**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-KSB**

 
| **(Mark One)** |
|----------------|
|           |   |   |
| **ý**     |   | **Annual  report under Section 13 or 15(d) of the Securities Exchange Act of  1934** |
| ** **     | ** ** | ** ** |
| ** **     | ** ** | **For fiscal year ended December 31, 2005** |
|           |   |   |
| **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.**

(Name of small business issuer inits charter)

 

| **South Carolina**                                               | ** ** | **58-2455444**                     |
|------------------------------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (IRS Employer  Identification No.) |
|                                                             |       |                               |
| **36 Sea Island Parkway,  Beaufort, South Carolina**             | ** ** | **29901**                          |
| (Address of Principal  Executive Offices)                        |       | (Zip Code)                         |
|                                                             |       |                               |
| **(843) 522-1228**                                               |
| (Issuer’s Telephone Number,  Including Area Code)           |

 

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 13or 15(d) of the Exchange Act.           o

 

Check whether the issuer:  (1) filedall reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period thatregistrant was required to file such reports) and (2) has been subject tosuch filing requirements for past 90 days.   Yes  ý   No  o

 

Check if there is no disclosure of delinquent filers in response toItem 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 informationstatements incorporated by reference in Part III of this Form 10-KSBor any amendment to this Form 10-KSB.   o

 

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

 

State issuer’s revenue for its most recent fiscal year:           **$13,059,434**

 

The aggregate number of shares of the Company’s common stock held bynon-affiliates as of March 21, 2006 was 2,052,772. The aggregate marketvalue of these shares as of March 21, 2006 was $39,618,500 based upon theestimated fair market value of the common stock of $19.30 per share, which isthe average bid and ask price on the Over the Counter Bulletin Board on March21, 2006.  This price reflectsinter-dealer prices without retail mark up, mark down, or commissions, and maynot represent actual transactions.

 

2,373,672shares of common stock were outstanding as of March 21, 2006.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Annual Report to Shareholders for the fiscal year endedDecember 31, 2005 are incorporated by reference into Parts I and II. Portionsof the Proxy Statement for the Annual Meeting of Shareholders, scheduled to beheld on May 19, 2006, are incorporated by reference into Part III.

 

Transitional Small BusinessDisclosure format (check one):                        Yes  o    No  ý

 

 

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**Part I**

 

**Item 1. Descriptionof Business**

 

This Report containsstatements which constitute forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and the Securities Exchange Act of 1934. Thesestatements are based on many assumptions and estimates and are not guaranteesof future performance. Our actual results may differ materially from thoseprojected in any forward-looking statements, as they will depend on manyfactors about which we are unsure, including many factors which are beyond ourcontrol. 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 anduncertainties include, but are not limited to those described below under “RiskFactors.”

 

**General**

 

Coastal Banking Company, Inc.was incorporated in June, 1999 to operate as a bank holding company pursuant tothe Federal Bank Holding Company Act of 1956 and the South Carolina Banking andBranching Efficiency Act, and to purchase 100% of the issued and outstandingstock of Lowcountry National Bank, an association organized under the laws ofthe 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 ofthe merger, acquired 100% of the issued and outstanding capital stock of FirstNational Bank of Nassau County (“First National Bank”). Through oursubsidiaries, we conduct a general commercial and retail banking businessprincipally in the markets of Beaufort County, South Carolina and Nassau County,Florida. First National also operates loan production offices in Jacksonville,Florida and Savannah, Georgia.

 

**Locationand Service Area**

 

Our primary service areasconsist of the areas within a 20 mile radius of the main offices of LowcountryNational Bank and First National Bank. The primary service area of LowcountryNational 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 primaryservice area of First National Bank includes the communities of Amelia Island,Fernandina Beach, O’Neil and Yulee, Florida. The borders of the primary servicearea of First National Bank are the St. Mary’s River and the Georgia border tothe north, the Atlantic Ocean to the east, Duval County to the south and BakerCounty to the west. First National Bank also serves the Savannah, Georgia marketarea through a loan production office.

 

**LendingActivities**

 

*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 orconduct a substantial portion of their business in the banks’ market areas.

 

*LoanApproval and Review.* The banks’ loan approval policies provide forvarious levels of officer lending authority. When the amount of aggregate loansto a single borrower exceeds an individual officer’s lending authority, theloan request will be considered and approved by an officer with a higherlending limit or the directors’ loan committee. Loans in excess of thedirectors’ loan committee’s limits must be approved by the full board ofdirectors of the applicable bank. Neither bank may make any loans to anydirector, officer, or employee of the bank unless the loan is approved by theboard of directors of the bank and is made on terms not more favorable to suchperson than would be available to a person not affiliated with the bank. Thebanks currently adhere to Federal National Mortgage Association and FederalHome Loan Mortgage Corporation guidelines in its mortgage loan review process,but may choose to alter this policy in the future. The banks currentlysell their mortgage loans on the secondary market, but may choose to holdthem in the portfolio in the future.

 

*LendingLimits.* The banks’ lending activities are subject to avariety of lending limits imposed by federal law. In general, the banks aresubject to a legal limit on loans to a single borrower equal to 15% of eachbank’s capital and unimpaired surplus. Different limits may apply incertain circumstances based on the type of loan or the nature of the borrower,including the borrower’s relationship to the banks. These limits will increaseor decrease as each bank’s capital increases or decreases. Based uponLowcountry National Bank’s capitalization of $14,714,000 as of December 31,2005, the bank has a self-imposed loan limit of $2,162,000, which represents 98%of our regulatory legal lending limit of $2,207,100. Based upon First NationalBank's capitalization of $15,063,743 as of December 31, 2005, it had a selfimposed legal lending limit of $2,000,000, which represents approximately 89%of its regulatory legal lending limit. Unless the banks are able to sellparticipations in its loans to other financial institutions, the banks will notbe able to meet all of the lending needs of loan customers requiring aggregateextensions of credit above these limits.

 

*RealEstate and Mortgage Loans.*Loans secured by first or second mortgages on real estate make upapproximately 92% of Lowcountry National’s loan portfolio, 94% of FirstNational Bank’s portfolio, and 93% of the consolidated loan portfolio. Theseloans generally fall into one of three categories: commercial real estateloans, construction and development loans, or residential real

 

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estate loans. Each of thesecategories is discussed in more detail below, including their specific risks. Homeequity loans are not included because they are classified as consumer loans,which are discussed below. Interest rates for all categories may be fixedor adjustable, and will more likely be fixed for shorter-term loans. The banksgenerally charge origination fees for each loan.

 

Real estate loans aresubject to the same general risks as other loans. They are particularlysensitive to fluctuations in the value of real estate. Fluctuations in thevalue of real estate, as well as other factors arising after a loan has beenmade, could negatively affect a borrower’s cash flow, creditworthiness, andability to repay the loan.

 

We have the ability tooriginate real estate loans for sale into the secondary market. We can limitour interest rate and credit risk on these loans by locking the interest ratefor each loan with the secondary investor and receiving the investor’sunderwriting approval prior to originating the loan.

 

•                                          *Commercial Real EstateLoans*. Commercial realestate loans generally have terms of five years or less, although payments may bestructured on a longer amortization basis. We evaluate each borrower on anindividual basis and attempt to determine its business risks and credit profile.We attempt to reduce credit risk in the commercial real estate portfolio byemphasizing loans on owner-occupied office and retail buildings where theloan-to-value ratio, established by independent appraisals, does not exceed 80%.We generally require that debtor cash flow exceed 115% of monthly debt serviceobligations. We typically review all of the personal financial statements ofthe principal owners and require their personal guarantees. These reviewsgenerally reveal secondary sources of payment and liquidity to support a loanrequest.

 

•                                          *Construction andDevelopment Real Estate Loans.*Weoffer adjustable and fixed rate residential and commercial construction loansto builders and developers and to consumers who wish to build their own home. Theterm of construction and development loans generally is limited to eighteenmonths, 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 thanlong term financing of existing properties. Repayment depends on the ultimatecompletion of the project and usually on the sale of the property. Specificrisks include:

 

•                                          cost overruns;

 

•                                          mismanaged construction;

 

•                                          inferior or improper construction techniques;

 

•                                          economic changes or downturns duringconstruction;

 

•                                          a downturn in the real estate market;

 

•                                          rising interest rates which may preventsale of the property; and

 

•                                          failure to sell completed projects in atimely manner.

 

We attempt to reduce risk byobtaining personal guarantees where possible, and by keeping the loan-to-valueratio of the completed project below specified percentages. We may alsoreduce risk by selling participations in larger loans to other institutionswhen possible.

 

*ResidentialReal Estate Loans*. Residentialreal estate loans generally have longer terms up to 30 years. We offer fixedand adjustable rate mortgages. We have limited credit risk on these loans asmost are sold to third parties soon after closing.

 

*CommercialLoans*. Our banks makeloans for commercial purposes in various lines of businesses. Commercial loansare generally considered to have greater risk than first or second mortgages onreal estate because they may be unsecured, or if they are secured, thevalue of the security may be difficult to assess and more likely todecrease than real estate.

 

Equipment loans typicallyare made for a term of five years or less at fixed or variable rates, with theloan fully amortized over the term and secured by the financed equipment andwith a loan-to-value ratio of 80% or less. We focus our efforts on commercialloans less than $500,000. Working capital loans typically have terms notexceeding one year and usually are secured by accounts receivable, inventory,or personal guarantees of the principals of the business. For loans secured byaccounts receivable or inventory, principal typically is repaid as the assetssecuring the loan are converted into cash, and in other cases principaltypically be due at maturity. Asset based lending, leasing, and factoring areoffered through third party vendors who can handle the paper work and servicingand generally assume most of the credit risk. Trade letters of credit, standbyletters of credit, and foreign exchange are handled through a correspondentbank as agent for the bank.

 

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We offer small businessloans utilizing government enhancements such as the Small BusinessAdministration’s 7(a) program and SBA’s 504 programs. These loanstypically are partially guaranteed by the government, which may help toreduce the bank’s risk. Government guarantees of SBA loans generally will notexceed 80% of the loan value and will generally be less, although it willguarantee up to 85% on loans of $150,000 or less.

 

The well established banksin the Beaufort County and Nassau County areas make proportionately more loansto medium to large-sized businesses than we do. Many of the banks’ commercialloans are made to small- to medium-sized businesses which may be less ableto withstand competitive, economic, and financial conditions than largerborrowers.

 

*ConsumerLoans*. Our banks makea 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 areamortized over periods up to 60 months. Consumer loans may be offered on asingle maturity basis where a specific source of repayment is available. Revolvingloan products typically require monthly payments of interest and a portion ofthe principal. Consumer loans are generally considered to have greater riskthan first or second mortgages on real estate because they may beunsecured, or if they are secured, the value of the security may bedifficult to assess and more likely to decrease than real estate.

 

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

 

*Deposits. *The banks offer awide range of commercial and consumer deposit accounts, including checkingaccounts, money market accounts, a variety of certificates of deposit, andindividual retirement accounts.  Theprimary sources of deposits are residents of, and businesses and their employeeslocated in, our primary market areas. Deposits are obtained through personal solicitation by officers anddirectors, direct mail solicitations and advertisements published in the localmedia.  To attract deposits, thesubsidiary banks offer a broad line of competitively priced deposit productsand services.

 

**RiskFactors**

 

***Our recent operating results may not be indicative of our futureoperating results.***

 

We may not be able tosustain our historical rate of organic growth and may not even be able togrow our business at all. Because of our relatively small size and shortoperating history, it will be difficult for us to generate similar earningsgrowth as we continue to expand, and consequently our historical results ofoperations will not be indicative necessarily of our future operations. Variousfactors, such as economic conditions, regulatory and legislativeconsiderations, and competition, may also impede our ability to expand ourmarket presence. If we experience a significant decrease in our historical rateof organic growth, our results of operations and financial condition may beadversely affected because a high percentage of our operating costs are fixedexpenses.

 

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

 

Making loans and otherextensions of credit is an essential element of our business. Although we seekto mitigate risks inherent in lending by adhering to specific underwritingpractices, our loans and other extensions of credit may not be repaid. Therisk 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, risksresulting from uncertainties about the future value of the collateral.

 

We attempt to maintain anappropriate allowance for loan losses to provide for potential losses in ourloan portfolio. We periodically determine the amount of the allowance based onconsideration of several factors, including:

 

•                                          an ongoing review of the quality, mix, andsize of our overall loan portfolio;

 

•                                          our historical loan loss experience;

 

•                                          evaluation of economic conditions;

 

•                                          regular reviews of loan delinquencies andloan portfolio quality; and

 

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

 

There is no precise methodof predicting credit losses; therefore, we face the risk that charge-offs infuture periods will exceed our

 

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allowance for loan lossesand 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 ournet income, and possibly our capital.

 

***Lack of seasoning of our loan portfolio may increase the risk ofcredit defaults in the future.***

 

Due to the growth of ourbanks over the past several years and their relatively short operatinghistories, a large portion of the loans in their loan portfolios and of theirlending relationships are of relatively recent origin. In general, loans do notbegin to show signs of credit deterioration or default until they have beenoutstanding for some period of time, a process we refer to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictablythan a newer portfolio. Because the loan portfolios of our banks are relativelynew, the current level of delinquencies and defaults may not berepresentative of the level that will prevail when the portfolios become moreseasoned, which may be higher than current levels. If delinquencies anddefaults increase, we may be required to increase the banks’ provisionsfor loan losses, which would adversely affect our results of operations andfinancial condition.

 

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

 

Our success significantlydepends upon the growth in population, income levels, deposits, and housingstarts in our markets, especially in the primary market areas of our banks,which are Beaufort County, South Carolina and Nassau County, Florida. If thecommunities in which we operate do not grow or if prevailing economicconditions locally or nationally are unfavorable, our business may notsucceed. An economic downturn would likely contribute to the deterioration ofthe quality of our loan portfolio and reduce our level of deposits, which inturn would hurt our business. Interest received on loans representedapproximately 84% of our interest income for the year ended December 31,2005. If an economic downturn occurs in the economy as a whole, or especiallyin our banks’ primary market areas, borrowers may be less likely to repaytheir loans as scheduled. Moreover, the value of real estate or othercollateral that may secure our loans could be adversely affected. Unlikemany larger institutions, we are not able to spread the risks of unfavorablelocal economic conditions across a large number of diversified economies. Aneconomic downturn could, therefore, result in losses that materially andadversely affect our business.

 

***Changes in prevailing interest rates may reduce our profitability.***

 

Our results of operationsdepend in large part upon the level of our net interest income, which isthe difference between interest income from interest-earning assets, such asloans and mortgage-backed securities, and interest expense on interest-bearingliabilities, such as deposits and other borrowings. Depending on the terms andmaturities of our assets and liabilities, a significant change in interest ratescould have a material adverse effect on our profitability. Many factors causechanges in interest rates, including governmental monetary policies anddomestic and international economic and political conditions. While we intendto manage the effects of changes in interest rates by adjusting the terms,maturities, and pricing of our assets and liabilities, our efforts may notbe effective and our financial condition and results of operations could suffer.After operating in a historically low interest rate environment, the FederalReserve began raising short-term interest rates in the second quarter of 2004. Weanticipate that our net interest income will decline in a rising interest rateenvironment. However, no assurance can be given that the Federal Reserve willactually continue to raise interest rates or that the results we anticipatewill actually occur.

 

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

 

The success of our banksdepends largely on the services of their respective chief executive officers. RandolphC. Kohn, the president and chief executive officer of Lowcountry National Bank,and Michael G. Sanchez, the president and chief executive officer of FirstNational Bank, have extensive and long-standing ties within our industry. If welose the services of either Mr. Kohn or Mr. Sanchez, our business anddevelopment could be materially and adversely affected.

 

Our success also depends, inpart, on our continued ability to attract and retain experienced loanoriginators, as well as other management personnel. The loss of the services ofseveral of such key personnel could adversely affect our growth strategy andprospects to the extent we are unable to replace such personnel.

 

***We are subject to extensive regulation that could limit or restrict ouractivities.***

 

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

 

The laws and regulationsapplicable to the banking industry could change at any time, and we cannot predictthe effects of these

 

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changes on our business andprofitability. Because government regulation greatly affects the business andfinancial results of all commercial banks and bank holding companies, our costof compliance could adversely affect our ability to operate profitably.

 

The Sarbanes-Oxley Act of2002, and the related rules and regulations promulgated by the Securitiesand Exchange Commission that are now applicable to us, have increased thescope, complexity, and cost of corporate governance, reporting, and disclosurepractices. We have experienced, and we expect to continue to experience,greater compliance costs, including costs related to internal controls, as aresult of the Sarbanes-Oxley Act.

 

***Our continued pace of growth may require us to raise additionalcapital in the future, but that capital may not be available when it isneeded.***

 

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

 

***We face strong competition for customers, which could prevent us fromobtaining customers and may cause us to pay higher interest rates toattract customers.***

 

The banking business ishighly competitive, and we experience competition in our market from many otherfinancial 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 othermutual funds, as well as other super-regional, national, and internationalfinancial institutions that operate offices in our primary market areas andelsewhere. We compete with these institutions both in attracting deposits andin making loans. In addition, we have to attract our customer base from otherexisting financial institutions and from new residents. Many of our competitorsare well-established, larger financial institutions. These institutions offersome services, such as extensive and established branch networks, that we donot provide. There is a risk that we will not be able to compete successfullywith other financial institutions in our market, and that we may have topay higher interest rates to attract deposits, resulting in reducedprofitability. In addition, competitors that are not depository institutionsare generally not subject to the extensive regulations that apply to us.

 

***We will face risks with respect to future expansion and acquisitions ormergers.***

 

We may seek to acquireother financial institutions or parts of those institutions. We may alsoexpand 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 andjudgments used to evaluate credit, operations, management, and market riskswith respect to a target institution;

 

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

 

•                                          the incurrence and possible impairment ofgoodwill associated with an acquisition and possible adverse effects on ourresults of operations; and

 

•                                          the risk of loss of key employees andcustomers.

 

In addition, we merged withFirst Capital Bank Holding Corporation on October 1, 2005. Through themerger, we acquired First National Bank of Nassau County. Even though we havenot encountered difficulties in integrating the two companies to this point,there is a risk that we would lose key employees and customers from bothLowcountry National Bank and First National Bank.

 

**SupervisionAnd Regulation**

 

CoastalBanking Company, Inc., Lowcountry National Bank and First National Bankare subject to extensive state and federal banking regulations that imposerestrictions on and provide for general regulatory oversight of theiroperations. These laws generally are intended to protect depositors and notshareholders. The following discussion describes the material elements of theregulatory framework that applies to us.

 

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**Coastal Banking Company, Inc.**

 

Because it owns all of the capital stock ofLowcountry 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 thesupervision, examination and reporting requirements of the Bank Holding CompanyAct and the regulations of the Federal Reserve. As a bank holding companylocated in South Carolina, the South Carolina State Board of FinancialInstitutions also regulates and monitors all significant aspects of ouroperations.

 

***Acquisitions of Banks****.*The Bank HoldingCompany Act requires every bank holding company to obtain the Federal Reserve’sprior approval before:

 

•                  acquiring direct orindirect ownership or control of any voting shares of any bank if, after theacquisition, the bank holding company will directly or indirectly own orcontrol more than 5% of the bank’s voting shares;

 

•                  acquiring all orsubstantially all of the assets of any bank; or

 

•                  merging orconsolidating with any other bank holding company.

 

Additionally, the Bank HoldingCompany Act provides that the Federal Reserve may not approve any of thesetransactions if it would result in or tend to create a monopoly orsubstantially lessen competition or otherwise function as a restraint of trade,unless the anti-competitive effects of the proposed transaction are clearlyoutweighed by the public interest in meeting the convenience and needs of thecommunity to be served. The Federal Reserve is also required to consider thefinancial and managerial resources and future prospects of the bank holdingcompanies and banks concerned. The Federal Reserve’s consideration of financialresources generally focuses on capital adequacy, which is discussed below.

 

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

 

***Change in BankControl****.*Subject to various exceptions, the Bank HoldingCompany Act and the Change in Bank Control Act, together with relatedregulations, require Federal Reserve approval prior to any person or companyacquiring “control” of a bank holding company. Control is conclusively presumedto exist if an individual or company acquires 25% or more of any class ofvoting securities of a bank holding company. Control is rebuttably presumed toexist if a person or company acquires 10% or more, but less than 25%, of any class ofvoting securities and either:

 

•                  thebank holding company has registered securities under Section 12 of theSecurities Exchange Act of 1934; or

 

•                  noother person owns a greater percentage of that class of voting securitiesimmediately after the transaction.

 

The regulations provide a procedure for challengingany rebuttable presumption of control.

 

***PermittedActivities***. A bank holding company is generally permittedunder the Bank Holding Company Act, to engage in, or acquire direct or indirectcontrol of more than 5% of the voting shares of any company engaged in, thefollowing activities:

 

•                  bankingor managing or controlling banks; and

 

•                  anyactivity that the Federal Reserve determines to be so closely related tobanking as to be a proper incident to the business of banking.

 

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

 

•                  factoringaccounts receivable;

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

•                  leasingpersonal or real property;

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

•                  trustcompany functions;

•                  financialand investment advisory activities;

•                  conductingdiscount securities brokerage activities;

•                  underwritingand dealing in government obligations and money market instruments;

•                  providingspecified management consulting and counseling activities;

•                  performingselected data processing services and support services;

 

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•                  actingas agent or broker in selling credit life insurance and other types ofinsurance in connection with credit transactions; and

•                  performingselected insurance underwriting activities.

 

The Federal Reserve may order a bank holdingcompany or its subsidiaries to terminate any of these activities or toterminate its ownership or control of any subsidiary when it has reasonablecause to believe that the bank holding company’s continued ownership, activityor control constitutes a serious risk to the financial safety, soundness orstability of it or any of its bank subsidiaries.

 

In addition to the permissible bank holding companyactivities listed above, a bank holding company may qualify and elect tobecome a financial holding company under the Gramm-Leach-Bliley Act FinancialServices Modernization Act of 1999. A financial holding company may engagein additional activities that are financial in nature or incidental orcomplementary to financial activity. The Bank Holding Company Act expresslylists the following activities as financial in nature:

 

•                  lending,trust and other banking activities;

•                  insuring,guaranteeing or indemnifying against loss or harm, or providing and issuingannuities and acting as principal, agent or broker for these purposes, in anystate;

•                  providingfinancial, investment or advisory services;

•                  issuingor selling instruments representing interests in pools of assets permissiblefor a bank to hold directly;

•                  underwriting,dealing in or making a market in securities;

•                  otheractivities that the Federal Reserve may determine to be so closely relatedto banking or managing or controlling banks as to be a proper incident tomanaging or controlling banks;

•                  foreignactivities permitted outside of the United States if the Federal Reserve hasdetermined them to be usual in connection with banking operations abroad;

•                  merchantbanking through securities or insurance affiliates; and

•                  insurancecompany portfolio investments.

 

To qualify to become a financial holding company,Lowcountry National Bank, First National Bank and any other depositoryinstitution subsidiary of Coastal Banking Company, Inc. are required to bewell capitalized and well managed and have a Community Reinvestment Act ratingof at least “satisfactory.” Additionally, we would be required to file an election with the FederalReserve to become a financial holding company and provide the Federal Reservewith 30 days’ written notice prior to engaging in a permitted financialactivity. While we meet the qualification standards applicable to financialholding companies, we have not elected to become a financial holding company atthis time.

 

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

 

**Lowcountry National Bank and First National Bank of Nassau County**

 

Because Lowcountry NationalBank and First National Bank are chartered as national banks, they areprimarily subject to the supervision, examination and reporting requirements ofthe National Bank Act and the regulations of the OCC. The OCC regularlyexamines the banks’ operations and has the authority to approve ordisapprove mergers, the establishment of branches and similar corporate actions.The OCC also has the power to prevent the continuance or development of unsafeor unsound banking practices or other violations of law. Because thebanks’ deposits are insured by the FDIC tothe maximum extent provided by law, they are also subject to certain FDICregulations. The banks are alsosubject to numerous state and federal statutes and regulations that affect itsbusiness, activities and operations.

 

***Branching****.*National banks are required by the NationalBank Act to adhere to branching laws applicable to state banks in the states inwhich their main office is located. Under both South Carolina and Florida law,the banks may open branch offices throughout their respective home stateswith the prior approval of the OCC. In addition, with prior regulatoryapproval, both banks may acquire branches of existing banks located intheir respective home states. The banks and any other national orstate-chartered bank generally may branch across state lines by mergingwith banks in other states if allowed by the target states’ laws. SouthCarolina and Florida law, with limited exceptions, currently permit branchingacross 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 newstart-up branch in the state. Currently, neither South Carolina nor Florida hasopted-in to this provision. Therefore, interstate merger is the only methodthrough which a bank located outside of these states may branch into them.This provides a limited barrier of entry into the South Carolina and Floridabanking markets, which protects us from an important segment of potentialcompetition. However, because neither South Carolina nor Florida has electednot to opt-in, our ability to establish a new start-up

 

8

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branchof either bank in another state is limited. Many states that have elected toopt-in have done so on a reciprocal basis, meaning that an out-of-state bank may establisha 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 wewill be able to branch into states that have elected to opt-in on a reciprocalbasis will be through interstate merger.

 

***Prompt Corrective Action.***The Federal DepositInsurance Corporation Improvement Act of 1991 established a system of promptcorrective action to resolve the problems of undercapitalized financialinstitutions. Under this system, the federal banking regulators haveestablished five capital categories (well capitalized, adequately capitalized,undercapitalized, significantly undercapitalized and criticallyundercapitalized) into which all institutions are placed. The federal bankingagencies have specified by regulation the relevant capital level for eachcategory. Federal banking regulators are required to take various mandatorysupervisory actions and are authorized to take other discretionary actions withrespect to institutions in the three undercapitalized categories. The severityof the action depends upon the capital category in which the institution isplaced. Generally, subject to a narrow exception, the banking regulator mustappoint a receiver or conservator for an institution that is criticallyundercapitalized.

 

Aninstitution that is categorized as undercapitalized, significantlyundercapitalized or critically undercapitalized is required to submit anacceptable capital restoration plan to its appropriate federal regulator. Abank holding company must guarantee that a subsidiary depository institutionmeets its capital restoration plan, subject to various limitations. Thecontrolling holding company’s obligation to fund a capital restoration plan is limitedto the lesser of 5% of an undercapitalized subsidiary’s assets at the time itbecame undercapitalized or the amount required to meet regulatory capitalrequirements. An undercapitalized institution is also generally prohibited fromincreasing its average total assets, making acquisitions, establishing anybranches or engaging in any new line of business, except under an acceptedcapital restoration plan or with FDIC approval. The regulations also establishprocedures for downgrading an institution to a lower capital category based onsupervisory factors other than capital.

 

***FDIC Insurance Assessments.***The FDIC has adopted arisk-based assessment system for insured depository institutions that takesinto account the risks attributable to different categories and concentrationsof assets and liabilities. The system assigns an institution to one of threecapital categories: (1) well capitalized; (2) adequately capitalized;and (3) undercapitalized. These three categories are substantially similarto the prompt corrective action categories described above, with the “undercapitalized”category including institutions that are undercapitalized, significantlyundercapitalized and critically undercapitalized for prompt corrective actionpurposes. The FDIC also assigns an institution to one of three supervisorysubgroups based on a supervisory evaluation that the institution’s primaryfederal regulator provides to the FDIC and information that the FDIC determinesto be relevant to the institution’s financial condition and the risk posed tothe deposit insurance funds. Assessments range from 0 to 27 cents per $100 ofdeposits, depending on the institution’s capital group and supervisory subgroup.In addition, the FDIC imposes assessments to help pay off the $780 million inannual interest payments on the $8 billion Financing Corporation bonds issuedin the late 1980s as part of the government rescue of the thrift industry.This assessment rate is adjusted quarterly and is set at 1.32 cents per$100 of deposits for the first quarter of 2006.

 

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

 

***Community Reinvestment Act.***The Community Reinvestment Act requires that, in connection withexaminations of financial institutions within their respective jurisdictions,the Federal Reserve, the FDIC or the OCC shall evaluate the record of eachfinancial institution in meeting the credit needs of its local community,including low and moderate-income neighborhoods. These facts are alsoconsidered in evaluating mergers, acquisitions and applications to open abranch or facility. Failure to adequately meet these criteria could imposeadditional requirements and limitations on Lowcountry National Bank or FirstNational Bank. Additionally, wemust publicly disclose the terms of various Community Reinvestment Act-relatedagreements.

 

***Other Regulations.***Interest and othercharges collected or contracted for by Lowcountry National Bank or First National Bank are subject to state usury laws and federal laws concerning interestrates. For example, under the Servicemembers Civil Relief Act, which amendedthe Soldiers’ and Sailors’ Civil Relief Act of 1940, a lender is generallyprohibited from charging an annual interest rate in excess of 6% on anyobligation of a borrower who is on active duty with the United States military.

 

Each bank’s loanoperations are also subject to federal laws applicable to credit transactions,such as the:

 

•                  FederalTruth-In-Lending Act, governing disclosures of credit terms to consumerborrowers;

 

•                  Home MortgageDisclosure Act of 1975, requiring financial institutions to provide informationto enable the public and public officials to determine whether a financialinstitution is fulfilling its obligation to help meet the housing needs of thecommunity it serves;

 

•                  Equal Credit OpportunityAct, prohibiting discrimination on the basis of race, creed or other prohibitedfactors in extending credit;

 

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•                  Fair Credit Reporting Act of 1978, as amendedby the Fair and Accurate Credit Transactions Act, governing the use andprovision of information to credit reporting agencies, certain identify theftprotections, and certain credit and other disclosures;

 

•                  Fair Debt CollectionAct, governing the manner in which consumer debts may be collected by collectionagencies; and

 

•                  the rules andregulations of the various federal agencies charged with the responsibility ofimplementing these federal laws.

 

The deposit operationsof each bank are subject to:

 

•                  the Right to FinancialPrivacy Act, which imposes a duty to maintain confidentiality of consumerfinancial records and prescribes procedures for complying with administrativesubpoenas of financial records; and

 

•                  the Electronic FundsTransfer Act and Regulation E issued by the Federal Reserve to implement thatact, which govern automatic deposits to and withdrawals from deposit accountsand customers’ rights and liabilities arising from the use of automated tellermachines and other electronic banking services.

 

**Capital Adequacy**

 

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

 

The risk-based capitalstandards are designed to make regulatory capital requirements more sensitiveto differences in risk profiles among banks and bank holding companies, to accountfor off-balance-sheet exposure, and to minimize disincentives for holdingliquid assets. Assets and off-balance-sheet items, such as letters of creditand unfunded loan commitments, are assigned to broad risk categories, each withappropriate risk weights. The resulting capital ratios represent capital as apercentage of total risk-weighted assets and off-balance-sheet items.

 

The minimum guideline for theratio of total capital to risk-weighted assets is 8%. Total capital consists oftwo components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generallyconsists of common stock, minority interests in the equity accounts ofconsolidated depository institution subsidiaries, noncumulative perpetualpreferred stock in consolidated non-depository subsidiaries and a limitedamount of qualifying cumulative perpetual preferred stock, less goodwill andother specified intangible assets. Tier 1 Capital must equal at least 4%of risk-weighted assets. Tier 2 Capital generally consists of subordinateddebt, other preferred stock and a limited amount of loan loss reserves. Thetotal amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. At December 31, 2005 our ratio of totalcapital to risk-weighted assets was 12.33% and our ratio of Tier 1 Capital torisk-weighted assets was 10.74%.

 

In addition, the FederalReserve has established minimum leverage ratio guidelines for bank holdingcompanies. These guidelines provide for a minimum ratio of Tier 1 Capital toaverage assets, less goodwill and other specified intangible assets, of 3% forbank holding companies that meet specified criteria, including having thehighest regulatory rating and implementing the Federal Reserve’s risk-basedcapital measure for market risk. All other bank holding companies generally arerequired to maintain a leverage ratio of at least 4%. At December 31, 2005, our leverage ratio was 9.81%. Theguidelines also provide that bank holding companies experiencing internalgrowth or making acquisitions will be expected to maintain strong capitalpositions substantially above the minimum supervisory levels without relianceon intangible assets. The Federal Reserve considers the leverage ratio andother indicators of capital strength in evaluating proposals for expansion ornew activities.

 

Failure to meet capitalguidelines could subject a bank or bank holding company to a variety ofenforcement remedies, including issuance of a capital directive, thetermination of deposit insurance by the FDIC, a prohibition on acceptingbrokered deposits and certain other restrictions on its business. As describedabove, significant additional restrictions can be imposed on FDIC-insureddepository institutions that fail to meet applicable capital requirements.

 

**Payment of Dividends**

 

Coastal Banking Company, Inc. is a legal entityseparate and distinct from both Lowcountry National Bank and First NationalBank. The principal sources of Coastal Banking Company, Inc.’s cash flow,including cash flow to pay dividends to its shareholders, are dividends thatLowcountry National Bank and First National Bank to Coastal Banking Company, Inc.as its sole shareholder. Statutory and regulatory limitations apply to thebanks’ payment of dividends to Coastal Banking Company, Inc. as well as toCoastal Banking Company, Inc.’s payment of dividends to its shareholders.

 

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Each bank is required byfederal law to obtain prior approval of the OCC for payments of dividends ifthe total of all dividends declared by each bank’s Board of Directors in anyyear 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, lessany required transfers to surplus. The payment of dividends by Coastal BankingCompany, Inc., Lowcountry National Bank and First National Bank may alsobe affected by other factors, such as the requirement to maintain adequatecapital above regulatory guidelines.

 

In addition, the OCC may require, after notice and a hearing, thatLowcountry National Bank or First National Bank stop or refrain from engagingany practice it considers unsafe or unsound. The federal banking agencies haveindicated that paying dividends that deplete a depository institution’s capitalbase to an inadequate level would be an unsafe and unsound banking practice. Underthe Federal Deposit Insurance Corporation Improvement Act of 1991, a depositoryinstitution may not pay any dividend if payment would cause it to becomeundercapitalized or if it already is undercapitalized. Moreover, the federalagencies have issued policy statements that provide that bank holding companiesand insured banks should generally only pay dividends out of current operatingearnings.

 

**Restrictions on Transactions with Affiliates**

 

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

 

•                  abank’s loans or extensions of credit to affiliates;

 

•                  abank’s investment in affiliates;

 

•                  assetsa bank may purchase from affiliates, except for real and personal propertyexempted by the Federal Reserve;

 

•                  loansor extensions of credit to third parties collateralized by the securities orobligations of affiliates; and

 

•                  abank’s guarantee, acceptance or letter of credit issued on behalf of anaffiliate.

 

The total amount of the above transactions islimited in amount, as to any one affiliate, to 10% of a bank’s capital andsurplus and, as to all affiliates combined, to 20% of a bank’s capital andsurplus. 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 otherprovisions designed to avoid the taking of low-quality assets.

 

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

 

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

 

**Privacy**

 

Financial institutions are required to disclosetheir policies for collecting and protecting confidential information. Customersgenerally may prevent financial institutions from sharing nonpublicpersonal financial information with nonaffiliated third parties except undernarrow circumstances, such as the processing of transactions requested by theconsumer or when the financial institution is jointly sponsoring a product orservice with a nonaffiliated third party. Additionally, financial institutionsgenerally may not disclose consumer account numbers to any nonaffiliatedthird party for use in telemarketing, direct mail marketing or other marketingto consumers.

 

**Anti-Terrorism and Money Laundering Legislation**

 

Lowcountry National Bankand First National Bank are subject to the Uniting and Strengthening America byProviding Appropriate Tools Required to Intercept and Obstruct Terrorism Act of2001 (the USA PATRIOT Act) as it amended the Bank Secrecy Act and the rules andregulations of the Office of Foreign Assets Control (OFAC). These statutes andrelated rules and regulations impose requirements and limitations onspecific financial transactions and account relationships, intended to guardagainst money laundering and terrorism financing. Both Lowcountry National Bankand First National Bank have established a customer identification programpursuant to Section 326 of the USA PATRIOT Act and the Bank Secrecy Act,and otherwise has implemented policies and procedures to comply with theforegoing rules.

 

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**Federal Deposit Insurance Reform**

 

On February 8, 2006, President Bush signed theFederal Deposit Insurance Reform Act of 2005 (FDIRA). The FDIC must adopt rules implementingthe various provisions of FDIRA by November 5, 2006.

 

Among other things, FDIRA changes the Federaldeposit insurance system by:

 

•                  raisingthe coverage level for retirement accounts to $250,000;

 

•                  indexingdeposit insurance coverage levels for inflation beginning in 2012;

 

•                  prohibitingundercapitalized financial institutions from accepting employee benefit plandeposits;

 

•                  mergingthe Bank Insurance Fund and Savings Association Insurance Fund into a newDeposit Insurance Fund (the DIF); and

 

•                  providingcredits to financial institutions that capitalized the FDIC prior to 1996 tooffset future assessment premiums.

 

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

 

**Proposed Legislation and Regulatory Action**

 

New regulations andstatutes are regularly proposed that contain wide-ranging potential changes tothe structures, regulations and competitive relationships of financialinstitutions operating and doing business in the United States. We cannotpredict whether or in what form any proposed regulation or statute will beadopted or the extent to which our business may be affected by any newregulation or statute.

 

**Effect of Governmental MonetaryPolices**

 

Our earnings are affectedby domestic economic conditions and the monetary and fiscal policies of theUnited States government and its agencies. The Federal Reserve has, and islikely to continue to have, an important impact on the operating results ofcommercial banks through its power to implement national monetary policy inorder, among other things, to curb inflation or combat a recession. The FederalReserve affects the levels of bank loans, investments and deposits through itscontrol over the issuance of United States government securities, itsregulation of the discount rate applicable to member banks and its influenceover reserve requirements to which member banks are subject. We cannot predictthe nature or impact of future changes in monetary and fiscal policies.

 

**DepositServices**

 

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

 

**OtherBanking Services**

 

Our banks also offer otherbank services including drive up ATMs, safe deposit boxes, traveler’s checks,direct deposit, U.S. Savings Bonds, banking by mail, and internet banking. Thebank is associated with the Plus and Star ATM networks, which may be usedby its customers throughout the banks’ primary market areas and other regions. Webelieve that by being associated with a shared network of ATMs, we are betterable to serve our customers and attract customers who are accustomed to theconvenience 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 March 15, 2006,Lowcountry National Bank had 30 full-time employees and 1 part-time employee,and First National Bank had 33 full-time employees and 3 part-time employees. Ourcompany had no employees other than its officers, who are also employees ofLowcountry National Bank or First National Bank.

 

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**Item 2.****          ****                                               ****Description of Property.**

 

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

 

Lowcountry National Bankowns a lot on Hwy 170, Bluffton, South Carolina in the Okatie Center, which waspurchased in 2001 for a future branch site. The bank has since decided againstbuilding on this site and has now listed the lot for sale.

 

During 2002, LowcountryNational Bank successfully established a loan production office to service theBluffton area. Based on the success of the establishment of the loan productionoffice, we decided to move forward with a full service branch to serve thismarket. We decided that leasing a branch facility was in the bank’s bestinterest as opposed to constructing our own building. To that end, LowcountryNational Bank entered into a lease to open our first branch at Moss CreekVillage, Bluffton, South Carolina. The Moss Creek office became fullyoperational during the second quarter of 2003.

 

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

 

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

 

**Item 3.****          ****                                               ****Legal Proceedings****.**

 

None.

 

**Item 4.****          ****                                               ****Submission of Matters to aVote of Security Holders****.**

 

No matter was submitted to avote of security holders during the fourth quarter of the fiscal year coveredby this report.

 

**PART II**

 

**Item 5.****          ****                                               ****Market for Common Equity,Related Stockholder Matters and Small Business Issuer Purchases of EquitySecurities****.**

 

In response to this Item, theinformation is contained on page         of thecompany’s annual report to shareholders for the year ended December 31,2005 and is incorporated herein by reference.

 

CoastalBanking Company issued no unregistered securities during the fiscal year endedDecember 31,2005 and did not repurchase any shares of its common stock duringthe fourth quarter of 2005.

 

**Item 6.****          ****                                               ****Management’s Discussion andAnalysis or Plan of Operation****.**

 

In response to this Item,the information contained on pages               through     of the company’s annual report to shareholders for the year ended December 31,2005 is incorporated herein by reference.

 

**Item 7.****          ****                                               ****Financial Statements****.**

 

In response to this Item,the information contained on pages               through     of the company’s annual report to shareholders for the year ended December 31,2005 is incorporated herein by reference.

 

**Item 8.****          ****                                               ****Changes in and Disagreementswith Accountants on Accounting and Financial Disclosure****.**

 

None

 

**Item 8A.****                                                 ****Controls and Procedures**

 

As of the end of the periodcovered by this report, we carried out an evaluation, under the supervision andwith the participation of our management, including our Principal ChiefExecutive Officer and Principal Accounting Officer, of the effectiveness of ourdisclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).Based upon that evaluation, our Chief Executive Officer and Chief FinancialOfficer have concluded that our current disclosure controls and procedures areeffective as of December 31, 2005. There have been no significant changesin our internal controls over financial reporting during the fourth fiscalquarter ended December 31, 2005 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

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

 

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**Item 8B.****                                                 ****Other Information**

 

None.

 

**PART III**

 

**Item 9.****          ****                                               ****Directors, ExecutiveOfficers, Promoters and Control Persons; Compliance with Section 16(a) ofthe Exchange Act****.**

 

The information for this Item is included in the company’s Proxy Statementfor the Annual Meeting of Shareholders to be held on May 19, 2006, underthe headings “Proposal:  Election ofDirectors”, “Code of Ethics”, “Security Ownership of Certain Beneficial Ownersand Management” and “Section 16(a) Beneficial Ownership ReportingCompliance” and are incorporated herein by reference.

 

**Item 10.****   ****                                               ****Executive Compensation****.**

 

The responses to this Item are included in the Company’s ProxyStatement for the Annual Meeting of Shareholders to be held on May 19,2006, under the heading “Compensation of Executive Officers and Directors” andare incorporated herein by reference.

 

**Item 11.****   ****                                               ****Security Ownership ofCertain Beneficial Owners and Management and Related Stockholder Matters****.**

 

The following table setsforth equity compensation plan information at December 31, 2005. All pershare amounts and number of shares outstanding have been adjusted to reflectall 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), (2)**               |       | 210,739                                                                                                                                              |       | $                                                                                    | 9.81       |                                                                         | 133,625    |   |
| **Equity  Compensation Plans Not Approved by Security  Holders(3),** |       | 208,407                                                                                                                                              |       | 9.16                                                                                 |       | 0                                                                            |       |
| **Total**                                                            |       | 419,146                                                                                                                                              |       | 9.29                                                                                 |       | 133,625                                                                      |       |
|                                                                      |            |                                                                                                                                                      |            |                                                                                      |            |                                                                              |            |  |

 

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(1)                                  The total number of shares of common stock reservedfor issuance under the 2000 Coastal Banking Company Stock Incentive Plan iscurrently 344,364, and it will automatically increase each time we issueadditional shares so that it continues to equal 15% of our total outstandingshares. The options assumed through the merger are adjusted for a 5% stockdividend paid in December of 2005 and had an original term of ten years.

 

(2)                                  In connection with the company’s merger withFirst Capital Bank Holding Corporation on October 1, 2005, we assumed86,765 options with a weighted average exercise price of $9.55 per share.

 

(3)                                  In connection with the company’s merger withFirst Capital Bank Holding Corporation on October 1, 2005, we assumed8,854 options with a weighted average exercise price of $11.29 per share. Theseshares assumed through the merger are adjusted for the 5% stock dividend paidin December of 2005 and had an original term of 10 years.

 

**StockWarrants**

 

Each of our organizersreceived, for no additional consideration, a warrant to purchase one share ofcommon stock for $9.07 per share

 

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for each share purchasedduring our initial public offering. The warrants are represented by separatewarrant agreements. One third of the warrants vested on each of the first threeanniversaries of the date our bank opened for business, and they areexercisable in whole or in part during the ten year period following thatdate. All warrants are now vested. The warrants may not be assigned,transferred, pledged, or hypothecated in any way. The shares issued pursuant tothe exercise of such warrants are transferable, subject to compliance with applicablesecurities laws. If the OCC or the FDIC issues a capital directive or otherorder requiring the bank to obtain additional capital, the warrants will beforfeited, if not immediately exercised.

 

The additional responses to this Item are included in the company’sProxy Statement for the Annual Meeting of Shareholders to be held on May 19,2006, under the heading “Security Ownership of Certain Beneficial Owners andManagement” and are incorporated herein by reference.

 

**Item 12.****   ****                                               ****Certain Relationships andRelated Transactions**

 

The responses to this Item are included in the company’s ProxyStatement for the Annual Meeting of Shareholders held on May 19, 2006,under the headings “Related Party Transactions” and “Compensation of ExecutiveOfficers and Directors” and are incorporated herein by reference.

 

**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*                                                                                                                                                                                                    |
| 10.12 | Salary Continuation  Agreement dated October 1, 2005 between the company and Leo Deas*                                                                                                                                                                                                         |
| 13.1  | Company’s 2005 Annual  Report.                                                                                                                                                                                                                                                                 |
| 21.1  | Subsidiaries of the  Company.                                                                                                                                                                                                                                                                       |
| 23.1  | Consent of Certified  Public Accountants.                                                                                                                                                                                                                                                           |
| 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.                                                                                                                                                                                                                                                                  |

 

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

 

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**Item 14.****   ****                                               ****Principal Accountant Feesand Services**

 

The responsesto this Item are included in the company’s Proxy Statement for the AnnualMeeting of Shareholders to be held on May 19, 2006, under the heading “IndependentRegistered Public Accounting Firm” and are incorporated herein by reference.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or15(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:                                  | April 13, 2006 |

 

**POWER OF ATTORNEY**

 

**KNOW ALL MEN BY THESE PRESENTS**, that each person whose signature appears on the signature page tothis Report constitutes and appoints Randolph C. Kohn and Michael G. Sanchezhis or her true and lawful attorneys-in-fact and agents, with full power ofsubstitution 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 thisReport, and to file the same, with all exhibits hereto, and other documents inconnection herewith with the Securities and Exchange Commission, granting untosaid attorneys-in-fact and agents, full power and authority to do and perform eachand every act and thing requisite and necessary to be done in and about thepremises, as fully to all intents and purposes as they might or could do inperson, hereby ratifying and confirming all that said attorneys-in-fact andagents or their substitute or substitutes, may lawfully do or cause to bedone by virtue hereof.

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this Report has been signed below by the followingpersons on behalf of Coastal Banking Company, Inc. and in the capacitiesand on the dates indicated.

 
| **Signature**                  | ** ** | **Title**                     | ** ** | **Date**       |
|--------------------------------|------------|-------------------------------|------------|----------------|
|                           |       |                          |       |           |
| /s/ Ron  Anderson              |       | Director                      |       | April 13, 2006 |
| Ron  Anderson                  |       |                          |       |           |
|                           |       |                          |       |           |
|                           |       |                          |       |           |
| /s/ Christina  H. Bryan        |       | Director                      |       | April 13, 2006 |
| Christina  H. Bryan            |       |                          |       |           |
|                           |       |                          |       |           |
|                           |       |                          |       |           |
| /s/ Suellen  Rodeffer Garner   |       | Chairman of the Board of      |       | April 13, 2006 |
| Suellen  Rodeffer Garner       |       | Directors                     |       |           |
|                           |       |                          |       |           |
|                           |       |                          |       |           |
| /s/ Dennis  O. Green           |       | Director                      |       | April 13, 2006 |
| Dennis  O. Green               |       |                          |       |           |
|                           |       |                          |       |           |
|                           |       |                          |       |           |
| /s/ James  W. Holden, Jr. |       | Director                      |       | April 13, 2006 |
| James  W. Holden, Jr.     |       |                          |       |           |
|                           |       |                          |       |           |
|                           |       |                          |       |           |
| /s/ Ladson  F. Howell          |       | Vice Chairman of the Board of |       | April 13, 2006 |
| Ladson  F. Howell              |       | Directors                     |       |           |
|                           |       |                          |       |           |
|                           |       |                          |       |           |
| /s/ James  C. Key              |       | Director                      |       | April 13, 2006 |
| James  C. Key                  |       |                          |       |           |

 

17

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| **Signature**                | ** ** | **Title**                   | ** ** | **Date**       |
|------------------------------|------------|-----------------------------|------------|----------------|
|                         |       |                        |       |           |
| /s/ Randolph  C. Kohn        |       | Chief Executive Officer and |       | April 13, 2006 |
| Randolph  C. Kohn*           |       | Director                    |       |           |
|                         |       |                        |       |           |
|                         |       |                        |       |           |
| /s/ James  L. Pate, III |       | Chief Financial Officer     |       | April 13, 2006 |
| James  L. Pate, III**   |       |                        |       |           |
|                         |       |                        |       |           |
|                         |       |                        |       |           |
| /s/ Robert  L. Peters        |       | Director                    |       | April 13, 2006 |
| Robert  L. Peters            |       |                        |       |           |
|                         |       |                        |       |           |
|                         |       |                        |       |           |
| /s/ Robert  B. Pinkerton     |       | Director                    |       | April 13, 2006 |
| Robert  B. Pinkerton         |       |                        |       |           |
|                         |       |                        |       |           |
|                         |       |                        |       |           |
| /s/ Michael  G. Sanchez      |       | President and Director      |       | April 13, 2006 |
| Michael  G. Sanchez          |       |                        |       |           |
|                         |       |                        |       |           |
|                         |       |                        |       |           |
| /s/ Edward  E. Wilson        |       | Director                    |       | April 13, 2006 |
| Edward  E. Wilson            |       |                        |       |           |

 

----

*                                         PrincipalExecutive Officer

**                                  PrincipalFinancial and Accounting Officer

 

18

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**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*                                                                                                                                                                                                    |
| 10.12 | Salary Continuation  Agreement dated October 1, 2005 between the company and Leo Deas*                                                                                                                                                                                                         |
| 13.1  | Company’s 2005 Annual  Report.                                                                                                                                                                                                                                                                 |
| 21.1  | Subsidiaries of the  Company.                                                                                                                                                                                                                                                                       |
| 23.1  | Consent of Certified  Public Accountants.                                                                                                                                                                                                                                                           |
| 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.                                                                                                                                                                                                                                                                  |

 

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

 

19

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