank commenced business on May 10, 2000. First National Bank of Nassau County began operations in 1999 and was acquired through merger on October 1, 2005.  On October 27, 2006, the Company acquired the Meigs, Georgia office of a bank in Thomas County, Georgia.  The Banks provide full commercial banking services to customers throughout Beaufort County, South Carolina; Nassau County, Florida; and Thomas County, Georgia and are subject to regulation by the Office of the Comptroller of the Currency (the OCC) and the Federal Deposit Insurance Corporation.  The Banks also have loan production offices in Savannah, Georgia and Jacksonville, Florida.  The Company is subject to regulation by the Federal Reserve Board of Governors. The Company also has an investment in Coastal Banking Company Statutory Trust I (Trust I) and Coastal Banking Company Trust II (Trust II). Both trusts are special-purpose subsidiaries organized for the sole purpose of issuing trust preferred securities.



The consolidated financial statements include the accounts of the Company and the Banks. All significant intercompany transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices in the banking industry.



Accounting Estimates



The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates.



Segments



The Company, through its subsidiaries, provides a broad range of financial services to individuals and companies. These services include demand, time and savings deposits, lending, and ATM processing and are substantially the same across subsidiaries. While the Companys decision-makers monitor the revenue streams of the various financial products and services by product line and by subsidiary, the operations and the allocation of resources are managed, and financial performance is evaluated, on an organization-wide basis. Accordingly, the Companys banking operation is considered by management to be one reportable operating segment.



Cash, Due from Banks and Cash Flows



For purposes of reporting cash flows, cash and due from banks includes cash on hand, cash items in process of collection and amounts due from banks. Cash flows from loans, federal funds sold, deposits, interest-bearing deposits in banks, federal funds purchased, restricted equity securities and securities sold under agreements to repurchase are reported net.



The Banks are required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank. The total of those reserve requirements was approximately $955,000 and $952,000 at December 31, 2006 and 2005, respectively.



Securities



The Company classifies its securities as available for sale or held to maturity.  Held to maturity securities are those securities for which the Company has the ability and intent to hold until maturity. All securities not included in held to maturity are classified as available for sale.



37





---



Available for sale securities are recorded at fair value. Held to maturity securities are recorded at cost, adjusted for the amortization or accretion of premiums or discounts. Unrealized holding gains and losses on securities available for sale, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders equity until realized.



A decline in the market value of securities below cost that is deemed other than temporary is charged to earnings and establishes a new cost basis for the security.



Premiums and discounts are amortized or accreted over the life of the related securities as adjustments to the yield. Realized gains and losses for securities classified as available for sale and held to maturity are included in earnings and are derived using the specific identification method for determining the cost of securities sold.



Other Investments



Other investments include restricted equity securities with no readily determinable fair value. These investments are carried at cost. The Bank, as a member institution, is required to own certain stock investments in the Federal Home Loan Bank of Atlanta (FHLB) and the Federal Reserve Bank (FRB). The stock is generally pledged against any borrowings from these institutions. No ready market exists for the stock and it has no quoted market price. However, redemption of these stocks has historically been at par value.



Loans Held for Sale



Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market value. The amount by which cost exceeds market value is accounted for as a valuation allowance. Changes, if any, in the valuation allowance are included in the determination of net income in the period in which the change occurs. The Company has recorded no valuation allowance related to its loans held for sale as their cost approximates market value.



Loans and Allowance for Loan Losses



Loans are stated at principal amount outstanding, net of deferred loan origination fees and costs and the allowance for loan losses. Interest on loans is calculated by using the interest method based upon the principal amount outstanding. Loan origination and commitment fees and direct loan origination costs are deferred and amortized over the contractual life of the related loan or commitments as an adjustment of the related loan yields.



A loan is considered impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. Impaired loans are measured based on the present value of expected future cash flows discounted at the loans effective interest rate, at the loans observable market price, or at the fair value of the collateral of the loan if the loan is collateral dependent. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts that the borrowers financial condition is such that collection of interest is doubtful. When the ultimate collectibility of an impaired loans principal is in doubt, wholly or partially, all cash receipts are applied to principal.



The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance represents an amount, which, in managements judgment, will be adequate to absorb probable losses on existing loans that may become uncollectible.



Managements judgment in determining the adequacy of the allowance is based on evaluations of the collectibility of loans. These evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions that may affect the borrowers ability to pay, overall portfolio quality and review of specific problem loans. In determining the adequacy of the allowance for loan losses management uses four different methods as indicators of the reasonableness of the allowance. The methods used include a risk method (using internal classifications along with regulatory classifications), historical charge-offs, comparison to a peer group, and current classifications based on the loan grading system. The combination of these results are compared quarterly to the recorded allowance for loan losses for reasonableness and material differences are adjusted by increasing or decreasing the provision for loan losses. Management uses an external loan review program to challenge and corroborate the internal loan grading system and provide additional analysis in determining the adequacy of the allowance and the future provisions for estimated loan losses.



38





---



Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks allowance for loan losses. Such agencies may require the Banks to recognize additions to the allowance based on judgments different than those of management.



Non-performing Assets



Loans are placed in a non-accrual status when, in the opinion of management, the collection of additional interest is questionable. Thereafter, no interest is taken into income unless received in cash or until such time as the borrower demonstrates the ability to pay principal and interest.



Premises and Equipment



Premises and equipment are stated at cost less accumulated depreciation. Costs incurred for maintenance and repairs that do not extend the useful life of the asset are expensed as incurred.



Depreciation expense is computed using the straight-line method over the following estimated useful lives:



|                          |  |               | 
|------------------------- |  | ------------- | 
|Building and improvements |  | 10 - 40 years | 
|Furniture and equipment   |  | 3 - 10 years  | 



Goodwill and Intangible Assets



Goodwill represents the excess of cost over the fair value of the net assets purchased in business combinations. Goodwill is required to be tested annually for impairment or whenever events occur that may indicate that the recoverability of the carrying amount is not probable. In the event of an impairment, the amount by which the carrying amount exceeds the fair value is charged to earnings. The Company performed its annual test of impairment in the fourth quarter and determined that there was no impairment in the carrying value of goodwill as of October 1, 2006.



Intangible assets consist of core deposit premiums acquired in connection with business combinations.  The core deposit premiums were initially recognized based on valuations performed as of the consummation date.  The core deposit premiums are amortized over the average remaining life of the acquired customer deposits. Amortization periods are reviewed annually in connection with the annual impairment testing of goodwill.



Included in the consolidated statements of income for December 31, 2006, and 2005 were charges for amortization of identifiable intangible assets in the amounts of $373,000 and $99,000, respectively.



Income Taxes



Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.



In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the assets and liabilities result in deferred tax assets, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for some portion or all of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.



39





---



Stock-Based Compensation



At December 31, 2006, the Company had an Incentive Stock Compensation Plan and a Director Stock Plan, which are described more fully in Note 14. On January 1, 2006, Coastal adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-Based Payment (SFAS 123(R)), using the modified-prospective-transition method. Under that transition method, compensation cost recognized beginning in 2006 includes: (a) the compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FASB Statement No. 123, and (b) the compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated.

Prior to January 1, 2006, Coastal accounted for stock-based compensation under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Under the provisions of Coastals stock option plans, the exercise price per share of each option granted cannot be less than the fair market value of the underlying common shares on the date of grant. As a result, Coastal previously did not recognize any stock-based employee compensation expense in net income prior to January 1, 2006. As a result of adopting SFAS 123(R), Coastals income before income taxes and net income at December 31, 2006 are $27,000 and $24,000 lower, respectively, than if Coastal had continued to account for stock-based compensation under the old method.  Basic and diluted earnings per share for the year ended December 31, 2006, would have been $1.42 and $1.31, respectively, if Coastal had not adopted SFAS 123(R), compared to reported basic and diluted earnings per share of $1.41 and $1.30, respectively.

The following table illustrates the effect on net income and earnings per share for the year ended December 31, 2005 had Coastal applied fair value recognition to stock-based employee compensation, assuming the estimated fair value of the options as of the grant date is amortized to expense over the vesting period:



|                                                                                                                                           |  |  |  |           |   |           |  |  | 
|------------------------------------------------------------------------------------------------------------------------------------------ |  |  |  | --------- | - | --------- |  |  | 
|Net income as reported                                                                                                                     |  |  |  |           | $ | 1,509,370 | 
|Add: Total stock-based employee compensation expense
included in reported net income, net of related tax effect                            |  |  |  |           |  
|Deduct: Total stock-based employee compensation expense
determined under fair-value based method for all awards,
net of related tax effect |  |  |  | (172,121) |  
|Pro forma net income                                                                                                                       |  |  |  |           | $ | 1,337,249 | 
|                                                                                                                                           |  |  |  |           |  
|Basic earnings per share:                                                                                                                  |  |  |  |           |  
|As reported                                                                                                                                |  |  |  |           | $ | 1.09      | 
|Pro forma                                                                                                                                  |  |  |  |           | $ | .96       | 
|Diluted earnings per share:                                                                                                                |  |  |  |           |  
|As reported                                                                                                                                |  |  |  |           | $ | .97       | 
|Pro forma                                                                                                                                  |  |  |  |           | $ | .86       | 



Earnings Per Share



The Company is required to report earnings per common share with and without the dilutive effects of potential common stock issuances from instruments such as options, convertible securities and warrants on the face of the statements of earnings. Basic earnings per common share are based on the weighted average number of common shares outstanding during the period, which was 2,377,942 in 2006 and 1,390,751 in 2005, while the effects of potential common shares outstanding during the period are included in diluted earnings per share. Additionally, the Company must reconcile the amounts used in the computation of both basic earnings per share and diluted earnings per share. At December 31, 2006, potential common shares of 26,500 were not included in the calculation of diluted earnings per share because the exercise of such shares would be anti-dilutive. There were no anti-dilutive potential common shares at December 31, 2005. All share amounts have been adjusted for the five percent stock dividend recorded in 2005. Earnings per common share amounts are as follows:



40





---



|                                                         |  |  |   |                        |  |                            |         |                  |  |  |       |   |      |  |  |  |  |  |  |  |  |  |  | 
|-------------------------------------------------------- |  |  | - | ---------------------- |  | -------------------------- | ------- | ---------------- |  |  | ----- | - | ---- |  |  |  |  |  |  |  |  |  |  | 
|For the year ended December 31, 2006                     |  |  |   | Net income
(Numerator) |  | Common
Share
(Denominator) |         | Per Share
Amount | 
|Basic earnings per share                                 |  |  | $ | 3,359,537              |  |                            |         | 2,377,942        |  |  |       | $ | 1.41 |  | 
|Effect of dilutive securitiesstock options and
warrants |  |  |  |                        |  |                            | 203,387 |                  |  |  | (.11) |   |     
|Diluted earnings per share                               |  |  | $ | 3,359,537              |  |                            |         | 2,581,329        |  |  |       | $ | 1.30 |  | 



|                                                         |  |  |   |                        |  |                            |         |                  |  |  |       |   |      |  |  |  | 
|-------------------------------------------------------- |  |  | - | ---------------------- |  | -------------------------- | ------- | ---------------- |  |  | ----- | - | ---- |  |  |  | 
|For the year ended December 31, 2005                     |  |  |   | Net income
(Numerator) |  | Common
Share
(Denominator) |         | Per Share
Amount | 
|Basic earnings per share                                 |  |  | $ | 1,509,370              |  |                            |         | 1,390,751        |  |  |       | $ | 1.09 |  | 
|Effect of dilutive securitiesstock options and
warrants |  |  |  |                        |  |                            | 170,539 |                  |  |  | (.12) |   |     
|Diluted earnings per share                               |  |  | $ | 1,509,370              |  |                            |         | 1,561,290        |  |  |       | $ | .97  |  | 



Recent Accounting Pronouncements



In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes  An Interpretation of FASB Statement No. 109.This interpretation addresses the accounting for uncertainty in income taxes recognized in a Companys financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes.  It prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken in a tax return.  It requires that only benefits from tax positions that are more-likely-than-not of being sustained upon examination should be recognized in the financial statements.  These benefits would be recorded at amounts considered to be the maximum amounts more-likely-than-not of being sustained.  At the time these positions become more-likely-than-not to be disallowed, their recognition would be reversed.  This interpretation is effective for fiscal years beginning after December 15, 2006 and is not expected to have a material impact on the Companys financial condition or results of operations.



In September 2006, the FASB issued SFAS 157, Fair Value Measurements.The standard provides guidance for using fair value to measure assets and liabilities.  It defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and expands disclosures about fair value measurement.  Under the standard, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts.  It clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability.  In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.  Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy.  Statement 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007.  The Company is currently evaluating the impact the adoption of this statement could have on its financial condition, results of operations and cash flows.



Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.



Risks and Uncertainties



In the normal course of its business, the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different bases, than its interest-earning assets. Credit risk is the risk of default on the Companys loan portfolio that results from borrowers inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable, the valuation of real estate held by the Company, and the valuation of loans held for sale and mortgage-backed securities available for sale.



The Company is subject to the regulations of various government agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances, and operating restrictions, resulting from the regulators judgments based on information available to them at the time of their examination.



41





---



Concentrations of Credit Risk



The Company, through its subsidiaries, makes loans to individuals and businesses in and around Beaufort County, South Carolina; in and around Chatham and Thomas Counties in Georgia; and in and around Duval and Nassau Counties in Florida for various personal and commercial purposes. The Company has a diversified loan portfolio and the borrowers ability to repay their loans is not dependent upon any specific economic sector.



The Company makes loans to individual and small businesses for various personal and commercial purposes primarily through our full-service offices in Beaufort County, South Carolina and Nassau County, Florida and through our loan production offices in Jacksonville, Florida and Savannah, Georgia.  The Companys loan portfolio is not concentrated in loans to any single borrower or in a relatively small number of borrowers. Our loan portfolio has a significant number of construction loans that if subjected to a real estate market down-turn could adversely affect the earnings of the Company.



In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk that could arise from potential concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral period, loans with initial interest-only payments, etc), and loans with high loan-to-value ratios. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loans life. For example, the Company makes variable-rate loans and fixed-rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon-payment loans). These loans are underwritten and monitored to manage the associated risks. Management has determined that there is no concentration of credit risk associated with its lending policies or practices.



The Companys investment portfolio consists principally of obligations of the United States, its agencies or its corporations and general obligation municipal securities. In the opinion of management, there is no concentration of credit risk in this investment portfolio. The Company places it deposits and correspondent accounts with and sells its federal funds to high quality institutions. Management believes credit risk associated with correspondent accounts is not significant.





Note 2.

Business Combinations



On October 27, 2006, the Company completed the acquisition of the Meigs, Georgia office of Cairo Banking Company, a Georgia State Bank, through the merger of a Georgia state bank charter with and into First National Bank of Nassau County. The name of the Meigs office was subsequently changed to The Georgia Bank. The acquisition was approved at a Coastal board meeting on May 19, 2006. The acquisition was accounted for using the purchase method of accounting, with the operating results of The Georgia Bank from October 27, 2006 forward included in the Companys financial statements.



The aggregate purchase price was $5,014,269, consisting of all cash.  The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at October 27, 2006, the date of acquisition, including subsequent adjustments to the allocation of the purchase price.



|                          |  |            |            | 
|------------------------- |  | ---------- | ---------- | 
|Cash and cash equivalents |  | $          | 10,399,050 | 
|Loans, net                |  | 812,296    |           
|Premises and equipment    |  | 17,335     |           
|Other assets              |  | 14,269     |           
|Goodwill                  |  | 983,403    |           
|Total assets acquired     |  | 12,226,353 |           
|                          |  |            |           
|Deposits                  |  | 7,212,084  |           
|Total liabilities assumed |  | 7,212,084  |           
|Net assets acquired       |  | $          | 5,014,269  | 



42





---



Proforma information relating to the impact of the acquisition on Coastals consolidated financial statements, assuming such acquisition had occurred at the beginning of the periods reported, is not presented as such impact is not significant.



On October 1, 2005, the Company completed its acquisition of First Capital Bank Holding Corporation, the holding company for First National Bank of Nassau County, Florida, located in Fernandina Beach, Florida. The acquisition was approved at a special shareholders meeting on August 24, 2005. First Capital shareholders were given 1.054 shares of the Companys common stock in exchange for each share of First Capital common stock. As a result of the exchange, First Capital shareholders were given a total of 1,246,402 shares of  the Companys common stock valued at $21.24 per share for a total market value of  $27,383,395, which included the value of stock options assumed and cash paid in lieu of fractional shares. The value of the common stock issued was determined based on the average closing price over the ten days prior to the closing of the transaction. The acquisition was accounted for using the purchase method of accounting, with the operating results of First Capital from October 1, 2005 forward included in the Companys financial statements. A summary of the purchase price of the transaction is as follows:

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at October 1, 2005, the date of acquisition, including subsequent adjustments to the allocation of the purchase price.

|                                         |  |             |            | 
|---------------------------------------- |  | ----------- | ---------- | 
|Cash and cash equivalents                |  | $           | 16,490,497 | 
|Securities                               |  | 34,735,395  |           
|Loans Held for sale                      |  | 1,579,744   |           
|Loans, net of allowance                  |  | 114,052,253 |           
|Premises and equipment                   |  | 3,815,530   |           
|Cash value of life insurance             |  | 3,122,971   |           
|Other assets                             |  | 1,090,433   |           
|Core deposit intangible                  |  | 1,212,435   |           
|Goodwill                                 |  | 9,722,772   |           
|Total assets acquired                    |  | 185,822,030 |           
|Deposits                                 |  | 137,933,242 |           
|Advances from the Federal Home Loan Bank |  | 17,958,741  |           
|Other liabilities                        |  | 1,278,726   |           
|Total liabilities assumed                |  | 157,170,709 |           
|Net assets acquired                      |  | $           | 28,651,321 | 



Goodwill includes merger-related expenses of $1,202,318. These fees include professional fees and costs associated with the termination of data processing contracts related to the combination.



43





---



Note 3.

Investment Securities



Investment securities are as follows:



|                                     |  |                   |            |                        |         |                         |  |            |           |           |  |            |            |  |  |  |  |  |  |  |  | 
|------------------------------------ |  | ----------------- | ---------- | ---------------------- | ------- | ----------------------- |  | ---------- | --------- | --------- |  | ---------- | ---------- |  |  |  |  |  |  |  |  | 
|                                     |  | December 31, 2006 |           
|                                     |  | Amortized
Cost    |            | Gross
Unrealized
Gains |         | Gross
Unrealized
Losses |  | Fair
Value |          
|Available for sale                   |  |                   |            |                        |         |                         |  |            |           |           |  |            |           
|U.S. Government and federal agencies |  | $                 | 5,482,833  |                        | $       | 3,112                   |  |            | $         | (90,232)  |  | $          | 5,395,713  | 
|Government-sponsored enterprises     |  | 17,275,311        |            |                        | 31,778  |                         |  |            | (164,443) |           |  | 17,142,646 |           
|State and municipal securities       |  | 3,301,637         |            |                        | 5,148   |                         |  |            | (32,534)  |           |  | 3,274,251  |           
|Mortgage-backed securities           |  | 34,844,010        |            |                        | 191,684 |                         |  |            | (475,564) |           |  | 34,560,130 |           
|                                     |  | $                 | 60,903,791 |                        | $       | 231,722                 |  |            | $         | (762,773) |  | $          | 60,372,740 | 
|                                     |  |                   |            |                        |         |                         |  |            |           |           |  |            |           
|Held to maturity                     |  |                   |            |                        |         |                         |  |            |           |           |  |            |           
|State and municipal securities       |  | $                 | 8,824,620  |                        | $       | 23,850                  |  |            | $         | (75,146)  |  | $          | 8,773,324  | 
|Mortgage-backed securities           |  |                   | 8,173,589  |                        |         |                        |  |            |           | (88,739)  |  |            | 8,084,850  | 
|                                     |  | $                 | 16,998,209 |                        | $       | 23,850                  |  |            | $         | (163,885) |  | $          | 16,858,174 | 
|                                     |  |                   |           
|                                     |  | December 31, 2005 |           
|                                     |  | Amortized
Cost    |            | Gross
Unrealized
Gains |         | Gross
Unrealized
Losses |  | Fair
Value |          
|Available for sale                   |  |                   |            |                        |         |                         |  |            |           |           |  |            |           
|U.S. Government and federal agencies |  | $                 | 4,930,265  |                        | $       | 1,718                   |  |            | $         | (115,272) |  | $          | 4,816,711  | 
|Government-sponsored enterprises     |  | 18,116,855        |            |                        | 30      |                         |  |            | (241,451) |           |  | 17,875,434 |           
|State and municipal securities       |  | 1,408,930         |            |                        |        |                         |  |            | (24,520)  |           |  | 1,384,410  |           
|Mortgage-backed securities           |  | 22,463,443        |            |                        |        |                         |  |            | (389,357) |           |  | 22,074,086 |           
|                                     |  | $                 | 46,919,493 |                        | $       | 1,748                   |  |            | $         | (770,600) |  | $          | 46,150,641 | 
|                                     |  |                   |            |                        |         |                         |  |            |           |           |  |            |           
|Held to maturity                     |  |                   |            |                        |         |                         |  |            |           |           |  |            |           
|State and municipal securities       |  | $                 | 8,467,980  |                        | $       | 2,298                   |  |            | $         | (178,175) |  | $          | 8,292,103  | 
|Mortgage-backed securities           |  |                   | 9,752,887  |                        |         |                        |  |            |           | (158,531) |  |            | 9,594,356  | 
|                                     |  | $                 | 18,220,867 |                        | $       | 2,298                   |  |            | $         | (336,706) |  | $          | 17,886,459 | 



The following table shows gross unrealized losses and fair value of securities, aggregated by category and length of time that securities have been in a continuous unrealized loss position, at December 31, 2006.



Investment securities available for sale:



|                                     |  |                     |            |                   |          |            |  |                   |            |            |           |                   |  |            |            |  |           |           |  | 
|------------------------------------ |  | ------------------- | ---------- | ----------------- | -------- | ---------- |  | ----------------- | ---------- | ---------- | --------- | ----------------- |  | ---------- | ---------- |  | --------- | --------- |  | 
|                                     |  | Less than 12 Months |            | 12 Months or More |          | Total      | 
|                                     |  | Fair
Value          |            | Unrealized
Losses |          | Fair
Value |  | Unrealized
Losses |            | Fair
Value |           | Unrealized
Losses | 
|U.S. Government
and federal
agencies |  | $                   |           |                   | $        |           |  | $                 | 135,243    |            | $         | (90,232)          |  | $          | 135,243    |  | $         | (90,232)  |  | 
|Government-sponsored
enterprises     |  | 1,988,825           |            |                   | (5,592)  |            |  | 14,004,691        |            |            | (158,851) |                   |  | 15,993,516 |            |  | (164,443) |           | 
|State and municipal
securities       |  | 1,431,861           |            |                   | (13,972) |            |  | 1,379,901         |            |            | (18,562)  |                   |  | 2,811,762  |            |  | (32,534)  |           | 
|Mortgage-backed
securities           |  | 6,693,759           |            |                   | (17,980) |            |  | 15,284,283        |            |            | (457,584) |                   |  | 21,978,042 |            |  | (475,564) |           | 
|Total                                |  | $                   | 10,114,445 |                   | $        | (37,544)   |  | $                 | 30,804,118 |            | $         | (725,229)         |  | $          | 40,918,563 |  | $         | (762,773) |  | 





44





---



Investment securities held to maturity:



|                               |  |                     |           |                   |   |            |  |                   |            |            |          |                   |  |           |             |  |          |           |  | 
|------------------------------ |  | ------------------- | --------- | ----------------- | - | ---------- |  | ----------------- | ---------- | ---------- | -------- | ----------------- |  | --------- | ----------- |  | -------- | --------- |  | 
|                               |  | Less than 12 Months |           | 12 Months or More |   | Total      | 
|                               |  | Fair
Value          |           | Unrealized
Losses |   | Fair
Value |  | Unrealized
Losses |            | Fair
Value |          | Unrealized
Losses | 
|State and municipal
securities |  | $                   | 1,768,839 |                   | $ | (14,164)   |  | $                 | 3,357,657  |            | $        | (60,982)          |  |           | $ 5,126,496 |  | $        | (75,146)  |  | 
|Mortgage-backed
securities     |  |                    |           |                   |  |            |  | 8,084,850         |            |            | (88,739) |                   |  | 8,084,850 |             |  | (88,739) |           | 
|Total                          |  | $                   | 1,768,839 |                   | $ | (14,164)   |  | $                 | 11,442,507 |            | $        | (149,721)         |  |           | $13,211,346 |  | $        | (163,885) |  | 



Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Fifty-one (51) individual securities available for sale were in a continuous loss position for twelve months or more.  Fourteen (14) individual securities held to maturity were in a continuous loss position for twelve months or more.  The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and not in the credit quality of the issuer. The unrealized losses are considered temporary because each security carries an acceptable investment grade and the repayment sources of principal and interest are government backed.  The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature.



The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005.

Investment securities available for sale:

|                                     |  |                     |            |                   |          |            |  |                   |            |            |           |                   |  |            |            |  |           |           |  | 
|------------------------------------ |  | ------------------- | ---------- | ----------------- | -------- | ---------- |  | ----------------- | ---------- | ---------- | --------- | ----------------- |  | ---------- | ---------- |  | --------- | --------- |  | 
|                                     |  | Less than 12 Months |            | 12 Months or More |          | Total      | 
|                                     |  | Fair
Value          |            | Unrealized
Losses |          | Fair
Value |  | Unrealized
Losses |            | Fair
Value |           | Unrealized
Losses | 
|U.S. Government
and federal
agencies |  | $                   | 3,677,735  |                   | $        | (36,542)   |  | $                 | 19,014,410 |            | $         | (320,181)         |  | $          | 22,692,145 |  | $         | (356,723) |  | 
|State and municipal
securities       |  | 1,384,410           |            |                   | (24,520) |            |  |                  |            |            |          |                   |  | 1,384,410  |            |  | (24,520)  |           | 
|Mortgage-backed
securities           |  | 6,548,267           |            |                   | (43,563) |            |  | 15,525,819        |            |            | (345,794) |                   |  | 22,074,086 |            |  | (389,357) |           | 
|Total                                |  | $                   | 11,610,412 |                   | $        | (104,625)  |  | $                 | 34,540,229 |            | $         | (665,975)         |  | $          | 46,150,641 |  | $         | (770,600) |  | 



Twenty one (21) individual securities were in a continuous loss position for twelve months or more. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature. The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary.

Investment securities held to maturity:

|                               |  |                     |         |                   |   |            |  |                   |           |            |  |                   |           |  |           |   |            |           |   |           |  |  |  | 
|------------------------------ |  | ------------------- | ------- | ----------------- | - | ---------- |  | ----------------- | --------- | ---------- |  | ----------------- | --------- |  | --------- | - | ---------- | --------- | - | --------- |  |  |  | 
|                               |  | Less than 12 Months |         | 12 Months or More |   | Total      | 
|                               |  | Fair
Value          |         | Unrealized
Losses |   | Fair
Value |  | Unrealized
Losses |           | Fair
Value |  | Unrealized
Losses |          
|State and municipal
securities |  | $                   | 102,492 |                   | $ | (471)      |  |                   | $         | 8,189,611  |  | $                 | (177,704) |  |           | $ | 8,292,103  |           | $ | (178,175) |  | 
|Mortgage backed
securities     |  |                     |        |                   |   |           |  |                   | 9,594,356 |            |  | (158,531)         |           |  | 9,594,356 |   |            | (158,531) |   |          
|Total                          |  | $                   | 102,492 |                   | $ | (471)      |  |                   | $         | 17,783,967 |  | $                 | (336,235) |  |           | $ | 17,886,459 |           | $ | (336,706) |  | 





45





---



The amortized cost and estimated fair value of investment securities at December 31, 2006, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.



|                                |  |                                 |            |                              |                             | 
|------------------------------- |  | ------------------------------- | ---------- | ---------------------------- | --------------------------- | 
|                                |  | Amortized
Cost                  |            | Fair Value                   |                            
|Available for sale              |  |                                 |            |                              |                            
|Due in one year or less         |  | $                               | 2,033,359  |                              | $                 2,021,874 | 
|Due from one year to five years |  | 15,625,317                      |            | 15,433,647                   |                            
|Due from five to ten years      |  | 7,501,778                       |            | 7,470,121                    |                            
|Due after ten years             |  | 899,327                         |            | 886,968                      |                            
|Mortgage-backed securities      |  | 34,844,010                      |            | 34,560,130                   |                            
|                                |  | $                               | 60,903,791 |                              | $               60,372,740  | 
|Held to maturity                |  |                                 |            |                              |                            
|Due in one year or less         |  | $                       305,382 |            | $                    305,172 |                            
|Due from one year to five years |  | 1,495,516                       |            | 1,481,772                    |                            
|Due from five to ten years      |  | 4,417,424                       |            | 4,386,944                    |                            
|Due after ten years             |  | 2,606,298                       |            | 2,599,436                    |                            
|Mortgage-backed securities      |  | 8,173,589                       |            | 8,084,850                    |                            
|                                |  | $                               | 16,998,209 |                              | $               16,858,174  | 



Securities with an amortized cost and fair value pledged to secure public deposits and for other purposes as required by law totaled $15,134,000 and $14,752,000 respectively as of December 31, 2006 and $20,592,000 and $20,364,000 respectively as of December 31, 2005.



Gains and losses on sales of securities available for sale consist of the following:



|                                                              |  |                                  |          |         |   |         | 
|------------------------------------------------------------- |  | -------------------------------- | -------- | ------- | - | ------- | 
|                                                              |  | For the Years Ended December 31, |         
|                                                              |  | 2006                             |          | 2005    |  
|Gross gains on sales of securities                            |  | $                                |         |         | $ |        | 
|Gross losses on sales of securities                           |  | (13,460)                         |          | (7,503) |  
|Net realized losses on sales of securities available for sale |  | $                                | (13,460) |         | $ | (7,503) | 



Note 4.

Loans and allowance for loan losses



The composition of loans is summarized as follows:



|                                    |  |              |             |             |   |             | 
|----------------------------------- |  | ------------ | ----------- | ----------- | - | ----------- | 
|                                    |  | December 31, |            
|                                    |  | 2006         |             | 2005        |  
|Commercial and financial            |  | $            | 13,053,338  |             | $ | 11,458,036  | 
|Agricultural                        |  | 54,583       |             | 58,000      |  
|Real estate  construction          |  | 138,041,293  |             | 95,457,276  |  
|Real estate  mortgage, farmland    |  | 13,894       |             | 18,000      |  
|Real estate  mortgage, commercial  |  | 64,334,282   |             | 65,998,249  |  
|Real estate  mortgage, residential |  | 72,000,668   |             | 63,648,185  |  
|Consumer installment loans          |  | 3,339,088    |             | 4,386,022   |  
|Other                               |  | 982,800      |             | 1,345,002   |  
|Gross loans                         |  | 291,819,946  |             | 242,368,770 |  
|Less: Allowance for loan losses     |  | 3,474,640    |             | 2,862,992   |  
|Net loans                           |  | $            | 288,345,306 |             | $ | 239,505,778 | 



The Banks grant loans and extensions of credit to individuals and a variety of businesses and corporations located in its general trade areas Beaufort, Beaufort County, South Carolina and adjoining counties, and Nassau County, Florida. Although the Banks have diversified loan portfolios, a substantial portion of the loan portfolios are collateralized by improved and unimproved real estate and are dependent upon the real estate market.



46





---



The following is a summary of information pertaining to impaired loans:



|                                              |  |                                  |   |         |   |   | 
|--------------------------------------------- |  | -------------------------------- | - | ------- | - | - | 
|                                              |  | For the Years Ended December 31, |  
|                                              |  | 2006                             |   | 2005    |  
|Impaired loans without a valuation allowance  |  | $                                |  |         | $ |  | 
|Impaired loans with a valuation allowance     |  | 85,519                           |   | 130,189 |  
|Total impaired loans                          |  | 85,519                           |   | 130,189 |  
|Valuation allowance related to impaired loans |  | 18,144                           |   | 65,095  |  
|Average investment in impaired loans          |  | 77,000                           |   | 199,750 |  
|Interest income recognized on impaired loans  |  | 42,626                           |   | 5,464   |  
|Forgone interest income on impaired loans     |  | 13,436                           |   | 24,545  |  



Loans on nonaccrual status amounted to $85,519 and $130,189 at December 31, 2006 and 2005, respectively.  There were $10,000 of loans past due ninety days or more and still accruing interest at December 31, 2006.  There were no loans past due ninety days or more and still accruing interest at December 31, 2005.



An analysis of the activity in the allowance for loan losses is presented below:



|                                           |  |                                  |           |           |   |           |  | 
|------------------------------------------ |  | -------------------------------- | --------- | --------- | - | --------- |  | 
|                                           |  | For the Years Ended December 31, |          
|                                           |  | 2006                             |           | 2005      |  
|Balance, beginning of year                 |  | $                                | 2,862,992 |           | $ | 1,136,911 | 
|Provision for loan losses                  |  | 726,700                          |           | 380,000   |  
|Loans charged off                          |  | (122,334)                        |           | (55,990)  |  
|Recoveries of loans previously charged off |  | 7,282                            |           | 6,304     |  
|Acquired loan loss reserve                 |  |                                 |           | 1,395,767 |  
|Balance, end of year                       |  | $                                | 3,474,640 |           | $ | 2,862,992 | 



In the ordinary course of business, the Company has granted loans to certain directors, executive officers and their affiliates. The interest rates on these loans were substantially the same as rates prevailing at the time of the transaction and repayment terms are customary for the type of loan.  Changes in related-party loans are summarized as follows:



|                                               |  |                                  |           |             |   |           |  | 
|---------------------------------------------- |  | -------------------------------- | --------- | ----------- | - | --------- |  | 
|                                               |  | For the Years Ended December 31, |           |            
|                                               |  | 2006                             |           | 2005        |   |          
|Balance, beginning of year                     |  | $                                | 5,110,092 |             | $ | 3,083,245 |  | 
|Advances                                       |  | 3,896,065                        |           | 1,924,405   |   |          
|Repayments                                     |  | (3,232,550)                      |           | (1,247,415) |   |          
|Transactions due to changes in related parties |  | (823,358)                        |           | 1,349,857   |   |          
|Balance, end of year                           |  | $                                | 4,950,249 |             | $ | 5,110,092 |  | 



Note 5.

Premises and Equipment



Premises and equipment are summarized as follows:



|                                                               |  |              |           |             |   |           | 
|-------------------------------------------------------------- |  | ------------ | --------- | ----------- | - | --------- | 
|                                                               |  | December 31, |          
|                                                               |  | 2006         |           | 2005        |  
|Land                                                           |  | $            | 3,288,989 |             | $ | 3,929,669 | 
|Building                                                       |  | 2,854,900    |           | 2,509,216   |  
|Furniture and equipment                                        |  | 2,264,021    |           | 1,661,102   |  
|Construction in progress, estimated cost to complete,
$753,000 |  | 1,054,355    |           | 84,141      |  
|                                                               |  | 9,462,265    |           | 8,184,128   |  
|Less accumulated depreciation                                  |  | (2,078,670)  |           | (1,563,476) |  
|                                                               |  | $            | 7,383,595 |             | $ | 6,620,652 | 





47





---



Lowcountry National Bank has entered into a non-cancelable operating lease related to land and buildings at its Bluffton branch, which expires in 2008. This lease was modified in 2005 to include additional space to provide for growth. In 2005, Lowcountry National Bank entered into a short-term lease with a director of the Company and a director of the Bank on property located in Port Royal, South Carolina. The lease began January 2006 with an initial term of nine months at a rate of $1,500 per month. The bank will continue to lease the building in Port Royal until the new branch building in Port Royal is completed in March 2007.  Lowcountry National Bank will also occupy leased space in the upstairs offices above the new branch building. The lease is for a term of five years that will expire in 2012 with options to renew for subsequent five year periods.



In 2005, First National entered into a three-year lease for rental space for a loan production office in Savannah, Georgia. First National also has an operating lease for rental space for a loan production office in Jacksonville, Florida.  This lease is cancelable at any time with four months notice.



At December 31, 2006, future minimum lease payments under the non-cancelable operating leases with initial or remaining terms of one year or more are as follows:



|     |  |         |         | 
|---- |  | ------- | ------- | 
|2007 |  | $       | 155,455 | 
|2008 |  | 126,699 |        
|2009 |  | 88,560  |        
|2010 |  | 63,876  |        
|2011 |  | 63,876  |        
|2012 |  | 10,646  |        
|     |  | $       | 509,112 | 



Total rental expense amounted to $125,764 and $46,434 for the years ended December 31, 2006 and 2005, respectively, under these operating leases.



Note 6.

Intangible Assets



Following is a summary of information related to acquired intangible assets:



|                         |  |              |           |      |   |           |  | 
|------------------------ |  | ------------ | --------- | ---- | - | --------- |  | 
|                         |  | December 31, |          
|                         |  | 2006         |           | 2005 |  
|Core deposit premiums    |  |              |           |      |   |          
|Gross carrying amount    |  | $            | 1,212,435 |      | $ | 1,212,435 | 
|Accumulated amortization |  | $            | 472,362   |      | $ | 99,237    | 



The aggregate amortization expense for intangible assets was $373,000 and $99,000 for the years ended December 31, 2006 and 2005, respectively.



The estimated amortization expense for each of the next five years is as follows:



|               |  |                       |         |  |  | 
|-------------- |  | --------------------- | ------- |  |  | 
|2007           |  | $                     | 280,929 | 
|2008           |  | 198,503               |        
|2009           |  | 124,160               |        
|2010           |  | 74,026                |        
|2011 and later |  | 62,455                |        
|               |  | $             740,073 |        



Changes in the carrying amount of goodwill are as follows:



|                                                                      |  |                                  |            |      |           |           | 
|--------------------------------------------------------------------- |  | -------------------------------- | ---------- | ---- | --------- | --------- | 
|                                                                      |  | For the years ended December 31, |           
|                                                                      |  | 2006                             |            | 2005 |          
|Beginning balance                                                     |  | $                                | 9,722,772  |      | $         |          | 
|Adjustment of previously acquired goodwill based on final
allocations |  |                                  | (490,568)  |      |          |          
|Goodwill acquired through purchase of subsidiary Bank                 |  |                                  | 983,403    |      | 9,722,772 |          
|Ending balance                                                        |  | $                                | 10,215,607 |      | $         | 9,722,772 | 



48





---



Note 7.

Deposits



The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2006 and 2005 was $119,006,645 and $91,330,380, respectively.  The scheduled maturities of time deposits at December 31, 2006 are as follows:



|     |  |            |             |  | 
|---- |  | ---------- | ----------- |  | 
|2007 |  | $          | 159,989,261 | 
|2008 |  | 23,589,858 |            
|2009 |  | 4,263,660  |            
|2010 |  | 4,862,281  |            
|2011 |  |            | 615,227     | 
|     |  | $          | 193,320,287 | 



At December 31, 2006 and 2005, overdraft demand deposits reclassified to loans totaled $34,164 and $66,708, respectively.



Note 8.

Securities Sold Under Repurchase Agreements



Securities sold under repurchase agreements, which are secured borrowings, generally mature within thirty to sixty days from the transaction date.  Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transactions.  The Company may be required to provide additional collateral based on the fair value of the underlying securities.  The Company monitors the fair value of the underlying securities on a daily basis.  Securities sold under repurchase agreements at December 31, 2006 were $2,000,000. There were no securities sold under repurchase agreements at December 31, 2005.



Note 9.

Employee Benefit Plans



The Company sponsors the Lowcountry National Bank Retirement Savings Plan and the First National Bank Savings Plan (collectively the Plans) for the benefit of all eligible employees. All full-time and part-time employees are eligible to participate in these Plans provided they have met the eligibility requirements.  Contributions may begin after 30 days of employment. Part-time employees must work a minimum of 1,000 hours per year to be eligible. The Plans allow a participant to defer a portion of his compensation and provides that the Company will match a portion of the deferred compensation. Company matched contributions are vested over a five year period. The Company contributes to the Plans annually upon approval by the Board of Directors. Contributions made to the Plans in 2006 and 2005 amounted to $99,342 and $47,753, respectively.



Note 10.

Deferred Compensation Plans



The Company adopted a Director and Executive Officer Deferred Compensation Plan in 2004 that allows directors and executive officers to defer compensation. Interest accrues quarterly on deferred amounts at a rate, which is equal to 75% of the previous quarters return on equity, not to exceed 12%.  Accrued deferred compensation of $47,937 and $28,390 at December 31, 2006 and 2005, respectively, is included in other liabilities.



Note 11.

Other Borrowings



Other borrowings consist of the following FHLB advances.



|                                     |  |                                             |            |         |      |               |   |                 |                |                  |  |  |  |  |  | 
|------------------------------------ |  | ------------------------------------------- | ---------- | ------- | ---- | ------------- | - | --------------- | -------------- | ---------------- |  |  |  |  |  | 
|                                     |  | FHLB Advances Outstanding
December 31, 2006 |           
|Type advance                         |  |                                             |            | Balance |      | Interest rate |   | Maturity date   |                | Convertible date | 
|Fixed rate                           |  | $                                           | 5,000,000  |         |      | 5.36          | % |                 | March 22, 2007 |                  |  | 
|Fixed rate                           |  | 5,000,000                                   |            |         | 5.65 | %             |   | June 1, 2011    |                |                  | 
|Convertible fixed rate advance       |  | 5,000,000                                   |            |         | 4.01 | %             |   | August 16, 2010 |                | August 16, 2007  | 
|Convertible fixed rate advance       |  | 10,000,000                                  |            |         | 4.25 | %             |   | May 21, 2014    |                | May 21, 2009     | 
|Convertible fixed rate advance       |  | 5,000,000                                   |            |         | 3.71 | %             |   | June 24, 2015   |                | June 24, 2010    | 
|Less purchase accounting adjustments |  | (26,949)                                    |            |         |      |               |   |                 |                |                  | 
|Total                                |  | $                                           | 29,973,051 |         |      | 4.54          | % |                 |                |                  |  | 





49





---



|                                     |  |                                             |            |         |      |               |   |                 |                  |                  |  |  |  |  |  | 
|------------------------------------ |  | ------------------------------------------- | ---------- | ------- | ---- | ------------- | - | --------------- | ---------------- | ---------------- |  |  |  |  |  | 
|                                     |  | FHLB Advances Outstanding
December 31, 2005 |           
|Type advance                         |  |                                             |            | Balance |      | Interest rate |   | Maturity date   |                  | Convertible date | 
|Fixed rate                           |  | $                                           | 2,000,000  |         |      | 4.55          | % |                 | October 26, 2006 |                  |  | 
|Fixed rate                           |  | 1,000,000                                   |            |         | 2.93 | %             |   | April 3, 2006   |                  |                  | 
|Convertible fixed rate advance       |  | 10,000,000                                  |            |         | 4.25 | %             |   | May 21, 2014    |                  | May 21, 2009     | 
|Convertible fixed rate advance       |  | 5,000,000                                   |            |         | 3.71 | %             |   | June 24, 2015   |                  | June 24, 2010    | 
|Convertible fixed rate advance       |  | 5,000,000                                   |            |         | 4.01 | %             |   | August 16, 2010 |                  | August 16, 2007  | 
|Less purchase accounting adjustments |  | (37,066)                                    |            |         |      |               |   |                 |                  |                  | 
|Total                                |  | $                                           | 22,962,934 |         |      | 4.05          | % |                 |                  |                  |  | 



At December 31, 2006, the Banks had $16,600,000 of availability on lines of credit to purchase federal funds from unrelated banks. These lines of credit are available on a one to seven day basis for general corporate purposes of the Banks. All of the lenders have reserved the right to withdraw these lines at their option.



Note 12.

Income Taxes



The components of income tax expense (benefit) are as follows:



|                     |  |                                  |           |           |   |         | 
|-------------------- |  | -------------------------------- | --------- | --------- | - | ------- | 
|                     |  | For the Years Ended December 31, |          
|                     |  | 2006                             |           | 2005      |  
|Currently payable    |  | $                                | 2,181,294 |           | $ | 903,665 | 
|Deferred tax benefit |  | (534,262)                        |           | (107,605) |  
|                     |  | $                                | 1,647,032 |           | $ | 796,060 | 



The Companys income tax expense differs from the amounts computed by applying the federal income tax statutory rates to income before income taxes.  A reconciliation of the differences is as follows:



|                                           |  |                                  |           |          |   |         |  | 
|------------------------------------------ |  | -------------------------------- | --------- | -------- | - | ------- |  | 
|                                           |  | For the Years Ended December 31, |           |         
|                                           |  | 2006                             |           | 2005     |   |        
|Tax at federal income tax rate             |  | $                                | 1,702,200 |          | $ | 783,800 |  | 
|Increase (decrease) resulting from:        |  |                                  |           |          |   |        
|State income taxes, net of federal benefit |  | 134,180                          |           | 58,200   |   |        
|Tax exempt interest                        |  | (203,142)                        |           | (94,300) |   |        
|Other                                      |  | 13,794                           |           | 48,360   |   |        
|Provision for income taxes                 |  | $                                | 1,647,032 |          | $ | 796,060 |  | 



Net deferred tax assets are included in other assets.  The components of deferred income taxes are as follows:



|                                                 |  |              |           |           |   |           |  | 
|------------------------------------------------ |  | ------------ | --------- | --------- | - | --------- |  | 
|                                                 |  | December 31, |           |          
|                                                 |  | 2006         |           | 2005      |   |          
|Deferred income tax assets:                      |  |              |           |           |   |          
|Loan loss reserves                               |  | $            | 1,121,742 |           | $ | 983,940   |  | 
|Deferred compensation                            |  | 16,299       |           | 208,687   |   |          
|Unrealized loss on securities available for sale |  | 180,557      |           | 267,506   |   |          
|Other                                            |  | 428,087      |           | 132,935   |   |          
|Total deferred tax assets                        |  | 1,746,685    |           | 1,593,068 |   |          
|                                                 |  |              |           |           |   |          
|Deferred income tax liabilities:                 |  |              |           |           |   |          
|Depreciation and amortization                    |  | 208,412      |           | 191,985   |   |          
|Intangible assets                                |  | 419,367      |           | 832,457   |   |          
|Other                                            |  | 142,639      |           | 39,672    |   |          
|Total deferred tax liabilities                   |  | $            | 770,418   |           | $ | 1,064,114 |  | 
|                                                 |  |              |           |           |   |           | 
|Net deferred tax asset                           |  | $            | 976,267   |           | $ | 528,954   |  | 





50





---



Note 13.

Junior Subordinated Debentures



In May 2004, Coastal Banking Company Statutory Trust I (the Trust) (a non-consolidated subsidiary) issued $3,000,000 of floating rate trust preferred securities with a maturity of May 18, 2034. In accordance with FIN No. 46(R), the trust has not been consolidated in these financial statements. The Company received from the Trust the $3,000,000 million proceeds from the issuance of securities and the $93,000 initial proceeds from the capital investment in the Trust, and accordingly has shown the funds due to the Trust as $3,093,000 junior subordinated debentures.



All of the common securities of the Trust are owned by the Company. The proceeds from the issuance of the trust preferred securities were used by the Trust to purchase $3,093,000 of junior subordinated debentures of the Company, which carry a floating rate equal to the 3-month LIBOR plus 2.75%. At December 31, 2006, this rate was 8.12%. The proceeds received by the Company from the sale of the junior subordinated debentures were used to strengthen the capital position of Lowcountry National Bank and to accommodate current and future growth. The current regulatory rules allow certain amounts of junior subordinated debentures to be included in the calculation of regulatory capital, and have been included in the Tier I calculation accordingly. The debentures and related accrued interest represent the sole assets of the Trust.



The trust preferred securities accrue and pay distributions quarterly, equal to 3-month LIBOR plus 2.75% per annum of the stated liquidation value of $1,000 per capital security. The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (i) accrued and unpaid distributions required to be paid on the trust preferred securities; (ii) the redemption price with respect to any trust preferred securities called for redemption by the Trust, and (iii) payments due upon a voluntary or involuntary dissolution, winding up, or liquidation of the Trust.



The trust preferred securities must be redeemed upon maturity of the debentures on May 18, 2034, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by the Trust in whole or in part, on or after May 18, 2009. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the unpaid principal amount, plus any accrued unpaid interest.



In June 2006, Coastal Banking Company Statutory Trust II (the Trust) (a non-consolidated subsidiary) issued $4,000,000 of fixed rate trust preferred securities with a maturity of September 30, 2036. In accordance with FIN No. 46(R), the trust has not been consolidated in these financial statements. The Company received from the Trust the $4,000,000 million proceeds from the issuance of securities and the $124,000 initial proceeds from the capital investment in the Trust, and accordingly has shown the funds due to the Trust as $4,124,000 junior subordinated debentures.



All of the common securities of the Trust are owned by the Company. The proceeds from the issuance of the trust preferred securities were used by the Trust to purchase $4,124,000 of junior subordinated debentures of the Company, which carry a fixed rate of 7.18% until September 30, 2011 and a floating rate equal to the 3-month LIBOR plus 1.60%, adjusted quarterly thereafter. The proceeds received by the Company from the sale of the junior subordinated debentures were used to strengthen the capital position of the Banks and to accommodate current and future growth. The current regulatory rules allow certain amounts of junior subordinated debentures to be included in the calculation of regulatory capital, and have been included in the Tier I calculation accordingly. The debentures and related accrued interest represent the sole assets of the Trust.



The trust preferred securities accrue and pay distributions quarterly at a rate of 7.18% per annum of the stated liquidation value of $1,000 per capital security. The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (i) accrued and unpaid distributions required to be paid on the trust preferred securities; (ii) the redemption price with respect to any trust preferred securities called for redemption by the Trust, and (iii) payments due upon a voluntary or involuntary dissolution, winding up, or liquidation of the Trust.



The trust preferred securities must be redeemed upon maturity of the debentures on September 30, 2036, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by the Trust in whole or in part, on or after September 30, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the unpaid principal amount, plus any accrued unpaid interest.



51





---



Note 14.

Stock Option Plans



In connection with the Companys initial public stock offering, the directors received warrants to purchase 212,100 shares of the Companys common stock at a price of $9.07 per share of which 199,556 shares are still outstanding. The warrants vested equally over a three-year period beginning December 2, 1999 and expire on December 2, 2009 or 120 days after the warrant holder ceased to serve as a member of the board of directors. As of December 31, 2006, all of the warrants are exercisable.



The Company adopted a Stock Incentive Plan in 2000 which currently covers 360,389 shares of the Companys common stock.  The Plan provides that the total number of shares will equal 15% of total outstanding shares.  The Plan is administered by a committee of the Board of Directors and provides for the granting of options to purchase shares of common stock to officers, directors, employees or consultants of the Company and Banks. The exercise price of each option granted under the Plan will not be less than the fair market value of the shares of common stock subject to the option on the date of grant as determined by the Board of Directors. Options are exercisable in whole or in part upon such terms as may be determined by the committee, and are exercisable no later than ten years after the date of grant. Options granted under the Plan generally vest over a five year vesting period. As of December 31, 2006, 117,169 shares were available for grant under this plan.



The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for grants in 2006 and 2005. Expected volatilities are based on historical volatility of the Companys stock. The company has not and does not expect to pay a dividend in the near future. Historical data is used to estimate option exercises and employee terminations within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.



|                                                                          |  |                                  |      |         |   |      | 
|------------------------------------------------------------------------- |  | -------------------------------- | ---- | ------- | - | ---- | 
|                                                                          |  | For the Years Ended December 31, |     
|                                                                          |  | 2006                             |      | 2005    |  
|Weighted average grant date fair value of options granted during the year |  | $                                | 7.90 |         | $ | 5.29 | 
|Assumptions used to estimate fair value:                                  |  |                                  |      |         |  
|Risk-free interest rate                                                   |  | 4.875                            | %    | 4.500   | %
|Dividend yield                                                            |  | 0                                | %    | 0       | %
|Expected volatility                                                       |  | 19                               | %    | 15      | %
|Expected life                                                             |  | 7 years                          |      | 7 years |  



Information pertaining to performance-based options outstanding at December 31, 2006 is as follows:



|                          |  |                                      |  |                                 |                          |                    |         |                                 |   |       |                         |  |                                 |  |   |       | 
|------------------------- |  | ------------------------------------ |  | ------------------------------- | ------------------------ | ------------------ | ------- | ------------------------------- | - | ----- | ----------------------- |  | ------------------------------- |  | - | ----- | 
|Options Outstanding       |  | Options Fully Vested and Exercisable |  |                                 | Options Expected to Vest |                   
|Option
Shares
Outstanding |  | Average
Remaining
Life
(In Years)    |  | Weighted
Average
Exercise
Price |                          | Number
Exercisable |         | Weighted
Average
Exercise
Price |   |       | Number
Expected
to Vest |  | Weighted
Average
Exercise
Price | 
|45,907                    |  | 2.8                                  |  | $                               | 9.04                     |                    | 45,907  |                                 | $ | 9.04  |                         |  |                                |  | $ |      | 
|63,300                    |  | 3.4                                  |  |                                 | 9.07                     |                    | 63,300  |                                 |   | 9.07  |                         |  |                                |  |   |      | 
|9,410                     |  | 4.4                                  |  |                                 | 9.49                     |                    | 9,410   |                                 |   | 9.49  |                         |  |                                |  |   |      | 
|11,025                    |  | 5.0                                  |  |                                 | 9.07                     |                    | 11,025  |                                 |   | 9.07  |                         |  |                                |  |   |      | 
|9,296                     |  | 5.4                                  |  |                                 | 11.29                    |                    | 7,436   |                                 |   | 11.29 |                         |  | 1,860                           |  |   | 11.29 | 
|14,300                    |  | 6.1                                  |  |                                 | 8.25                     |                    | 14,300  |                                 |   | 8.25  |                         |  |                                |  |   |      | 
|4,426                     |  | 6.2                                  |  |                                 | 12.42                    |                    | 2,656   |                                 |   | 12.42 |                         |  | 1,770                           |  |   | 12.42 | 
|11,025                    |  | 6.4                                  |  |                                 | 11.18                    |                    | 11,025  |                                 |   | 11.18 |                         |  |                                |  |   |      | 
|10,500                    |  | 7.5                                  |  |                                 | 15.71                    |                    | 10,500  |                                 |   | 15.71 |                         |  |                                |  |   |      | 
|2,625                     |  | 8.2                                  |  |                                 | 15.95                    |                    | 2,625   |                                 |   | 15.95 |                         |  |                                |  |   |      | 
|1,575                     |  | 8.6                                  |  |                                 | 18.81                    |                    | 1,575   |                                 |   | 18.81 |                         |  |                                |  |   |      | 
|6,000                     |  | 9.6                                  |  |                                 | 20.80                    |                    |        |                                 |   |      |                         |  | 6,000                           |  |   | 20.80 | 
|20,500                    |  | 9.9                                  |  |                                 | 23.01                    |                    |        |                                 |   |      |                         |  | 20,500                          |  |   | 23.01 | 
|209,889                   |  | 5.0                                  |  | $                               | 11.49                    |                    | 179,759 |                                 | $ | 9.86  |                         |  | 30,130                          |  | $ | 21.22 | 
|                          |  |                                      |  |                                 |                          |                    |         |                                 |   |       |                         |  |                                 |  |   |       | 





52





---



A summary status of the Companys stock option plan as of December 31, 2006 and changes during the year is presented below:



|                                |  |          |  |                                 |       |                                                     |  |                           |     |  |           |   |           |  |  | 
|------------------------------- |  | -------- |  | ------------------------------- | ----- | --------------------------------------------------- |  | ------------------------- | --- |  | --------- | - | --------- |  |  | 
|                                |  | Shares   |  | Weighted
Average
Exercise
Price |       | Weighted
Average
Remaining
Contractual
Term (years) |  | Aggregate
Intrinsic
Value |     | 
|Outstanding, beginning of year  |  | 219,593  |  |                                 | $     | 9.87                                                |  |                           | 5.2 |  |           | $ | 2,231,192 |  |  | 
|Granted during the year         |  | 27,500   |  |                                 | 22.45 |                                                     |  |                           |     |  |           |   |           | 
|Exercised during the year       |  | (33,331) |  |                                 | 9.53  |                                                     |  |                           |     |  |           |   |           | 
|Cancelled during the year       |  | (3,873)  |  |                                 | 14.23 |                                                     |  |                           |     |  |           |   |           | 
|Outstanding, end of year        |  | 209,889  |  |                                 | 11.49 |                                                     |  | 5.0                       |     |  | 2,553,434 |   |           | 
|Options exercisable at year end |  | 179,759  |  |                                 | 9.86  |                                                     |  | 4.3                       |     |  | 2,480,046 |   |           | 



The weighted-average grant-date fair value of options granted during the years 2006 and 2005 was $7.90 and $5.29, respectively.  The total intrinsic value of options exercised during the year ended December 31, 2006 was $470,813.  There were no stock options exercised during the year ended December 31, 2005.

The following table summarizes activity with regard to non-vested stock options since December 31, 2005:



|                                 |  |                  |        |                                        |      |      | 
|-------------------------------- |  | ---------------- | ------ | -------------------------------------- | ---- | ---- | 
|Nonvested Stock Options          |  | Number of Shares |        | Weighted Average Grant Date Fair Value |     
|Outstanding at December 31, 2005 |  |                  | 11,908 |                                        | $    | 4.38 | 
|Granted during the year          |  | 27,500           |        | 7.90                                   |     
|Vested during the year           |  | (6,509)          |        | 4.16                                   |     
|Cancelled during the year        |  | (2,769)          |        | 5.65                                   |     
|Outstanding at December 31, 2006 |  | 30,130           |        | $                                      | 7.52 |     



It is Coastals policy to issue new shares for stock option exercises and restricted stock rather than issue treasury shares. Coastal recognizes stock-based compensation expense on a straight-line basis over the options related vesting term. As of December 31, 2006, there was $226,677 of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the Plan.  That cost is expected to be recognized over a weighted-average period of 4.7 years.  The total fair value of shares vested during the years ended December 31, 2006 and 2005 was $27,071 and $172,121, respectively.



On October 1, 2005, the Company acquired First Capital Bank Holding Corporation, the holding company for First National Bank of Nassau County, Florida.  First Capital had a Phantom Stock Appreciation Rights (PSARs) plan.  As a result of the merger, the Company acquired a PSARs plan in which the participants were fully vested as a result of the merger.  The PSARs Plan authorized 30,434 rights to be granted to certain officers and key employees at the discretion of the Board of Directors of First Capital.  The Company does not plan to grant additional PSARs.  Prior to the adoption of SFAS No. 123R, the Company accounted for phantom stock appreciation rights (PSARs) according to FASB Interpretation No. 28 (FIN 28).  Under FIN 28, the intrinsic value of the PSARs was reflected as a liability in the balance sheet.  The liability was adjusted every quarter based on the intrinsic value as of the reporting date. Upon adoption of SFAS No. 123R, the Company accounts for PSARs using liability accounting.  This method requires the Company to record the liability for PSARs at fair value, rather than intrinsic value, in the balance sheet.  The Company uses the Black-Scholes model to determine the fair value of PSARs.  The expense related to the PSARs plan was approximately $97,000 and $21,000 for the years ended December 31, 2006 and 2005, respectively.  The total amount in accrued expenses was approximately $223,000 and $126,000 at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, there were 30,434 PSARS outstanding with a weighted-average exercise price of $15.95.  The PSARs outstanding are currently exercisable and have an intrinsic value of $235,000 and $126,000 at December 31, 2006 and 2005, respectively.



All share numbers and prices are restated for the effects of a 5% stock dividend paid to shareholders of record on December 1, 2005.



53





---



Note 15.

Commitments and Contingent Liabilities



Loan Commitments



The Banks are parties to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and loans sold with limited recourse. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. The contractual amounts of those instruments reflect the extent of involvement the Banks have in particular classes of financial instruments.



Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customers creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on managements credit evaluation of the counterparty. The Banks loans are primarily collateralized by residential and other real properties, automobiles, savings deposits, accounts receivable, inventory and equipment.



Standby letters of credit are written conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. Most letters of credit extend for less than one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.



Loans sold with limited recourse are 1-4 family residential mortgages originated by the Banks and sold to various other financial institutions. These loans are sold with the agreement that a loan may be returned to the Bank within 90 days of any one of the loans first four payments being missed. The Banks exposure to credit loss in the event of non-performance by the other party to the loan is represented by the contractual notional amount of the loan. The Banks use the same credit policies in making loans held for sale as it does for on-balance-sheet instruments.



The Banks exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and loans sold with limited recourse is represented by the contractual amount of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. In most cases, the Banks require collateral to support financial instruments with credit risk.



|                                 |  |              |            |      |   |            | 
|-------------------------------- |  | ------------ | ---------- | ---- | - | ---------- | 
|                                 |  | December 31, |           
|                                 |  | 2006         |            | 2005 |  
|Commitments to extend credit     |  | $            | 64,381,000 |      | $ | 70,577,000 | 
|Standby letters of credit        |  | $            | 800,000    |      | $ | 1,068,000  | 
|Loans sold with limited recourse |  | $            | 21,796,000 |      | $ | 26,072,000 | 



Contingencies



The Company has, from time to time, various lawsuits and claims arising from the conduct of its business. Such items are not expected to have any material adverse effect on the financial position or results of operations of the Company.



Note 16.

Concentrations of Credit



The Banks make commercial, residential, construction, agricultural, agribusiness and consumer loans to customers South Carolina, Florida, and Georgia. A substantial portion of the Company's customers' abilities to honor their contracts is dependent on the business economy in the geographical area served by the Banks.



A substantial portion of the Company's loans are secured by real estate in the Company's primary market area. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio is susceptible to changes in real estate conditions in the Company's primary market area.



54





---



Note 17.

Regulatory Matters



The Company and the Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under certain adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices must be met. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.



Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 Capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 Capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006, that the Company and the Banks meet all capital adequacy requirements to which they are subject.



As of December 31, 2006, the most recent notification from the Federal Deposit Insurance Corporation categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Banks must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Banks category. Prompt corrective action provisions are not applicable to bank holding companies.



The actual capital amounts and ratios are also presented in the table below.



|                                       |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |           |            |  |       |   |  |  |  |  |  | 
|-------------------------------------- |  | ------ | ---------- | ----------------------------- | ----- | ---------------------------------------------------------------- | - | ---------- |  | ------ | ---- | ----- |  | --------- | ---------- |  | ----- | - |  |  |  |  |  | 
|                                       |  | Actual |            | For Capital
Adequacy Purposes |       | To Be Well
Capitalized Under
Prompt Corrective
Action Provisions |   |           
|                                       |  | Amount |            | Ratio                         |       | Amount                                                           |   | Ratio      |  | Amount |      | Ratio |  |          
|As of December 31, 2006:               |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |          
|Total Capital to Risk Weighted Assets  |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |          
|Consolidated                           |  | $      | 43,471,376 |                               | 13.06 | %                                                                | $ | 26,632,240 |  |        | 8.00 | %     |  | ---N/A--- |            | 
|Lowcountry National Bank               |  | $      | 18,066,910 |                               | 11.88 | %                                                                | $ | 12,167,040 |  |        | 8.00 | %     |  | $         | 15,208,800 |  | 10.00 | % | 
|First National Bank of Nassau County   |  | $      | 21,876,690 |                               | 12.19 | %                                                                | $ | 14,355,200 |  |        | 8.00 | %     |  | $         | 17,944,000 |  | 10.00 | % | 
|Tier I Capital to Risk Weighted Assets |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |          
|Consolidated                           |  | $      | 39,783,299 |                               | 11.95 | %                                                                | $ | 13,316,120 |  |        | 4.00 | %     |  | ---N/A--- |            | 
|Lowcountry National Bank               |  | $      | 16,412,642 |                               | 10.79 | %                                                                | $ | 6,083,520  |  |        | 4.00 | %     |  | $         | 9,125,280  |  | 6.00  | % | 
|First National Bank of Nassau County   |  | $      | 19,842,881 |                               | 11.06 | %                                                                | $ | 7,177,600  |  |        | 4.00 | %     |  | $         | 10,766,400 |  | 6.00  | % | 
|Tier I Capital to Average Assets       |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |          
|Consolidated                           |  | $      | 39,783,299 |                               | 10.44 | %                                                                | $ | 15,237,280 |  |        | 4.00 | %     |  | ---N/A--- |            | 
|Lowcountry National Bank               |  | $      | 16,412,642 |                               | 8.66  | %                                                                | $ | 7,584,200  |  |        | 4.00 | %     |  | $         | 9,480,250  |  | 5.00  | % | 
|First National Bank of Nassau County   |  | $      | 19,842,881 |                               | 9.23  | %                                                                | $ | 8,597,160  |  |        | 4.00 | %     |  | $         | 10,746,450 |  | 5.00  | % | 





55





---



|                                       |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |           |            |  |       |   |  |  |  |  |  | 
|-------------------------------------- |  | ------ | ---------- | ----------------------------- | ----- | ---------------------------------------------------------------- | - | ---------- |  | ------ | ---- | ----- |  | --------- | ---------- |  | ----- | - |  |  |  |  |  | 
|                                       |  | Actual |            | For Capital
Adequacy Purposes |       | To Be Well
Capitalized Under
Prompt Corrective
Action Provisions |   |           
|                                       |  | Amount |            | Ratio                         |       | Amount                                                           |   | Ratio      |  | Amount |      | Ratio |  |          
|As of December 31, 2005:               |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |          
|Total Capital to Risk Weighted Assets  |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |          
|Consolidated                           |  | $      | 35,081,827 |                               | 12.55 | %                                                                | $ | 22,365,966 |  |        | 8.00 | %     |  | ---N/A--- |            | 
|Lowcountry National Bank               |  | $      | 14,719,430 |                               | 11.01 | %                                                                | $ | 10,695,360 |  |        | 8.00 | %     |  | $         | 13,369,200 |  | 10.00 | % | 
|First National Bank of Nassau County   |  | $      | 17,079,133 |                               | 11.74 | %                                                                | $ | 11,638,080 |  |        | 8.00 | %     |  | $         | 14,547,600 |  | 10.00 | % | 
|Tier I Capital to Risk Weighted Assets |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |          
|Consolidated                           |  | $      | 32,074,602 |                               | 10.93 | %                                                                | $ | 11,182,983 |  |        | 4.00 | %     |  | ---N/A--- |            | 
|Lowcountry National Bank               |  | $      | 13,616,205 |                               | 9.96  | %                                                                | $ | 5,347,680  |  |        | 4.00 | %     |  | $         | 8,021,520  |  | 6.00  | % | 
|First National Bank of Nassau County   |  | $      | 15,475,133 |                               | 10.64 | %                                                                | $ | 5,819,040  |  |        | 4.00 | %     |  | $         | 8,728,560  |  | 6.00  | % | 
|Tier I Capital to Average Assets       |  |        |            |                               |       |                                                                  |   |            |  |        |      |       |  |          
|Consolidated                           |  | $      | 32,074,602 |                               | 9.99  | %                                                                | $ | 12,839,007 |  |        | 4.00 | %     |  | ---N/A--- |            | 
|Lowcountry National Bank               |  | $      | 13,616,205 |                               | 8.26  | %                                                                | $ | 6,278,184  |  |        | 4.00 | %     |  | $         | 7,847,730  |  | 5.00  | % | 
|First National Bank of Nassau County   |  | $      | 15,475,133 |                               | 9.46  | %                                                                | $ | 6,544,560  |  |        | 4.00 | %     |  | $         | 8,180,700  |  | 5.00  | % | 



There are no current plans to initiate payment of cash dividends and future dividend policy will depend on the Banks and the Companys earnings, capital requirements, financial condition and other factors considered relevant by the Companys Board of Directors. The Banks are restricted in their ability to pay dividends under national banking laws and regulations of the OCC. Generally, these restrictions require the Banks to pay dividends derived solely from net profits. Moreover, the OCCs prior approval is required if dividends declared by either Bank in any calendar year exceed that Banks net profit for that year combined with its retained net profits for the preceding two years.



Note 18.

Fair Value of Financial Instruments



The fair value of a financial instrument is the current amount that would be exchanged between willing parties. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Companys various financial instruments. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered as representative of the liquidation value of the Banks, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Banks since purchase, origination, or issuance. This analysis has not undertaken any steps to value any intangibles, which is permitted by the provisions of SFAS No. 107.



SFAS No. 107,Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheets, for which it is practical to estimate that value. Certain items are specifically excluded from the disclosure requirements, including the Companys common stock, premises and equipment and other assets and liabilities.



56





---



The following methods and assumptions were used in this analysis in estimating the fair value of financial instruments:



§

Cash, due from banks, interest-bearing deposits in banks: The carrying amount of cash, due from banks and interest-bearing deposits in banks approximates fair value.



§

Securities:Fair value of securities is based on available quoted market prices. The carrying amount of equity securities with no readily determinable fair value approximates fair value.



§

Loans:The carrying amount of variable-rate loans that reprice frequently and have no significant change in credit risk approximates fair value. The fair value of fixed-rate loans is estimated based on discounted contractual cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable.



§

Deposits:The carrying amount of demand deposits, savings deposits and variable-rate certificates of deposits approximates fair value.  The fair value of fixed-rate certificates of deposit is estimated based on discounted contractual cash flows using interest rates currently being offered for certificates of similar maturities.



§

Federal funds Sold and Purchased, Repurchase Agreements and Other Borrowings:The carrying amount of variable rate borrowings, federal funds purchased and securities sold under repurchase agreements approximates fair value.  The fair value of fixed rate other borrowings is estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements.



§

Junior Subordinated Debentures:The fair value of the Companys fixed rate trust preferred securities is based on available quoted market prices.



§

Accrued Interest:The carrying amount of accrued interest approximates fair value.



§

Off-Balance-Sheet Instruments:The carrying amount of commitments to extend credit and standby letters of credit approximates fair value.  The carrying amount of the off-balance-sheet financial instruments is based on fees charged to enter into such agreements.



57





---



The carrying amount and estimated fair value of the Companys financial instruments are as follows:



|                                                              |  |                 |           |             |           |                 |   |             |  |           | 
|------------------------------------------------------------- |  | --------------- | --------- | ----------- | --------- | --------------- | - | ----------- |  | --------- | 
|                                                              |  | December 31,    |          
|                                                              |  | 2006            |           | 2005        |          
|                                                              |  | Carrying
Amount |           | Fair
Value  |           | Carrying
Amount |   | Fair
Value  | 
|Financial assets:                                             |  |                 |           |             |           |                 |   |             | 
|Cash, due from banks, and interest-
bearing deposits in banks |  | $               | 6,703,162 |             | 6,703,162 |                 | $ | 6,432,444   |  | 6,432,444 | 
|Federal funds sold                                            |  | 18,967,745      |           | 18,967,745  |           | 13,598,435      |   | 13,598,435  | 
|Securities available for sale                                 |  | 60,372,740      |           | 60,372,740  |           | 46,150,641      |   | 46,150,641  | 
|Securities held to maturity                                   |  | 16,998,209      |           | 16,858,174  |           | 18,220,867      |   | 17,886,459  | 
|Restricted equity securities                                  |  | 3,710,217       |           | 3,710,217   |           | 2,734,567       |   | 2,734,567   | 
|Loans held for sale                                           |  | 1,039,976       |           | 1,039,976   |           | 2,449,651       |   | 2,449,651   | 
|Loans, net                                                    |  | 288,345,306     |           | 288,580,074 |           | 239,505,778     |   | 238,372,045 | 
|Accrued interest receivable                                   |  | 2,422,575       |           | 2,422,575   |           | 1,630,448       |   | 1,630,448   | 
|                                                              |  |                 |           |             |           |                 |   |             | 
|Financial liabilities:                                        |  |                 |           |             |           |                 |   |             | 
|Deposits                                                      |  | 340,058,621     |           | 341,319,966 |           | 286,395,980     |   | 287,687,445 | 
|Securities sold under agreements
to repurchase                |  | 2,000,000       |           | 2,000,000   |           |                |   |            | 
|Other borrowings                                              |  | 29,973,051      |           | 28,377,165  |           | 22,962,931      |   | 22,748,580  | 
|Junior subordinated debentures                                |  | 7,217,000       |           | 7,282,039   |           | 3,093,000       |   | 3,093,000   | 
|Accrued interest payable                                      |  | 956,571         |           | 956,571     |           | 699,445         |   | 699,445     | 



Note 19.

Condensed Financial Information of Coastal Banking Company (Parent Company Only)



Condensed Balance Sheets



|                                                             |  |              |            |            |   |            |  |  | 
|------------------------------------------------------------ |  | ------------ | ---------- | ---------- | - | ---------- |  |  | 
|                                                             |  | December 31, |           
|                                                             |  | 2006         |            | 2005       |  
|Assets                                                       |  |              |            |            |  
|Cash and due from banks                                      |  | $            | 2,256,398  |            | $ | 2,859,874  | 
|Investment in Coastal Banking Company Statutory Trust I & II |  | 217,000      |            | 93,000     |  
|Investment in subsidiary banks                               |  | 46,860,710   |            | 39,124,904 |  
|Premises and equipment                                       |  |             |            | 414,904    |  
|Other assets                                                 |  | 1,170,358    |            | 137,135    |  
|Total assets                                                 |  | $            | 50,504,466 |            | $ | 42,629,817 | 
|                                                             |  |              |            |            |  
|Liabilities                                                  |  |              |            |            |  
|Junior subordinated debentures                               |  | $            | 7,217,000  |            | $ | 3,093,000  | 
|Other liabilities                                            |  | 115,980      |            | 221,649    |  
|Total liabilities                                            |  | 7,332,980    |            | 3,314,649  |  
|                                                             |  |              |            |            |  
|Shareholders Equity                                         |  |              |            |            |  
|Shareholders equity                                         |  | 43,171,486   |            | 39,315,168 |  
|Total liabilities and shareholders equity                   |  | $            | 50,504,466 |            | $ | 42,629,817 | 





58





---



Condensed Statements of Income



|                                                                                     |  |                                  |           |           |   |           | 
|------------------------------------------------------------------------------------ |  | -------------------------------- | --------- | --------- | - | --------- | 
|                                                                                     |  | For the years ended December 31, |          
|                                                                                     |  | 2006                             |           | 2005      |  
|Income                                                                               |  |                                  |           |           |   |          
|Interest income                                                                      |  | $                                | 126,107   |           | $ | 32,465    | 
|Gain on sale of real estate                                                          |  | 321,038                          |           |          |  
|Other income                                                                         |  | 175                              |           | 12        |  
|Total income                                                                         |  | 447,320                          |           | 32,477    |  
|                                                                                     |  |                                  |           |           |  
|Expenses                                                                             |  |                                  |           |           |  
|Interest expense                                                                     |  | 391,932                          |           | 192,680   |  
|Other operating expenses                                                             |  | 450,133                          |           | 109,478   |  
|Total expense                                                                        |  | 842,065                          |           | 302,158   |  
|                                                                                     |  |                                  |           |           |  
|Loss before income tax benefits and equity in undistributed
earnings of subsidiaries |  | (394,745)                        |           | (269,681) |  
|                                                                                     |  |                                  |           |           |  
|Income tax benefits                                                                  |  | 127,716                          |           | 91,700    |  
|                                                                                     |  |                                  |           |           |  
|Loss before equity in undistributed earnings of subsidiaries                         |  | (267,029)                        |           | (177,981) |  
|                                                                                     |  |                                  |           |           |  
|Equity in undistributed earnings of subsidiaries                                     |  | 3,626,566                        |           | 1,687,351 |  
|                                                                                     |  |                                  |           |           |  
|Net income                                                                           |  | $                                | 3,359,537 |           | $ | 1,509,370 | 





Condensed Statements of Cash Flows



|                                                                              |  |                                  |           |             |   |           | 
|----------------------------------------------------------------------------- |  | -------------------------------- | --------- | ----------- | - | --------- | 
|                                                                              |  | For the years ended December 31, |          
|                                                                              |  | 2006                             |           | 2005        |  
|Cash flows from operating activities:                                         |  |                                  |           |             |  
|Net income                                                                    |  | $                                | 3,359,537 |             | $ | 1,509,370 | 
|Adjustments to reconcile net income to net cash used by
operating activities: |  |                                  |           |             |  
|Equity in undistributed earnings of Bank                                      |  | (3,626,566)                      |           | (1,687,351) |  
|Amortization                                                                  |  | 4,500                            |           | 4,500       |  
|Stock-based compensation expense                                              |  | 27,071                           |           |            |  
|Gain on sale of real estate                                                   |  | (321,038)                        |           |            |  
|Change in other assets and liabilities                                        |  | (1,100,721)                      |           | (875,433)   |  
|Net cash used by operating activities                                         |  | (1,657,217)                      |           | (1,048,914) |  
|                                                                              |  |                                  |           |             |  
|Cash flows from investing activities:                                         |  |                                  |           |             |  
|Cash from acquisition of First Capital                                        |  |                                 |           | 2,703,452   |  
|Contribution of capital to subsidiary banks                                   |  | (4,000,000)                      |           |            |  
|Sale of investment security                                                   |  |                                 |           | 268,125     |  
|Investment in Coastal Banking Company Statutory Trust II                      |  | (124,000)                        |           |            |  
|Proceeds from sale of real estate                                             |  | 735,942                          |           |            |  
|Net cash provided (used) by investing activities                              |  | (3,388,058)                      |           | 2,971,577   |  
|                                                                              |  |                                  |           |             |  
|Cash flows from financing activities:                                         |  |                                  |           |             |  
|Proceeds from junior subordinated debt                                        |  | 4,124,000                        |           |            |  
|Proceeds from exercise of stock options                                       |  | 317,799                          |           |            |  
|Net cash provided by financing activities                                     |  | 4,441,799                        |           |            |  
|                                                                              |  |                                  |           |             |  
|Net change in cash and due from banks                                         |  | (603,476)                        |           | 1,922,663   |  
|Cash and due from banks at beginning of year                                  |  | 2,859,874                        |           | 937,211     |  
|Cash and due from banks at end of year                                        |  | $                                | 2,256,398 |             | $ | 2,859,874 | 



59





---



Item 8.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure



The financial statements of Coastal Banking Company, Inc. as of December 31, 2006, and for the year then ended, contained in this Form 10-KSB have been included in reliance upon the report of Mauldin & Jenkins, LLC, Albany, Georgia, independent certified public accountants, and upon the authority of such firm as experts in accounting and auditing. The financial statements of Coastal Banking Company, Inc. and Subsidiaries as of December 31, 2005 and for each of the two years in the period ended December 31, 2005 were included in reliance upon the report of Elliot Davis, LLC, Greenville, South Carolina, independent certified public accountants, and upon the authority of such firm as experts in accounting and auditing.



Item 8A.

Controls and Procedures



As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Principal Chief Executive Officer and Principal Accounting Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of December 31, 2006. There have been no significant changes in our internal controls over financial reporting during the fourth fiscal quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



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



Item 8B.

Other Information



None.





60





---

PART III



Item 9.



Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance with Section 16(a) of the Exchange Act.



The information for this Item is included in the companys Proxy Statement for the Annual Meeting of Shareholders to be held on May 18, 2007, under the headings Proposal:  Election of Directors, Code of Ethics, Security Ownership of Certain Beneficial Owners and Management and Section 16(a) Beneficial Ownership Reporting Compliance and are incorporated herein by reference.



Item 10.

Executive Compensation.



The responses to this Item are included in the Companys Proxy Statement for the Annual Meeting of Shareholders to be held on May 18, 2007, under the heading Compensation of Executive Officers and Directors and are incorporated herein by reference.





Item 11.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.



The following table sets forth equity compensation plan information at December 31, 2006. All per share amounts and number of shares outstanding have been adjusted to reflect all stock dividends.



Equity Compensation Plan Information



|                                                           |  |                                                                                             |  |                                                        |       |                                                    |        | 
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------- |  | ------------------------------------------------------ | ----- | -------------------------------------------------- | ------ | 
|Plan                                                       |  | Number of Securities to be
Issued Upon Exercise of
Outstanding Options,
Warrants and Rights |  | Weighted Average Exercise
Price of Outstanding Options |       | Number of Securities
Remaining for Future
Issuance |       
|Equity Plans Approved by Security Holders(1)               |  | 175,710                                                                                     |  | $                                                      | 11.92 |                                                    | 24,649 | 
|Equity Compensation Plans Not Approved by Security
Holders |  | 233,735                                                                                     |  | 9.10                                                   |       |                                                   |       
|Total                                                      |  | 409,445                                                                                     |  | 10.31                                                  |       | 24,649                                             |       
|                                                           |  |                                                                                             |  |                                                        |       |                                                    |        | 



(1)

The total number of shares of common stock reserved for issuance under the 2000 Coastal Banking Company Stock Incentive Plan is currently 360,389.  The total number of shares available will automatically increase each time we issue additional shares so that it continues to equal 15% of our total outstanding shares.



Stock Warrants



Each of our organizers received, for no additional consideration, a warrant to purchase one share of common stock for $9.07 per share for each share purchased during our initial public offering. The warrants are represented by separate warrant agreements. One third of the warrants vested on each of the first three anniversaries of the date our bank opened for business, and they are exercisable in whole or in part during the ten year period following that date. All warrants are now vested. The warrants may not be assigned, transferred, pledged, or hypothecated in any way. The shares issued pursuant to the exercise of such warrants are transferable, subject to compliance with applicable securities laws. If the OCC or the FDIC issues a capital directive or other order requiring the bank to obtain additional capital, the warrants will be forfeited, if not immediately exercised.



The additional responses to this Item are included in the companys Proxy Statement for the Annual Meeting of Shareholders to be held on May 18, 2007, under the heading Security Ownership of Certain Beneficial Owners and Management and are incorporated herein by reference.



Item 12.

Certain Relationships and Related Transactions



The responses to this Item are included in the companys Proxy Statement for the Annual Meeting of Shareholders held on May 18, 2007, under the headings Related Party Transactions and Compensation of Executive Officers and Directors and are incorporated herein by reference.





61





---



Item 13.

Exhibits



|      |                                                                                                                                                                                                                                                                            
|----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   | Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Registration Statement on Form SB-2, File No. 333-86371).                                                                                                                  
|3.2.  | Bylaws (incorporated by reference to Exhibit 3.3 of the Registration Statement on Form SB-2, File No. 333-86371).                                                                                                                                                          
|4.1.  | See Exhibits 3.1, 3.2, and 3.3 for provisions in the companys Articles of Incorporation and Bylaws defining the rights of holders of the common stock (incorporated by reference to Exhibits 3.1 and 3.2 of the Registration Statement on Form SB-2, File No. 333-86371).
|4.2.  | Form of certificate of common stock (incorporated by reference to Exhibit 4.2 of the Registration Statement on Form SB-2, File No. 333-86371).                                                                                                                             
|10.1  | Employment Agreement dated August 12, 1999 between the company and Randolph Kohn (incorporated by reference to Exhibit 10.1 of the Registration Statement on Form SB-2, File No. 333-86371).*                                                                              
|10.2  | Form of Stock Warrant Agreement (incorporated by reference to Exhibit 10.8 of the Registration Statement on Form SB-2, File No. 333-86371).*                                                                                                                               
|10.3  | Coastal Banking Company, Inc. 2000 Stock Incentive Plan and Form of Stock Option Agreement (incorporated by reference to Exhibit 10.7 of the Form 10-KSB for the period ended December 31, 2002, File No. 333-86371).*                                                     
|10.4  | Lease Agreement between Lowcountry National Bank and Bright OHare Moss Creek Partnership, dated January 14, 2003 (incorporated by reference to Exhibit 10.7 of the Form 10-KSB for the period ended December 31, 2002, File No. 333-86371).                               
|10.5  | Form of Lowcountry National Bank Director Deferred Fee Agreement. (incorporated by reference to Exhibit 10.5 of the Form 10-KSB for the period ended December 31, 2004, File No. 000-28333)*                                                                               
|10.6  | Form of Lowcountry National Bank Executive Deferred Compensation Fee Agreement.(incorporated by reference to Exhibit 10.5 of the Form 10-KSB for the period ended December 31, 2004, File No. 333-86371)*                                                                  
|10.7  | Employment Agreement dated April 6, 2005 between the company and Randolph Kohn (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, File No. 000-28333).*                                                                                         
|10.8  | Employment Agreement dated October 1, 2005 between the company and Michael Sanchez (incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K, File No. 000-28333).*                                                                                     
|10.9  | Salary Continuation Agreement dated April 6, 2005 between the company and Gary Horn (incorporated by reference to Exhibit 10.4 of the Current Report on Form 8-K, File No. 000-28333).*                                                                                    
|10.10 | Salary Continuation Agreement dated April 6, 2005 between the company and James Pate (incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K, File No. 000-28333).*                                                                                   
|10.11 | Salary Continuation Agreement dated October 1, 2005 between the company and Timothy Ayers (incorporated by reference to Exhibit 10.11 of the Annual Report on Form 10-KSB; File No. 000-28333)*                                                                            
|10.12 | Salary Continuation Agreement dated October 1, 2005 between the company and Leo Deas (incorporated by reference to Exhibit 10.11 of the Annual Report on Form 10-KSB; File No. 000-28333)*                                                                                 
|10.13 | Form of Amendment to Lowcountry National Bank Director Deferred Fee Agreement*                                                                                                                                                                                             
|10.14 | Form of Amendment to Lowcountry National Bank Executive Deferred Fee Agreement*                                                                                                                                                                                            
|21.1  | Subsidiaries of the Company.                                                                                                                                                                                                                                               
|23.1  | Consent of Mauldin & Jenkins, LLC                                                                                                                                                                                                                                          
|23.2  | Consent of Elliott Davis, LLC                                                                                                                                                                                                                                              
|24.1  | Power of Attorney (contained as part of the signature pages herewith).                                                                                                                                                                                                     
|31.1  | Rule 13a-14(a) Certification of the Chief Executive Officer.                                                                                                                                                                                                               
|31.2  | Rule 13a-14(a) Certification of the Chief Financial Officer.                                                                                                                                                                                                               
|32.1  | Section 1350 Certifications.                                                                                                                                                                                                                                               



*               Management contract or compensatory plan or arrangement required to be filed as an Exhibit to this Annual Report on Form 10-KSB.



Item 14.

Principal Accountant Fees and Services



The responses to this Item are included in the companys Proxy Statement for the Annual Meeting of Shareholders to be held on May 18, 2007, under the heading Independent Registered Public Accounting Firm and are incorporated herein by reference.



62





---

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Coastal Banking Company, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.



| |                               |                         | 
| | ----------------------------- | ----------------------- | 
| | COASTAL BANKING COMPANY, INC.
| |                              
| |                              
| | By:                           | /s/ Randolph C. Kohn    | 
| |                               | Randolph C. Kohn       
| |                               | Chief Executive Officer
| |                               |                        
| | Date:                         | March 30, 2007         



POWER OF ATTORNEY



KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears on the signature page to this Report constitutes and appoints Randolph C. Kohn and Michael G. Sanchez his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place, and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits hereto, and other documents in connection herewith with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as they might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.



Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of Coastal Banking Company, Inc. and in the capacities and on the dates indicated.



|                            |  |                               |  |               
|--------------------------- |  | ----------------------------- |  | --------------
|Signature                   |  | Title                         |  | Date          
|                            |  |                               |  |               
|/s/ Ron Anderson            |  | Director                      |  | March 30, 2007
|Ron Anderson                |  |                               |  |               
|                            |  |                               |  |               
|                            |  |                               |  |               
|/s/ Christina H. Bryan      |  | Director                      |  | March 30, 2007
|Christina H. Bryan          |  |                               |  |               
|                            |  |                               |  |               
|                            |  |                               |  |               
|/s/ Suellen Rodeffer Garner |  | Chairman of the Board of      |  | March 30, 2007
|Suellen Rodeffer Garner     |  | Directors                     |  |               
|                            |  |                               |  |               
|                            |  |                               |  |               
|/s/ Dennis O. Green         |  | Director                      |  | March 30, 2007
|Dennis O. Green             |  |                               |  |               
|                            |  |                               |  |               
|                            |  |                               |  |               
|/s/ James W. Holden, Jr.    |  | Director                      |  | March 30, 2007
|James W. Holden, Jr.        |  |                               |  |               
|                            |  |                               |  |               
|                            |  |                               |  |               
|/s/ Ladson F. Howell        |  | Vice Chairman of the Board of |  | March 30, 2007
|Ladson F. Howell            |  | Directors                     |  |               
|                            |  |                               |  |               
|                            |  |                               |  |               



63





---



|                 |  |          |  |               
|---------------- |  | -------- |  | --------------
|/s/ James C. Key |  | Director |  | March 30, 2007
|James C. Key     |  |          |  |               







|                        |  |                             |  |               
|----------------------- |  | --------------------------- |  | --------------
|Signature               |  | Title                       |  | Date          
|                        |  |                             |  |               
|/s/ Randolph C. Kohn    |  | Chief Executive Officer and |  | March 30, 2007
|Randolph C. Kohn*       |  | Director                    |  |               
|                        |  |                             |  |               
|                        |  |                             |  |               
|/s/ James L. Pate, III  |  | Chief Financial Officer     |  | March 30, 2007
|James L. Pate, III**    |  |                             |  |               
|                        |  |                             |  |               
|                        |  |                             |  |               
|/s/ Robert L. Peters    |  | Director                    |  | March 30, 2007
|Robert L. Peters        |  |                             |  |               
|                        |  |                             |  |               
|                        |  |                             |  |               
|/s/ Robert B. Pinkerton |  | Director                    |  | March 30, 2007
|Robert B. Pinkerton     |  |                             |  |               
|                        |  |                             |  |               
|                        |  |                             |  |               
|/s/ Michael G. Sanchez  |  | President and Director      |  | March 30, 2007
|Michael G. Sanchez      |  |                             |  |               
|                        |  |                             |  |               
|                        |  |                             |  |               
|/s/ Edward E. Wilson    |  | Director                    |  | March 30, 2007
|Edward E. Wilson        |  |                             |  |               



*Principal Executive Officer

**Principal Financial and Accounting Officer





64





---

EXHIBIT LIST

|      |                                                                                                                                                                                                                                                                            
|----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   | Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Registration Statement on Form SB-2, File No. 333-86371).                                                                                                                  
|3.2.  | Bylaws (incorporated by reference to Exhibit 3.3 of the Registration Statement on Form SB-2, File No. 333-86371).                                                                                                                                                          
|4.1.  | See Exhibits 3.1, 3.2, and 3.3 for provisions in the companys Articles of Incorporation and Bylaws defining the rights of holders of the common stock (incorporated by reference to Exhibits 3.1 and 3.2 of the Registration Statement on Form SB-2, File No. 333-86371).
|4.2.  | Form of certificate of common stock (incorporated by reference to Exhibit 4.2 of the Registration Statement on Form SB-2, File No. 333-86371).                                                                                                                             
|10.1  | Employment Agreement dated August 12, 1999 between the company and Randolph Kohn (incorporated by reference to Exhibit 10.1 of the Registration Statement on Form SB-2, File No. 333-86371).*                                                                              
|10.2  | Form of Stock Warrant Agreement (incorporated by reference to Exhibit 10.8 of the Registration Statement on Form SB-2, File No. 333-86371).*                                                                                                                               
|10.3  | Coastal Banking Company, Inc. 2000 Stock Incentive Plan and Form of Stock Option Agreement (incorporated by reference to Exhibit 10.7 of the Form 10-KSB for the period ended December 31, 2002, File No. 333-86371).*                                                     
|10.4  | Lease Agreement between Lowcountry National Bank and Bright OHare Moss Creek Partnership, dated January 14, 2003 (incorporated by reference to Exhibit 10.7 of the Form 10-KSB for the period ended December 31, 2002, File No. 333-86371).                               
|10.5  | Form of Lowcountry National Bank Director Deferred Fee Agreement. (incorporated by reference to Exhibit 10.5 of the Form 10-KSB for the period ended December 31, 2004, File No. 000-28333)*                                                                               
|10.6  | Form of Lowcountry National Bank Executive Deferred Compensation Fee Agreement.(incorporated by reference to Exhibit 10.5 of the Form 10-KSB for the period ended December 31, 2004, File No. 333-86371)*                                                                  
|10.7  | Employment Agreement dated April 6, 2005 between the company and Randolph Kohn (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, File No. 000-28333).*                                                                                         
|10.8  | Employment Agreement dated October 1, 2005 between the company and Michael Sanchez (incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K, File No. 000-28333).*                                                                                     
|10.9  | Salary Continuation Agreement dated April 6, 2005 between the company and Gary Horn (incorporated by reference to Exhibit 10.4 of the Current Report on Form 8-K, File No. 000-28333).*                                                                                    
|10.10 | Salary Continuation Agreement dated April 6, 2005 between the company and James Pate (incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K, File No. 000-28333).*                                                                                   
|10.11 | Salary Continuation Agreement dated October 1, 2005 between the company and Timothy Ayers (incorporated by reference to Exhibit 10.11 of the Annual Report on Form 10-KSB; File No. 000-28333)*                                                                            
|10.12 | Salary Continuation Agreement dated October 1, 2005 between the company and Leo Deas (incorporated by reference to Exhibit 10.11 of the Annual Report on Form 10-KSB; File No. 000-28333)*                                                                                 
|10.13 | Form of Amendment to Lowcountry National Bank Director Deferred Fee Agreement*                                                                                                                                                                                             
|10.14 | Form of Amendment to Lowcountry National Bank Executive Deferred Fee Agreement*                                                                                                                                                                                            
|21.1  | Subsidiaries of the Company.                                                                                                                                                                                                                                               
|23.1  | Consent of Mauldin & Jenkins, LLC                                                                                                                                                                                                                                          
|23.2  | Consent of Elliott Davis, LLC                                                                                                                                                                                                                                              
|24.1  | Power of Attorney (contained as part of the signature pages herewith).                                                                                                                                                                                                     
|31.1  | Rule 13a-14(a) Certification of the Chief Executive Officer.                                                                                                                                                                                                               
|31.2  | Rule 13a-14(a) Certification of the Chief Financial Officer.                                                                                                                                                                                                               
|32.1  | Section 1350 Certifications.                                                                                                                                                                                                                                               



*               Management contract or compensatory plan or arrangement required to be filed as an Exhibit to this Annual Report on Form 10-KSB.







65