**Exhibit13**

**HCSBFINANCIAL CORPORATION**

****

**HORRYCOUNTY STATE BANK**

Loris, SouthCarolina

Annual Report

2006

www.horrycountystatebank.com

----

# **HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

# **Contents**

| ** **                                                                                  | ** ** | Page   |
|---------------------------------------------------------------------------------------------|------------|--------|
| Message to Shareholders                                                                     |       | 2      |
|                                                                                        |       |   |
| Ten Year History                                                                            |       | 3      |
|                                                                                        |       |   |
| Selected Financial Data                                                                     |       | 4      |
|                                                                                        |       |   |
| Description of Company’s Business                                                      |       | 5      |
|                                                                                        |       |   |
| Market for Common Share and Dividends                                                       |       | 6      |
|                                                                                        |       |   |
| Management’s Discussion and Analysis of Financial  Condition and Results of Operations |       | 7-23   |
|                                                                                        |       |   |
| Report of Independent Registered Public Accounting  Firm                                    |       | 24     |
|                                                                                        |       |   |
| Consolidated Balance Sheets                                                                 |       | 25     |
|                                                                                        |       |   |
| Consolidated Statements of Income                                                           |       | 26     |
|                                                                                        |       |   |
| Consolidated Statements of Changes in Shareholders’  Equity and Comprehensive Income   |       | 27     |
|                                                                                        |       |   |
| Consolidated Statements of Cash Flows                                                       |       | 28     |
|                                                                                        |       |   |
| Notes to Consolidated Financial Statements                                                  |       | 29-55  |
|                                                                                        |       |   |
| Board of Directors                                                                          |       | 56     |
|                                                                                        |       |   |
| Corporate Officers                                                                          |       | 57     |
|                                                                                        |       |   |
| Branch Locations                                                                            |       | 57     |

 

# **Headquarters**

| 5201 Broad Street            | Mailing Address:             |
|------------------------------|------------------------------|
| Loris, South  Carolina 29569 | Post Office Box  218         |
| (843) 756-6333               | Loris, South  Carolina 29569 |

 

Certain statementsin this annual report contain “forward-looking statements” within the meaningof the Private Securities Litigation Reform Act of 1995, such as statementsrelating to the future plans and expectations, and are thus prospective. Suchforward-looking statements are subject to risks, uncertainties and otherfactors that could cause actual results to differ materially from futureresults expressed or implied by such forward-looking statements.  Please see our annual report filed on Form10-KSB for further discussion of these risks.

**HCSBFinancial Corporation will furnish, free of charge, copies of the Annual Reportand the Company’s Report to the Securities and Exchange Commission (Form10-KSB) upon written request to James R. Clarkson, President and C.E.O., HCSBFinancial Corporation, Post Office Box 218, Loris, South Carolina 29569.**

----

**HCSBFINANCIAL CORPORATION AND SUBSIDIARY**

**MESSAGETO SHAREHOLDERS**

It is once again mypleasure to present to the shareholders of HCSB Financial Corporation thisAnnual Report of the performance of your company and its subsidiary, HorryCounty State Bank, for the year 2006.

This past year was ournineteenth year in operation, and we continued our trends of growth in assets,profitability and marketplace during 2006. During the year total assets increased by 8.40% to $359.5 million, loansnet of reserve for losses achieved growth of 8.32% to a level of $251.8 millionat year end and deposits likewise grew by 8.27% to $275.2 million.

As in the prior year of2005 our rate of growth in earnings exceeded the balance sheet items as netincome for the year 2006 slightly exceeded $2.8 million, or an improvement of16.49% over earnings in 2005.  As aresult, the company’s capital increased by 12.0% in 2006.

Other significantachievements in 2006 included the opening of our Carolina Forest branch inOctober.  This community continues togrow steadily and offers us an excellent opportunity.  We have assembled a fine staff at thisoffice, and we expect to do quite well.

In addition, last year weacquired a lot and a 3-story building at 1300 2nd Avenue in Conway along with three adjacentproperties fronting on 3rd Avenue. We expect to open a branch in the first floor of the 2nd Avenue building during the third quarter of2007 and construct a drive-up banking facility and a parking lot on the 3rd Avenue properties.  I am quite pleased that the Thompson &Henry Law Firm has partnered with our bank in this endeavor, and they willrelocate their Conway law practice into the third floor of the building on 2nd Avenue. We expect to lease space on the second floor of this building.

And, too, last year wepurchased a 5-acre tract in the Loris Commerce Center on which we intend tobuild a new 30,000 square foot Operations Center which will house all of thebank’s support services and executive offices. We hope to begin this construction in 2007.

The marketplace in whichwe operate continues to provide us with excellent diversification in our loanportfolio and growth in our assets. While our Myrtle Beach office has provided our bank with the best growthin recent years, we continue to provide ample support to the agriculturalsector which provided us with our primary loan base in the bank’s earlyyears.  We believe that our new Conwayfacility will enable us to significantly improve our presence in and support ofthe Conway market which has experienced significant growth of late.

Thus it is obvious thatour banking company looks to continue our pattern of growth and expansion ofour branch network.  As has been the casesince our bank’s origin, however, our ability to attract and retain excellentemployees has been most responsible for our success story.  It is our sincere intent as employees of yourbank to operate HCSB in such a manner as to provide quality banking services atcompetitive prices which will enable our bank to produce a sufficient return onyour investment so that you will allow us to continue to operate as anindependent, community bank.

We continue to appreciatethe support of our shareholders.  I trustthat we shall always continue to work together to do the little things thatmake a little bank...BIG!

Most respectfully,
| /s/ James R. Clarkson |   |
|-----------------------|--------|
| James R.  Clarkson    |
| President &  CEO  |

2

----

**Ten Year History**

*(Omit 000’s)*

| Year   | ** ** | **Assets** | ** ** | **Deposits** | ** ** | **Loans (net)** | ** ** | **Capital** | ** ** | **Earnings** | ** ** |
|--------|------------|------------|------------|--------------|------------|----------------------|------------|-------------|------------|--------------|------------|
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 1997   |       | $          | 72,156     |         | $          | 63,885               |       | $           | 40,711     |         | $          | 7,473 |   | $ | 429 |   |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 1998   |       | 83,586     |       | 69,970       |       | 55,061               |       | 8,024       |       | 511          |       |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 1999   |       | 114,326    |       | 94,829       |       | 74,871               |       | 8,341       |       | 994          |       |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 2000   |       | 143,718    |       | 123,500      |       | 90,300               |       | 9,781       |       | 1,037        |       |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 2001   |       | 148,651    |       | 120,073      |       | 116,596              |       | 10,895      |       | 996          |       |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 2002   |       | 211,598    |       | 164,161      |       | 161,381              |       | 19,850      |       | 1,161        |       |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 2003   |       | 269,714    |       | 209,931      |       | 190,055              |       | 21,509      |       | 1,568        |       |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 2004   |       | 296,807    |       | 222,389      |       | 210,649              |       | 23,454      |       | 2,055        |       |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 2005   |       | 331,662    |       | 254,137      |       | 232,509              |       | 25,303      |       | 2,408        |       |
|   |       |       |       |         |       |                 |       |        |       |         |       |
| 2006   |       | 359,357    |       | 275,151      |       | 251,849              |       | 28,350      |       | 2,805        |       |
|        |            |            |            |              |            |                      |            |             |            |              |            |  |  |  |  |  |

 

3

----

**SelectedFinancial Data**

The followingtable sets forth certain selected financial data concerning the Company.  The selected financial data has been derivedfrom the financial statements.  Thisinformation should be read in conjunction with the financial statements of theCompany, including the accompanying notes, included elsewhere herein.

| Year Ended December 31,               | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| *(Dollars  in thousands, except per share)*          |       |       |       |       |       |       |       |       |       |       |       |
| **Financial  Condition:**                            |       |       |       |       |       |       |       |       |       |       |       |
| Investment  securities, available for sale           |       | $          | 50,830     |       | $          | 38,233     |       | $          | 42,597     |       | $          | 28,115 |   | $ | 18,060 |   |
| Allowance for  loan losses                           |       | 2,718      |       | 2,569      |       | 2,155      |       | 1,774      |       | 1,452      |       |
| Net loans                                            |       | 251,849    |       | 232,509    |       | 210,649    |       | 190,055    |       | 161,381    |       |
| Premises and  equipment, net                         |       | 16,139     |       | 11,681     |       | 11,803     |       | 9,377      |       | 7,908      |       |
| Total assets                                         |       | 359,537    |       | 331,662    |       | 296,807    |       | 269,714    |       | 211,598    |       |
| Noninterest-bearing  deposits                        |       | 26,428     |       | 25,418     |       | 27,973     |       | 23,149     |       | 16,714     |       |
| Interest-bearing  deposits                           |       | 248,723    |       | 228,719    |       | 194,416    |       | 186,782    |       | 147,447    |       |
| Total deposits                                       |       | 275,151    |       | 254,137    |       | 222,389    |       | 209,931    |       | 164,161    |       |
| Advances from  the Federal Home Loan Bank            |       | 43,390     |       | 43,390     |       | 43,390     |       | 36,690     |       | 26,690     |       |
| Total  liabilities                                   |       | 331,187    |       | 306,359    |       | 273,353    |       | 248,205    |       | 191,748    |       |
| Total  shareholders’ equity                     |       | 28,350     |       | 25,303     |       | 23,454     |       | 21,509     |       | 19,850     |       |
|                                                 |       |       |       |       |       |       |       |       |       |       |       |
| **Results  of Operations:**                          |       |       |       |       |       |       |       |       |       |       |       |
| Interest income                                      |       | $          | 23,680     |       | $          | 19,164     |       | $          | 15,172     |       | $          | 14,237 |   | $ | 12,366 |   |
| Interest expense                                     |       | 11,114     |       | 7,456      |       | 4,936      |       | 5,540      |       | 5,211      |       |
|                                                 |       |       |       |       |       |       |       |       |       |       |       |
| Net interest  income                                 |       | 12,566     |       | 11,708     |       | 10,236     |       | 8,697      |       | 7,155      |       |
| Provision for  loan losses                           |       | 770        |       | 1,070      |       | 1,285      |       | 857        |       | 535        |       |
| Net interest  income after provision for loan losses |       | 11,796     |       | 10,638     |       | 8,951      |       | 7,840      |       | 6,620      |       |
| Other income                                         |       | 2,604      |       | 1,931      |       | 2,156      |       | 2,002      |       | 1,708      |       |
| Other expense                                        |       | 10,308     |       | 8,903      |       | 7,961      |       | 7,436      |       | 6,550      |       |
|                                                 |       |       |       |       |       |       |       |       |       |       |       |
| Income before  income taxes                          |       | 4,092      |       | 3,666      |       | 3,146      |       | 2,406      |       | 1,778      |       |
| Income tax  expense                                  |       | 1,287      |       | 1,258      |       | 1,091      |       | 838        |       | 617        |       |
|                                                 |       |       |       |       |       |       |       |       |       |       |       |
| Net income                                           | ** ** | **$**      | **2,805**  | ** ** | **$**      | **2,408**  | ** ** | **$**      | **2,055**  | ** ** | **$**      | **1,568** | ** ** | **$** | **1,161** |   |
|                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |       |
| **Per  Share Data (1):**                             |       |       |       |       |       |       |       |       |       |       |       |
| Net income                                           |       | $          | 0.79       |       | $          | 0.68       |       | $          | 0.59       |       | $          | 0.45 |   | $ | 0.36 |   |
|                                                 |       |       |       |       |       |       |       |       |       |       |       |
| Period end book value                                |       | $          | 7.94       |       | $          | 7.08       |       | $          | 6.60       |       | $          | 6.06 |   | $ | 5.60 |   |

 

----

(1)        Adjusted for 5% stockdividends declared in February, 2001, February, 2002 and February, 2003, and the7.5% stock dividend declared in January, 2004. Adjustments have also been made for the 3% stock dividends declared inJanuary 2005 and 2006, as well as, the two-for-one stock split in the form of a100% stock dividend declared in January, 2007.

4

----

**Descriptionof Company’s Business**

HCSB FinancialCorporation (the Company) was incorporated on June 10, 1999 to become a holdingcompany for Horry County State Bank.  TheCompany’s only significant asset is its wholly owned subsidiary, Horry CountyState Bank (the Bank).  The Bank is astate-chartered bank incorporated on December 18, 1987 and located at 5201Broad Street, Loris, South Carolina.  TheCompany’s primary market includes Horry County in South Carolina and Columbusand Brunswick Counties in North Carolina. From its 11 branch locations, the Company offers a full range of depositservices, including checking accounts, savings accounts, certificates ofdeposit, money market accounts, and IRAs, as well as a broad range ofnon-deposit investment services.

The Company is primarilyengaged in the business of attracting deposits from the general public andusing these deposits together with other funds to make agricultural,commercial, consumer, and real estate loans. The Company’s operating results depend to a substantial extent on thedifference between interest and fees earned on loans and investments and theCompany’s interest expense, consisting principally of interest paid on depositsand borrowings.  Unlike most industrialcompanies, virtually all of the assets and liabilities of financialinstitutions are monetary.  As a result,interest rates have a greater effect on the financial institution’sperformance.  In addition to competingwith other traditional financial institutions, the Company also competes forsavings dollars with nontraditional financial intermediaries, such as mutualfunds.  This has resulted in a highlycompetitive market area.  The Companyattempts to compete in this highly competitive market by focusing on providingpersonal service and attention to its customers.

In 1995 the Companyopened its first branch office in the Mt. Olive community of Horry County andhas since expanded its branch network to 11 banking offices located throughoutHorry County, as well as an Operations Center in Loris, South Carolina whichhouses the Company’s support services. This expansion of its branch system has enabled the Company to moreeffectively compete for deposits and loans. By expanding into different communities, the Company has been able tosubstantially diversify its market place from one of a predominantlyagricultural  flavor to one which blendsresidential developments of retirees and others, tourism, major employmentareas, central county government and the market’s most active overall growthareas.  In so doing, the Company hasreduced considerably the seasonality in its loan portfolio as well as the risksthat are at times inherent with concentration of loans in one particularsegment of the economy.

In order to support thisgrowth in its branch network, the Company has undertaken several secondarycommon stock offerings.  Prior to itsreorganization from a bank into the holding company, Horry County State Bank undertookthree such secondary offerings of its common stock in efforts to strengthen thebank’s regulatory capital position to support projected future growth inassets.  Since the reorganization wasconsummated in 1999, the Company committed to another secondary offering in2002 whereby the Company issued an additional 365,712 shares of common stock ata price per share of $22.00, resulting in over $8,000,000 in added capital.

In December, 2004, theCompany participated in the issuance of $6,000,000 of trust preferredsecurities through its non-consolidated subsidiary HCSB Financial Trust I(the Trust) to enable the company to pursue its growth goals and  yet maintain a “well-capitalized” status asdefined by banking regulatory agencies.  This method of raising capital only recently became available tocompanies such as HCSB Financial Corporation in increments that the Companycould utilize.  It allows the Company tocontinue its growth trends without issuing additional common stock, and thusthere is no dilution of ownership among the Company’s shareholders.

During the year2006, the Company relocated some of its executive offices temporarily to thesecond floor of its branch bank at 1701 N. Oak Street, Myrtle Beach, S.C. dueto the need for additional space in its Operations Center.  The Company purchased a 5-acre tract of landin the Loris Commerce Center in 2006 and expects to begin construction of a newOperations Center on this site in 2007 in order to accommodate its executiveoffices and all support services in this new facility.  The Company intends to offer its presentOperations Center for sale.

Also in 2006 theCompany acquired a lot and 25,710 square foot building thereon at 1300 SecondAvenue, Conway, South Carolina as well as the adjacent lots which front onThird Avenue in Conway, South Carolina. In February 2007, the Company sold an interest in a portion of theseproperties to TLF Myrtle Beach Properties, LLC, the real estate ownershippartnership for the law firm of Thompson & Henry, P.A.  The Company intends to operate a full servicebranch bank in the first floor of the Second Avenue building and construct adrive-up banking facility on two

5

----

of the ThirdAvenue lots.  Thompson & Henry, P.A.will relocate its law offices to the third floor of the Second Avenue buildingand the Company and law firm intend to lease the second floor to reputabletenants.

6

----

# **Marketfor Common Share and Dividends**

As of December 31,2006, there were 3,569,874 shares of our common stock outstanding held byapproximately 2,254 shareholders of record. There is currently no established public trading market in our commonstock, and trading and quotations of our common stock have been limited andsporadic.  Because there has not been anestablished market for our common stock, we may not be aware of all prices atwhich our common stock has been traded. We have not determined whether the trades of which we are aware were theresult of arm’s-length negotiations between the parties.  Based on information available to us from alimited number of sellers and purchasers of common stock who have engaged inprivately negotiated transactions of which we are aware, we believetransactions in our common stock can be fairly summarized as follows for theperiods indicated:
| 2006           | ** ** | **Low**    | ** ** | **High**   | ** ** |
|----------------|------------|------------|------------|------------|------------|
| ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fourth Quarter |       | $          | 20.50      |       | $          | 20.50 |   |
| Third Quarter  |       | $          | 19.00      |       | $          | 20.00 |   |
| Second Quarter |       | $          | 16.00      |       | $          | 20.00 |   |
| First Quarter  |       | $          | 18.50      |       | $          | 18.50 |   |

 
| 2005           | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------|------------|------------|------------|------------|------------|
| Fourth Quarter |       | $          | 17.96      |       | $          | 18.93 |   |
| Third Quarter  |       | $          | 16.99      |       | $          | 16.99 |   |
| Second Quarter |       | $          | 16.51      |       | $          | 16.99 |   |
| First Quarter  |       | $          | 14.57      |       | $          | 16.51 |   |

 

Allshare and per share data in this report has been adjusted to reflect all stockdividends and splits declared by the Company.

No cash dividends haveever been declared or paid by the Company. However, the Board of Directors approved a 10% stock dividend for eachof the five years ending December 31, 1996. The Company also paid a two-for-one stock split in the form of a 100%stock dividend in 2000, a 5% stock dividend in each of the years 2001, 2002,and 2003, a 7.5% stock dividend in 2004, and a 3% stock dividend in 2005 and2006.  The Board of Directors hasdeclared a two-for-one stock split in the form of a 100% stock dividend payableFebruary 13, 2007 to shareholders of record January 30, 2007. **  **Management does notexpect the Company to pay cash dividends in the foreseeable future.  The Company’s ability to pay dividendsdepends on the ability of its subsidiary, Horry County State Bank, to paydividends to the Company.  As a SouthCarolina state bank, the Bank may only pay dividends out of its net profits,after deducting expenses, including losses and bad debts.  In addition, the Bank is prohibited fromdeclaring a dividend on its shares of common stock until its surplus equals itsstated capital.

7

----

# **INTRODUCTION**

The followingdiscussion describes our results of operations for 2006 as compared to 2005 andalso analyzes our financial condition as of December 31, 2006 as compared toDecember 31, 2005.  Like most communitybanks, we derive most of our income from interest we receive on our loans andinvestments.  Our primary source of fundsfor making these loans and investments is our deposits, both interest-bearingand noninterest-bearing.  Consequently,one of the key measures of our success is our amount of net interest income, orthe difference between the income on our interest-earning assets, such as loansand investments, and the expense on our interest-bearing liabilities, such asdeposits and borrowed funds.  In order tomaximize our net interest income, we must not only manage the volume of thesebalance sheet items, but also the yields that we earn on our interest-earningassets and the rates that we pay on interest-bearing liabilities.

We have included anumber of tables to assist in our description of these measures.  For example, the “Average Balances” tableshows the average balance during 2006, 2005, and 2004 of each category of ourassets and liabilities, as well as the yield we earned or the rate we paid withrespect to each category.  A review ofthis table shows that our loans typically provide higher interest yields thando other types of interest earning assets, which is why we direct a substantialpercentage of our earning assets into our loan portfolio.  Similarly, the “Rate/Volume Analysis” tablehelps demonstrate the impact of changing interest rates and changing volume ofassets and liabilities during the years shown. We also track the sensitivity of our various categories of assets andliabilities to changes in interest rates, and we have included an “InterestRate Sensitivity Analysis” table to help explain this.  Finally, we have included a number of tablesthat provide details about our investment securities, our loans, and ourdeposits and other borrowings.

Of course, thereare risks inherent in all loans, so we maintain an allowance for loan losses toabsorb probable losses on existing loans that may become uncollectible.  We establish and maintain this allowance bycharging a provision for loan losses against our operating earnings.  In the Loan Portfolio section we haveincluded a detailed discussion of this process, as well as several tablesdescribing our allowance for loan losses and the allocation of this allowanceamong our various categories of loans.

In addition to earninginterest on our loans and investments, we earn income through fees that wecharge to our customers. Likewise, we incur other operating expenses aswell.  We describe the various componentsof this noninterest income, as well as our noninterest expense, in the OtherIncome and Other Expense section.

**GENERAL**

With the rising interestrate environment, the bank continued to grow throughout 2006.  Total assets increased by $27,875,000, or8.40 %, and net loans increased by $19,340,000, or 8.32 %.  Much of this growth is attributable to thesuccess of our branch network, especially the office in Myrtle Beach.

Profitability continued asteady upward trend in 2006.  Net incomeincreased by 16.49 %, from $2,408,000 in 2005 to $2,805,000 in 2006, primarilyas a result of increased income from loans and related fees.  The growth of the loan portfolio resulted ina loan to deposit ratio of 92.52%.  TheCompany will need to attract additional deposits, borrow more money, or acombination of the two to continue expansion of the loan portfolio.  A more detailed discussion of the factorscontributing to growth and challenges is presented below.

8

----

# **RESULTSOF OPERATIONS**

The Company experiencedan increase of $3,674,000, or 21.94 %, in interest income on loans and relatedfees for the year ended December 31, 2006. Because of the rising interest rate environment and increase in growthin interest-bearing deposits, total interest expense increased $3,658,000, or49.06 %, to $11,114,000.  Although netinterest income increased significantly during 2006, the Company alsoexperienced a significant increase in noninterest expense during 2006.  The primary factor contributing to theincrease of noninterest expense was salaries and employee benefits, whichincreased $1,000,000, or 19.99%, from $5,002, 000 for the year ended December31, 2005.  This increase was primarily aresult of normal salary increases of existing employees during the year and theadditional hiring of employees especially those needed to operate the newCarolina Forest office.  Overall, theCompany had net income for the year ended December 31, 2006 of $2,805,000,compared to $2,408,000 for the year ended December 31, 2005.  This represents an increase in net income of$397,000, or 16.49%.

# **ASSETS,LIABILITIES, AND SHAREHOLDERS’ EQUITY**

During the twelvemonths ended December 31, 2006, total assets increased $27,875,000, or 8.4%,when compared to December 31, 2005.  Theprimary reason for the increase in total assets was an increase in net loans of$19,340,000, or 8.32%, during 2006 from $232,509,000 at December 31, 2005.  Total deposits increased  $21,014,000, or 8.27%, from theDecember 31, 2005 amount of $254,137,000. Within the deposit area, interest-bearing deposits increased$20,004,000, or 8.75%, and noninterest-bearing deposits increased $1,010,000,or 3.97%, during 2006.  The increase indeposits was primarily due to the increase in our Horry Prime InsuredInvestment account, which increased $41,323,000, or 97.29%, from $42,472,000 atDecember 31, 2005 to $83,795,000 at December 31, 2006.

# **DISTRIBUTIONOF ASSETS, LIABILITIES, AND SHAREHOLDERS’ EQUITY**

The Company hassought to maintain a conservative approach in determining the distribution ofits assets and liabilities. The following table presents the percentagerelationships of significant components of the Company’s average balance sheetsfor the last three fiscal years.

9

----

**BalanceSheet Categories as a Percent of Average Total Assets**
|                                                  | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Assets:**                                      |       |       |       |       |       |       |       |
| Interest earning assets:                         |       |       |       |       |       |       |       |
| Federal funds sold                               |       | 5.86       | %          | 6.67       | %          | 4.68       | %          |
| Time deposits with other banks                   |       | —     |       | 0.06       |       | 0.01       |       |
| Investment securities                            |       | 14.36      |       | 13.84      |       | 11.86      |       |
| Loans                                            |       | 71.72      |       | 70.87      |       | 75.19      |       |
| Total interest earning assets                    |       | 91.94      |       | 91.44      |       | 91.74      |       |
| Cash and due from banks                          |       | 3.06       |       | 3.79       |       | 3.77       |       |
| Allowance for loan losses                        |       | (0.77      | )          | (0.73      | )          | (.71       | )          |
| Premises and equipment                           |       | 3.75       |       | 3.51       |       | 3.66       |       |
| Other assets                                     |       | 2.02       |       | 1.99       |       | 1.54       |       |
| Total assets                                     | ** ** | **100.00** | **%**      | **100.00** | **%**      | **100.00** | **%**      |
|                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Liabilities  and shareholders’ equity:**  |       |       |       |       |       |       |       |
| Interest-bearing liabilities:                    |       |       |       |       |       |       |       |
| Interest-bearing deposits                        |       | 68.82      | %          | 68.17      | %          | 69.09      | %          |
| Federal funds purchased                          |       | —     |       | —     |       | .01        |       |
| Advances from the Federal Home Loan Bank         |       | 12.57      |       | 13.57      |       | 13.20      |       |
| Notes Payable                                    |       | 0.25       |       | —     |       | —     |       |
| Debt due to trust                                |       | 1.79       |       | 1.94       |       | —     |       |
| Total interest-bearing liabilities               |       | 83.43      |       | 83.68      |       | 82.30      |       |
|                                             |       |       |       |       |       |       |       |
| Noninterest-bearing deposits                     |       | 7.94       |       | 7.95       |       | 9.60       |       |
| Accrued interest and other liabilities           |       | 0.87       |       | 0.71       |       | 0.56       |       |
| Total liabilities                                |       | 92.24      |       | 92.34      |       | 92.46      |       |
| Shareholders’ equity                        |       | 7.76       |       | 7.66       |       | 7.54       |       |
| Total liabilities  and shareholders’ equity | ** ** | **100.00** | **%**      | **100.00** | **%**      | **100.00** | **%**      |

 

**NETINTEREST INCOME**

Earnings aredependent to a large degree on net interest income.  Net interest income represents the differencebetween gross interest earned on earning assets, primarily loans and investmentsecurities, and interest paid on deposits and borrowed funds. Net interestincome is affected by the interest rates earned or paid and by volume changesin loans, investment securities, deposits, and borrowed funds.  The interest rate spread and the net yield onearning assets are two significant elements in analyzing the Company’s netinterest income.  The interest ratespread is the difference between the yield on average earning assets and therate on average interest-bearing liabilities. The net yield on earning assets is computed by dividing net interestincome by the average earning assets.

For the year endedDecember 31, 2006, net interest income was $12,566,000, an increase of$858,000, or 7.33%, over net interest income of $11,708,000 in 2005.  Interest income from loans, including fees,was $20,417,000, an increase of $3,674,000, or 21.94%, from 2005 to 2006 asdemand for loans in the Company’s marketplace continued to grow and ratescontinued to rise. Interest expense for the year ended December 31, 2006 was$11,114,000, compared to $7,456,000 for 2005. This represents a increase of $3,656,000, or 49.06%, compared to theprior year.  The interest rate spread andnet yield on earning assets reflected the pressure created by the risinginterest rate environment when compared to the previous year as our customersbegan to move more of their money out of interest bearing demand deposits intoMoney Market deposit accounts, which increased $41,323,000, or 97.29%,throughout 2006.  Our Money Marketdeposit accounts reprice with prime, which has become very attractive to ourcustomers in a rising interest rate environment.  The net yield realized on earning assets was3.96% for 2006, compared to 4.01% in 2005. The interest rate spread was 3.60% and 3.77% in 2006 and 2005,respectively.

10

----

The followingtable sets forth, for the periods indicated, the weighted-average yieldsearned, the weighted-average yields paid, the interest rate spread, and the netyield on earning assets.  The table alsoindicates the average daily balance and the interest income or expense byspecific categories.

**AverageBalances, Income and Expenses, and Rates**
| ** **                                      | ** ** | **2006**    | ** **  | **2005**    | ** ** | **2004**   | ** ** |
|-------------------------------------------------|------------|-------------|-------------|-------------|------------|------------|------------|
| **Year ended December 31,**      | ** ** | **Average** | ** **  | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** |
| **(Dollars in thousands)**            | ** ** | **Balance** | ** **  | **Expense** | ** ** | **Rate**   | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets:**                                     |       |        |        |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Earning Assets:                                 |       |        |        |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Securities, taxable                             |       | $           | 39,395      |        | $          | 1,869      |       | 4.74 |   | $ | 35,499 |   | $ | 1,391 |   | 3.92 | % | $ | 27,223 |   | $ | 850 |   | 3.12 | % |
| Securities, nontaxable                          |       | 7,273       |        | 274         |       | 3.77       |       | 5,897 |   | 225 |   | 3.82 |   | 4,186 |   | 165 |   | 3.94 |   |
| Loans (1)                                       |       | 247,614     |        | 20,417      |       | 8.25       |       | 226,528 |   | 16,743 |   | 7.39 |   | 211,028 |   | 13,921 |   | 6.60 |   |
| Federal funds sold                              |       | 20,230      |        | 964         |       | 4.77       |       | 21,330 |   | 694 |   | 3.25 |   | 13,350 |   | 170 |   | 1.27 |   |
| Time deposits with other banks                  |       | —      |        | —      |       | —     |       | 183 |   | 4 |   | 2.19 |   | 3 |   | — |   | — |   |
| Nonmarketable equity securities                 |       | 2,933       |        | 156         |       | 5.32       |       | 2,830 |   | 107 |   | 3.78 |   | 1,912 |   | 66 |   | 3.45 |   |
| Total earning assets                            |       | 317,445     | ** **  | **$**       | **23,680** |       | 7.46       |   | 292,267 | ** ** | **$** | **19,164** |   | 6.56 |   | 257,702 | ** ** | **$** | **15,172** |   | 5.89 |   |
| Cash and due from banks                         |       | 10,572      |        |        |       |       |       | 12,113 |   |   |   |   |   | 10,384 |   |   |   |   |   |
| Allowance for loan losses                       |       | (2,673      | )           |        |       |       |       |   |   | (2,328 | ) |   |   |   |   | (2,000 | ) |   |   |
| Premises and equipment                          |       | 12,966      |        |        |       |       |       | 11,224 |   |   |   |   |   | 10,289 |   |   |   |   |   |
| Other assets                                    |       | 6,961       |        |        |       |       |       | 6,356 |   |   |   |   |   | 4,383 |   |   |   |   |   |
| Total assets                                    | ** ** | **$**       | **345,271** | ** **  | ** ** | ** ** | ** ** |   |   |   | **$** | **319,632** |   |   |   |   |   | **$** | **280,758** |   |   |   |
| ** **                                      |       |        |        |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities:**                                |       |        |        |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Bearing Liabilities:                   |       |        |        |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits                       |       | $           | 237,599     |        | $          | 8,391      |       | 3.53 | % | $ | 217,905 |   | $ | 5,271 |   | 2.42 | % | $ | 193,981 |   | $ | 3,542 |   | 1.83 | % |
| Other borrowings                                |       | 50,446      |        | 2,723       |       | 5.40       |       | 49,576 |   | 2,185 |   | 4.41 |   | 37,336 |   | 1,394 |   | 3.73 |   |
| Total interest-bearing liabilities              |       | 288,045     |        | 11,114      |       | 3.86       |       | 267,481 |   | 7,456 |   | 2.79 |   | 231,317 |   | 4,936 |   | 2.13 |   |
| Noninterest-bearing deposits                    |       | 27,415      |        |        |       |       |       | 25,402 |   |   |   |   |   | 26,946 |   |   |   |   |   |
| Accrued interest and other liabilities          |       | 3,006       |        |        |       |       |       | 2,265 |   |   |   |   |   | 1,339 |   |   |   |   |   |
| Shareholders’ equity                       |       | 26,805      |        |        |       |       |       | 24,484 |   |   |   |   |   | 21,156 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | **$**       | **345,271** |        |       |       |       |   | **$** | **319,632** |   |   |   |   |   | **$** | **280,758** |   |   |   |   |   |
| Net interest  income/spread                     | ** ** | ** **  |        | **$**       | **12,566** | ** ** | 3.60       | % |   | ** ** | **$** | **11,708** |   | 3.77 | % |   |   | **$** | **10,236** |   | 3.75 | % |
| Net interest margin                             |       |        |        |        |       | 3.96       | %          |   |   |   |   | 4.01 | % |   |   |   |   | 3.97 | % |

 

----

(1)   The effects of loans in nonaccrual status andfees collected are not significant to the computations.

11

----

**RATE/VOLUMEANALYSIS**

Net interest income can alsobe analyzed in terms of the impact of changing rates and changing volume.  The following table describes the extent towhich changes in interest rates and changes in the volume of earning assets andinterest-bearing liabilities have affected the Company’s interest income andinterest expense during the periods indicated. Information on changes in eachcategory attributable to (i) changes due to volume (change in volume multipliedby prior period rate), (ii) changes due to rates (changes in rates multipliedby prior period volume), and (iii) changes in rate and volume (change in ratemultiplied by the change in volume) is provided as follows:
| ** **                           | ** ** | **2006 compared to 2005**              | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                           | ** ** | **Due to increase (decrease) in** | ** ** |
| **(Dollars in thousands)** | ** ** | **Volume(1)**                                         | ** ** | **Rate (1)** | ** ** | **Volume/Rate** | ** ** | **Total** | ** ** |
| Interest income:                     |       |                                                  |       |   |   |   |   |   |   |
| Taxable securities                   |       | $                                                     | 153        |   | $ | 293 |   | $ | 32 |   | $ | 478 |   |
| Nontaxable securities                |       | 53                                                    |       | (3 | ) | (1 | ) | 49 |   |
| Loans                                |       | 1,558                                                 |       | 1,935 |   | 181 |   | 3,674 |   |
| Federal funds sold                   |       | (36                                                   | )          | 323 |   | (17 | ) | 270 |   |
| Time deposits with other banks       |       | (4                                                    | )          | — |   | — |   | (4 | ) |
| Nonmarketable equity securities      |       | 4                                                     |       | 43 |   | 2 |   | 49 |   |
| Total interest income                |       | 1,728                                                 |       | 2,591 |   | 197 |   | 4,516 |   |
|                                 |       |                                                  |       |   |   |   |   |   |   |
| Interest  expense:                   |       |                                                  |       |   |   |   |   |   |   |
| Interest-bearing deposits            |       | 476                                                   |       | 2,424 |   | 219 |   | 3,120 |   |
| Other borrowings                     |       | 38                                                    |       | 491 |   | 9 |   | 538 |   |
| Total interest expense               |       | 514                                                   |       | 2,915 |   | 228 |   | 3,658 |   |
| Net interest  income                 | ** ** | **$**                                                 | **1,214**  | ** ** | **$** | **(324** | **)** | **$** | **(31** | **)** | **$** | **858** | ** ** |

 
| ** **                           | ** ** | **2005 compared to 2004**              | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                           | ** ** | **Due to increase (decrease) in** | ** ** |
| **(Dollars in thousands)** | ** ** | **Volume(1)**                                         | ** ** | **Rate (1)** | ** ** | **Volume/Rate** | ** ** | **Total** | ** ** |
| Interest income:                     |       |                                                  |       |   |   |   |   |   |   |
| Taxable securities                   |       | $                                                     | 193        |   | $ | 162 |   | $ | 186 |   | $ | 541 |   |
| Nontaxable securities                |       | 50                                                    |       | (4 | ) | 14 |   | 60 |   |
| Loans                                |       | 765                                                   |       | 1,254 |   | 803 |   | 2,822 |   |
| Federal funds sold                   |       | 76                                                    |       | 198 |   | 250 |   | 524 |   |
| Time deposits with other banks       |       | —                                                |       | — |   | 4 |   | 4 |   |
| Nonmarketable equity securities      |       | 24                                                    |       | 5 |   | 12 |   | 41 |   |
| Total interest income                |       | 1,108                                                 |       | 1,615 |   | 1,269 |   | 3,992 |   |
|                                 |       |                                                  |       |   |   |   |   |   |   |
| Interest  expense:                   |       |                                                  |       |   |   |   |   |   |   |
| Interest-bearing deposits            |       | 327                                                   |       | 860 |   | 542 |   | 1,729 |   |
| Other borrowings                     |       | 169                                                   |       | 136 |   | 486 |   | 791 |   |
| Total interest expense               |       | 496                                                   |       | 996 |   | 1,028 |   | 2,520 |   |
| Net interest  income                 | ** ** | **$**                                                 | **612**    | ** ** | **$** | **619** | ** ** | **$** | **241** | ** ** | **$** | **1,472** | ** ** |

 

----

(1)  Volume-ratechanges have been allocated to each category based on a consistent basisbetween rate and volume.

12

----

**RATESENSITIVITY**

Interest rates paid ondeposits and borrowed funds and interest rates earned on loans and investmentshave generally followed the fluctuations in market rates in 2006 and 2005.  However, fluctuations in market interestrates do not necessarily have a significant impact on net interest income,depending on the Company’s interest rate sensitivity position. A rate-sensitiveasset or liability is one that can be repriced either up or down in interestrate within a certain time interval. When a proper balance exists betweenrate-sensitive assets and rate-sensitive liabilities, market interest ratefluctuations should not have a significant impact on liquidity andearnings.  The larger the imbalance, thegreater the interest rate risk assumed and the greater the positive or negativeimpact of interest fluctuations on liquidity and earnings.

Interest ratesensitivity management is concerned with the management of both the timing andthe magnitude of repricing characteristics of interest-earning assets andinterest-bearing liabilities and is an important part of asset/liabilitymanagement.  The objectives of interestrate sensitivity management are to ensure the adequacy of net interest incomeand to control the risks to net interest income associated with movements ininterest rates.  The following table, “InterestRate Sensitivity Analysis,” indicates that, on a cumulative basis, after threethrough twelve months, rate-sensitive liabilities exceeded rate-sensitiveassets, resulting in a twelve month liability sensitive position.  For a bank with a liability-sensitiveposition, or negative gap, falling interest rates would generally be expectedto have a positive effect on net interest income, and rising interest rateswould generally be expected to have the opposite effect.  The following table presents the Company’srate sensitivity at each of the time intervals indicated as of December 31,2006 and may not be indicative of the Company’s rate-sensitivity position atother points in time:

**InterestRate Sensitivity Analysis**
| ** **                                       | ** ** | ** **          | ** ** | **After One** | ** ** | **After Three** | ** ** | ** ** | ** **  | **Greater**       | ** ** | ** **  | ** ** |
|--------------------------------------------------|------------|---------------------|------------|--------------------|------------|----------------------|------------|------------|-------------|-------------------|------------|-------------|------------|
| ** **                                       | ** ** | ** **          | ** ** | **Through**        | ** ** | **Through**          | ** ** | **Within** | ** **  | **Than One** | ** ** | ** **  | ** ** |
| **December 31, 2006**                  | ** ** | **Within One** | ** ** | **Three**          | ** ** | **Twelve**           | ** ** | **One**    | ** **  | **Year or**  | ** ** | ** **  | ** ** |
| **(Dollars in thousands)**             | ** ** | **Month**           | ** ** | **Months**         | ** ** | **Months**           | ** ** | **Year**   | ** **  | **Non-Sensitive** | ** ** | **Total**   | ** ** |
| **Assets**                                       |       |                |       |               |       |                 |       |       |        |              |       |        |       |
| Interest-earning  assets                         |       |                |       |               |       |                 |       |       |        |              |       |        |       |
| Federal fund sold                                |       | $                   | 19,238     |               | $          | —               |       | $          | —      |              | $          | 19,238      |       | $ | — |   | $ | 19,238 |   |
| Loans                                            |       | 127,135             |       | 3,870              |       | 19,097               |       | 150,102    |        | 106,698           |       | 256,800     |       |
| Securities                                       |       | —              |       | —             |       | 495                  |       | 495        |        | 53,283            |       | 53,778      |       |
| Total earning assets                             |       | 146,373             |       | 3,870              |       | 19,592               |       | 169,835    |        | 159,981           |       | 329,816     |       |
|                                             |       |                |       |               |       |                 |       |       |        |              |       |        |       |
| **Liabilities**                                  |       |                |       |               |       |                 |       |       |        |              |       |        |       |
| Interest-bearing  liabilities:                   |       |                |       |               |       |                 |       |       |        |              |       |        |       |
| Interest-bearing deposits:                       |       |                |       |               |       |                 |       |       |        |              |       |        |       |
| Demand deposits                                  |       | 53,693              |       | —             |       | —               |       | 53,693     |        | —            |       | 53,693      |       |
| Savings deposits                                 |       | 89,089              |       | —             |       | —               |       | 89,089     |        | —            |       | 89,089      |       |
| Time deposits                                    |       | 7,028               |       | 14,358             |       | 77,351               |       | 98,737     |        | 7,204             |       | 105,941     |       |
| Total interest-bearing deposits                  |       | 149,810             |       | 14,358             |       | 77,351               |       | 241,519    |        | 7,204             |       | 248,723     |       |
| Other borrowings                                 |       | —              |       | —             |       | —               |       | —     |        | 43,390            |       | 43,390      |       |
| Junior  subordinated debentures                  |       | —              |       | —             |       | —               |       | —     |        | 6,186             |       | 6,186       |       |
| Total interest-bearing liabilities               |       | 149,810             |       | 14,358             |       | 77,351               |       | 241,519    |        | 56,780            |       | 298,299     |       |
| Period gap                                       | ** ** | **$**               | **(3,437** | **)**              | **$**      | **(10,488**          | **)**      | **$**      | **(57,759** | **)**             | **$**      | **(71,684** | **)**      | **$** | **103,201** |   |   |   |
| Cumulative gap                                   | ** ** | **$**               | **(3,437** | **)**              | **$**      | **(13,925**          | **)**      | **$**      | **(71,684** | **)**             | **$**      | **(71,684** | **)**      | **$** | **31,517** |   |   |   |
| Ratio of cumulative gap  to total earning assets |       | (1.04               | )%         | (4.22              | )%         | (21.73               | )%         | (21.73     | )%          | 9.56              | %          |        |       |
|                                                  |            |                     |            |                    |            |                      |            |            |             |                   |            |             |            |  |  |  |  |  |  |

 

13

----

**PROVISIONFOR LOAN LOSSES**

The provision forloan losses is charged to earnings based upon management’s evaluation ofspecific loans in its portfolio and general economic conditions and trends inthe marketplace.  The 2006 and 2005provisions for loan losses and their related effect of increasing the allowancefor loan losses are related to growth in the loan portfolio.  Please refer to the section “Loan Portfolio”for a discussion of management’s evaluation of the adequacy of the allowancesfor loan losses. In 2006 and 2005, the provisions for loan losses were $770,000and $1,070,000, respectively.

# **NONINTERESTINCOME**

Noninterest incomewas $2,604,000 for the year ended December 31, 2006, an increase of $673,000,or 34.85%, when compared with the year ended December 31, 2005.  The increase is primarily a result of feeincome of $542,000 from residential mortgage loans sold in the secondary marketfor the year ended December 31, 2006 as compared to $155,000 for the same periodin 2005, an increase of $387,000, or 249.68%. This increase is largely due to additional staffing in our mortgagelending department as well as an increased marketing effort.  This trend may continue as the bank expandsits branch network and employs additional staffing in this area, but it couldbe negatively affected by a potential general downturn in the local housingmarket.  This increase in noninterestincome is also a result of an increase of $123,000, or 74.10%, in brokeragecommissions related to the sale of non-deposit investment products from$166,000 for the year ended December 31, 2005 to $289,000 for the year endedDecember 31, 2006.  In addition, servicecharges on deposit accounts increased $97,000, or 7.28%, from $1,332,000 forthe year ended December 31, 2005 to $1,429,000 for the year ended December 31,2006.

# **NONINTERESTEXPENSES**

Most categories ofnoninterest expenses increased during 2006 due to continued growth of theCompany.  Salaries and employee benefitsincreased $1,000,000, or 19.99%, due to a normal salary increases amongexisting employees as well as an increase in the number of employees due to theexpansion of the branch network.  Also,marketing and advertising expenses increased $131,000, or 55.74%, from $235,000for the year ended December 31, 2005 to $366,000 for the year ended December31, 2006. In addition, furniture and equipment expenses also increased$124,000, due mainly to the opening of a new branch in the Carolina Forest areain October 2006. Other operating expenses were $2,160,000 for the year endedDecember 31, 2006, compared to $1,955,000for the year ended December31, 2005.

## **INCOME TAXES**

The Company’sincome tax expense for 2006 was $1,287,000, an increase of $29,000 from the2005 expense of $1,258,000. The increase in the expense results from increasedincome before taxes.  The Company’seffective tax rates for the years ended December 31, 2006 and 2005 were 31.45%and 34.32%, respectively.

# **LIQUIDITY**

Liquidity is theability to meet current and future obligations through liquidation or maturity ofexisting assets or the acquisition of additional liabilities.  The Company manages both assets andliabilities to achieve appropriate levels of liquidity.  Cash and federal funds sold are the Company’sprimary sources of asset liquidity. These funds provide a cushion against short-term fluctuations in cashflow from both deposits and loans.  Theinvestment securities portfolio is the Company’s principal source of secondaryasset liquidity.  However, theavailability of this source of funds is influenced by market conditions.  Individual and commercial deposits are theCompany’s primary source of funds for credit activities.  Although not historically used as principalsources of liquidity, federal funds purchased from correspondent banks andadvances from the Federal Home Loan Bank are other options available tomanagement.

As of December 31,2006, the Company had unused lines of credit to purchase federal funds fromunrelated banks totaling $16,500,000. These lines of credit are available on a one to fourteen day basis forgeneral corporate purposes.  The lendershave reserved the right not to renew their respective lines.  Unpledged securities available-

14

----

for-sale, whichtotaled $21,329,000 at December 31, 2006, also serve as a ready source ofliquidity. Management believes that the Company’s liquidity sources areadequate to meet its operating needs. The level of liquidity is measured by the loans-to-total borrowed fundsratio, which was at 79.92% and 79.01% at December 31, 2006 and 2005,respectively.

15

----

# **IMPACT OFOFF-BALANCE-SHEET INSTRUMENTS**

The Company is a party tofinancial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  These financial instruments consist ofcommitments to extend credit and standby letters of credit.  Commitments to extend credit are legallybinding agreements to lend to a customer at predetermined interest rates aslong as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require payment ofa fee.  A commitment involves, to varyingdegrees, elements of credit and interest rate risk in excess of the amountrecognized in the balance sheets.  TheCompany’s exposure to credit loss in the event of nonperformance by the otherparty to the instrument is represented by the contractual notional amount ofthe instrument.  Since certaincommitments are expected to expire without being drawn upon, the totalcommitment amounts do not necessarily represent future cash requirements.  Letters of credit are conditional commitmentsissued to guarantee a customer’s performance to a third party and haveessentially the same credit risk as other lending facilities.  Standby letters of credit often expirewithout being used.  Management believesthat through various sources of liquidity, the Company has the necessaryresources to meet obligations arising from these financial instruments.

The Company uses the samecredit underwriting procedures for commitments to extend credit and standbyletters of credit as for on-balance-sheet instruments.  The credit worthiness of each borrower isevaluated and the amount of collateral, if deemed necessary, is based on thecredit evaluation.  Collateral held forcommitments to extend credit and standby letters of credit varies but mayinclude accounts receivable, inventory, property, plant, equipment, andincome-producing commercial properties, as well as liquid assets such as timedeposit accounts, brokerage accounts, and cash value of life insurance.

The Company is notinvolved in off-balance-sheet contractual relationships, other than thosedisclosed in this report, which it believes could result in liquidity needs orother commitments or that could significantly impact earnings.

As of December 31, 2006, commitments to extend credittotaled $37,852,000 and standby letters of credit totaled $814,000.

The following table sets forth the length of timeuntil maturity for unused commitments to extend credit and standby letters ofcredit at December 31, 2006.
|                                      | ** ** | ** ** | ** ** | **After One** | ** ** | **After Three** | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|--------------------|------------|----------------------|------------|------------|------------|-------------------|------------|------------|------------|
| ** **                           | ** ** | **Within** | ** ** | **Through**        | ** ** | **Through**          | ** ** | **Within** | ** ** | **Greater**       | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **One**    | ** ** | **Three**          | ** ** | **Twelve**           | ** ** | **One**    | ** ** | **Than**          | ** ** | ** ** | ** ** |
| **(Dollars in thousands)** | ** ** | **Month**  | ** ** | **Months**         | ** ** | **Months**           | ** ** | **Year**   | ** ** | **One Year** | ** ** | **Total**  | ** ** |
| Unused  commitments to extend credit |       | $          | 1,073      |               | $          | 3,843                |       | $          | 20,233     |              | $          | 25,149     |       | $ | 12,703 |   | $ | 37,852 |   |
| Standby letters  of credit           |       | —     |       | 100                |       | 707                  |       | 807        |       | 7                 |       | 814        |       |
|                                 |       |       |       |               |       |                 |       |       |       |              |       |       |       |
| Totals                               | ** ** | **$**      | **1,073**  | ** **         | **$**      | **3,943**            | ** ** | **$**      | **20,940** | ** **        | **$**      | **25,956** | ** ** | **$** | **12,710** | ** ** | **$** | **38,666** |   |

 

The Company entered into interest swap agreementsassociated with Federal Home Loan Bank advances during the third quarter of2003.  The interest rate swapseffectively converted the fixed interest rates on the advances to a variablerate. The notional amount of advances involved in this transaction totaled$14,600,000.  The unrealized gain relatedto the interest rate swaps was $788,000 at December 31, 2006.  The Company believes that the hedging of suchdebt was very effective as management protected against further declines ininterest rates as well as a continuation of interest rates at  or near their low levels at the time thetransaction was consummated.

16

----

# **IMPACT OFINFLATION AND CHANGING PRICES**

The financialstatements and related financial data presented herein have been prepared inaccordance with generally accepted accounting principles which require themeasurement of financial position and operating results in terms of historicaldollars without considering changes in relative purchasing power over time dueto inflation.  Unlike most industrialcompanies, virtually all of the assets and liabilities of a financialinstitution are monetary in nature.  As aresult, interest rates generally have a more significant impact on a financialinstitution’s performance than does the effect of inflation.

While the effectof inflation on a bank is normally not as significant as its influence on thosebusinesses that have large investments in plant and inventories, it does havean effect.  Interest rates generally increaseas the rate of inflation increases, but the magnitude of the change in ratesmay not be the same.  While interestrates have traditionally moved with inflation, the effect on income isdiminished because both interest earned on assets and interest paid onliabilities vary directly with each other unless the Company is in a highliability sensitive position.  Also,general increases in the price of goods and services will result in increasedoperating expenses.

# **CAPITALRESOURCES**

The Company uses severalindicators of capital strength.  The mostcommonly used measure is average common equity to average assets, which was7.76% in 2006 compared to 7.66% in 2005. The change in this ratio reflects an increase in earnings at a greaterrate than the growth in the Company’s assets in 2006.

The Company andthe Bank are subject to various regulatory capital requirements administered bythe federal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a materialeffect on the Company’s financial statements. Under capital adequacy guidelinesand the regulatory framework for prompt corrective action, the Company and theBank must meet specific capital guidelines that involve quantitative measuresof their assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The capital amounts and classifications are also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.

The FederalReserve guidelines contain an exemption from the capital requirements for“small bank holding companies.”  On March 31, 2006, the FederalReserve changed the definition of a small bank holding company to bankholding companies with less than $500 million in total assets (an increase from$150 million under the prior rule).  However, bank holding companieswill not qualify under the new definition if they (i) are engaged insignificant non-banking activities either directly or indirectly through asubsidiary, (ii) conduct significant off-balance sheet activities, includingsecuritizations or managing or administering assets for third parties, or (iii)have a material amount of debt or equity securities (including trust preferredsecurities) outstanding that are registered with the SEC.  Although wehave less than $500 million in assets, it is unclear at this point whether weotherwise meet the requirements for qualifying as a “small bank holdingcompany.”  According to the Federal Reserve Board, the revision of thecriterion to exclude any bank holding company that has outstanding a materialamount of SEC-registered debt or equity securities reflects the fact that SECregistrants typically exhibit a degree of complexity of operations and accessto multiple funding sources that warrants excluding them from the new policystatement and subjecting them to the capital guidelines.  In theadopting release for the new rule, the Federal Reserve Board stated that whatconstitutes a “material” amount of SEC-registered debt or equity for aparticular bank holding company depends on the size, activities and conditionof the relevant bank holding company.  In lieu of using fixed measurableparameters of materiality across all institutions, the rule provides theFederal Reserve with supervisory flexibility in determining, on acase-by-case basis, the significance or materiality of activities or securitiesoutstanding such that a bank holding company should be excluded from the policystatement and subject to the capital guidelines.  Until the Federal Reserve provides furtherguidance on the new rules, it will be unclear whether our holding company willbe subject to the exemption from the capital requirements for small bankholding companies.  Regardless, both theCompany and the Bank are currently “well capitalized” under these minimumcapital requirements as set per bank regulatory agencies.

17

----

Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum ratios of Tier 1 and total capital asa percentage of assets and off-balance-sheet exposures, adjusted for riskweights ranging from 0% to 100%.  Tier 1capital consists of common shareholders’ equity, excluding the unrealized gainor loss on securities available-for-sale, minus certain intangible assets.  Tier 2 capital consists of the allowance forloan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists ofthe sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 and 8% for totalrisk-based capital.

The Company andthe Bank are also required to maintain capital at a minimum level based onquarterly average assets, which is known as the leverage ratio.  Only the strongest banks are allowed tomaintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios1% to 2% above the minimum.

As of December 31, 2006,the most recent notifications from the Bank’s primary regulator categorized theBank as well-capitalized under the regulatory framework for prompt correctiveaction.  There are no conditions orevents that management believes have changed the Bank’s category.

# The Company and the Bank arerequired to maintain certain risk-based and leverage ratios.  The Company and the Bank exceeded theseregulatory capital ratios at December 31, 2006, 2005, and 2004 as set forth inthe following tables.

| December 31,  (Dollars in thousands)                 | ** ** | **2006**   | ** **  | **2005**   | ** ** | **2004**    | ** ** |
|---------------------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| ** **                                                          | ** ** | ** ** | ** **  | ** ** | ** ** | ** **  | ** ** |
| **The  Company**                                                    |       |       |        |       |       |        |       |
| Tier 1 capital                                                      |       | $          | 34,773      |       | $          | 31,855      |       | $ | 29,472 |   |
| Tier 2 capital                                                      |       | 2,718      |        | 2,569      |       | 2,155       |       |
| Total qualifying capital                                            | ** ** | **$**      | **37,491**  | ** ** | **$**      | **34,424**  | ** ** | **$** | **31,627** | ** ** |
|                                                                | ** ** | ** ** | ** **  | ** ** | ** ** | ** **  | ** ** |
| Risk-adjusted total  assets (including off-balance-sheet exposures) |       | **$**      | **270,498** |       | **$**      | **249,307** |       | **$** | **226,418** |   |
|                                                                |       | ** ** |        | ** ** |       | ** **  |       |
| Tier 1 risk-based capital ratio                                     |       | 12.86      | %           | 12.78      | %          | 13.02       | %          |
| Total risk-based capital ratio                                      |       | 13.86      | %           | 13.81      | %          | 13.97       | %          |
| Tier 1 leverage  ratio                                              |       | 10.07      | %           | 9.61       | %          | 10.09       | %          |

 
| December 31,  (Dollars in thousands)                           | ** ** | **2006**   | ** **  | **2005**   | ** ** | **2004**    | ** ** |
|---------------------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| ** **                                                          | ** ** | ** ** | ** **  | ** ** | ** ** | ** **  | ** ** |
| **The  Bank**                                                       |       |       |        |       |       |        |       |
| Tier 1 capital                                                      |       | $          | 33,885      |       | $          | 30,664      |       | $ | 28,003 |   |
| Tier 2 capital                                                      |       | 2,718      |        | 2,569      |       | 2,155       |       |
| Total qualifying  capital                                           | ** ** | **$**      | **36,603**  | ** ** | **$**      | **33,233**  | ** ** | **$** | **30,158** | ** ** |
|                                                                | ** ** | ** ** | ** **  | ** ** | ** ** | ** **  | ** ** |
| Risk-adjusted  total assets (including off-balance-sheet exposures) |       | **$**      | **266,373** |       | **$**      | **248,743** |       | **$** | **225,480** |   |
|                                                                |       | ** ** |        | ** ** |       | ** **  |       |
| Tier 1 risk-based capital ratio                                     |       | 12.72      | %           | 12.33      | %          | 12.42       | %          |
| Total risk-based capital ratio                                      |       | 13.74      | %           | 13.36      | %          | 13.38       | %          |
| Tier 1 leverage  ratio                                              |       | 9.71       | %           | 9.25       | %          | 9.59        | %          |

 

The Company doesnot expect to pay cash dividends to shareholders during 2006.

18

----

# **INVESTMENTPORTFOLIO**

Managementclassifies investment securities as either held-to-maturity oravailable-for-sale based on their intentions and the Company’s ability to holdthem until maturity.  In determining suchclassifications, securities that management has the positive intent and theCompany has the ability to hold until maturity are classified as held-to-maturityand carried at amortized cost.  All othersecurities are designated as available-for-sale and carried at estimated fairvalue with unrealized gains and losses included in shareholders’ equity on anafter-tax basis.  As of December 31, 2006and 2005, all securities were classified as available-for-sale.

The following tablessummarize the carrying value of investment securities as of the indicated datesand the weighted-average yields of those securities at December 31, 2006.

**InvestmentSecurities Portfolio Composition**
| December 31,  (Dollars in thousands) | ** ** | **2006** | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------------------|------------|----------|------------|------------|------------|------------|------------|
| Government-Sponsored  Enterprises                   |       | $        | 19,092     |       | $          | 8,437      |       | $ | 13,191 |   |
| Obligations of  state and local governments         |       | 7,435    |       | 5,734      |       | 6,230      |       |
| Mortgage-backed  securities                         |       | 23,449   |       | 23,242     |       | 22,356     |       |
| Equity  securities available-for-sale               |       | 854      |       | 820        |       | 820        |       |
| Nonmarketable  equity securities                    |       | 2,948    |       | 2,867      |       | 2,763      |       |
| Total securities                                    | ** ** | **$**    | **53,778** | ** ** | **$**      | **41,100** | ** ** | **$** | **45,360** | ** ** |

 

**InvestmentSecurities Portfolio Maturity Schedule**
|                                                   | ** ** | **Available-for-Sale** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| **December 31, 2006**                   | ** ** | **Carrying**           | ** ** | ** ** | ** ** |
| **(Dollars in thousands)**              | ** ** | **Amount**             | ** ** | **Yield** | ** ** |
| Government-Sponsored  Enterprises due:            |       |                   |       |   |   |
| Less than one  year                               |       | $                      | 495        |   | 4.276 | % |
| After one year  but within five years             |       | 12,841                 |       | 4.236 | % |
| After five years  but within ten years            |       | 1,820                  |       | 5.189 | % |
| After ten years                                   |       | 3,936                  |       | 5.931 | % |
|                                              |       |                   |       |   |   |
| Obligations of states  and local governments due: |       |                   |       |   |   |
| After one year  but within five years             |       | 993                    |       | 4.032 | % |
| After five years  but within ten years            |       | 4,260                  |       | 3.565 | % |
| After ten years                                   |       | 2,182                  |       | 3.836 | % |
|                                              |       | 7,435                  |       | 3.706 | % |
| Mortgage-backed securities                        |       | 22,513                 |       | 4.985 | % |
| Collateralized Mortgage  Obligation (CMOs)        |       | 936                    |       | 4.489 | % |
| Equities  available-for-sale                      |       | 854                    |       | 6.385 | % |
| ** **                                        | ** ** | **$**                  | **50,830** |   | **4.703** | **%** |

 

19

----

# **LOANPORTFOLIO**

Managementbelieves the loan portfolio is adequately diversified.  There are no foreign loans, and agriculturalloans as of December 31, 2006 are limited. There are no significant concentrations of loans in any particularindividuals or industry or group of related individuals or industries.

The Company hasexperienced continued growth of its loan portfolio throughout 2006 and 2005,resulting in increases of $19,489,000 and $22,274,000, respectively.  Management has concentrated on maintainingquality in the loan portfolio. The loan-to-deposit ratio is used to monitor afinancial institution’s potential profitability and efficiency of assetdistribution and utilization.  Generally,a higher loan-to-deposit ratio is indicative of higher interest income sinceloans typically yield a higher return than other interest-earning assets.  The loan-to-deposit ratios were 92.52% and92.50% at December 31, 2006 and 2005, respectively.  The loans-to-total borrowed funds ratio was77.56% and 77.40% at December 31, 2006 and 2005, respectively.  Management intends to deploy available fundsto loans to the extent it deems prudent to achieve its targeted ratio of loansto deposits; however, there can be no assurance that management will be able toexecute its strategy or that loan demand will continue to support growth.
| **December 31,**                            | ** ** | **Loan Portfolio Composition** | ** **  | ** ** | ** ** | ** **  | ** ** |
|--------------------------------------------------|------------|------------------------------------------|-------------|------------|------------|-------------|------------|
| **(Dollars in thousands)**             | ** ** | **2006**                                 | ** **  | **2005**   | ** ** | **2004**    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Real estate -  construction and land development |       | $                                        | 28,124      |       | $          | 18,686      |       | $ | 8,026 |   | $ | 13,845 |   | $ | 17,032 |   |
| Real estate -  mortgage and commercial           |       | 147,156                                  |        | 133,527    |       | 110,584     |       | 89,801 |   | 65,245 |   |
| Agricultural                                     |       | 6,099                                    |        | 5,141      |       | 6,136       |       | 6,891 |   | 5,496 |   |
| Commercial and  industrial                       |       | 54,313                                   |        | 55,909     |       | 62,991      |       | 48,479 |   | 48,403 |   |
| Consumer                                         |       | 18,267                                   |        | 21,168     |       | 22,881      |       | 27,325 |   | 25,020 |   |
| All other loans  (including overdrafts)          |       | 608                                      |        | 647        |       | 2,186       |       | 5,488 |   | 1,637 |   |
| Total gross  loans                               | ** ** | **$**                                    | **254,567** | ** ** | **$**      | **235,078** | ** ** | **$** | **212,804** | ** ** | **$** | **191,829** | ** ** | **$** | **162,833** | ** ** |

 

## **Credit Risk Management**

Credit riskentails both general risk, which is inherent in the process of lending, andrisk that is specific to individual borrowers. The management of credit risk involves the processes of loanunderwriting and loan administration. The Company seeks to manage credit risk through a strategy of makingloans within the Company’s primary marketplace and within the Company’s limitsof expertise.  Although management seeksto avoid concentrations of credit by loan type or industry throughdiversification, a substantial portion of the borrowers’ ability to honor theterms of their loans is dependent on the business and economic conditions inHorry and Marion Counties in South Carolina and Columbus and Brunswick Countiesin North Carolina.  Additionally, sincereal estate is considered by the Company as the most desirable nonmonetarycollateral, a significant portion of the Company’s loans are collateralized byreal estate; however, the cash flow of the borrower or the business enterpriseis generally considered as the primary source of repayment.  Generally, the value of real estate is notconsidered by the Company as the primary source of repayment for performingloans.  The Company also seeks to limittotal exposure to individual and affiliated borrowers.  The Company seeks to manage risk specific toindividual borrowers through the loan underwriting process and through anongoing analysis of the borrower’s ability to service the debt as well as thevalue of the pledged collateral.

The Company’s loanofficers and loan administration staff are charged with monitoring theCompany’s loan portfolio and identifying changes in the economy or in aborrower’s circumstances which may affect the ability to repay the debt or thevalue of the pledged collateral.  Inorder to assess and monitor the degree of risk in the Company’s loan portfolio,several credit risk identification and monitoring processes are utilized.  The Company assesses credit risk initiallythrough the assignment of a risk grade to each loan based upon an assessment ofthe borrower’s financial capacity to service the debt and the presence andvalue of any collateral.

20

----

# Credit grading is adjusted during the life of the loanto reflect economic and individual changes having an impact on the borrowers’abilities to honor the terms of their commitments.  Management uses the risk grades as a tool foridentifying known and inherent losses in the loan portfolio and for determiningthe adequacy of the allowance for loan losses.

**Maturitiesand Sensitivity of Loans to Changes in Interest Rates:**

The followingtable summarizes the loan maturity distribution, by type, at December 31, 2006and related interest rate characteristics:
|                                                  | ** ** | ** **        | ** **  | **Over**            | ** ** | ** **         | ** ** | ** ** | ** **  |
|--------------------------------------------------|------------|-------------------|-------------|---------------------|------------|--------------------|------------|------------|-------------|
| ** **                                       | ** ** | ** **        | ** **  | **One Year**   | ** ** | ** **         | ** ** | ** ** | ** **  |
| **December 31, 2006**                  | ** ** | **One Year** | ** **  | **Through**         | ** ** | **Over Five** | ** ** | ** ** | ** **  |
| **(Dollars in thousands)**             | ** ** | **or Less**  | ** **  | **Five Years** | ** ** | **Years**          | ** ** | **Total**  | ** **  |
| Real estate -  construction and land development |       | $                 | 19,044      |                | $          | 7,168              |       | $          | 1,913       |   | $ | 28,125 |   |
| Real estate -  other                             |       | 51,645            |        | 56,852              |       | 38,659             |       | 147,156    |        |
| Agricultural                                     |       | 2,500             |        | 1,524               |       | 2,075              |       | 6,099      |        |
| Commercial and  industrial                       |       | 27,969            |        | 18,444              |       | 7,900              |       | 54,313     |        |
| Consumer                                         |       | 5,307             |        | 11,955              |       | 1,004              |       | 18,266     |        |
| All other loans  (including overdrafts)          |       | 176               |        | 135                 |       | 297                |       | 608        |        |
| ** **                                       | ** ** | **$**             | **106,641** | ** **          | **$**      | **96,078**         | ** ** | **$**      | **51,848**  |   | **$** | **254,567** |   |
| Loans maturing  after one year with:             |       |              |        |                |       |               |       |       |        |
| Fixed interest rates                             |       |              |        |                |       |               |       | $          | 106,831     |   |
| Floating interest rates                          |       |              |        |                |       |               |       | 41,397     |        |
| ** **                                       |       |              |        |                |       |               |       | **$**      | **148,228** |   |

 

## **Risk Elements**

Loans are definedas impaired when it is probable that a creditor will be unable to collect allamounts due according to the contractual terms of the loan agreement.  Impairment of a loan is based on the presentvalue of the expected future cash flows discounted at the loan’s effectiveinterest rate or at the fair value of the collateral if the loan is collateraldependent.

Loans on theCompany’s problem loan watch list are considered potentially impairedloans.  These loans are evaluated indetermining whether all outstanding principal and interest are expected to becollected.  Loans are not consideredimpaired if a minimal delay occurs and all amounts due, including accruedinterest at the contractual interest rate for the period of delay, are expectedto be collected.

The followingtable sets forth our nonperforming assets for the dates indicated.
| Nonperforming Assets                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **(Dollars in thousands)**                        | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
| Nonaccrual loans                                            |       | $          | 760        |       | $          | 2,044      |       | $          | 4,295      |       | $          | 1,641 |   | $ | 915 |   |
| Restricted or  impaired loans                               |       | —     |       | —     |       | —     |       | —     |       | —     |       |
| Total nonperforming loans                                   |       | 760        |       | 2,044      |       | 4,295      |       | 1,641      |       | 915        |       |
| Other real  estate owned                                    |       | 95         |       | 485        |       | 964        |       | 390        |       | 210        |       |
| Total nonperforming assets                                  | ** ** | **$**      | **855**    | ** ** | **$**      | **2,529**  | ** ** | **$**      | **5,259**  | ** ** | **$**      | **2,031** | ** ** | **$** | **1,125** | ** ** |
| Loans 90 days or  more past due and still accruing interest |       | $          | 1,714      |       | $          | 843        |       | $          | 378        |       | $          | 2,315 |   | $ | 381 |   |
| Nonperforming assets to  period end loans                   |       | 0.33       | %          | 1.08       | %          | 2.47       | %          | 1.06       | %          | 0.69       | %          |

 

21

----

# For loans to be in excess of 90 days delinquent andstill accruing interest, the borrowers must be either remitting paymentsalthough not able to get current, liquidation on loans deemed to be wellsecured must be near completion, or the Company must have a reason to believethat correction of the delinquency status by the borrower is near.  The amount of both nonaccrual loans and loanspast due 90 days or more were considered in computing the allowance for loanlosses as of December 31, 2006. Nonaccrual loans as of December 31, 2004 and 2005 were primarily relatedto one large customer relationship. Payments on this relationship in 2005 reduced the nonaccrual balances ona portion of this relationship and additional payments and liquidation ofassets by the borrower served to further reduce the balances in total loans onnon-accrual as of December 31, 2006. Management expects that future non-accrual loan balances should moreclosely mirror the balances as of December 31, 2006.

**Summary of Loan Loss Experience**
| **(Dollars in thousands)**                         | ** ** | **2006** | ** **  | **2005**   | ** ** | **2004**    | ** ** | **2003** | ** **  | **2002**   | ** ** |
|--------------------------------------------------------------|------------|----------|-------------|------------|------------|-------------|------------|----------|-------------|------------|------------|
| Total loans  outstanding at end of period                    |       | **$**    | **256,800** |       | **$**      | **235,669** |       | **$**    | **212,808** |       | **$**      | **192,304** |   | **$** | **162,833** |   |
| Average loans  outstanding                                   | ** ** | **$**    | **247,614** | ** ** | **$**      | **226,528** | ** ** | **$**    | **211,028** | ** ** | **$**      | **182,445** | ** ** | **$** | **144,266** | ** ** |
| Balance of  allowance for loan losses at beginning of period |       | 2,569    |        | 2,155      |       | $           | 1,774      |     | $           | 1,452      |       | $ | 1,112 |   |
| Charge-offs:                                                 |       |     |        |       |       |        |       |     |        |       |       |
| Real estate                                                  |       | 4        |        | 122        |       | 354         |       | 27       |        | 4          |       |
| Commercial                                                   |       | 418      |        | 382        |       | 286         |       | 368      |        | 145        |       |
| Consumer and credit card                                     |       | 289      |        | 287        |       | 328         |       | 175      |        | 89         |       |
|                                                         |       |     |        |       |       |        |       |     |        |       |       |
| Total charge-offs                                            |       | 711      |        | 791        |       | 968         |       | 570      |        | 238        |       |
|                                                         |       |     |        |       |       |        |       |     |        |       |       |
| Recoveries of  loans previous charged-off                    |       | 90       |        | 135        |       | 64          |       | 35       |        | 43         |       |
|                                                         |       |     |        |       |       |        |       |     |        |       |       |
| Net charge-offs                                              |       | 621      |        | 656        |       | 904         |       | 535      |        | 195        |       |
|                                                         |       |     |        |       |       |        |       |     |        |       |       |
| Provision  charged to operations                             |       | 770      |        | 1,070      |       | 1,285       |       | 857      |        | 535        |       |
|                                                         |       |     |        |       |       |        |       |     |        |       |       |
| Balance of  allowance for loan losses at end of period       |       | **$**    | **2,718**   |       | **$**      | **2,569**   |       | **$**    | **2,155**   |       | **$**      | **1,774** |   | **$** | **1,452** |   |
|                                                         |       |     |        |       |       |        |       |     |        |       |       |
| Ratios:                                                      |       |     |        |       |       |        |       |     |        |       |       |
| Net charge-offs to average loans outstanding                 |       | 0.25     | %           | 0.29       | %          | 0.43        | %          | 0.30     | %           | 0.14       | %          |
| Net charge-offs to loans at end of year                      |       | 0.24     | %           | 0.28       | %          | 0.42        | %          | 0.28     | %           | 0.12       | %          |
| Allowance for loan losses to average loans                   |       | 1.10     | %           | 1.13       | %          | 1.02        | %          | 0.97     | %           | 1.01       | %          |
| Allowance for loan losses to loans at end of year            |       | 1.06     | %           | 1.09       | %          | 1.01        | %          | 0.92     | %           | 0.89       | %          |
| Net charge-offs to allowance for loan losses                 |       | 22.85    | %           | 25.54      | %          | 41.95       | %          | 30.16    | %           | 13.43      | %          |
| Net charge-offs  to provisions for loan losses               |       | 80.65    | %           | 61.31      | %          | 70.35       | %          | 62.43    | %           | 36.45      | %          |

 

22

----

Management hasestablished an allowance for loan losses through a provision for loan lossescharged to expense.  The allowancerepresents an amount which management believes will be adequate to absorbprobable losses on existing loans that may become uncollectible.  Management does not allocate specificpercentages of our allowance for loan losses to the various categories of loansbut evaluates the adequacy on an overall portfolio basis utilizing severalfactors.  The primary factor consideredis the credit risk grading system, which is applied to each loan.  The amount of both nonaccrual loans and loanspast due 90 days or more is also considered. The historical loan loss experience, the size of our lending portfolio,and current and anticipated economic conditions is also considered indetermining the provision for loan losses. The amount of the allowance isadjusted periodically based on changing circumstances.  Recognized losses are charged to theallowance for loan losses, while subsequent recoveries are added to theallowance.

Managementregularly monitors past due and classified loans.  However, it should be noted that noassurances can be made that future charges to the allowance for loan losses orprovisions for loan losses may not be significant to a particular accountingperiod.  At December 31, 2006 and 2005,management considers the allowances for loan losses adequate based on itsjudgments, evaluations, and analysis of the loan portfolio.

Management’sjudgment as to the adequacy of the allowance is based upon a number ofassumptions about future events which it believes to be reasonable, but whichmay or may not prove to be accurate. Because of the inherent uncertainty of assumptions made during theevaluation process, there can be no assurance that loan losses in futureperiods will not exceed the allowance for loan losses or that additionalallocations will not be required.  Ourlosses will undoubtedly vary from our estimates, and there is a possibilitythat charge-offs in future periods will exceed the allowance for loan losses asestimated at any point in time.

# **AVERAGEDAILY DEPOSITS**

The following tablesummarizes the Company’s average daily deposits during the years ended December31, 2006, 2005, and 2004.  These totalsinclude time deposits $100,000 and over, which at December 31, 2006 totaled$47,369,000. Of this total, scheduled maturities within three months were$10,712,000; over three through twelve months were $35,731,000; and over twelvemonths were $926,000.
|                                        | ** ** | **2006**    | ** **  | **2005**    | ** ** | **2004**    | ** ** |
|----------------------------------------|------------|-------------|-------------|-------------|------------|-------------|------------|
| ** **                             | ** ** | ** **  | ** **  | **Average** | ** ** | ** **  | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                             | ** ** | **Average** | ** **  | **Rate**    | ** ** | **Average** | ** ** | **Rate** | ** ** | **Average** | ** ** | **Rate** | ** ** |
| ** **                             | ** ** | **Amount**  | ** **  | **Paid**    | ** ** | **Amount**  | ** ** | **Paid** | ** ** | **Amount** | ** ** | **Paid** | ** ** |
| Noninterest-bearing  demand            |       | $           | 27,415      |        | 0.00       | %           | $          | 25,402 |   | 0.00 | % | 26,946 |   | 0.00 | % |
| Interest-bearing  transaction accounts |       | 65,145      |        | 1.73        |       | 88,477      |       | 1.88 |   | 81,342 |   | 1.70 |   |
| Money market  savings account          |       | 67,634      |        | 4.51        |       | 29,308      |       | 2.74 |   | 22,475 |   | 1.24 |   |
| Other savings  accounts                |       | 5,846       |        | 1.27        |       | 6,146       |       | 0.86 |   | 5,973 |   | 0.28 |   |
| Time deposits                          |       | 98,974      |        | 4.19        |       | 93,974      |       | 2.93 |   | 84,191 |   | 2.22 |   |
| Total deposits                         | ** ** | **$**       | **265,014** | ** **  | ** ** | ** **  | **$**      | **243,307** |   |   |   | **$** | **220,927** |   |   |   |
|                                        |            |             |             |             |            |             |            |  |  |  |  |  |  |  |  |  |

 

23

----

**ADVANCESFROM THE FEDERAL HOME LOAN BANK**

The following table summarizes the Company’sshort-term borrowings for the years ended December 31, 2006, 2005 and 2004.
| ** **                            | ** ** | **Maximum**        | ** ** | ** **  | ** ** | **Weighted** | ** ** | ** **            | ** ** |
|---------------------------------------|------------|--------------------|------------|-------------|------------|--------------|------------|-----------------------|------------|
| ** **                            | ** ** | **Outstanding**    | ** ** | ** **  | ** ** | **Average**  | ** ** | ** **            | ** ** |
| ** **                            | ** ** | **at any**    | ** ** | **Average** | ** ** | **Interest** | ** ** | **Balance**           | ** ** |
| **(Dollars in thousands)**  | ** ** | **Month End** | ** ** | **Balance** | ** ** | **Rate**     | ** ** | **December 31,** | ** ** |
| **2006**                              |       |               |       |        |       |         |       |                  |       |
| Advances from  Federal Home Loan Bank |       | $                  | 43,390     |        | $          | 43,390       |       | 4.37                  | %          | $ | 43,390 |   |
|                                  |       |               |       |        |       |         |       |                  |       |
| **2005**                              |       |               |       |        |       |         |       |                  |       |
| Advances from  Federal Home Loan Bank |       | $                  | 43,390     |        | $          | 43,390       |       | 4.27                  | %          | $ | 43,390 |   |
|                                  |       |               |       |        |       |         |       |                  |       |
| **2004**                              |       |               |       |        |       |         |       |                  |       |
| Advances from Federal  Home Loan Bank |       | $                  | 43,390     |        | $          | 37,057       |       | 4.53                  | %          | $ | 43,390 |   |

 

Advances from theFederal Home Loan Bank are collateralized by one-to-four family residentialmortgage loans, certain commercial real estate loans, certain securities in thebank’s investment portfolio and the Company’s investment in Federal Home LoanBank stock.  Although we expect tocontinue using Federal Home Loan Bank advances as a secondary funding source,core deposits will continue to be our primary funding source.  Of the $43,390,000 advances from Federal HomeLoan Bank outstanding at December 31, 2006, $6,700,000 have scheduled principalreductions in 2008, $9,600,000 in 2010, $5,000,000 in 2011 and the remainderafter five years.

# As discussed in the notesto the financial statements, the Company has entered into interest rate swapagreements associated with Federal Home Loan Bank advances maturing on March 1,2010, May 24, 2010 and March 22, 2011. The interest rate swaps effectively converted the fixed interest rateson the advances to a variable rate.  Thevariable rate was 5.365% at December 31, 2006 and is based on the three monthLIBOR index.

**JUNIORSUBORDINATED DEBENTURES**

On  December 17, 2005, HCSB Financial Trust I(the “ Trust”), a non-consolidated subsidiary of the Company, issued and sold atotal of 6,000 trust preferred securities, with $1,000 liquidation amount percapital security (the “Capital Securities”), to institutional buyers in a pooledtrust preferred issue.  The CapitalSecurities, which are reported on the consolidated balance sheet as juniorsubordinated debentures, generated proceeds of $6 million.  The Trust loaned these proceeds to theCompany to use for general corporate purposes. The junior subordinated debentures qualify as Tier 1 capital underFederal Reserve Board guidelines, subject to limitations.  See Note 10 to the consolidated financialstatements for more information about the terms of the junior subordinateddebentures.

Debt issuancecosts, net of accumulated amortization, from junior subordinated debenturestotaled $102,361 and $106,028 at December 31, 2006, and December 31, 2005,respectively, and are included in other assets on the consolidated balancesheet.  Amortization of debt issuancecosts from junior subordinated debentures totaled $3,667 for the years endedDecember 31, 2006, and December 31, 2005, and are reported in other expenses onthe consolidated income statement for the years ended  December 31, 2006, and December 31, 2005.

# **RETURN ONEQUITY AND ASSETS**

The followingtable shows the return on average assets (net income divided by average totalassets), return on average equity (net income divided by average daily equity),and equity to assets ratio (average daily equity divided by average totalassets) for the period indicated.  Sinceits inception, the Company has not paid cash dividends.
|                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Return on  average assets |       | 0.81     | %          | 0.75     | %          | 0.73     | %          |
| Return on  average equity |       | 10.46    | %          | 9.83     | %          | 9.71     | %          |
| Equity to assets ratio    |       | 7.77     | %          | 7.66     | %          | 7.54     | %          |

 

24

----

# **ACCOUNTINGAND FINANCIAL REPORTING ISSUES**

We have adopted various accounting policies whichgovern the application of accounting principles generally accepted in theUnited States in the preparation of our financial statements.  Our significant accounting policies aredescribed in the footnotes to the consolidated financial statements at December31, 2006, as filed on our annual report on Form 10-KSB. Certain accountingpolicies involve significant judgments and assumptions by us which have amaterial impact on the carrying value of certain assets and liabilities.  We consider these accounting policies to becritical accounting policies. The judgments and assumptions we use are based onhistorical experience and other factors, which we believe to be reasonableunder the circumstances.  Because of thenature of the judgments and assumptions we make, actual results could differfrom these judgments and estimates which could have a material impact on ourcarrying values of assets and liabilities and our results of operations.

We believe theallowance for loan losses is a critical accounting policy that requires themost significant judgments and estimates used in preparation of ourconsolidated financial statements.  Referto the portion of this discussion that addresses our allowance for loan lossesfor a description of our processes and methodology for determining ourallowance for loan losses.

# **INDUSTRYDEVELOPMENTS**

**Sarbanes-Oxley Act of 2002**

The Congress of the United States of America passedthe Sarbanes-Oxley Act in 2002 in the aftermath of corporate scandals amongseveral major publicly traded corporations. The intent of the Act was to legislate corporate governance and betterascertain the accuracy of financial reporting by companies regulated by theSecurities and Exchange Commission.

Section 404 of the Sarbanes-Oxley Act, which becomeseffective for the Company in 2007, requires that the Company adopt and maintaineffective internal controls that will, among other things, permit thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America.  Management of the Company has the responsibilityto adopt sound accounting policies, maintain an adequate and efficientaccounting system, safeguard assets and devise policies to ensure that theCompany complies with applicable laws and regulations.

To assist in this process the company has purchasedsoftware from the national accounting firm of Crowe Chizek and retained theservices of Elliott Davis, LLC and Crowe Chizek to work with management andparticipate in the Section 404 process. Elliott Davis, LLC will perform only those services in this regard thatare acceptable by the Public Company Accounting Oversight Board (PCAOB).  Compliance with Section 404 of theSarbanes-Oxley Act will certainly add to the Company’s operating expenses dueto requirements for additional technology, record keeping, and professionalassistance that is necessary.

From time to time,various bills are introduced in the United States Congress with respect to theregulation of financial institutions. Certain of these proposals, if adopted, could significantly change theregulation of banks and the financial services industry.  The Company cannot predict whether any ofthese proposals will be adopted or, if adopted, how these proposals wouldaffect the Company.

25

----

## **REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

The Board of Directors

HCSB Financial Corporationand Subsidiary

Loris, SouthCarolina

We have auditedthe accompanying consolidated balance sheets of HCSB Financial Corporation andits subsidiary as of December 31, 2006 and 2005, and the related consolidatedstatements of income, changes in shareholders’ equity and comprehensive income(loss), and cash flows for the years then ended.  These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statementsbased on our audits.

We conducted ouraudits in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and the significant estimates made by management aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

In our opinion,the financial statements referred to above present fairly, in all materialrespects, the consolidated financial position of HCSB Financial Corporation andits subsidiary as of December 31, 2006 and 2005, and the consolidated resultsof their operations and their cash flows for the years then ended, inconformity with U. S. generally accepted accounting principles.

 
| /s/ Elliott Davis, LLC    |   |
|---------------------------|--------|
| Elliott Davis,  LLC       |
| Columbia, South  Carolina |
| March 15, 2007            |

 

26

----

# **HCSB FINANCIAL CORPORATION AND SUBSIDIARY**

# **Consolidated Balance Sheets**

| ** **                                                                                                                                          | ** ** | **December 31,** | ** **  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|
| **(Dollars in thousands)**                                                                                                                | ** ** | **2006**              | ** **  | **2005** | ** ** |
| **Assets:**                                                                                                                                         |       |                  |        |   |   |
| Cash and cash  equivalents:                                                                                                                         |       |                  |        |   |   |
| Cash and due  from banks                                                                                                                            |       | $                     | 9,463       |   | $ | 10,143 |   |
| Federal funds  sold                                                                                                                                 |       | 19,238                |        | 29,262 |   |
| Total cash and  cash equivalents                                                                                                                    |       | 28,701                |        | 39,405 |   |
| Investment  securities:                                                                                                                             |       |                  |        |   |   |
| Securities  available-for-sale                                                                                                                      |       | 50,830                |        | 38,233 |   |
| Nonmarketable  equity securities                                                                                                                    |       | 2,948                 |        | 2,867 |   |
| Total investment  securities                                                                                                                        |       | 53,778                |        | 41,100 |   |
| Loans held for  sale                                                                                                                                |       | 2,233                 |        | 591 |   |
| Loans receivable                                                                                                                                    |       | 254,567               |        | 235,078 |   |
| Less allowance  for loan losses                                                                                                                     |       | (2,718                | )           | (2,569 | ) |
| Loans, net                                                                                                                                          |       | 251,849               |        | 232,509 |   |
| Premises,  furniture and equipment, net                                                                                                             |       | 16,139                |        | 11,681 |   |
| Accrued interest  receivable                                                                                                                        |       | 2,880                 |        | 2,238 |   |
| Other assets                                                                                                                                        |       | 3,957                 |        | 4,138 |   |
| Total assets                                                                                                                                        | ** ** | **$**                 | **359,537** | ** ** | **$** | **331,662** | ** ** |
|                                                                                                                                                | ** ** | ** **            | ** **  | ** ** | ** ** |
| **Liabilities:**                                                                                                                                    |       |                  |        |   |   |
| Deposits:                                                                                                                                           |       |                  |        |   |   |
| Noninterest-bearing  transaction accounts                                                                                                           |       | $                     | 26,428      |   | $ | 25,418 |   |
| Interest-bearing  transaction accounts                                                                                                              |       | 53,693                |        | 84,082 |   |
| Money market  savings accounts                                                                                                                      |       | 83,795                |        | 42,472 |   |
| Other savings  accounts                                                                                                                             |       | 5,294                 |        | 6,116 |   |
| Time deposits  $100 and over                                                                                                                        |       | 47,369                |        | 48,424 |   |
| Other time  deposits                                                                                                                                |       | 58,572                |        | 47,625 |   |
| Total deposits                                                                                                                                      |       | 275,151               |        | 254,137 |   |
| Advances from  the Federal Home Loan Bank                                                                                                           |       | 43,390                |        | 43,390 |   |
| Notes Payable                                                                                                                                       |       | 3,478                 |        | — |   |
| Junior  subordinated debentures                                                                                                                     |       | 6,186                 |        | 6,186 |   |
| Accrued interest  payable                                                                                                                           |       | 772                   |        | 549 |   |
| Other  liabilities                                                                                                                                  |       | 2,210                 |        | 2,097 |   |
| Total  liabilities                                                                                                                                  |       | 331,187               |        | 306,359 |   |
|                                                                                                                                                |       |                  |        |   |   |
| **Commitments and Contingencies  (Notes 4, 12 and 13)**                                                                                             |       |                  |        |   |   |
| ** **                                                                                                                                          |       |                  |        |   |   |
| **Shareholders’ Equity:**                                                                                                                      |       |                  |        |   |   |
| Common stock,  $0.01 par value, 10,000,000 shares authorized; 3,569,874 and 1,788,201 shares  issued and outstanding in 2006 and 2005, respectively |       | 36                    |        | 18 |   |
| Capital surplus                                                                                                                                     |       | 25,756                |        | 25,685 |   |
| Nonvested  restricted stock                                                                                                                         |       | (645                  | )           | (703 | ) |
| Retained  earnings                                                                                                                                  |       | 3,626                 |        | 865 |   |
| Accumulated  other comprehensive loss                                                                                                               |       | (423                  | )           | (562 | ) |
| Total  shareholders’ equity                                                                                                                    |       | 28,350                |        | 25,303 |   |
| Total liabilities and  shareholders’ equity                                                                                                    | ** ** | **$**                 | **359,537** | ** ** | **$** | **331,662** | ** ** |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

27

----

# **HCSB FINANCIAL CORPORATION AND SUBSIDIARY**

**ConsolidatedStatements of Income**
| ** **                                                               | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands except share amounts)** | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| **Interest  income:**                                                    |       |                                        |       |   |   |
| Loans, including fees                                                    |       | $                                           | 20,417     |   | $ | 16,743 |   |
| Investment securities:                                                   |       |                                        |       |   |   |
| Taxable                                                                  |       | 1,869                                       |       | 1,391 |   |
| Tax-exempt                                                               |       | 274                                         |       | 225 |   |
| Nonmarketable equity securities                                          |       | 156                                         |       | 107 |   |
| Federal funds sold and other                                             |       | 964                                         |       | 698 |   |
| Total                                                                    |       | 23,680                                      |       | 19,164 |   |
|                                                                     |       |                                        |       |   |   |
| **Interest  expense:**                                                   |       |                                        |       |   |   |
| Deposits                                                                 |       | 8,391                                       |       | 5,271 |   |
| Borrowings                                                               |       | 2,723                                       |       | 2,185 |   |
| Total                                                                    |       | 11,114                                      |       | 7,456 |   |
| **Net  interest income**                                                 |       | 12,566                                      |       | 11,708 |   |
| Provision for  loan losses                                               |       | 770                                         |       | 1,070 |   |
| **Net  interest income after provision for loan losses**                 |       | 11,796                                      |       | 10,638 |   |
| ** **                                                               |       |                                        |       |   |   |
| **Noninterest  income:**                                                 |       |                                        |       |   |   |
| Service charges on deposit accounts                                      |       | 1,429                                       |       | 1,332 |   |
| Credit life insurance commissions                                        |       | 48                                          |       | 41 |   |
| Gain on sale of residential mortgage loans                               |       | 542                                         |       | 155 |   |
| Brokerage commissions                                                    |       | 289                                         |       | 166 |   |
| Other fees and commissions                                               |       | 206                                         |       | 221 |   |
| Gains (losses) on sales of securities                                    |       | —                                      |       | (52 | ) |
| Other                                                                    |       | 90                                          |       | 68 |   |
| Total                                                                    |       | 2,604                                       |       | 1,931 |   |
| **Noninterest  expenses:**                                               |       |                                        |       |   |   |
| Salaries and employee benefits                                           |       | 6,002                                       |       | 5,002 |   |
| Net occupancy                                                            |       | 668                                         |       | 655 |   |
| Marketing and advertising                                                |       | 366                                         |       | 235 |   |
| Loss on sale of assets                                                   |       | —                                      |       | 68 |   |
| Furniture and equipment                                                  |       | 1,112                                       |       | 988 |   |
| Other operating                                                          |       | 2,160                                       |       | 1,955 |   |
| Total                                                                    |       | 10,308                                      |       | 8,903 |   |
| **Income  before income taxes**                                          |       | 4,092                                       |       | 3,666 |   |
| Income tax  provision                                                    |       | 1,287                                       |       | 1,258 |   |
| **Net  income**                                                          | ** ** | **$**                                       | **2,805**  | ** ** | **$** | **2,408** | ** ** |
| **Net  income per common share**                                         |       |                                        |       |   |   |
| Basic                                                                    | ** ** | **$**                                       | **0.79**   | ** ** | **$** | **0.68** | ** ** |
| Diluted                                                                  | ** ** | **$**                                       | **0.79**   | ** ** | **$** | **0.68** | ** ** |
| **Average  common shares outstanding**                                   |       |                                        |       |   |   |
| Basic                                                                    | ** ** | **3,542,073**                               | ** ** | **3,528,384** | ** ** |
| Diluted                                                                  | ** ** | **3,558,316**                               | ** ** | **3,547,572** | ** ** |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

28

----

# **HCSB FINANCIAL CORPORATION AND SUBSIDIARY**

**Consolidated Statements ofChanges in Shareholders’ Equity and Comprehensive Income (Loss)**

**Yearsended December 31, 2006 and 2005**
| ** **                                                     | ** ** | ** **            | ** ** | ** **     | ** ** | ** **    | ** ** | ** **   | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|---------------|------------|--------------|------------|--------------|------------|------------------------|------------|------------|------------|
| ** **                                                     | ** ** | ** **            | ** ** | ** **     | ** ** | ** **    | ** ** | ** **   | ** ** | ** **   | ** ** | **other**              | ** ** | ** ** | ** ** |
| ** **                                                     | ** ** | ** **            | ** ** | ** **     | ** ** | **Nonvested** | ** ** | ** **   | ** ** | ** **   | ** ** | **compre-**            | ** ** | ** ** | ** ** |
| **(Dollars in thousands,**                           | ** ** | **Common Stock** | ** ** | **restricted** | ** ** | **Capital**   | ** ** | **Retained** | ** ** | **hensive**  | ** ** | ** **             | ** ** |
| **except share amounts)**                            | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **stock**     | ** ** | **surplus**  | ** ** | **earnings** | ** ** | **income (loss)** | ** ** | **Total**  | ** ** |
| ** **                                                     | ** ** | ** **            | ** ** | ** **     | ** ** | ** **    | ** ** | ** **   | ** ** | ** **   | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Balance,  December 31, 2004**                                |       | 1,725,261             |       | $              | 17         |          | $          | (313         | )          | $            | 23,357     |                   | $          | 419        |       | $ | (26 | ) | $ | 23,454 |   |
| Net income                                                     |       |                  |       |           |       |          |       |         |       | 2,408        |       |                   |       | 2,408      |       |
| Other  comprehensive income, (loss) net of tax benefit of $316 |       |                  |       |           |       |          |       |         |       |         |       | (536                   | )          | (536       | )          |
| Comprehensive income                                           |       |                  |       |           |       |          |       |         |       |         |       |                   |       | 1,872      |       |
| Payment for  fractional shares                                 |       | (1,081                | )          |           |       |          |       |         |       | (35          | )          |                   |       | (35        | )          |
| Issuance of  restricted stock                                  |       | 11,470                |       |           |       | (390          | )          | 390          |       |         |       |                   |       | —     |       |
| Exercise of stock  options                                     |       | 468                   |       |           |       |          |       | 12           |       |         |       |                   |       | 12         |       |
| Declaration of  3.0% stock dividend on January 26, 2006        |       | 52,083                |       | 1              |       |          |       | 1,926        |       | (1,927       | )          |                   |       | —     |       |
| **Balance,  December 31, 2005**                                | ** ** | 1,788,201             | ** ** | 18             | ** ** | (703          | )          | 25,685       | ** ** | 865          | ** ** | (562                   | )          | 25,303     | ** ** |
| ** **                                                     | ** ** | ** **            | ** ** | ** **     | ** ** | ** **    | ** ** | ** **   | ** ** | ** **   | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net income                                                     |       |                  |       |           |       |          |       |         |       | 2,805        |       |                   |       | 2,805      |       |
| Other  comprehensive income, (loss) net of tax expense of $81  |       |                  |       |           |       |          |       |         |       |         |       | 139                    |       | 139        |       |
| Comprehensive  income                                          |       |                  |       |           |       |          |       |         |       |         |       |                   |       | 2,944      |       |
| Payment for  fractional shares                                 |       | (1,247                | )          |           |       |          |       |         |       | (44          | )          |                   |       | (44        | )          |
| Forfeiture of  restricted stock                                |       | (2,017                | )          |           |       | 58            |       | (58          | )          |         |       |                   |       |       |       |
| Stock option  expense                                          |       |                  |       |           |       |          |       | 147          |       |         |       |                   |       | 147        |       |
| Declaration of 2  for 1 stock split on January 18, 2007        |       | 1,784,937             |       | 18             |       |          |       | (18          | )          |         |       |                   |       | —     |       |
| **Balance, December 31, 2006**                                 | ** ** | **3,569,874**         | ** ** | **$**          | **36**     | ** **    | **$**      | **(645**     | **)**      | **$**        | **25,756** | ** **             | **$**      | **3,626**  | ** ** | **$** | **(423** | **)** | **$** | **28,350** | ** ** |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

29

----

# **HCSB FINANCIAL CORPORATION AND SUBSIDIARY**

**ConsolidatedStatements of Cash Flows**
| ** **                                                                                   | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)**                                                         | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities:**                                                   |       |                                        |       |   |   |
| Net income                                                                                   |       | $                                           | 2,805      |   | $ | 2,408 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:           |       |                                        |       |   |   |
| Provision for loan losses                                                                    |       | 770                                         |       | 1,070 |   |
| Deferred income tax benefit                                                                  |       | (269                                        | )          | 55 |   |
| Depreciation expense                                                                         |       | 636                                         |       | 619 |   |
| Premium amortization less discount accretion                                                 |       | 86                                          |       | 163 |   |
| Amortization of net deferred loan costs                                                      |       | 10                                          |       | 124 |   |
| Net gain on sale of securities available-for-sale                                            |       | —                                      |       | 52 |   |
| (Gain) Loss on sale of other real estate owned                                               |       | (26                                         | )          | 77 |   |
| Gain on disposal of premises and equipment                                                   |       | (20                                         | )          | (2 | ) |
| Increase in interest receivable                                                              |       | (642                                        | )          | (542 | ) |
| Increase in interest payable                                                                 |       | 223                                         |       | 160 |   |
| Increase in other assets                                                                     |       | (21                                         | )          | (948 | ) |
| Stock compensation expense                                                                   |       | 147                                         |       | — |   |
| Increase in other liabilities                                                                |       | 113                                         |       | 1,098 |   |
| Net cash provided by operating activities                                                    |       | 3,812                                       |       | 4,334 |   |
| **Cash  flows from investing activities:**                                                   |       |                                        |       |   |   |
| Purchases of securities available-for-sale                                                   |       | (17,350                                     | )          | (9,715 | ) |
| Maturities of securities available-for-sale                                                  |       | 4,887                                       |       | 8,879 |   |
| Proceeds from sales of securities available-for-sale                                         |       | —                                      |       | 4,237 |   |
| Net increase in loans to customers                                                           |       | (22,221                                     | )          | (24,417 | ) |
| Purchase of premises, furniture and equipment                                                |       | (5,094                                      | )          | (515 | ) |
| Proceeds from sale of premises, furniture and  equipment                                     |       | 20                                          |       | 20 |   |
| Proceeds from sale of other real estate owned                                                |       | 875                                         |       | 1,178 |   |
| Purchase of nonmarketable equity securities                                                  |       | (81                                         | )          | (104 | ) |
| Net cash used by investing activities                                                        |       | (38,964                                     | )          | (20,437 | ) |
| **Cash  flows from financing activities:**                                                   |       |                                        |       |   |   |
| Net increase in demand deposits, interest-bearing transaction  accounts and savings accounts |       | 11,122                                      |       | 18,423 |   |
| Net increase in time deposits                                                                |       | 9,892                                       |       | 13,325 |   |
| Net increase in notes payable                                                                |       | 3,478                                       |       |   |   |
| Proceeds from stock issuance                                                                 |       | —                                      |       | 12 |   |
| Cash paid for fractional shares                                                              |       | (44                                         | )          | (35 | ) |
| Net cash provided by financing activities                                                    |       | 24,448                                      |       | 31,725 |   |
| **Net  increase (decrease) in cash and cash equivalents**                                    |       | (10,704                                     | )          | 15,622 |   |
| **Cash  and cash equivalents, beginning of year**                                            |       | 39,405                                      |       | 23,783 |   |
| **Cash and cash equivalents, end  of year**                                                  | ** ** | **$**                                       | **28,701** | ** ** | **$** | **39,405** | ** ** |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

30

----

# **IICSB FINANCIAL CORPORATION AND SUBSIDIARY**

#### **Notes to Consolidated Financial Statements**

#### **NOTE1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES**

**Basis ofPresentation and Consolidation** - The accompanyingconsolidated financial statements include the accounts of HCSB FinancialCorporation and Subsidiary (the Company) and its wholly owned subsidiary, HorryCounty State Bank (the Bank) and all of the stock of HCSB Financial Trust I(the Trust).  The Company was incorporatedon June 10, 1999. The Bank was incorporated on December 18, 1987, and openedfor operations on January 4, 1988.  Theprincipal business activity of the Company is to provide commercial bankingservices in Horry County, South Carolina, and in Columbus and BrunswickCounties, North Carolina.  The Bank is astate-chartered bank, and its deposits are insured by the Federal DepositInsurance Corporation.  The Trust is aspecial purpose subsidiary organized for the sole purpose of issuing trustpreferred securities.  The operations ofthe Trust have not been consolidated in these financial statements.

**Management’sEstimates** - In preparing the consolidated financialstatements, management is required to make estimates and assumptions thataffect the reported amounts of assets and liabilities as of the balance sheetdate and income and expenses for the period. Actual results could differ significantly from those estimates.

Material estimatesthat are particularly susceptible to significant change relate to thedetermination of the allowance for loan losses, including valuation allowancesfor impaired loans, and the carrying amount of real estate acquired inconnection with foreclosures or in satisfaction of loans.  Management must also make estimates indetermining the estimated useful lives and methods for depreciating premisesand equipment.

While managementuses available information to recognize losses on loans and foreclosed realestate, future additions to the allowance may be necessary based on changes inlocal economic conditions.  In addition,regulatory agencies, as an integral part of their examination process,periodically review the Company’s allowances for losses on loans and foreclosedreal estate.  Such agencies may requirethe Company to recognize additions to the allowances based on their judgmentsabout information available to them at the time of their examination.  Because of these factors, it is reasonablypossible that the allowances for losses on loans and foreclosed real estate maychange materially in the near term.

**InvestmentSecurities** - Investment securities available-for-sale bythe Company are carried at amortized cost and adjusted to their estimated fairvalue.  The unrealized gain or loss isrecorded in shareholders’ equity net of the deferred tax effects.  Management does not actively trade securitiesclassified as available-for-sale, but intends to hold these securities for anindefinite period of time and may sell them prior to maturity to achievecertain objectives.  Reductions in fairvalue considered by management to be other than temporary are reported as arealized loss and a reduction in the cost basis in the security.  The adjusted cost basis of securitiesavailable-for-sale is determined by specific identification and is used incomputing the realized gain or loss from a sales transaction.

**NonmarketableEquity Securities** - Nonmarketable equity securitiesinclude the Company’s investments in the stock of the Federal Home Loan Bankand Community Financial Services.  Thestocks are carried at cost because they have no quoted market value and noready market exists.  Investment inFederal Home Loan Bank stock is a condition of borrowing from the Federal HomeLoan Bank, and the stock is pledged to collateralize the borrowings.  Dividends received on Federal Home Loan Bank stockand Community Financial Services stock are included as a separate component ininterest income.

At December 31, 2006 and2005, the investment in Federal Home Loan Bank stock was $2,615,000 and$2,544,000, respectively.  The investmentin Community Financial Services stock was $122,000 and $112,000 at December 31,2006 and 2005, respectively.  The Companyalso had a $25,000 investment in the holding company of a community bank atDecember 31, 2006.  Also included innonmarketable equities is investment in the Trust, which totaled $186,000 atDecember 31, 2006 and 2005.

31

----

**Loansheld for Sale** - Loans held for sale consist ofresidential mortgage loans the Company originates for sale to secondary marketinvestors.  They are carried at the lowerof aggregate cost or market value.  Netunrealized losses, if any, are recognized through a valuation allowance bycharges to income.  Fees collected inconjunction with origination activities are deferred as part of the cost basisof the loan and recognized when the loan is sold.  Gains or losses on sales are recognized whenthe loans are sold and are determined as the difference between the sales priceand the carrying value of the loans.

The Company issuesrate lock commitments to borrowers based on prices quoted by secondary marketinvestors.  When rates are locked withborrowers, a sales commitment is immediately entered (on a best efforts basis)at a specified price with a secondary market investor.  Accordingly, any potential liabilitiesassociated with rate lock commitments are offset by sales commitments toinvestors.

**LoansReceivable** - Loans receivable are stated at their unpaidprincipal balance.  Interest income onloans is computed based upon the unpaid principal balance.  Interest income is recorded in the periodearned.

The accrual ofinterest income is generally discontinued when a loan becomes contractually 90days past due as to principal or interest. Management may elect to continue the accrual of interest when theestimated net realizable value of collateral exceeds the principal balance andaccrued interest.

Loan originationand commitment fees and certain direct loan origination costs (principallysalaries and employee benefits) are deferred and amortized to income over thecontractual life of the related loans or commitments, adjusted for prepayments,using the straight-line method.

Under Statement ofFinancial Accounting Standards (SFAS) No. 114, *Accountingby Creditors for the Impairment of a Loan,*and SFAS No. 118, *Accounting by Creditors for Impairment of a Loan - Income Recognitionand Disclosures,* loans are defined as impaired when it is probablethat a creditor will be unable to collect all amounts due according to thecontractual terms of the loan agreement. All loans are subject to this criteria except for smaller balancehomogeneous loans that are collectively evaluated for impairment and loansmeasured at fair value or at the lower of cost or fair value.  The Company considers its consumerinstallment portfolio, credit card loans, and home equity lines as suchexceptions.  Therefore, the real estateand commercial loan portfolios are primarily affected by these statements.

Impairment of aloan is measured based on the present value of expected future cash flowsdiscounted at the loan’s effective interest rate or the fair value of thecollateral if the loan is collateral dependent. When management determines that a loan is impaired, the differencebetween the Company’s investment in the related loan and the present value ofthe expected future cash flows, or the fair value of the collateral, is chargedto bad debt expense with a corresponding entry to the allowance for loanlosses.  The accrual of interest isdiscontinued on an impaired loan when management determines the borrower may beunable to meet payments as they become due. As discussed in Note 4, impaired loans closely approximated nonaccrualloans at December 31, 2006 and 2005.

**Concentrationsof Credit Risk** - Financial instruments, which potentiallysubject the Company to concentrations of credit risk, consist principally ofloans receivable, investment securities, federal funds sold and amounts duefrom banks.

The Company makesloans to individuals and small businesses for various personal and commercialpurposes primarily throughout Horry county in South Carolina and Columbus andBrunswick counties of North Carolina. The Company’s loan portfolio is not concentrated in loans to any singleborrower or a relatively small number of borrowers. Additionally, management isnot aware of any concentrations of loans to classes of borrowers or industriesthat would be similarly affected by economic conditions except for loanssecured by residential and commercial real estate and commercial and industrialnon-real estate loans.  These concentrationsof residential and commercial real estate loans and commercial and industrialnon-real estate loans totaled $177,513,000 and $54,313,000, respectively, atDecember 31, 2006, representing 626.16% and 191.58%, respectively, of totalequity and 70.48% and 21.57%, respectively, of net loans receivable.

32

----

In addition tomonitoring potential concentrations of loans to particular borrowers or groupsof borrowers, industries and geographic regions, management monitors exposureto credit risk from concentrations of lending products and practices such asloans that subject borrowers to substantial payment increases (e.g. principaldeferral periods, loans with initial interest-only periods, etc.), and loanswith high loan-to-value ratios. Management has determined that there is noconcentration of credit risk associated with its lending policies or practices.Additionally, there are industry practices that could subject the Company toincreased credit risk should economic conditions change over the course of aloan’s life.  For example, the Companymakes variable rate loans and fixed rate principal-amortizing loans withmaturities prior to the loan being fully paid (i.e. balloon paymentloans).  These loans are underwritten andmonitored to manage the associated risks. Therefore, management believes that these particular practices do notsubject the Company to unusual credit risk.

The Company’sinvestment portfolio consists principally of obligations of the United States,its agencies or its corporations and general obligation municipalsecurities.  In the opinion ofmanagement, there is no concentration of credit risk in its investmentportfolio.  The Company places itsdeposits and correspondent accounts with and sells its federal funds to highquality institutions.  Managementbelieves credit risk associated with correspondent accounts is not significant.

**Allowancefor Loan Losses** - An allowance for loan losses ismaintained at a level deemed appropriate by management to provide adequatelyfor known and inherent risks in the loan portfolio.  The allowance is based upon a continuingreview of past loan loss experience, current economic conditions which mayaffect the borrowers’ ability to pay, and the underlying collateral value ofthe loans.  Loans deemed uncollectibleare charged off and deducted from the allowance. The provision for loan losses,including provisions for loan impairment, and recoveries on loans previouslycharged off, are added to the allowance.

**Premises,Furniture and Equipment** - Premises, furniture andequipment are stated at cost less accumulated depreciation.  The provision for depreciation is computed bythe straight-line method.  Rates ofdepreciation are generally based on the following estimated useful lives:  buildings - 40 years; furniture and equipment- 3 to 25 years.  The cost of assets soldor otherwise disposed of and the related accumulated depreciation is eliminatedfrom the accounts, and the resulting gains or losses are reflected in theincome statement.

Maintenance andrepairs are charged to current expense as incurred, and the costs of majorrenewals and improvements are capitalized.

**OtherReal Estate Owned** - Other real estate owned includes realestate acquired through foreclosure. Other real estate owned is initially recorded at the lower of cost(principal balance of the former loan plus costs of improvements) or fairvalue, less estimated costs to sell.

Any write-downs atthe dates of acquisition are charged to the allowance for loan losses.  Expenses to maintain such assets, subsequentwrite-downs, and gains and losses on disposal are included in other expenses.

**DerivativeFinancial Instruments** - The Company has entered intocertain interest rate swap agreements which are derivative financialinstruments (“derivatives”).  The derivativesare recognized as other assets on the balance sheet at their fair value. On thedate the derivative contract is entered into, the Company designates thederivative as a hedge of fair value of a recognized asset or liability (“fairvalue hedge”).  Changes in the fair valueof a derivative that is highly effective as - and that is designated andqualifies - as a fair value hedge, along with the loss or gain on the hedgedasset or liability that is attributable to the hedged risk, are recorded in current-periodearnings.

The Companyformally documents all relationships between hedging instruments and hedgeditems, as well as its risk-management objective and strategy for undertakinghedged transactions.  This processincludes linking all derivatives that are designated as fair value hedges tospecific assets and liabilities on the balance sheet.  The derivatives in which the Company is acounterparty qualify for the “shortcut” method of assessing the ongoingeffectiveness of its hedging relationship with the underlying hedged item.

33

----

The Companydiscontinues hedge accounting prospectively when (1) the derivative expires oris sold, terminated, or exercised; (2) management determines that designationof the derivative as a hedge instrument is no longer appropriate; or (3) theunderlying hedged item is liquidated. When hedge accounting is discontinued, the derivative is carried at itsfair value on the balance sheet, with changes in its fair value recognized incurrent-period earnings.

**Incomeand Expense Recognition** - The accrual method ofaccounting is used for all significant categories of income and expense.  Immaterial amounts of insurance commissionsand other miscellaneous fees are reported when received.

**IncomeTaxes** - Amounts provided for income taxes are based onincome reported for financial statement purposes. Deferred income taxes areprovided for the temporary differences between the financial reporting basisand the tax basis of the Company’s assets and liabilities.  Deferred tax assets are reduced by avaluation allowance when, in the opinion of management, it is more likely thannot that some portion or all of the deferred tax assets will not be realized.Management has determined that it is more likely than not that the entiredeferred tax asset at December 31, 2006, will be realized, and accordingly, hasnot established a valuation allowance. Deferred tax assets and liabilities are adjusted for the effects ofchanges in tax laws and rates on the date of enactment.

**AdvertisingExpense** - Advertising and public relations costs aregenerally expensed as incurred.  Externalcosts incurred in producing media advertising are expensed the first time theadvertising takes place.  External costsrelating to direct mailing costs are expensed in the period in which the directmailings are sent.  Advertising andpublic relations costs of $366,000 and $235,000, were included in the Company’sresults of operations for 2006 and 2005, respectively.

**NetIncome Per Share** - Basic income per share is calculatedby dividing net income by the weighted-average number of shares outstandingduring the year.  Diluted net income pershare is computed based on net income divided by the weighted average number ofcommon and potential common shares. Retroactive recognition has been given for the effects of all stockdividends and splits in computing the weighted-average number of shares.  The only potential common share equivalentsare those related to stock options and restricted stock awards.  Stock options which are anti-dilutive areexcluded from the calculation of diluted net income per share.

**Stock-BasedCompensation** – On January 1, 2006, the Company adoptedthe fair value recognition provisions of Financial Accounting Standards Board (“FASB”)Statement of Financial Accounting Standards (“SFAS”) No. 123(R), *Accounting of Stock-Based Compensation*, toaccount for compensation costs under its stock option plans.  The Company previously utilized the intrinsicvalue method under Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees (as amended)*(“APB 25”).  Under the intrinsic valuemethod prescribed by APB 25, no compensation costs were recognized for theCompany’s stock options because the option exercise price in its plans equalsthe market price on the date of grant. Prior to January 1, 2006, the Company only disclosed the pro formaeffects on net income and earnings per share as if the fair value recognitionprovisions of SFAS 123(R ) had been utilized.

In adopting SFASNo. 123, the Company elected to use the modified prospective method to accountfor the transition from the intrinsic value method to the fair valuerecognition method.  Under the modifiedprospective method, compensation cost is recognized from the adoption dateforward for all new stock options granted and for any outstanding unvestedawards as if the fair value method had been applied to those awards as of thedate of grant.  The following tableillustrates the effect on net income and earnings per share as if the fairvalue based method had been applied to all outstanding and unvested awards ineach period.

34

----

** **
|                                                                                                                                               | ** ** | **Years ended**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                    | ** ** | **December 31,** | ** ** |
| **(Dollars in thousands)**                                                                                                          | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Net income, as  reported                                                                                                                      |       | $                     | 2,805      |   | $ | 2,408 |   |
| Add: Stock-based  employee compensation expense Included in reported net income, net of related  tax effects                                  |       | 93                    |       | — |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (93                   | )          | 85 |   |
| Pro forma net  income                                                                                                                         | ** ** | **$**                 | **2,805**  | ** ** | **$** | **2,323** | ** ** |
| Earnings per  share:                                                                                                                          |       |                  |       |   |   |
| Basic - as reported                                                                                                                           | ** ** | **$**                 | **0.79**   | ** ** | **$** | **0.68** | ** ** |
| Basic - pro forma                                                                                                                             | ** ** | **$**                 | **0.79**   | ** ** | **$** | **0.66** | ** ** |
| Diluted - as reported                                                                                                                         | ** ** | **$**                 | **0.79**   | ** ** | **$** | **0.68** | ** ** |
| Diluted - pro  forma                                                                                                                          | ** ** | **$**                 | **0.79**   | ** ** | **$** | **0.66** | ** ** |

 

35

----

In calculating thepro forma disclosures, the fair value of options granted is estimated as of thedate granted using the Black-Scholes option pricing model based on assumptionsset forth in Note 17.

**ComprehensiveIncome** - Accounting principles generally requirerecognized income, expenses, gains, and losses to be included in netincome.  Although certain changes inassets and liabilities, such as unrealized gains and losses onavailable-for-sale securities, are reported as a separate component of theequity section of the balance sheet, such items, along with net income, arecomponents of comprehensive income.

The components ofother comprehensive income and related tax effects are as follows:
|                                                                        | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)**                                   | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Unrealized gains  (losses) on securities available-for-sale            |       | $                                           | 220        |   | $ | (904 | ) |
| Reclassification  adjustment for (gains) losses realized in net income |       | —                                      |       | 52 |   |
| Net unrealized  losses on securities                                   |       | 220                                         |       | (852 | ) |
| Tax effect                                                             |       | (81                                         | )          | 316 |   |
| Net-of-tax amount                                                      | ** ** | **$**                                       | **139**    | ** ** | **$** | **(536** | **)** |

 

**Statementsof Cash Flows**- For purposes of reporting cash flows, theCompany considers certain highly liquid debt instruments purchased with amaturity of three months or less to be cash equivalents.  Cash equivalents include amounts due frombanks, federal funds sold, and time deposits with other banks with maturitiesof three months or less.

The followingsummarizes supplemental cash flow information:
|                                                           | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)**                      | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Cash paid for  interest                                   |       | $                                           | 10,539     |   | $ | 7,296 |   |
| Cash paid for  income taxes                               |       | 1,716                                       |       | 1,303 |   |
| Supplemental  noncash investing and financing activities: |       |                                        |       |   |   |
| Foreclosures on loans                                     |       | 459                                         |       | 776 |   |
|                                                           |            |                                             |            |  |  |  |  |

 

**Off-Balance-SheetFinancial Instruments** - In the ordinary course ofbusiness, the Company enters into off-balance-sheet financial instrumentsconsisting of commitments to extend credit and letters of credit.  These financial instruments are recorded inthe financial statements when they become payable by the customer.

36

----

#### **Recently Issued Accounting Pronouncements**-The following is a summary ofrecent authoritative pronouncements that affect accounting, reporting, anddisclosure of financial information by the Company.

In February 2006,the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—anamendment of FASB Statements No. 133 and 140.” This Statement amends SFAS No.133, “Accounting for Derivative Instruments and Hedging Activities,” and SFASNo. 140, “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities.” This Statement resolves issues addressed inSFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 toBeneficial Interests in Securitized Financial Assets.” FAS 155 permits fairvalue re-measurement for any hybrid financial instrument that contains anembedded derivative that otherwise would require bifurcation, clarifies whichinterest only-strips and principal-only strips are not subject to therequirements of Statement 133, establishes a requirement to evaluate interests insecuritized financial assets to identify interests that are freestandingderivatives or that are hybrid financial instruments that contain an embeddedderivative requiring bifurcation, clarifies that concentrations of credit riskin the form of subordination are not embedded derivatives, and amends Statement140 to eliminate the prohibition on a qualifying special purpose entity fromholding a derivative financial instrument that pertains to a beneficialinterest other than another derivative financial instrument. SFAS No. 155 iseffective for all financial instruments acquired or issued after the beginningof an entity’s first fiscal year that begins after September 15, 2006. TheCompany does not believe that the adoption of SFAS No. 155 will have a materialimpact on its financial position, results of operations or cash flows.

In March 2006, the FASB issued SFAS No. 156, “**Accounting for Servicingof Financial Assets—an amendment of FASB Statement No. 140.” **This Statement amendsFASB No. 140, “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities,” with respect to the accounting for separatelyrecognized servicing assets and servicing liabilities. SFAS No. 156 requires anentity to recognize a servicing asset or servicing liability each time itundertakes an obligation to service a financial asset by entering into aservicing contract; requires all separately recognized servicing assets andservicing liabilities to be initially measured at fair value, if practicable; permitsan entity to choose its subsequent measurement methods for each class ofseparately recognized servicing assets and servicing liabilities; at itsinitial adoption, permits a one-time reclassification of available-for-salesecurities to trading securities by entities with recognized servicing rights,without calling into question the treatment of other available-for-salesecurities under Statement 115, provided that the available-for-sale securitiesare identified in some manner as offsetting the entity’s exposure to changes infair value of servicing assets or servicing liabilities that a service electsto subsequently measure at fair value; and requires separate presentation ofservicing assets and servicing liabilities subsequently measured at fair valuein the statement of financial position and additional disclosures for allseparately recognized servicing assets and servicing liabilities. An entityshould adopt SFAS No. 156 as of the beginning of its first fiscal year thatbegins after September 15, 2006. The Company does not believe the adoption ofSFAS No. 156 will have a material impact on its financial position, results ofoperations or cash flows.

In July 2006, theFASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty inIncome Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in enterprises’ financial statements in accordance with FASBStatement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes arecognition threshold and measurement attributable for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosures andtransitions. FIN 48 is effective forfiscal years beginning after December 15, 2006. The Company is currentlyanalyzing the effects of FIN 48 on its financial position, results ofoperations and cash flows.

37

----

#### In September2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 definesfair value, establishes a framework for measuring fair value in generallyaccepted accounting principles, and expands disclosures about fair valuemeasurements. This standard does not require any new fair value measurements,but rather eliminates inconsistencies found in various prior pronouncements.SFAS 157 is effective for the Company on January 1, 2008 and is not expected tohave a material impact on its financial position, results of operations or cashflows.

In September 2006,the FASB issued SFAS No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans”**(“SFAS 158”), which amends SFAS 87and SFAS 106 to require recognition of the overfunded or underfunded status ofpension and other postretirement benefit plans on the balance sheet. Under SFAS158, gains and losses, prior service costs and credits, and any remainingtransition amounts under SFAS 87 and SFAS 106 that have not yet been recognizedthrough net periodic benefit cost will be recognized in accumulated othercomprehensive income, net of tax effects, until they are amortized as acomponent of net periodic cost. The measurement date — the date at which thebenefit obligation and plan assets are measured — is required to be the company’sfiscal year end. SFAS 158 is effective for publicly – held companies for fiscalyears ending after December 15, 2006, except for the measurement dateprovisions, which are effective for fiscal years ending after December 15,2008. The Company does not have a defined benefit pension plan.  Therefore,SFAS 158 will not impact the Company’s financial conditions, results ofoperations or cash flows.

In September,2006, The FASB ratified the consensuses reached by the FASB’s Emerging IssuesTask Force (“EITF”) relating to EITF 06-4 “Accounting for the DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements”.  EITF 06-4addresses employer accounting for endorsement split-dollar life insurancearrangements that provide a benefit to an employee that extends topostretirement periods should recognize a liability for future benefits inaccordance with SFAS No. 106, “**Employers’Accounting for Postretirement Benefits Other Than Pensions”*,*orAccounting Principles Board (“APB”) Opinion No. 12, “**Omnibus Opinion—1967”*. *EITF 06-4 is effective for fiscal yearsbeginning after December 15, 2007. Entities should recognize the effects ofapplying this Issue through either (a) a change in accounting principle througha cumulative-effect adjustment to retained earnings or to other components ofequity or net assets in the statement of financial position as of the beginningof the year of adoption or (b) a change in accounting principle throughretrospective application to all prior periods. The Company is currentlyanalyzing the effect of adoption of EITF 06-4 on its financial position,results of operations and cash flows.

In September 2006,the FASB ratified the consensus reached related to EITF 06-5,**“Accountingfor Purchases of Life Insurance—Determining the Amount That Could Be Realizedin Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchasesof Life Insurance.”  EITF 06-5 states that a policyholder shouldconsider any additional amounts included in the contractual terms of theinsurance policy other than the cash surrender value in determining the amountthat could be realized under the insurance contract.  EITF 06-5 alsostates that a policyholder should determine the amount that could be realizedunder the life insurance contract assuming the surrender of an individual-lifeby individual-life policy (or certificate by certificate in a group policy).EITF 06-5 is effective for fiscal years beginning after December 15,2006.  The Company is currentlyanalyzing the effect of adoption of EITF 06-5 on its financial position,results of operations and cash flows.

In September 2006,the SEC issued Staff Accounting Bulleting No. 108 (“SAB 108”). SAB 108 providesinterpretive guidance on how the effects of the carryover or reversal of prioryear misstatements should be considered in quantifying a potential current yearmisstatement. Prior to SAB 108, Companies might evaluate the materiality offinancial statement misstatements using either the income statement or balancesheet approach, with the income statement approach focusing on newmisstatements added in the current year, and the balance sheet approachfocusing on the cumulative amount of misstatement present in a company’sbalance sheet. Misstatements that would be material under one approach could beviewed as immaterial under another approach, and not be corrected. SAB 108 nowrequires that companies view financial statement misstatements as material ifthey are material according to either the income statement or balance sheetapproach. The Company has analyzed SAB 108 and determined that upon adoption itwill have no impact on its financial position, results of operation or cashflows.

38

----

#### In February2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities – Including an amendment of FASB Statement No. 115.”  This statement permits, but does not require,entities to measure many financial instruments at fair value.  The objective is to provide entities with anopportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities differently without having to apply complexhedge accounting provisions.  Entitieselecting this option will apply it when the entity first recognizes an eligibleinstrument and will report unrealized gains and losses on such instruments incurrent earnings.  This statement 1)applies to all entities, 2) specifies certain election dates, 3) can be appliedon an instrument-by-instrument basis with some exceptions, 4) is irrevocableand 5) applies only to entire instruments. One exception is demand deposit liabilities which are explicitlyexcluded as qualifying for fair value. With respect to SFAS 115, available-for-sale and held –to-maturitysecurities at the effective date are eligible for the fair value option at thatdate.  If the fair value option iselected for those securities at the effective date, cumulative unrealized gainsand losses at that date shall be included in the cumulative-effect adjustmentand thereafter, such securities will be accounted for as tradingsecurities.  SFAS 159 is effective forthe Company on January 1, 2008.  Earlieradoption is permitted in 2007 if the Company also elects to apply theprovisions of SFAS 157, “Fair Value Measurement.”  The Company is currently analyzing the fairvalue option provided under SFAS 159.

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

**Risks andUncertainties** - In the normal course of its business, theCompany encounters two significant types of risks: economic andregulatory.  There are three maincomponents of economic risk:  interestrate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that itsinterest-bearing liabilities mature or reprice at different speeds, or ondifferent basis, than its interest-earning assets.  Credit risk is the risk of default on theCompany’s loan portfolio that results from borrower’s inability orunwillingness to make contractually required payments.  Market risk reflects changes in the value ofcollateral underlying loans receivable and the valuation of real estate held bythe Company.

The Company issubject to the regulations of various governmental agencies.  These regulations can and do changesignificantly from period to period.  TheCompany also undergoes periodic examinations by the regulatory agencies, whichmay subject it to further changes with respect to asset valuations, amounts ofrequired loss allowances and operating restrictions from the regulators’judgments based on information available to them at the time of theirexamination.

**Reclassifications**- Certain captions and amounts in the 2005 financial statements werereclassified to conform with the 2006 presentation.

**NOTE 2 - CASH AND DUE FROM BANKS**

The Bank is required byregulation to maintain an average cash reserve balance based on a percentage ofdeposits.  At December 31, 2006 and 2005,the requirements were satisfied by amounts on deposit with the Federal ReserveBank and cash on hand.

39

----

#### **NOTE3 - INVESTMENT SECURITIES**

Securitiesavailable-for-sale consisted of the following:
|                                            | ** ** | **Amortized** | ** ** | **Gross Unrealized** | ** ** | **Estimated** | ** ** |
|--------------------------------------------|------------|---------------|------------|---------------------------|------------|---------------|------------|
| **(Dollars in thousands)**       | ** ** | **Cost**      | ** ** | **Gains**                 | ** ** | **Losses**    | ** ** | **Fair Value** | ** ** |
| **December  31, 2006**                     |       |          |       |                      |       |          |       |   |   |
| Government-sponsored enterprises           |       | $             | 19,216     |                      | $          | 31            |       | $ | 155 |   | $ | 19,092 |   |
| Mortgage-backed securities                 |       | 23,943        |       | 25                        |       | 519           |       | 23,449 |   |
| Equity securities                          |       | 835           |       | 19                        |       | —        |       | 854 |   |
| Obligations of state and local governments |       | 7,508         |       | 39                        |       | 112           |       | 7,435 |   |
| Total                                      | ** ** | **$**         | **51,502** | ** **                | **$**      | **114**       | ** ** | **$** | **786** | ** ** | **$** | **50,830** | ** ** |
| **December  31, 2005**                     |       |          |       |                      |       |          |       |   |   |
| Government-sponsored enterprises           |       | $             | 8,630      |                      | $          | —        |       | $ | 193 |   | $ | 8,437 |   |
| Mortgage-backed securities                 |       | 23,917        |       | —                    |       | 675           |       | 23,242 |   |
| Equity securities                          |       | 834           |       | —                    |       | 14            |       | 820 |   |
| Obligations of state and local governments |       | 5,745         |       | 42                        |       | 53            |       | 5,734 |   |
| Total                                      | ** ** | **$**         | **39,126** | ** **                | **$**      | **42**        | ** ** | **$** | **935** | ** ** | **$** | **38,233** | ** ** |

 

The following is asummary of maturities of securities available-for-sale as of December 31,2006.  The amortized cost and estimatedfair values are based on the contractual maturity dates.  Actual maturities may differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without penalty.
|                                            | ** ** | **Securities**         | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **Available-For-Sale** | ** ** |
| ** **                                 | ** ** | **Amortized**          | ** ** | **Estimated** | ** ** |
| **(Dollars in thousands)**       | ** ** | **Cost**               | ** ** | **Fair Value** | ** ** |
| Due in less than  one year                 |       | $                      | 499        |   | $ | 495 |   |
| Due after one  year but within five years  |       | 15,459                 |       | 15,251 |   |
| Due after five  years but within ten years |       | 8,701                  |       | 8,654 |   |
| Due after ten  years                       |       | 26,843                 |       | 26,430 |   |
|                                       |       |                   |       |   |   |
| Total                                      | ** ** | **$**                  | **51,502** | ** ** | **$** | **50,830** | ** ** |

 

Thefollowing table shows gross unrealized losses and fair value, aggregated by investmentcategory, and length of time that individual securities have been in acontinuous unrealized loss position, at December 31, 2006.

**SecuritiesAvailable for Sale**
|                                             | ** ** | **Less than**     | ** ** | **Twelve months** | ** ** | ** **          | ** ** | ** **     | ** ** |
|---------------------------------------------|------------|------------------------|------------|------------------------|------------|---------------------|------------|----------------|------------|
| ** **                                  | ** ** | **twelve months** | ** ** | **or more**       | ** ** | **Total**           | ** ** |
| ** **                                  | ** ** | ** **             | ** ** | **Unrealized**         | ** ** | ** **          | ** ** | **Unrealized** | ** ** | ** ** | ** ** | **Unrealized** | ** ** |
| **(Dollars in thousands)**        | ** ** | **Fair value**    | ** ** | **losses**             | ** ** | **Fair value** | ** ** | **losses**     | ** ** | **Fair value** | ** ** | **losses** | ** ** |
| Government-sponsored  enterprises           |       | $                      | 5,892      |                   | $          | 23                  |       | $              | 5,860      |   | $ | 132 |   | $ | 11,752 |   | $ | 155 |   |
| Mortgage-backed  securities                 |       | 2,399                  |       | 19                     |       | 18,222              |       | 499            |       | 20,621 |   | 518 |   |
| Obligations of  state and local governments |       | 2,721                  |       | 104                    |       | 1,634               |       | 9              |       | 4,355 |   | 113 |   |
| Total                                       | ** ** | **$**                  | **11,012** | ** **             | **$**      | **146**             | ** ** | **$**          | **25,716** | ** ** | **$** | **640** | ** ** | **$** | **36,728** | ** ** | **$** | **786** | ** ** |

 

40

----

#### Managementevaluates its investment portfolio periodically to identify any impairment thatis other than temporary.  At December 31,2006, the Company had twenty individual securities, or 50.69% of the securityportfolio, that have been in an unrealized loss position for more than twelvemonths.  Management believes these lossesare temporary and are a result of the current interest rate environment.

At December 31, 2006 and2005, investment securities with a book value of $29,978,000 and $31,064,000,respectively, and a market value of $29,501,000 and $30,299,000, respectively,were pledged as collateral.

There were no sales ofavailable-for-sale securities for the year ended December 31, 2006.  Gross realized gains on sales ofavailable-for-sale securities were $22,000 in 2005.  Gross realized losses on available-for-salesecurities were  $74,000 in 2005.  Proceeds from the sale of securities totaled$4,237,000 in 2005.

#### **NOTE4 - LOANS RECEIVABLE**

Loans consisted ofthe following:
|                                                  | ** ** | **December 31,**                                                                        | ** **  |
|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------|-------------|
| **(Dollars in thousands)**             | ** ** | **       2006       ** | ** **  | **       2005       ** | ** ** |
| Real estate -  construction and land development |       | $                                                                                            | 28,124      |   | $ | 18,686 |   |
| Real estate -  mortgage and commercial           |       | 147,156                                                                                      |        | 133,527 |   |
| Agricultural                                     |       | 6,099                                                                                        |        | 5,141 |   |
| Commercial and  industrial                       |       | 54,313                                                                                       |        | 55,909 |   |
| Consumer                                         |       | 18,267                                                                                       |        | 21,168 |   |
| All other loans  (including overdrafts)          |       | 608                                                                                          |        | 647 |   |
| Total gross  loans                               | ** ** | **$**                                                                                        | **254,567** | ** ** | **$** | **235,078** | ** ** |

 

Certain parties(principally certain directors and officers of the Company, their immediatefamilies, and business interests) were loan customers and had othertransactions in the normal course of business with the Company.  Related party loans are made on substantiallythe same terms, including interest rates and collateral, as those prevailing atthe time for comparable transactions with unrelated persons and do not involvemore than normal risk of collectibility. The aggregate dollar amounts of loans to related parties were$12,354,000 and $3,719,000 at December 31, 2006 and 2005, respectively.  During 2006, advances on related party loanstotaled $5,234,000, and repayments were $749,000.

Transactions in theallowance for loan losses are summarized below:
|                                             | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)**        | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Balance,  beginning of year                 |       | $                                           | 2,569      |   | $ | 2,155 |   |
| Provision  charged to operations            |       | 770                                         |       | 1,070 |   |
| Recoveries on loans  previously charged off |       | 90                                          |       | 135 |   |
| Loans charged  off                          |       | (711                                        | )          | (791 | ) |
| Balance, end of  year                       | ** ** | **$**                                       | **2,718**  | ** ** | **$** | **2,569** | ** ** |

 

Loans on theCompany’s problem loan watch list are considered potentially impairedloans.  These loans are evaluated indetermining whether all outstanding principal and interest are expected to becollected.  Loans are not consideredimpaired if a minimal delay occurs and all amounts due, including accruedinterest at the contractual interest rate for the period of the delay, areexpected to be collected.

41

----

#### As of December31, 2006 and 2005, the Company had nonaccrual loans of approximately $760,000and $2,044,000, respectively, and loans that were contractually past due 90days or more and still accruing interest of approximately $1,714,000 and $843,000,respectively, for which impairment had not been recognized.  The additional interest income, which wouldhave been recognized into earnings if the Company’s nonaccrual loans had beencurrent in accordance with their original terms, was $133,000 and $274,000during 2006 and 2005, respectively.  AtDecember 31, 2006 and 2005, impaired loans closely approximated nonaccrualloans.

The balance of loanscontractually past due 90 days or more still accruing interest as of December31, 2006 was one loan collateralized by commercial real estate.  This loan was repaid in full on January 9,2007 through the liquidation of a portion of the bank’s collateral.

The Company is aparty to financial instruments with off-balance-sheet risk in the normal courseof business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit and standby letters of credit.  These instruments involve, to varyingdegrees, elements of credit and interest rate risk in excess of the amountrecognized in the balance sheets.

The Company’sexposure to credit loss in the event of nonperformance by the other party tothe financial instrument for commitments to extend credit and standby lettersof credit is represented by the contractual or notional amount of thoseinstruments.  The Company uses the samecredit policies in making commitments and conditional obligations as it doesfor on-balance-sheet instruments.

Standby letters ofcredit are conditional commitments issued by the Company to guarantee theperformance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially thesame as that involved in extending loans to customers.  The fair value of standby letters of creditis insignificant.

Commitments toextend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract.  Commitments generally have fixed expirationdates or other termination clauses and may require payment of a fee.  Since some of the commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-casebasis.  The amount of collateralobtained, if deemed necessary by the Company upon extension of credit, is basedon management’s credit evaluation of the counter-party.

Collateral held forcommitments to extend credit and standby letters of credit varies but mayinclude accounts receivable, inventory, property, plant, equipment, andincome-producing commercial properties. The following table summarizes the Company’s off-balance-sheet financialinstruments whose contract amounts represent credit risk:
|                                      | ** ** | **December 31,**                                                            | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** |
| Commitments to  extend credit        |       | $                                                                                | 37,852     |   | $ | 35,134 |   |
| Standby letters of  credit           |       | 814                                                                              |       | 778 |   |
|                                      |            |                                                                                  |            |  |  |  |  |

 

42

----

#### **NOTE5 - PREMISES, FURNITURE AND EQUIPMENT**

Premises,furniture and equipment consisted of the following:
|                                         | ** ** | **December 31,**                                                            | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)**    | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** |
| Land                                    |       | $                                                                                | 4,202      |   | $ | 4,115 |   |
| Buildings and  land improvements        |       | 7,683                                                                            |       | 6,875 |   |
| Furniture and  equipment                |       | 4,757                                                                            |       | 4,154 |   |
| Leasehold  improvements                 |       | 41                                                                               |       | 41 |   |
| Construction in  progress               |       | 3,537                                                                            |       | 1 |   |
|                                    |       | 20,220                                                                           |       | 15,186 |   |
| Less accumulated  depreciation          |       | (4,081                                                                           | )          | (3,505 | ) |
| Premises,  furniture and equipment, net | ** ** | **$**                                                                            | **16,139** | ** ** | **$** | **11,681** | ** ** |

 

Depreciation expense forthe years ended December 31, 2006 and 2005 was $637,000 and $619,000,respectively.

The Company had$4,000 in capitalized interest during construction in 2006.  No interest was capitalized in 2005.

#### **NOTE6 - OTHER ASSETS**

Other assetsconsisted of the following:
|                                      | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Cash value of  life insurance        |       | $                     | 929        |   | $ | 936 |   |
| Other real  estate owned             |       | 95                    |       | 485 |   |
| Prepaid expenses  and insurance      |       | 304                   |       | 220 |   |
| Unamortized  software                |       | 472                   |       | 623 |   |
| Net deferred tax  asset              |       | 765                   |       | 543 |   |
| Other                                |       | 1,392                 |       | 1,331 |   |
| Total                                | ** ** | **$**                 | **3,957**  | ** ** | **$** | **4,138** | ** ** |

 

**NOTE 7 -DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES**

The Companymaintains an overall interest-rate risk-management strategy that incorporatesthe use of derivatives to minimize significant unplanned fluctuations inearnings that are caused by interest-rate volatility.  As part of this strategy, the Company enteredcertain interest rate swap agreements, which remain in place.  Such interest rate swaps are derivative financialinstruments (“derivatives”).  Interestrate swaps generally involve the exchange of fixed and variable rate interestpayments between two parties, based on a common notional amount and maturitydate.  The Company’s goal is to manageinterest-rate sensitivity by modifying the repricing or maturitycharacteristics of specific balance-sheet assets and liabilities so that thenet-interest margin is not, on a material basis, adversely affected bymovements in interest rates. The interest-rate swaps entered by the Companyconverted certain nonprepayable fixed rate long term debt to floating rates. Asa result of interest-rate fluctuations, hedged assets and liabilities willappreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation willgenerally be offset by income or loss on the derivatives that are linked to thehedged assets and liabilities.  TheCompany views this strategy as a prudent management of interest-ratesensitivity, such that earnings are not exposed to undue risk presented bychanges in interest rates.

43

----

By usingderivative instruments, the Company is exposed to credit and market risk.  If the counterparty fails to perform, creditrisk is equal to the extent of the fair-value gain in a derivative.  When the fair value of a derivative contractis positive, this generally indicates that the counterparty owes the Company,and, therefore, creates a repayment risk for the Company.  When the fair value of a derivative contractis negative, the Company owes the counterparty and, therefore, it has norepayment risk.  The Company minimizesthe credit (or repayment) risk in derivative instruments by entering intotransactions with high-quality counterparties that are reviewed by the Company’scredit committee.

Market risk is the adverse effect that a change ininterest rates, currency, or implied volatility rates has on the value of afinancial instrument.  The Companymanages the market risk associated with interest rate swap contracts byestablishing and monitoring limits as to the types and degree of risk that maybe undertaken.  The Company periodicallymeasures this risk by using a value-at-risk methodology.

The Company’s derivatives activities are monitored byits risk-management committee as part of that committee’s oversight of theCompany’s asset/liability and treasury functions.  The Company’s asset/liability committee isresponsible for implementing various hedging strategies that are developedthrough its analysis of data from financial simulation models and otherinternal and industry sources.  The resultinghedging strategies are then incorporated into the Company’s overallinterest-rate risk-management and trading strategies.

The interest rate swap agreements provide for theCompany to make payments at a variable rate determined by a specified index(three month LIBOR) in exchange for receiving payments at a fixed rate of3.4%.  During 2006 and 2005, the Companyrecognized ($233,000) and $20,000, respectively, as a reduction of (increasein) interest expense on Federal Home Loan Bank Advances as a result of itsinterest rate swaps.

At December 31,2006 and 2005, the information pertaining to outstanding interest rate swapagreements used to hedge fixed rate debt is as follows:
| (Dollars in thousands)                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Notional amount                                  |       | $        | 14,600     |     | $          | 14,600 |   |
| Weighted average  fixed (receive) rate           |       | 3.43     | %          | 3.43     | %          |
| Weighted average  variable (pay) rate            |       | 5.07     | %          | 3.88     | %          |
| Weighted average  maturity in years              |       | 3.6      |       | 4.6      |       |
| Unrealized gain  relating to interest rate swaps |       | $        | 788        |     | $          | 772 |   |

 

At December 31, 2006 and 2005, the unrealized gain of$788,000 and $772,000, respectively, related to interest rate swaps wererecorded in derivative assets and other liabilities at the same amount.

Risk management results for the year ended December31, 2006 and 2005 related to the balance sheet hedging of long-term debtindicate that the hedges were 100% effective and that there was no component ofthe derivative instruments’ gain or loss which was excluded from the assessmentof hedge effectiveness.

**NOTE 8 –NOTE PAYABLE**

On September 22, 2006, the Company executed a line of credit with NexityBank to borrow up to $3,600,000.  Theentire principal balance of the note is due September 30, 2007, with interestpayments due monthly.  The interest rateon the note is a variable rate equal to the Wall Street Journal Prime Rate less1%.  The note is secured by a first realestate mortgage on the four properties that were acquired with the loanproceeds.  Proceeds from the note wereused to acquire four parcels of property in Conway, S.C. on which the Companyintends to establish a branch.  AtDecember 31, 2006, the Company had borrowed $3,478,000 on this line ofcredit.  This line of credit was paid infull on January 12, 2007.

44

----

#### **NOTE9 - DEPOSITS**

At December 31,2006, the scheduled maturities of time deposits were as follows:
| (Dollars in thousands) | ** ** | ** ** | ** **  |
|----------------------------------|------------|------------|-------------|
| **Maturing In**             | ** ** | **Amount** | ** **  |
| 2007                             |       | $          | 93,687      |   |
| 2008                             |       | 5,791      |        |
| 2009                             |       | 5,373      |        |
| 2010                             |       | 791        |        |
| 2011 and thereafter              |       | 299        |        |
| Total                            | ** ** | **$**      | **105,941** | ** ** |

 

Overdrawntransaction accounts in the amount of $130,000 and $108,000 were classified asloans as of December 31, 2006 and 2005, respectively.

Deposits bydirectors including their affiliates and executive officers totaledapproximately $2,671,000 and $1,973,000 at December 31, 2006 and 2005,respectively.

#### **NOTE10 - ADVANCES FROM THE FEDERAL HOME LOAN BANK**

Advances from the FederalHome Loan Bank consisted of the following:
| (Dollars in thousands)               | ** ** | **Interest** | ** ** | **December 31,**                                                | ** ** |
|------------------------------------------------|------------|--------------|------------|----------------------------------------------------------------------|------------|
| **Advances maturing on:**            | ** ** | **Rate**     | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| March 11, 2008 (converted to fixed rate)       |       | 3.09         | %          | $                                                                    | 5,000      |   | $ | 5,000 |   |
| December 8, 2008 (converted to fixed rate)     |       | 3.87         | %          | 1,700                                                                |       | 1,700 |   |
| March 1, 2010                                  |       | 5.92         | %          | 5,000                                                                |       | 5,000 |   |
| May 24, 2010                                   |       | 5.36         | %          | 4,600                                                                |       | 4,600 |   |
| March 22, 2011                                 |       | 5.37         | %          | 5,000                                                                |       | 5,000 |   |
| January, 17, 2012 (converted to variable rate) |       | 5.36         | %          | 5,000                                                                |       | 5,000 |   |
| July 23, 2012                                  |       | 3.81         | %          | 5,000                                                                |       | 5,000 |   |
| September 4, 2012                              |       | 3.56         | %          | 2,090                                                                |       | 2,090 |   |
| January 30, 2013                               |       | 3.36         | %          | 5,000                                                                |       | 5,000 |   |
| December 8, 2014                               |       | 3.24         | %          | 5,000                                                                |       | 5,000 |   |
| Total                                          | ** ** | ** **   | ** ** | **$**                                                                | **43,390** |   | **$** | **43,390** |   |

 

Interest is payablequarterly.  Initially all advances bearinterest at a fixed rate; however, at a certain date for each of the advances,at the Federal Home Loan Bank’s option, the rates can be converted tofloating.  Also on these dates theFederal Home Loan Bank has the option to call the advances.  As of December 31, 2006, $6,700,000 werefixed rate credits; $17,090,000 were convertible advances; and $19,600,000 wereadjustable rate credits.

As of December 31,2006, scheduled principal reductions include $6,700,000 in 2008, $9,600,000 in2010,  $5,000,000 in 2011, and theremainder after five years.

As collateral, theCompany has pledged its portfolio of first mortgage one-to-four familyresidential loans aggregating $16,909,000 at December 31, 2006, as well as halfof its commercial real estate loan portfolio, totaling $3,818,000 at December31, 2006.  Also, the Company has pledgedhalf of its portfolio of HELOCS and second mortgage loans totaling $1,046,000,and its investment in Federal Home Loan Bank stock with a carrying value of$2,615,000.

As discussed inNote 7, the Company has entered into interest rate swap agreements associatedwith Federal Home Loan Bank advances maturing on March 1, 2010, May 24, 2010and March 22, 2011.  The interest rateswaps effectively converted the fixed interest rates on the advances to avariable rate.  The variable rate of theswap payable was 5.365% at December 31, 2006 and is based on the three monthLIBOR index.

45

----

**NOTE 11 -JUNIOR SUBORDINATED DEBENTURES**

On December 21,2004, HCSB Financial Trust I, (a non-consolidated subsidiary) issued $6.0million floating rate trust preferred securities with a maturity of December31, 2034.  The rate is adjusted quarterlyand was 7.71% at December 31, 2006.  Inaccordance with the revised FIN 46, the trust has not been consolidated inthese financial statements.  The Companyreceived from the Trust the $6.0 million proceeds from the issuance of thesecurities and the $186,000 initial proceeds from the capital investment in theTrust, and accordingly has shown the funds due to the trust as a $6,186,000junior subordinated debenture.  Thecurrent regulatory rules allow certain amounts of junior subordinateddebentures to be included in the calculation of regulatory capital.  The debenture issuance costs, net ofaccumulated amortization, totaled $102,000 at December 31, 2006 and is includedin other assets on the consolidated balance sheet.  Amortization of debt issuance costs totaled$3,667 for each of the years ended December 31, 2006 and 2005.

The Companyinvested $5,880,000 in the Company’s wholly-owned subsidiary, Horry CountyState Bank.  The remaining balance willbe maintained by the Company to fund operations.

#### **NOTE12 - LEASE COMMITMENTS**

On May 15, 1997,the Company entered into a lease agreement for land on which to operate itsTabor City branch.  The lease had aninitial five-year term that expired June 5, 2002, and the Company chose toexercise its option for a five-year renewal of the lease at that time.  In December 2002, the Company and theproperty owners chose to negotiate a new lease that began January 1, 2003 andends January 1, 2008 with the Company having an option for nine additionalfive-year renewal periods thereafter. Subsequent to the date of the renegotiated lease, the lease was amendedand resulted in a new rental amount of $1,000 per month through January 1,2008.  The lease gives the Company thefirst right of refusal to purchase the property at an unimproved value if theowners decide to sell.  The Company alsopays applicable property taxes on the property.

On February 15, 1999, theCompany entered into an annual lease agreement for use of a parking lotadjacent to the Meeting Street branch in Loris, S.C.  The initial term was for one year with therenewal thereof renegotiable annually. The lease has subsequently been renewedeach year at an annual cost of $600.  TheCompany expects to renew this lease again in February, 2007.

Expected futureminimum lease payments over the next year for these long-term operating leasesare as follows:

| (Dollars in thousands) | ** ** | **   Amount   ** | ** ** |
|----------------------------------|------------|------------------------------------------------|------------|
| 2007                             |       | $                                              | 12,600     |   |
| Total                            | ** ** | **$**                                          | **12,600** | ** ** |

 

#### **NOTE13 - COMMITMENTS AND CONTINGENCIES**

In the ordinarycourse of business, the Company may, from time to time, become a party to legalclaims and disputes.  At December 31,2006, management was not aware of any pending or threatened litigation orunasserted claims that could result in losses, if any, that would be materialto the financial statements.

46

----

#### **NOTE14 - SHAREHOLDERS’ EQUITY**

**StockDividends** - In January 2007, the Board of Directorsdeclared a 2 for 1 stock split payable on March 13, 2007, to shareholders ofrecord at January 30, 2007.  As a resultof the stock split in the form of a 100% stock dividend, 1,784,937 shares wereissued.  In January 2006, the Board ofDirectors declared a 3.0% stock dividend payable on March 13, 2006, toshareholders of record on February 10, 2006. As a result of the dividend, 52,083 shares were issued.  All share and per share amounts have beenadjusted to reflect these dividends.

**Restrictionson Dividends** - South Carolina banking regulationsrestrict the amount of dividends that can be paid to shareholders.  All of the Bank’s dividends to HCSB FinancialCorporation and Subsidiary are payable only from the undivided profits of theBank.  At December 31, 2006, the Bank’sundivided profits were $13,723,209.  TheBank is authorized to pay cash dividends up to 100% of net income in anycalendar year without obtaining the prior approval of the Commissioner of Bankingprovided that the Bank received a composite rating of one or two at the lastFederal or State regulatory examination. Under Federal Reserve Board regulations, the amounts of loans oradvances from the Bank to the parent company are also restricted.

#### **NOTE15 - CAPITAL REQUIREMENTS**

The Company andthe Bank are subject to various regulatory capital requirements administered bythe federal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a materialeffect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Bank must meet specific capital guidelines thatinvolve quantitative measures of the Company’s and the Bank’s assets,liabilities, and certain off-balance-sheet items as calculated under regulatoryaccounting practices.  The Company’s andthe Bank’s capital amounts and classifications are also subject to qualitativejudgments by the regulators about components, risk-weightings, and otherfactors.

Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum ratios (set forth in the table below)of Tier 1 and total capital as a percentage of assets and off-balance-sheetexposures, adjusted for risk-weights ranging from 0% to 100%.  Tier 1 capital of the Bank consists of commonshareholders’ equity, excluding the unrealized gain or loss on securitiesavailable for sale, minus certain intangible assets.  Tier 2 capital consists of the allowance forloan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists ofthe sum of Tier 1 and Tier 2 capital.

The Company andthe Bank are also required to maintain capital at a minimum level based onquarterly average assets (as defined), which is known as the leverageratio.  Only the strongest institutionsare allowed to maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios1% to 2% above the minimum.

47

----

As of the mostrecent regulatory examination, the Bank was deemed well capitalized under theregulatory framework for prompt corrective action.  To be categorized as well capitalized, theBank must maintain total risk-based, Tier 1 risk-based, and Tier 1 leverageratios as set forth in the table below. There are no conditions or events that management believes have changedthe Company’s or the Bank’s categories.

The followingtable summarizes the capital ratios and the regulatory minimum requirements forthe Company and the Bank.
|                                          | ** ** | ** **                                     | ** ** | ** **                 | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | **To Be Well-**                      | ** ** |
|------------------------------------------|------------|------------------------------------------------|------------|----------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                               | ** ** | ** **                                     | ** ** | ** **                 | ** ** | **Minimum Requirement**                   | ** ** | **Capitalized Under**                    | ** ** |
| ** **                               | ** ** | ** **                                     | ** ** | ** **                 | ** ** | **For Capital**                           | ** ** | **Prompt Corrective**                    | ** ** |
| ** **                               | ** ** | **Actual**                                     | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions**                     | ** ** |
| **(Dollars in thousands)**     | ** ** | **   Amount   ** | ** ** | **Ratio**                  | ** ** | **   Amount   ** | ** ** | **   Ratio   ** | ** ** | **   Amount   ** | ** ** | **Ratio** | ** ** |
| **December  31, 2006**                   |       |                                           |       |                       |       |                                           |       |                                          |       |                                           |       |   |   |
| **The  Company**                         |       |                                           |       |                       |       |                                           |       |                                          |       |                                           |       |   |   |
| Total capital (to risk-weighted assets)  |       | $                                              | 37,491     |                       | 13.86      | %                                              | 21,640     |                                          | 8.00       | %                                              | N/A        |   | N/A |   |
| Tier 1 capital (to risk-weighted assets) |       | 34,773                                         |       | 12.86                      | %          | 10,820                                         |       | 4.00                                          | %          | N/A                                            |       | N/A |   |
| Tier 1 capital (to average assets)       |       | 34,773                                         |       | 10.07                      | %          | 13,811                                         |       | 4.00                                          | %          | N/A                                            |       | N/A |   |
| **The Bank**                             |       |                                           |       |                       |       |                                           |       |                                          |       |                                           |       |   |   |
| Total capital (to risk-weighted assets)  |       | $                                              | 36,603     |                       | 13.74      | %                                              | $          | 21,310                                        |       | 8.00                                           | %          | $ | 26,637 |   | 10.00 | % |
| Tier 1 capital (to risk-weighted assets) |       |        33,885    |       | 12.72                      | %          |        10,655    |       | 4.00                                          | %          | $                                              | 15,982     |   | 6.00 | % |
| Tier 1 capital (to average assets)       |       |        33,885    |       | 9.71                       | %          |        13,956    |       | 4.00                                          | %          | $                                              | 17,445     |   | 5.00 | % |
| **December  31, 2005**                   |       |                                           |       |                       |       |                                           |       |                                          |       |                                           |       |   |   |
| **The  Company**                         |       |                                           |       |                       |       |                                           |       |                                          |       |                                           |       |   |   |
| Total capital (to risk-weighted assets)  |       | $                                              | 34,424     |                       | 13.81      | %                                              | $          | 19,945                                        |       | 8.00                                           | %          | N/A |   | N/A |   |
| Tier 1 capital (to risk-weighted assets) |       | 31,855                                         |       | 12.78                      | %          | 9,972                                          |       | 4.00                                          | %          | N/A                                            |       | N/A |   |
| Tier 1 capital (to average assets)       |       | 31,855                                         |       | 9.61                       | %          | 13,263                                         |       | 4.00                                          | %          | N/A                                            |       | N/A |   |
| **The Bank**                             |       |                                           |       |                       |       |                                           |       |                                          |       |                                           |       |   |   |
| Total capital (to risk-weighted assets)  |       | $                                              | 33,233     |                       | 13.36      | %                                              | $          | 19,899                                        |       | 8.00                                           | %          | $ | 24,874 |   | 10.00 | % |
| Tier 1 capital (to risk-weighted assets) |       | 30,664                                         |       | 12.33                      | %          | 9,950                                          |       | 4.00                                          | %          | 14,925                                         |       | 6.00 | % |
| Tier 1 capital  (to average assets)      |       | 30,664                                         |       | 9.25                       | %          | 13,263                                         |       | 4.00                                          | %          | 16,579                                         |       | 5.00 | % |

 

#### **NOTE16 - RETIREMENT AND BENEFITS**

##### **TrusteedRetirement Savings Plan  -** The Bank has a trustee retirementsavings plan which provides retirement benefits to substantially all officersand employees who meet certain age and service requirements.  The plan includes a “salary reduction”feature pursuant to Section 401(k) of the Internal Revenue Code.  Under the plan and present policies,participants are permitted to contribute up to 15% of their annualcompensation.  At its discretion, theBank can make matching contributions up to 4% of the participants’compensation.  The Company charged$153,000 and $128,000 to earnings for the retirement savings plan in 2006 and2005, respectively.

**DirectorsDeferred Compensation Plan** - The Company has a deferredcompensation plan whereby directors may elect to defer the payment of theirfees.  Under the terms of the plan, theCompany accrues an expense equal to the amount deferred plus an interestcomponent based on the prime rate of interest at the beginning of each year.  The Company has also purchased life insurancecontracts on each of the participating directors.  At December 31, 2006 and 2005, $645,000 and$519,000, respectively, of directors’ fees were deferred and are included inother liabilities.

**PerformanceCompensation for Incentive Plan** - The Company implementedan employee bonus program in 2003 which it refers to as its PerformanceCompensation Plan.  The plan paysemployees based on a schedule of key performance indicators they are requiredto meet in order to be rewarded.  Theplan accrues for its employee bonuses based on a percentage of each employee’sannual salary.  The plan has a fiscalyear ending on December 31, and pays out on January 30 of the followingyear.   The Company charged $88,000 and$125,000 to earnings for the stakeholder plan in 2006 and 2005, respectively.

48

----

**NOTE 17 - EARNINGS PER SHARE**

Earningsper share - basic is computed by dividing net income by the weighted averagenumber of common shares outstanding. Earnings per share - diluted is computed by dividing net income by theweighted average number of common shares outstanding and dilutive common shareequivalents using the treasury stock method. Dilutive common share equivalents include common shares issuable uponexercise of outstanding stock options. All share amounts have been adjusted for stock splits and dividends.
|                                                                                          | ** ** | **Years ended December 31,**                                                                          | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| **(Dollars in thousands, except per share amounts)**       | ** ** | **         2006         ** | ** ** | **         2005         ** | ** ** |
| **Basic  earnings per share:**                                                           |       |                                                                                                                 |       |   |   |
| Net income  available to common shareholders                                             | ** ** | **$**                                                                                                                | **2,805**  | ** ** | **$** | **2,408** | ** ** |
| Average common  shares outstanding - basic                                               | ** ** | **3,542,073**                                                                                                        | ** ** | **3,528,384** | ** ** |
| Basic earnings  per share                                                                | ** ** | **$**                                                                                                                | **0.79**   | ** ** | **$** | **0.68** | ** ** |
| **Diluted  earnings per share:**                                                         |       |                                                                                                                 |       |   |   |
| Net income  available to common shareholders                                             |       | $                                                                                                                    | 2,805      |   | $ | 2,408 |   |
| Average common  shares outstanding - basic                                               |       | 3,542,073                                                                                                            |       | 3,528,384 |   |
| Incremental  shares from assumed conversion of stock options and restricted stock awards |       | 16,243                                                                                                               |       | 19,188 |   |
| Average common  shares outstanding - diluted                                             | ** ** | **3,558,316**                                                                                                        | ** ** | **3,547,572** | ** ** |
| Diluted earnings per share                                                               | ** ** | **$**                                                                                                                | **0.79**   | ** ** | **$** | **0.68** | ** ** |

 

**NOTE 18 -STOCK COMPENSATION PLAN**

#### In 2004, upon shareholder approval, the Company adopted an OmnibusStock Ownership and Long Term Incentive Plan (the “Stock Plan”).  The Stock Plan authorizes the grant ofoptions and awards of restricted stock to certain of our employees for up to400,000 shares of the Company’s common stock from time to time during the termof the Stock Plan, subject to adjustments upon change in capitalization.  The Stock Plan is administered by theCompensation Committee of the Board of Directors of the Company.

#### Options granted under the Stock Plan are incentive stock options, andthey are vested over a five year period with none vesting at the time of thegrant.  All unexercised incentive stockoptions expire ten years after the date of the grant.  A summary of the Company’s incentive stockoptions as of December 31, 2006 and 2005 is as follows *(withadjustments for the 3% stock dividend and the 2-for1stock split for eachperiod):*

|                                   | ** ** | **2006**   | ** ** | **2005**     | ** ** |
|-----------------------------------|------------|------------|------------|--------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of year |       | 86,822     |       | $            | 14.38      |   | 39,904 |   | $ | 11.78 |   |
| Granted                           |       | —     |       | —       |       | 47,854 |   | 16.51 |   |
| Exercised                         |       | —     |       | —       |       | (936 | ) | 12.50 |   |
| Forfeited                         |       | (4,034     | )          | 14.54        |       | — |   |   |   |
| Outstanding at end of  year       | ** ** | **82,788** |       | 14.94        | ** ** | **86,822** |   | 14.38 |   |
|                                   |            |            |            |              |            |  |  |  |  |  |  |

 

49

----

#### The Company had no options exercised during 2006.  The total intrinsic value of optionsexercised in 2005 was $4,000.

#### Restricted stock awards included in the Stock Plan vest after the firstthree consecutive periods during which the Bank’s return on average assets(ROAA) averages 1.15%.  At December 31,2006 and 2005, none of the restricted stock had vested; therefore, nocompensation expense related to the vesting was recognized.  All ungranted restricted stock awardsexpire.  A summary of the Company’sunrestricted stock awards as of December 31, 2006 and 2005 is as follows *(with adjustments for3% stock dividend and the 2-for-1 stock split foreach period):*

|                                  | ** ** | **2006**   | ** ** | **2005**     | ** ** |
|----------------------------------|------------|------------|------------|--------------|------------|
| ** **                       | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                       | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** |
| Outstanding at beginning of year |       | 50,232     |       | $            | 14.00      |   | 26,606 |   | $ | 11.78 |   |
| Granted                          |       | —     |       | —       |       | 23,626 |   | 16.51 |   |
| Exercised                        |       | —     |       | —       |       | — |   |   |   |
| Forfeited                        |       | (4,034     | )          | 14.54        |       | — |   |   |   |
| Outstanding at end of  year      | ** ** | **46,198** |       | 14.94        | ** ** | **50,232** |   | 14.00 |   |
|                                  |            |            |            |              |            |  |  |  |  |  |  |

 

The followingtable summarizes information about stock options outstanding under the Company’splans at December 31, 2006 *(withadjustments for the 2-for-1 stock split for the two periods):*
|                                  | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|----------------------------------|------------|-----------------|------------|-----------------|------------|
| Number of  options               |       | 128,986         |       | 24,262          |       |
| Weighted average  remaining life |       | 6.5 years       |       | 4.1 years       |       |
| Weighted average  exercise price |       | $               | 14.94      |            | $          | 14.94 |   |
|                                  |            |                 |            |                 |            |  |  |

 

The aggregateintrinsic value of shares outstanding at December 31, 2006 was $717,000.

The Companymeasures the fair value of each option award on the date of grant using theBlack-Scholes option-pricing model.  TheCompany determines the assumptions used in the Black-Scholes option pricingmodel as follows:  the risk-free interestrate is based on the U.S. Treasury yield curve in effect at the time of thegrant; the dividend yield is based on the Company’s dividend yield at the timeof the grant (subject to adjustment if the dividend yield on the grant date isnot expected to approximate the dividend yield over the expected life of theoptions); the volatility factor is based on the historical volatility of theCompany’s stock (subject to adjustment if historical volatility is reasonablyexpected to differ from the past); the weighted-average expected life is basedon the historical behavior of employees related to exercises, forfeitures andcancellations.

50

----

The per shareweighted average fair value of options granted during 2006 and 2005, was $21.78and $14.30, respectively, on the date of grant using the Black-Scholes optionpricing model with the following weighted-average assumptions:
|                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Expected  dividend yield |       | —   |       | —   |       |
| Risk-free  interest rate |       | 3.089    | %          | 2.15     | %          |
| Expected life            |       | 7 years  |       | 7 years  |       |
| Expected volatility      |       | 63.41    | %          | 55.57    | %          |

 

There were nostock options exercised or granted in 2006. The Company received $11,700 as a result of stock option exercisesduring the year ended December 31, 2005.  The Company recorded $93,000 in associated taxbenefits from the exercise of nonqualified stock options during the year endedDecember 31, 2005.  In accordance withStatement 123(R), this benefit is included as a financing activity in theaccompanying Statements of Cash Flows for period subsequent to the adoption ofStatement 123(R), but continues to be reported as an operating activity inperiods prior to its adoption.

A summary of thestatus of the nonvested shares as of December 31, 2006, and changes during theyear ended December 31, 2006, is presented below:
|                                 | ** ** | ** ** | ** ** | **Weighted-**       | ** ** |
|---------------------------------|------------|------------|------------|---------------------|------------|
| ** **                      | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Grant-Date**      | ** ** |
| **Nonvested Shares**       | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Nonvested at  January 1, 2006   |       | 57,384     |       | $                   | 18.44      |   |
| Granted                         |       | —     |       | —              |       |
| Vested                          |       | (15,572    | )          | 17.61               |       |
| Forfeited                       |       | (4,034     | )          | 17.57               |       |
| Nonvested at December  31, 2006 |       | 37,778     |       | 18.88               |       |
|                                 |            |            |            |                     |            |  |

 

As of December 31, 2006,there was $156,968 of total unrecognized compensation cost related to nonvestedshare-based compensation arrangements granted under the plans.  That cost is expected to be recognized over aweighted-average period of 2.5 years. The total fair value of shares vested during the years ended December31, 2006 and 2005 was $339,158 and $124,267, respectively.

#### **NOTE19 - OTHER EXPENSES**

Other expenses are summarizedas follows:
|                                      | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Stationery,  printing, and postage   |       | $                                           | 363        |   | $ | 362 |   |
| Telephone                            |       | 199                                         |       | 191 |   |
| Director and  advisory fees          |       | 154                                         |       | 113 |   |
| Insurance                            |       | 130                                         |       | 76 |   |
| ATM services                         |       | 101                                         |       | 111 |   |
| Courier services                     |       | 126                                         |       | 95 |   |
| Other                                |       | 1,087                                       |       | 1,007 |   |
| Total                                | ** ** | **$**                                       | **2,160**  | ** ** | **$** | **1,955** | ** ** |

 

51

----

#### **NOTE20 - INCOME TAXES**

Income tax expenseis summarized as follows:
|                                              | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)**         | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Currently payable:                           |       |                                        |       |   |   |
| Federal                                      |       | $                                           | 1,089      |   | $ | 1,446 |   |
| State                                        |       | 145                                         |       | 120 |   |
| Total current                                |       | 1,234                                       |       | 1,566 |   |
| Deferred income  taxes                       |       | 134                                         |       | (624 | ) |
| Income tax expense                           | ** ** | **$**                                       | **1,368**  | ** ** | **$** | **942** | ** ** |
| Income tax  expense is allocated as follows: |       |                                        |       |   |   |
| To continuing operations                     |       | $                                           | 1,287      |   | $ | 1,258 |   |
| To shareholders’ equity                 |       | 81                                          |       | (316 | ) |
| Total                                        | ** ** | **$**                                       | **1,368**  | ** ** | **$** | **942** | ** ** |

 

The components ofthe net deferred tax asset are as follows:
|                                                      | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**                 | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Deferred tax  assets:                                |       |                  |       |   |   |
| Allowance for loan losses                            |       | $                     | 690        |   | $ | 659 |   |
| Net capitalized loan costs                           |       | 146                   |       | 152 |   |
| State net operating loss                             |       | 42                    |       | 24 |   |
| Deferred directors’ fees                        |       | 219                   |       | 176 |   |
| Prepaid expenses                                     |       | —                |       | 66 |   |
| Nonaccruing interest                                 |       | 60                    |       | 93 |   |
| Net unrealized loss on securities available-for-sale |       | 249                   |       | 330 |   |
| Other                                                |       | 12                    |       | — |   |
| Total deferred tax assets                            |       | 1,418                 |       | 1,500 |   |
| Deferred tax  liabilities:                           |       |                  |       |   |   |
| Accumulated depreciation                             |       | 464                   |       | 463 |   |
| Gain on sale of real estate                          |       | 73                    |       | 73 |   |
| Software amortization                                |       | —                |       | 11 |   |
| Prepaid expenses                                     |       | 62                    |       | — |   |
| Total deferred tax liabilities                       |       | 599                   |       | 547 |   |
| Net deferred tax  asset                              | ** ** | **$**                 | **819**    | ** ** | **$** | **953** | ** ** |

 

52

----

#### Deferred taxassets represent the future tax benefit of future deductible differences and,if it is more likely than not that a tax asset will not be realized, avaluation allowance is required to reduce the recorded deferred tax assets tonet realizable value.  Management hasdetermined that it is more likely than not that the entire deferred tax assetat December 31, 2006 and 2005 will be realized and, accordingly, has not establisheda valuation allowance.  Deferred taxassets are included in other assets.

A reconciliation betweenthe income tax expense and the amount computed by applying the Federalstatutory rates of 34% to income before income taxes follows:
|                                                      | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)**                 | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Tax expense at  statutory rate                       |       | $                                           | 1,391      |   | $ | 1,246 |   |
| State income  tax, net of federal income tax benefit |       | 95                                          |       | 79 |   |
| Tax-exempt  interest income                          |       | (98                                         | )          | (77 | ) |
| Stock  compensation expense                          |       | 50                                          |       | — |   |
| Other                                                |       | (151                                        | )          | 10 |   |
| Income tax provision                                 | ** ** | **$**                                       | **1,287**  | ** ** | **$** | **1,258** | ** ** |

 

#### **NOTE21 - UNUSED LINES OF CREDIT**

As of December 31,2006, the Company had unused lines of credit to purchase federal funds fromunrelated banks totaling $16,500,000. These lines of credit are available on aone to fourteen day basis for general corporate purposes.  The lenders have reserved the right not torenew their respective lines.  TheCompany may also utilize its unpledged securities, which totaled $21,329,000 atDecember 31, 2006, if liquidity needs should arise.

53

----

#### **NOTE22 - FAIR VALUE OF FINANCIAL INSTRUMENTS**

The fair value of afinancial instrument is the amount at which the asset or obligation could beexchanged in a current transaction between willing parties, other than in aforced or liquidation sale.  Fair value estimatesare made at a specific point in time based on relevant market information andinformation about the financial instruments. Because no market value exists for a significant portion of thefinancial instruments, fair value estimates are based on judgments regardingfuture expected loss, current economic conditions, risk characteristics ofvarious financial instruments, and other factors.

The following methods andassumptions were used to estimate the fair value of significant financialinstruments:

***Cashand Due from Banks***- The carrying amount is a reasonableestimate of fair value.

***FederalFunds Sold**and Purchased***-Federal funds sold and purchased are for a term of one day and the carryingamount approximates the fair value.

***TimeDeposits with Other Banks*** - Time deposits with otherbanks have a term less than 90 days and the carrying amount approximates thefair value.

***InvestmentSecurities Available-for-Sale***- For securitiesavailable-for-sale, fair value equals the carrying amount which is the quotedmarket price.  If quoted market pricesare not available, fair values are based on quoted market prices of comparablesecurities.

***NonmarketableEquity Securities***- The carrying amount is a reasonableestimate of fair value since no ready market exists for these securities.

***MortgageLoans Held-for-Sale*** - Fair values of mortgage loans heldfor sale are based on commitments on hand from investors or market prices.

***LoansReceivable***- For certain categories of loans, such asvariable rate loans which are repriced frequently and have no significantchange in credit risk and credit card receivables, fair values are based on thecarrying amounts.  The fair value ofother types of loans is estimated by discounting the future cash flows usingthe current rates at which similar loans would be made to the borrowers withsimilar credit ratings and for the same remaining maturities.

***Deposits***- The fair value of demand deposits, savings, and money market accounts isthe amount payable on demand at the reporting date.  The fair values of certificates of depositare estimated using a discounted cash flow calculation that applies currentinterest rates to a schedule of aggregated expected maturities.

***Advancesfrom the Federal Home Loan Bank***- For the portion ofborrowings immediately callable, fair value is based on the carryingamount.  The fair value of the portionmaturing at a later date is estimated using a discounted cash flow calculationthat applies the interest rate of the immediately callable portion to theportion maturing at the future date.

***JuniorSubordinated Debentures*** - The carrying value of juniorsubordinated debentures is a reasonable estimate of fair value since thedebentures were issued at a floating rate.

***NotePayable***-The fair value of the note payable approximates itscarrying value because it reprices periodically.

54

----

***AccruedInterest Receivable and Payable***- The carrying value ofthese instruments is a reasonable estimate of fair value.

***Commitmentsto Extend Credit and Standby Letters of Credit***- The contractualamount is a reasonable estimate of fair value for the instruments becausecommitments to extend credit and standby letters of credit are issued on ashort-term or floating rate basis and include no unusual credit risks.

***InterestRate Swaps*** - Fair values are based on the present valueof future cash flows based on the interest rate spread between the fixed rateand the floating rate.

The carryingvalues and estimated fair values of the Company’s financial instruments were asfollows:
|                                                                     | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                          | ** ** | **2006**              | ** ** | **2005** | ** ** |
| ** **                                                          | ** ** | **Carrying**          | ** ** | **Estimated** | ** ** | **Carrying** | ** ** | **Estimated** | ** ** |
| **(Dollars in thousands)**                                | ** ** | **Amount**            | ** ** | **Fair Value** | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| **Financial  Assets:**                                              |       |                  |       |   |   |   |   |   |   |
| Cash and due from banks                                             |       | $                     | 9,463      |   | $ | 9,463 |   | $ | 10,143 |   | $ | 10,143 |   |
| Federal funds sold                                                  |       | 19,238                |       | 19,238 |   | 29,262 |   | 29,262 |   |
| Time deposits with other banks                                      |       | —                |       | — |   | — |   | — |   |
| Investment securities available-for-sale                            |       | 50,830                |       | 50,830 |   | 38,233 |   | 38,233 |   |
| Nonmarketable equity securities                                     |       | 2,948                 |       | 2,948 |   | 2,867 |   | 2,867 |   |
| Loans and loans held-for-sale                                       |       | 256,800               |       | 253,146 |   | 235,669 |   | 231,593 |   |
| Accrued interest receivable                                         |       | 2,880                 |       | 2,880 |   | 2,238 |   | 2,238 |   |
| Other assets - interest rate swaps                                  |       | 788                   |       | 788 |   | 772 |   | 772 |   |
|                                                                |       |                  |       |   |   |   |   |   |   |
| **Financial  Liabilities:**                                         |       |                  |       |   |   |   |   |   |   |
| Demand deposit, interest-bearing transaction, and  savings accounts |       | $                     | 169,210    |   | $ | 169,210 |   | $ | 158,088 |   | $ | 158,088 |   |
| Certificates of deposit                                             |       | 105,941               |       | 106,124 |   | 96,049 |   | 95,947 |   |
| Advances from the Federal Home Loan Bank                            |       | 43,390                |       | 42,006 |   | 43,390 |   | 41,874 |   |
| Notes Payable                                                       |       | 3,478                 |       | 3,478 |   | — |   | — |   |
| Junior subordinated debentures                                      |       | 6,186                 |       | 6,186 |   | 6,186 |   | 6,186 |   |
| Accrued interest payable                                            |       | 772                   |       | 772 |   | 549 |   | 549 |   |
| Other  liabilities - interest rate swaps                            |       | 788                   |       | 788 |   | 772 |   | 772 |   |

 
|                                               | ** ** | **Notional** | ** ** | **Estimated**       | ** ** | **Notional** | ** ** | **Estimated**       | ** ** |
|-----------------------------------------------|------------|--------------|------------|---------------------|------------|--------------|------------|---------------------|------------|
| ** **                                    | ** ** | **Amount**   | ** ** | **Fair Value** | ** ** | **Amount**   | ** ** | **Fair Value** | ** ** |
| **Off-Balance  Sheet Financial Instruments:** |       |         |       |                |       |         |       |                |       |
| Commitments to extend credit                  |       | $            | 37,852     |                | $          | —       |       | $                   | 35,134     |   | $ | — |   |
| Standby letters of credit                     |       | 814          |       | —              |       | 778          |       | —              |       |
| Interest rate  swaps                          |       | 14,600       |       | 788                 |       | 14,600       |       | 772                 |       |
|                                               |            |              |            |                     |            |              |            |                     |            |  |  |  |  |

 

55

----

**NOTE 23 -HCSB FINANCIAL CORPORATION (*PARENT COMPANY ONLY*)**

Presented beloware the condensed financial statements for HCSB Financial Corporation andSubsidiary (Parent Company Only).

**CondensedBalance Sheets**
|                                                  | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**             | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **Assets**                                       |       |                  |       |   |   |
| Cash                                             |       | $                     | 183        |   | $ | 832 |   |
| Investment in banking subsidiary                 |       | 33,462                |       | 30,111 |   |
| Investment in trust                              |       | 186                   |       | 186 |   |
| Nonmarketable equity securities                  |       | 25                    |       | 25 |   |
| Premises, furniture, and equipment, net          |       | 3,529                 |       | — |   |
| Other assets                                     |       | 661                   |       | 353 |   |
| Total assets                                     | ** ** | **$**                 | **38,046** | ** ** | **$** | **31,507** |   |
|                                             | ** ** | ** **            | ** ** | ** ** |   |
| **Liabilities  and shareholders’ equity**   |       |                  |       |   |   |
| Interest payable-notes payable                   |       | $                     | 11         |   | $ | — |   |
| Interest payable-junior subordinated debentures  |       | 21                    |       | 18 |   |
| Notes payable                                    |       | 3,478                 |       | — |   |
| Junior subordinated debentures                   |       | 6,186                 |       | 6,186 |   |
| Total liabilities                                |       | 9,696                 |       | 6,204 |   |
| Shareholders’ equity                        |       | 28,350                |       | 25,303 |   |
| Total  liabilities and shareholder’s equity | ** ** | **$**                 | **38,046** | ** ** | **$** | **31,507** |   |

 

**CondensedStatements of Income**
|                                                                                                    | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)**                                                               | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| **Income**                                                                                         |       |                                        |       |   |   |
| Dividends from banking subsidiary                                                                  |       | $                                           | 14         |   | $ | 11 |   |
| Other Income                                                                                       |       | 2                                           |       |   |   |
|                                                                                               |       | 16                                          |       | 11 |   |
| **Expenses**                                                                                       |       |                                        |       |   |   |
| Interest expense on notes payable                                                                  |       | 27                                          |       |   |   |
| Interest expense on junior subordinated debentures                                                 |       | 465                                         |       | 354 |   |
| Other expenses                                                                                     |       | 200                                         |       | 68 |   |
|                                                                                               |       |                                        |       |   |   |
| **Income  (loss) before income taxes and equity in undistributed earnings of banking  subsidiary** |       | (676                                        | )          | (411 | ) |
| Income tax  benefit                                                                                |       | (269                                        | )          | (156 | ) |
| Equity in  undistributed earnings of banking subsidiary                                            |       | 3,212                                       |       | 2,663 |   |
| **Net  income**                                                                                    | ** ** | **$**                                       | **2,805**  | ** ** | **$** | **2,408** | ** ** |

 

56

----

**Condensed Statements of Cash Flows**
|                                                                                    | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(Dollars in thousands)**                                               | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities:**                                         |       |                                        |       |   |   |
| Net income                                                                         |       | $                                           | 2,805      |   | $ | 2,408 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                        |       |   |   |
| Equity in undistributed earnings of banking  subsidiary                            |       | (3,212                                      | )          | (2,663 | ) |
| Increase in other assets                                                           |       | (309                                        | )          | (153 | ) |
| Increase in other liabilities                                                      |       | 14                                          |       | 10 |   |
| Stock compensation expense                                                         |       | 147                                         |       | — |   |
| Net cash used by operating activities                                              |       | (555                                        | )          | (398 | ) |
|                                                                               |       |                                        |       |   |   |
| **Cash  flows from investing activities:**                                         |       |                                        |       |   |   |
| Purchase of land and building                                                      |       | (3,528                                      | )          | — |   |
| Proceeds from sale of land and building                                            |       | —                                      |       | 1,006 |   |
| Net cash provided (used) from investing activities                                 |       | (3,528                                      | )          | 1,006 |   |
|                                                                               |       |                                        |       |   |   |
| **Cash  flows from financing activities:**                                         |       |                                        |       |   |   |
| Proceeds from stock issuance                                                       |       | —                                      |       | 12 |   |
| Proceeds from notes payable                                                        |       | 3,478                                       |       | — |   |
| Cash paid for fractional shares                                                    |       | (44                                         | )          | (35 | ) |
| Net cash provided (used) by financing activities                                   |       | 3,434                                       |       | (23 | ) |
|                                                                               |       |                                        |       |   |   |
| **Increase  (decrease) in cash**                                                   |       | (649                                        | )          | 585 |   |
| **Cash  and cash equivalents, beginning of year**                                  |       | 832                                         |       | 247 |   |
| **Cash and cash equivalents, end  of year**                                        | ** ** | **$**                                       | **183**    | ** ** | **$** | **832** | ** ** |

 

57

----

# **BOARD OF DIRECTORS**

| Michael S. Addy.         | President, Addy’s  Harbor Dodge, Inc.                                                         |
|--------------------------|----------------------------------------------------------------------------------------------------|
|                     |                                                                                               |
| Johnny C. Allen.         | Retired, Horry County  Treasurer                                                                   |
|                     |                                                                                               |
| D. Singleton  Bailey     | President, Loris Drug  Store, Inc.                                                                 |
|                     |                                                                                               |
| Franklin C.  Blanton     | President,  Blanton Supplies, Inc.  President, Blanton Supplies of Little River, Inc.              |
|                     |                                                                                               |
| Clay D.  Brittain, III   | Attorney, Thompson  & Henry, P.A.                                                              |
|                     |                                                                                               |
| Rachel B.  Broadhurst    | President, Century 21 –  Broadhurst & Associates, Inc.                                    |
|                     |                                                                                               |
| Russell R.  Burgess, Jr. | Owner, Aladdin  Realty Company  Owner and Broker-In-Charge  Burgess Realty & Appraisal Service |
|                     |                                                                                               |
| William H.  Caines       | President, Caines  Realty & Appraisals, Inc.                                                   |
|                     |                                                                                               |
| James R.  Clarkson       | President and CEO  HCSB Financial Corporation  and Horry County State Bank                         |
|                     |                                                                                               |
| J. Lavelle  Coleman      | Retired, Tabor City  Oil, Inc.                                                                     |
|                     |                                                                                               |
| Larry G. Floyd           | President, Floyd’s  Insulation, Inc.  President, Cherry Grove Sales, Inc.                     |
|                     |                                                                                               |
| Boyd R. Ford,  Jr.       | Retired, Ford’s Fuel  Services, Inc.  & Ford’s Propane Gas, Inc.                     |
|                     |                                                                                               |
| Tommie W.  Grainger      | President, Coastal  Timber Co., Inc.                                                               |
|                     |                                                                                               |
| Randy B. Hardee          | Retired, Hardee  Business Services, P.C.                                                           |
|                     |                                                                                               |
| Gwyn G.  McCutchen       | Dentist                                                                                            |
|                     |                                                                                               |
| T. Freddie Moore         | Retired, Gateway Drug  Store, Inc.                                                                 |
|                     |                                                                                               |
| Carroll D.  Padgett, Jr. | Attorney, Carroll D.  Padgett, Jr., P.A.                                                           |

 

# **OFFICERS OF THE BOARD OF DIRECTORS**

| Clay D. Brittain, III | Johnny C. Allen      |
|-----------------------|----------------------|
| Chairman              | Vice Chairman        |
|                  |                 |
| James R. Clarkson     | D. Singleton  Bailey |
| President and CEO     | Secretary            |

 

58

----

**HORRYCOUNTY STATE BANK CORPORATE OFFICERS**

James R. Clarkson,President/CEO

Glenn R. Bullard,Executive Vice President

Denise Floyd, VicePresident/Personnel Officer

Margaret H. Fowler, VicePresident/Operations Officer

Loretta B. Gerald,Vice President/Cashier/Internal Auditor

**HORRYCOUNTY STATE BANK BRANCHES AND ATM LOCATIONS**
| **Broad Street, Loris Office***  | **Windy Hill Office***    | **Homewood Office***             |
|----------------------------------|---------------------------|----------------------------------|
| 5009 Broad  Street               | 4400 Hwy. 17 South        | 3201 Hwy. 701 North              |
| Loris, SC 29569                  | N. Myrtle Beach, SC 29582 | Conway, SC 29526                 |
| 843-756-6333                     | 843-663-5600              | 843-369-4272                     |
|                             |                      |                             |
| **Mt.  Olive Office***           | **Socastee Office***      | **Meeting Street, Loris Office** |
| 5264 Hwy. 9                      | 4600 Hwy. 17 Bypass S.    | 4011 Meeting Street              |
| Green Sea, SC  29545             | Myrtle Beach, SC 29577    | Loris, SC 29569                  |
| 843-392-6333                     | 843-293-7595              | 843-756-7168                     |
|                             |                      |                             |
| **Little  River Office***        | **Myrtle Beach Office***  | **Carolina Forest Office***      |
| 3187 Hwy. 9 E.                   | 1701 N. Oak Street        | 273 Carolina Forest Blvd.        |
| Little River, SC  29566          | Myrtle Beach, SC 29577    | Myrtle Beach, SC 29579           |
| 843-399-9523                     | 843-839-9339              | 843-903-3223                     |
|                             |                      |                             |
| **Conway  Office***              | **Tabor City Office***    |                             |
| 1627-A Church  Street (Hwy. 501) | 3210 Hwy. 701 Bypass      |                             |
| Conway, SC 29526                 | Loris, SC 29569           |                             |
| 843-248-8250                     | 910-653-3222              |                             |

 

###### **Investment Services**

| 4400 Hwy. 17 South           | 3201 Hwy. 701 North |
|------------------------------|---------------------|
| N. Myrtle Beach,  S.C. 29582 | Conway, SC 29526    |
| 843-839-6864                 | 843-488-6323        |

 

## **Residential Mortgage Lending**

| 1701 N. Oak Street      | 5009 Broad Street | 273 Carolina Forest Blvd. |
|-------------------------|-------------------|---------------------------|
| Myrtle Beach, SC  29577 | Loris, SC 29569   | Myrtle Beach, SC 29579    |
| 843-839-6255            | 843-716-6145      | 843-903-3223              |

 

----

*****    Denotes ATM Location

59

----