** **

**UNITED STATES**

**SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**Form 10-KSB**

** **

**(Mark One)**

**x**                               ANNUALREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the fiscal year endedDecember 31, 2006**

**or**

**o**                                 TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the transition periodfrom               to               **

**Commission FileNumber:  000-26995**

**HCSB FINANCIALCORPORATION**

(Name of small businessIssuer in its charter)

| **South Carolina**                        | ** ** | **57-1079444**       |
|-------------------------------------------|------------|----------------------|
| (State or other  jurisdiction             |       | (I.R.S. Employer     |
| of incorporation  or organization)        |       | Identification  No.) |
|                                      |       |                 |
| **5201  Broad Street**                    | ** ** | ** **           |
| **Loris,  South Carolina**                | ** ** | **29569**            |
| (Address of  principal executive offices) |       | (Zip Code)           |

 

Issuer’s telephone number: **(843)756-6333**

Securities registered under Section 12(b) of theExchange Act:  **None**

Securities registered under Section 12(g) of theExchange Act: **Common Stock**

Check whether the issuer is not required to filereports pursuant to Section 13 or 15(d) of the Exchange Act o

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yesx  No o

Check if there is no disclosureof delinquent filers in response to Item 405 of Regulation S-B in this form,and no disclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-KSB or any amendment to this Form 10-KSB.  x

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

Yes o  No x

The issuer’s revenue for itsmost recent fiscal year was $26,284,000. As of March 13, 2007, 3,571,306 shares of Common Stock were issued andoutstanding.

The aggregate market value ofthe Common Stock held by non-affiliates (shareholders holding less than 5% of an outstanding class of stock,excluding directors and executive officers) ofthe Company on March 3, 2007 was $24,371,671. Because there is not an active trading market for the Common Stock, wehave used our book value of $7.94 as of February 28, 2007 to calculate ourpublic float.

Transitional Small BusinessDisclosure Format.  (Check one):  Yes o       No x

**DOCUMENTSINCORPORATED BY REFERENCE**

| Annual Report to Shareholders for the                   |   | Part II (Items 5-7)                      |
|---------------------------------------------------------|--------|------------------------------------------|
| Year Ended December 31, 2006                            |   |                                     |
|                                                    |   |                                     |
| Proxy Statement for the Annual Meeting of  Shareholders |   | Part III (Portions of Items 9-12 and 14) |
| to be held on April 26, 2007                            |   |                                     |

 

 

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# **PART I**

**Item 1. Description of Business.**

This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These statements are based on many assumptions and estimates and are not guarantees of future performance.  Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control.  The words “may,” “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties that could cause our actual results to differ from those anticipated in our forward-looking statements include, but are not limited, to those described below under “Risk Factors” and the following:

·                  significantincreases in competitive pressure in the banking and financial servicesindustries;

·                  changesin the interest rate environment which could reduce anticipated or actualmargins;

·                  changesin political conditions or the legislative or regulatory environment;

·                  generaleconomic conditions, either nationally or regionally and especially in ourprimary service area, becoming less favorable than expected resulting in, amongother things, a deterioration in credit quality;

·                  changesoccurring in business conditions and inflation;

·                  changesin technology;

·                  changesin monetary and tax policies;

·                  thelevel of allowance for loan loss;

·                  therate of delinquencies and amounts of charge-offs;

·                  therates of loan growth;

·                  adversechanges in asset quality and resulting credit risk-related losses and expenses;

·                  lossof consumer confidence and economic disruptions resulting from terroristactivities;

·                  changesin the securities markets; and

·                  otherrisks and uncertainties detailed from time to time in our filings with theSecurities and Exchange Commission.

# **General Overview**

HCSBFinancial Corporation was incorporated on June 10, 1999 to become a holdingcompany for Horry County State Bank.  Thebank is a state-chartered bank which commenced operations on January 4, 1988.  Our primary market includes Horry County inSouth Carolina and Columbus and Brunswick Counties in North Carolina.  From our 11 branch locations, we offer a fullrange of deposit services, including checking accounts, savings accounts,certificates of deposit, money market accounts, and IRAs, as well as a broadrange of non-deposit investment services.

**Operatingand Growth Strategy**

Our goal is to be theleading community bank in our market area. We intend to achieve this goal chiefly by providing personalized serviceto our customers.  Other strategies thatwe will use to support our goal are hiring, developing, and retaining highcaliber and motivated employees, focusing each of our branches on the uniqueneeds and cultures of the community in which it is located, maintaining highasset quality, increasing asset size through internal growth and branchexpansion, and offering our customers a breadth of products competitive withthose offered by much larger institutions. These goals are intended to build long-term shareholder value.

·                  *Personalized Service.* We view banking as a service industry in which personal relationshipscan provide a competitive advantage. This paradigm is captured in our marketing tagline “It’s the littlethings that make a little bank . . . BIG!” We strive to be “BIG” (important) to our customers by doing “little”things like identifying our customers’ needs and promoting products to satisfythem, knowing our customers by name, and providing our products with superior 

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                        levelsof quality and service.  We seekcustomers who prefer to conduct business with a locally owned and managed bankthat demonstrates an active interest in their business and personal financialaffairs.  We believe that by consistentlyproviding high levels of service to customers who value that service, wedevelop and strengthen relationships that provide a competitive advantage.

·                  *Motivated Employees. *Webelieve that the key to our success lies with our employees, because it isthrough our employees that we are able to provide our customers with the highlevel of service and attention that they expect and deserve.  To this end, we hire people who are familiarwith their community and are committed to providing a superior level of bankingservice to our customers.  By selectingonly knowledgeable and committed employees, we believe we can provide anunsurpassed level of customer service and satisfaction.  We strive to develop, sustain the motivationof, and retain our employees through training, personal attention, recognition,and competitive compensation.  Weencourage and equip each employee to focus on the individual needs of ourcustomers and to deliver the specific products and services that will best helpthese customers achieve their financial goals.

·                  *Community Focus.*  Weapproach banking with a community focus, particularly at the branch level.  We operate each branch as an independentbusiness unit and encourage our branch managers to promote those products thatbest meet the need of their customer base. This strategy enables our branches to serve diverse populations andeconomies effectively.  We support ourbranches by supporting the economic development of our communities and byencouraging our employees to be active in community affairs.  We have located our existing offices, andplan to locate proposed offices, in communities in which we believe we candevelop strong relationships.  We favorgrowth areas and areas in which there are opportunities to differentiateourselves by providing customers with superior service.

·                  *High Asset Quality.* We place a great deal of emphasis onmaintaining high asset quality and believe that the outstanding asset qualityexperienced to date is principally due to the closeness of our lenders, seniorofficers, and directors to our customers and their significant knowledge of thecommunities in which they reside.

·                  *Internal Growth, BranchExpansion.*  We have grownsignificantly over the last five years. We will continue to focus onacquiring market share, particularly from large Southeastern regional bankholding companies, by emphasizing our local management and decision-making andpersonal services.

·                  *Broad Range of Products andServices.*  We strive to provide our customers with thebreadth of products and services comparable to a regional bank, whilemaintaining the quick response and personal service of a locally owned andmanaged bank.  In addition to offering afull range of deposit services and commercial and personal loans, we offerproducts such as mortgage loan originations, on-line banking, and investmentproducts and brokerage services through a third party arrangement.

**Locationand Service Area**

Our primary market includes Horry County in SouthCarolina and Columbus and Brunswick Counties in North Carolina.  Most of the banks in these areas are nowlocal branches of large regional banks. Although size gives the larger banks certain advantages in competing forbusiness from large corporations, including higher lending limits and theability to offer services in other areas of South Carolina and North Carolina,we believe that there is a void in the community banking market in our marketthat we successfully fill.  We alsobelieve that the Horry County market will continue to grow, particularly alongthe Atlantic coast.  We intend to continueto expand our branch network to take advantage of opportunities caused by thisgrowth.  We generally do not attempt tocompete for the banking relationships of large corporations, but concentrateour efforts on small- to medium-sized businesses and on individuals.

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**BankingServices**

We offer a full range of deposit servicesthat are typically available in most banks and savings and loan associations,including checking accounts, NOW accounts, savings accounts, and other timedeposits of various types, ranging from daily money market accounts tolonger-term certificates of deposit.  Thetransaction accounts and time certificates are tailored to our principal marketarea at rates competitive to those offered in our market area.  In addition, we offer certain retirementaccount services, such as Individual Retirement Accounts.  All deposit accounts are insured by the FDICup to the maximum amount allowed by law (generally, $100,000 per depositor,subject to aggregation rules).  Wesolicit these accounts from individuals, businesses, associations andorganizations, and governmental authorities.

**Lending Activities**

*General*.  We emphasize a range of lending services,including real estate, commercial, agricultural and consumer loans, toindividuals and small to medium-sized businesses and professional concerns thatare located in or conduct a substantial portion of their business in our marketarea. The characteristics of our loan portfolio and our underwritingprocedures, collateral types, risks, approval process and lending limits arediscussed below.

*Real Estate Loans.* The primarycomponent of our loan portfolio is real estate mortgage loans, which made upapproximately 57.8% of our loan portfolio at December 31, 2006.  These loans are secured generally by first orsecond mortgages on residential or commercial property.  These loans consist of commercial real estateloans, construction and development loans, and residential real estate loans(but exclude home equity loans, which are classified as consumer loans).

*Commercial Loans. *At December 31, 2006, approximately 21.6% of our loanportfolio consisted of commercial loans. Commercial loans consist of secured and unsecured loans, lines ofcredit, and working capital loans.  Wemake these loans to various types of businesses.  Included in this category are loans topurchase equipment, finance accounts receivable or inventory, and loans madefor working capital purposes.

*Consumer Loans.*  Consumer loans made up approximately 7.2% ofour loan portfolio at December 31, 2006. These are loans made to individuals for personal and household purposes,such as secured and unsecured installment and term loans, home equity loans andlines of credit, and revolving lines of credit such as overdraftprotection.  Automobiles and smallrecreational vehicles are pledged as security for their purchase.

*Agricultural Loans. *Approximately 2.4% of our loan portfolio consisted ofagricultural loans at December 31, 2006. These are loans made to individuals and businesses for agriculturalpurposes, including loans to finance crop production and livestock operatingexpenses, to purchase farm equipment, and to store crops.  These loans are secured generally by liens ongrowing crops and farm equipment.  Alsoincluded in this category are loans to agri-businesses, which are substantiallysimilar to commercial loans, as discussed above.

*Construction and Development Loans.*  The remaining 11.1% of our loan portfolio atDecember 31, 2006 was composed of consumer and commercial real estate constructionand commercial development loans.  Theseloans are secured by the real estate for which construction is planned and, inmany cases, by supplementary collateral.

*Underwriting Procedures, Collateral, and Risk. *We use our establishedcredit policies and procedures when underwriting each type of loan.  Although there are minor variances in thecharacteristics and criteria for each loan type, which may require additionalunderwriting procedures, we generally evaluate borrowers using the followingdefined criteria:

·                  Character— we evaluate whether the borrower has sound character and integrity byexamining the borrower’s history.

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·                  Capital— we evaluate the borrower’s overall financial strength, as well as the equityinvestment in the asset being financed.

·                  Collateral— we evaluate whether the collateral is adequate from the standpoint ofquality, marketability, value and income potential.

·                  Capacity— we evaluate the borrower’s ability to service the debt.

·                  Conditions— we underwrite the credit in light of the effects of external factors, such aseconomic conditions and industry trends.

Itis our practice to obtain collateral for most loans to help mitigate the riskassociated with lending.  We generallylimit our loan-to-value ratio to 80%. For example, we obtain a security interest in real estate for loanssecured by real estate, including construction and development loans, and othercommercial loans.  For commercial loans,we typically obtain security interests in equipment and other company assets.  For agricultural loans, we typically obtain asecurity interest in growing crops, farm equipment, or real estate.  For consumer loans used to purchase vehicles,we obtain appropriate title documentation. For secured loans that are not associated with real estate, or for whichthe mortgaged real estate does not provide an acceptable loan-to-value ratio,we typically obtain other available collateral such as stocks or savingsaccounts.

Everyloan carries a credit risk, simply defined as the potential that the borrowerwill not be willing or able to repay the debt. While this risk is common to all loan types, each type of loan may carryrisks that distinguish it from other loan types.  The following paragraphs discuss certainrisks that are associated with each of our loan types.

Eachreal estate loan is sensitive to fluctuations in the value of the real estatethat secures that loan.  Certain types ofreal estate loans have specific risk characteristics that vary according to thetype of collateral that secures the loan, the terms of the loan, and therepayment sources for the loan. Commercial real estate loans have risk that the primary source ofrepayment will be insufficient to service the debt.  Construction and development real estateloans generally carry a higher degree of risk than long term financing ofexisting properties.  These projects areusually dependent on the completion of the project on schedule and within costestimates and on the timely sale of the property.  Inferior or improper construction techniques,changes in economic conditions during the construction and marketing period,and rising interest rates which may slow the sale of the property are all risksunique to this type of loan.  Residentialmortgage loans, in contrast to commercial real estate loans, generally havelonger terms and may have fixed or adjustable interest rates.

Commercialloans primarily have risk that the primary source of repayment will beinsufficient to service the debt.  Oftenthis occurs as the result of changes in economic conditions in the location orindustry in which the borrower operates which impact cash flow or collateralvalue.  Consumer loans, other than homeequity loan products, are generally considered to have more risk than loans toindividuals secured by first or second mortgages on real estate due todependence on the borrower’s employment status as the sole source ofrepayment.  Agricultural loans carry therisk of crop failure, which adversely impacts both the borrower’s ability torepay the loan and the value of the collateral.

Byfollowing defined underwriting criteria as noted above, we can help to reducethese risks.  Additionally we help toreduce the risk that the underlying collateral may not be sufficient to pay theoutstanding balance by using appraisals or taking other steps to determine thatthe value of the collateral is adequate, and lending amounts based upon lowerloan-to-value ratios.  We also controlrisks by reducing concentration of our loan portfolio in any one type of loan.

*Loan Approval and Review*.  Our loan approval policies provide forvarious levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds thatindividual officer’s lending authority, the loan request is considered by an officerwith a higher lending limit.  Any loan inexcess of this lending limit is approved by the directors’ loan committee.  We do not make any loans to any of ourdirectors or executive officers unless the loan is approved by a three-fourth’svote of the board of directors of the bank and is made on terms not morefavorable to such person than would be available to a person not affiliatedwith us.  Aggregate credit in excess of10% of the bank’s aggregate capital, surplus, 

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retainedearnings, and reserve for loan losses must be approved by a three-fourth’s voteof our bank’s board of directors.

*Lending Limits.*  Our lending activities are subject to avariety of lending limits imposed by federal law.  While differing limits apply to certain loantypes or borrowers, in general we are subject to a loan-to-one-borrowerlimit.  These limits increase or decreaseas our capital increases or decreases. Unless we sell participations in loans to other financial institutions,we are not able to meet all of the lending needs of loan customers requiringaggregate extensions of credit above these limits.

**Other Banking and RelatedServices**

Other bank services which are in place or plannedinclude cash management services, safe deposit boxes, travelers checks, directdeposit of payroll and social security checks, and automatic drafts for variousaccounts.  We are associated with ashared network of automated teller machines that may be used by our customersthroughout South Carolina and other regions. One of our non-executive officers is a registered representative ofUVEST and effects transactions in securities and other non-deposit investmentproducts.  We also offer MasterCard andVISA credit card services through a correspondent bank as an agent for thebank.  We continue to seek and evaluateopportunities to offer additional financial services to our customers.

**Competition**

The bankingbusiness is highly competitive.  Wecompete with other commercial banks, savings and loan associations, creditunions, and money market mutual funds operating in our service area andelsewhere.  According to the FDIC data asof June 30, 2006, there were 21 financial institutions operating in HorryCounty, 10 financial institutions operating in Brunswick County and 6 financialinstitutions operating in Columbus County. We believe that our community bank focus, with our emphasis on serviceto small businesses, individuals, and professional concerns, gives us anadvantage in our markets.  Nevertheless,a number of these competitors are well established in our service area.  Most of them have substantially greaterresources and lending limits than the bank and offer certain services, such asextensive and established branch networks and trust services, that we do notprovide.  As a result of thesecompetitive factors, we may have to pay higher rates of interest to attractdeposits.

**Employees**

As of March 15, 2007, wehad 132 full-time employees and no part-time employees.  We are not a party to a collective bargainingagreement, and we consider our relations with our employees to be good.

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**SUPERVISIONAND REGULATION**

Both HCSBFinancial Corporation and Horry County State Bank are subject to extensivestate and federal banking regulations that impose restrictions on and providefor general regulatory oversight of their operations.  These laws generally are intended to protectdepositors and not shareholders.  Thefollowing summary is qualified by reference to the statutory and regulatoryprovisions discussed.  Changes inapplicable laws or regulations may have a material effect on our business andprospects.  Our operations may beaffected by legislative changes and the policies of various regulatoryauthorities.  We cannot predict theeffect that fiscal or monetary policies, economic control, or new federal orstate legislation may have on our business and earnings in the future.

The followingdiscussion is not intended to be a complete list of all the activitiesregulated by the banking laws or of the impact of such laws and regulations onour operations.  It is intended only tobriefly summarize some material provisions.

**HCSBFinancial Corporation**

We own 100% of theoutstanding capital stock of the bank, and therefore we are considered to be abank holding company under the federal Bank Holding Company Act of 1956 (the “BankHolding Company Act”).  As a result, weare primarily subject to the supervision, examination and reportingrequirements of the Board of Governors of the Federal Reserve (the “FederalReserve”) under the Bank Holding Company Act and its regulations promulgatedthereunder.  As a bank holding companylocated in South Carolina, the South Carolina Board of Financial Institutionsalso regulates and monitors all significant aspects of our operations.

***Permitted Activities.*** Under the Bank Holding Company Act, a bankholding company is generally permitted to engage in, or acquire direct orindirect control of more than 5% of the voting shares of any company engagedin, the following activities:

·                  bankingor managing or controlling banks; and

·                  furnishingservices to or performing services for our subsidiaries; and

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

Activities thatthe Federal Reserve has found to be so closely related to banking as to be aproper incident to the business of banking include:

·                  factoringaccounts receivable;

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

·                  leasingpersonal or real property;

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

·                  trustcompany functions;

·                  financialand investment advisory activities;

·                  conductingdiscount securities brokerage activities;

·                  underwritingand dealing in government obligations and money market instruments;

·                  providingspecified management consulting and counseling activities;

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·                  performingselected data processing services and support services;

·                  actingas agent or broker in selling credit life insurance and other types of insurancein connection with credit transactions; and

·                  performingselected insurance underwriting activities.

As a bank holding company we also can elect to be treated as a “financialholding company,” which would allow us engage in a broader array of activities.  In sum, a financial holding company canengage in activities that are financial in nature or incidental orcomplementary to financial activities, including insurance underwriting, salesand brokerage activities, providing financial and investment advisory services,underwriting services and limited merchant banking activities.  We have not sought financial holding companystatus, but may elect such status in the future as our business matures.  If we were to elect in writing for financialholding company status, each insured depository institution we control wouldhave to be well capitalized, well managed and have at least a satisfactoryrating under the CRA (discussed below).

The FederalReserve has the authority to order a bank holding company or its subsidiariesto terminate any of these activities or to terminate its ownership or controlof any subsidiary when it has reasonable cause to believe that the bank holdingcompany’s continued ownership, activity or control constitutes a serious riskto the financial safety, soundness or stability of it or any of its banksubsidiaries.

***Change in Control****. *In addition, andsubject to certain exceptions, the Bank Holding Company Act and the Change inBank Control Act, together with regulations promulgated there under, requireFederal Reserve approval prior to any person or company acquiring “control” ofa bank holding company.  Moreover, theSouth Carolina Board of Financial Institutions also must approve an acquisitionof a South Carolina bank holding company. Control is conclusively presumed to exist if an individual or companyacquires 25% or more of any class of voting securities of a bank holdingcompany.  Control is rebuttably presumedto exist if a person acquires 10% or more, but less than 25%, of any class ofvoting securities and either:

·                  the company hasregistered securities under Section 12 of the Securities Exchange Act of 1934;or

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

Our common stockis registered under Section 12 of the Securities Exchange Act of 1934.  Any shareholder of 10% or more, but less than25% of any class of our voting securities would be required to either file as acontrolling shareholder of the company or rebut the presumption of control inaccordance with Federal Reserve regulations**.**  The regulations provide a procedure forrebutting control when ownership of any class of voting securities is below25%.

***Source of Strength****.*  In accordance with Federal Reserve Boardpolicy, we are expected to act as a source of financial strength to the bankand to commit resources to support the bank in circumstances in which we mightnot otherwise do so.  Under the bankHolding Company Act, the Federal Reserve Board may require a bank holdingcompany to terminate any activity or relinquish control of a nonbanksubsidiary, other than a nonbank subsidiary of a bank, upon the Federal ReserveBoard’s determination that such activity or control constitutes a serious riskto the financial soundness or stability of any depository institutionsubsidiary of the bank holding company. Further, federal bank regulatory authorities have additional discretionto require a bank holding company to divest itself of any bank or nonbanksubsidiaries if the agency determines that divestiture may aid the depositoryinstitution’s financial condition.

***CapitalRequirements.***  TheFederal Reserve Board imposes certain capital requirements on the bank holdingcompany under the bank Holding Company Act, including a minimum leverage ratioand a minimum ratio of “qualifying” capital to risk-weighted assets.  These requirements are described below under “HorryCounty State Bank - Capital Regulations.” Subject to our capital requirements and certain 

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other restrictions, weare able to borrow money to make a capital contribution to the bank, and theseloans may be repaid from dividends paid from the bank to the Company.  Ourability to pay dividends is subject to regulatory restrictions as describedbelow in “Horry County State Bank — Dividends.” We are also able to raise capital for contribution to the bank byissuing securities without having to receive regulatory approval, subject tocompliance with federal and state securities laws.

***SouthCarolina State Regulation.***  As a South Carolina bank holding companyunder the South Carolina Banking and Branching Efficiency Act, we are subjectto limitations on sale or merger and to regulation by the South Carolina Boardof Financial Institutions.  We are notrequired to obtain the approval of the S.C. Board prior to acquiring thecapital stock of a national bank, but we must notify them at least 15 daysprior to doing so.  We must receive theBoard’s approval prior to engaging in the acquisition of a South Carolina statechartered bank or another South Carolina bank holding company.

**Horry County State Bank**

Thebank operates as a state bank incorporated under the laws of the State of SouthCarolina and is subject to examination by the South Carolina Board of FinancialInstitutions.

TheSouth Carolina Board of Financial Institutions and the FDIC regulate or monitorvirtually all areas of the bank’s operations, including:

·                  security devicesand procedures;

·                  adequacy ofcapitalization and loss reserves;

·                  loans;

·                  investments;

·                  borrowings;

·                  deposits;

·                  mergers;

·                  issuances ofsecurities;

·                  payment ofdividends;

·                  interest ratespayable on deposits;

·                  interest ratesor fees chargeable on loans;

·                  establishment ofbranches;

·                  corporatereorganizations;

·                  maintenance of booksand records; and

·                  adequacy ofstaff training to carry on safe lending and deposit gathering practices.

TheSouth Carolina Board of Financial Institutions requires the bank to maintainspecified capital ratios and imposes limitations on the bank’s aggregateinvestment in real estate, bank premises, and furniture and fixtures.  The South Carolina Board of FinancialInstitutions also requires the bank to prepare quarterly reports on the bank’sfinancial condition in compliance with its minimum standards and procedures.

Allinsured institutions must undergo regular on site examinations by theirappropriate banking 

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agency.  The cost of examinations of insureddepository institutions and any affiliates may be assessed by the appropriateagency against each institution or affiliate as it deems necessary orappropriate.  Insured institutions arerequired to submit annual reports to the FDIC, their federal regulatory agency,and their state supervisor when applicable. The FDIC has developed a method for insured depository institutions toprovide supplemental disclosure of the estimated fair market value of assetsand liabilities, to the extent feasible and practicable, in any balance sheet,financial statement, report of condition or any other report of any insureddepository institution.  The FDICImprovement Act also requires the federal banking regulatory agencies toprescribe, by regulation, standards for all insured depository institutions anddepository institution holding companies relating, among other things, to thefollowing:

·                  internalcontrols;

·                  informationsystems and audit systems;

·                  loandocumentation;

·                  creditunderwriting;

·                  interest raterisk exposure; and

·                  asset quality.

***Prompt Corrective Action. ***As an insured depository institution, the bank isrequired to comply with the capital requirements promulgated under the FederalDeposit Insurance Act and the regulations thereunder, which set forth****five capital categories, each with specific regulatoryconsequences.  Under these regulations,the categories are:

·                  Well Capitalized— The institution exceeds the required minimum level for each relevant capitalmeasure.  A well capitalized institutionis one (i) having a total capital ratio of 10% or greater, (ii) havinga tier 1 capital ratio of 6% or greater, (iii) having a leverage capitalratio of 5% or greater and (iv) that is not subject to any order orwritten directive to meet and maintain a specific capital level for any capitalmeasure.

·                  AdequatelyCapitalized — The institution meets the required minimum level for eachrelevant capital measure.  No capitaldistribution may be made that would result in the institution becomingundercapitalized.  An adequatelycapitalized institution is one (i) having a total capital ratio of 8% orgreater, (ii) having a tier 1 capital ratio of 4% or greater and(iii) having a leverage capital ratio of 4% or greater or a leveragecapital ratio of 3% or greater if the institution is rated composite 1 underthe CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity tomarket risk) rating system.

·                  Undercapitalized— The institution fails to meet the required minimum level for any relevantcapital measure.  An undercapitalizedinstitution is one (i) having a total capital ratio of less than 8% or (ii) havinga tier 1 capital ratio of less than 4% or (iii) having a leverage capital ratioof less than 4%, or if the institution is rated a composite 1 under the CAMELSrating system, a leverage capital ratio of less than 3%.

·                  SignificantlyUndercapitalized — The institution is significantly below the required minimumlevel for any relevant capital measure. A significantly undercapitalized institution is one (i) having atotal capital ratio of less than 6% or (ii) having a tier 1 capital ratioof less than 3% or (iii) having a leverage capital ratio of less than 3%.

·                  CriticallyUndercapitalized — The institution fails to meet a critical capital level setby the appropriate federal banking agency. A critically undercapitalized institution is one having a ratio oftangible equity to total assets that is equal to or less than 2%.

If the FDIC determines, after notice and an opportunity for hearing,that the bank is in an unsafe or unsound condition, the regulator is authorizedto reclassify the bank to the next lower capital category 

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(other than critically undercapitalized) and require the submission ofa plan to correct the unsafe or unsound condition.

If the bank is not well capitalized, it cannot accept brokered depositswithout prior FDIC approval and, if approval is granted, cannot offer aneffective yield in excess of 75 basis points on interests paid on deposits ofcomparable size and maturity in such institution’s normal market area fordeposits accepted from within its normal market area, or national rate paid ondeposits of comparable size and maturity for deposits accepted outside the bank’snormal market area.  Moreover, if thebank becomes less than adequately capitalized, it must adopt a capitalrestoration plan acceptable to the FDIC. The bank also would become subject to increased regulatory oversight,and is increasingly restricted in the scope of its permissible activities.  Each company having control over anundercapitalized institution also must provide a limited guarantee that theinstitution will comply with its capital restoration plan.  Except under limited circumstances consistentwith an accepted capital restoration plan, an undercapitalized institution maynot grow.  An undercapitalizedinstitution may not acquire another institution, establish additional branchoffices or engage in any new line of business unless determined by theappropriate Federal banking agency to be consistent with an accepted capitalrestoration plan, or unless the FDIC determines that the proposed action will furtherthe purpose of prompt corrective action. The appropriate federal banking agency may take any action authorizedfor a significantly undercapitalized institution if an undercapitalizedinstitution fails to submit an acceptable capital restoration plan or fails inany material respect to implement a plan accepted by the agency.  A critically undercapitalized institution issubject to having a receiver or conservator appointed to manage its affairs andfor loss of its charter to conduct banking activities.

An insured depository institution may not pay a management fee to abank holding company controlling that institution or any other person havingcontrol of the institution if, after making the payment, the institution, wouldbe undercapitalized.  In addition, aninstitution cannot make a capital distribution, such as a dividend or otherdistribution that is in substance a distribution of capital to the owners ofthe institution if following such a distribution the institution would beundercapitalized.  Thus, if payment ofsuch a management fee or the making of such would cause the bank to becomeundercapitalized, it could not pay a management fee or dividend to us.

Asof December 31, 2006, the bank was deemed to be “well capitalized.”

***FDIC Assessments.***  Deposits at the bank are insured by theDeposit Insurance Fund (the “DIF”) as administered by the FDIC, up to theapplicable limits established by law — generally $100,000 per accountholder and$250,000 for certain retirement accountholders. In accordance with regulations adopted to implement the Federal DepositInsurance Reform Act of 2005 (“FDIRA”), deposit insurance premium assessmentsare based upon perceived risks to the DIF, by evaluating an institution’ssupervisory ratios and other financial ratios and then determining insurancepremiums based upon the likelihood an institution could be downgraded to aCAMELS 3 or worse in the succeeding year. As a result, institutions deemed to pose less risk,  pay lower premiums than those institutionsdeemed to pose more risk, which  paymore.

FDIRAcaps the amount of the DIF at 1.50% of domestic deposits.  The FDIC must issue cash dividends, awardedon a historical basis, for the amount of the DIF over the 1.50% ratio.  Additionally, if the DIF exceeds 1.35% ofdomestic deposits at year-end, the FDIC is required to  issue cash dividends, awarded on a historicalbasis, for half of the amount of the excess. Pursuant to the FDIRA, the FDICwill begin indexing deposit insurance coverage levels for inflationbeginning in 2012.  Moreover, if webecome undercapitalized we cannot accept employee benefit plan deposits.

***Transactionswith Affiliates and Insiders.***  The bank is subject to the provisions ofSection 23A of the Federal Reserve Act, which places limits on the amount ofloans or extensions of credit to, or investments in, or certain othertransactions with, affiliates and on the amount of advances to third partiescollateralized by the securities or obligations of affiliates.  The aggregate of all covered transactions islimited in amount, as to any one affiliate, to 10% of the bank’s capital andsurplus and, as to all affiliates combined, to 20% of the bank’s capital andsurplus.  Furthermore, within theforegoing limitations as to amount, each covered transaction must meetspecified collateral requirements. Compliance is also required with certain provisions designed to avoidthe taking of low quality assets.

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The bank also issubject to the provisions of Section 23B of the Federal Reserve Act which,among other things, prohibits an institution from engaging in certaintransactions with certain affiliates unless the transactions are on termssubstantially the same, or at least as favorable to such institution or itssubsidiaries, as those prevailing at the time for comparable transactions withnonaffiliated companies.  The bank issubject to certain restrictions on extensions of credit to executive officers,directors, certain principal shareholders, and their related interests.  Such extensions of credit (i) must be made onsubstantially the same terms, including interest rates and collateral, as thoseprevailing at the time for comparable transactions with third parties and (ii)must not involve more than the normal risk of repayment or present otherunfavorable features.

The FederalReserve Board has issued Regulation W, which codifies prior regulations underSections 23A and 23B of the Federal Reserve Act and interpretative guidancewith respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transactionrules but expands the exemption to cover the purchase of any type of loan orextension of credit from an affiliate. In addition, under Regulation W:

·                                          abank and its subsidiaries may not purchase a low-quality asset from anaffiliate;

·                                          coveredtransactions and other specified transactions between a bank or itssubsidiaries and an affiliate must be on terms and conditions that areconsistent with safe and sound banking practices; and

·                                          withsome exceptions, each loan or extension of credit by a bank to an affiliatemust be secured by collateral with a market value ranging from 100% to 130%,depending on the type of collateral, of the amount of the loan or extension ofcredit.

Regulation Wgenerally excludes all non-bank and non-savings association subsidiaries ofbanks from treatment as affiliates, except to the extent that the FederalReserve Board decides to treat these subsidiaries as affiliates.  The regulation also limits the amount ofloans that can be purchased by a bank from an affiliate to not more than 100%of the bank’s capital and surplus.

***Branching****.*  Under current SouthCarolina law, we may open branch offices throughout South Carolina with theprior approval of the South Carolina Board of Financial Institutions.   In addition, with prior regulatory approval,the bank will be able to acquire existing banking operations in SouthCarolina.  Furthermore, federal legislationhas been passed that permits interstate branching by banks if allowed by statelaw, and interstate merging by banks.

***CommunityReinvestment Act****.*  The Community Reinvestment Act requires that,in connection with examinations of financial institutions within theirrespective jurisdictions, a financial institution’s primary regulator, which isthe FDIC for the bank, shall evaluate the record of each financial institutionin meeting the credit needs of its local community, including low and moderateincome neighborhoods.  These factors arealso considered in evaluating mergers, acquisitions, and applications to open abranch or facility.  Failure toadequately meet these criteria could impose additional requirements andlimitations on our bank.  Additionally,we must publicly disclose the terms of various Community ReinvestmentAct-related agreements.

***FinanceSubsidiaries.*** Under the Gramm-Leach-Bliley Act (the “GLBA”), subject to certainconditions imposed by their respective banking regulators, national andstate-chartered banks are permitted to form “financial subsidiaries” that mayconduct financial or incidental activities, thereby permitting banksubsidiaries to engage in certain activities that previously wereimpermissible.  The GLBA imposes severalsafeguards and restrictions on financial subsidiaries, including that theparent bank’s equity investment in the financial subsidiary be deducted fromthe bank’s assets and tangible equity for purposes of calculating the bank’scapital adequacy.  In addition, the GLBAimposes new restrictions on transactions between a bank and its financialsubsidiaries similar to restrictions applicable to transactions between banksand non-bank affiliates.

***Other Regulations.*** Interest and other charges collected or contractedfor by the bank are subject to state usury laws and federal laws concerninginterest rates.  The bank’s loanoperations are also subject 

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to federal lawsapplicable to credit transactions, such as the:

·                  The federalTruth-In-Lending Act, governing disclosures of credit terms to consumerborrowers;

·                  The HomeMortgage Disclosure Act of 1975, requiring financial institutions to provideinformation to enable the public and public officials to determine whether afinancial institution is fulfilling its obligation to help meet the housingneeds of the community it serves;

·                  The Equal CreditOpportunity Act, prohibiting discrimination on the basis of race, creed orother prohibited factors in extending credit;

·                  The Fair CreditReporting Act of 1978, as amended by the Fair and Accurate Credit TransactionsAct, governing the use and provision of information to credit reportingagencies, certain identity theft protections and certain credit and otherdisclosures;

·                  The Fair DebtCollection Act, governing the manner in which consumer debts may be collectedby collection agencies; and

·                  The Rules andregulations of the various federal agencies charged with the responsibility ofimplementing these federal laws.

The deposit operations of the bank also are subject to:

·                  theRight to Financial Privacy Act, which imposes a duty to maintainconfidentiality of consumer financial records and prescribes procedures forcomplying with administrative subpoenas of financial records; and

·                                          theElectronic Funds Transfer Act and Regulation E issued by the Federal ReserveBoard to implement that Act, which governs automatic deposits to andwithdrawals from deposit accounts and customers’ rights and liabilities arisingfrom the use of automated teller machines and other electronic bankingservices.

***EnforcementPowers.***  The bankand its “institution-affiliated parties,” including its management, employees,agents, independent contractors, and consultants such as attorneys andaccountants and others who participate in the conduct of the financialinstitution’s affairs, are subject to potential civil and criminal penaltiesfor violations of law, regulations or written orders of a government agency.These practices can include the failure of an institution to timely filerequired reports or the filing of false or misleading information or thesubmission of inaccurate reports.  Civilpenalties may be as high as $1,000,000 a day for such violations.  Criminal penalties for some financialinstitution crimes have been increased to twenty years.  In addition, regulators are provided withgreater flexibility to commence enforcement actions against institutions andinstitution-affiliated parties.  Possibleenforcement actions include the termination of deposit insurance.  Furthermore, banking agencies’ power to issuecease-and-desist orders were expanded. Such orders may, among other things, require affirmative action tocorrect any harm resulting from a violation or practice, including restitution,reimbursement, indemnifications or guarantees against loss.  A financial institution may also be orderedto restrict its growth, dispose of certain assets, rescind agreements orcontracts, or take other actions as determined by the ordering agency to beappropriate.

## ***USA PATRIOT Act.***** The USA PATRIOT Act became effective onOctober 26, 2001, amended, in part, the bank Secrecy Act, and provides, inpart, for the facilitation of information sharing among governmental entitiesand financial institutions for the purpose of combating terrorism and moneylaundering by enhancing anti-money laundering and financial transparency laws,as well as enhanced information collection tools and enforcement mechanics forthe U.S. government, including: (i) requiring standards for verifyingcustomer identification at account opening; (ii) rules to promotecooperation among financial institutions, regulators, and law enforcemententities in identifying parties that may be involved in terrorism or moneylaundering; (iii) reports by nonfinancial trades and businesses filed withthe Treasury Department’s Financial Crimes Enforcement Network for transactionsexceeding $10,000; and (iv) filing 

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## suspicious activities reports by brokers and dealers if they believe acustomer may be violating U.S. laws and regulations and requires enhanced duediligence requirements for financial institutions that administer, maintain, ormanage private bank accounts or correspondent accounts for non-U.S. persons.

Under the USA PATRIOT Act, the Federal Bureau of Investigation (“FBI”)can send our banking regulatory agencies lists of the names of personssuspected of involvement in terrorist activities.  The bank can be requested, to search itsrecords for any relationships or transactions with persons on those lists.  If the bank finds any relationships ortransactions, it must file a suspicious activity report and contact the FBI.

The Office of Foreign Assets Control (“OFAC”), which is a division ofthe U.S. Department of the Treasury, is responsible for helping to insure thatUnited States entities do not engage in transactions with “enemies” of theUnited States, as defined by various Executive Orders and Acts ofCongress.  OFAC has sent, and will send,our banking regulatory agencies lists of names of persons and organizationssuspected of aiding, harboring or engaging in terrorist acts.  If the bank finds a name on any transaction,account or wire transfer that is on an OFAC list, it must freeze such account,file a suspicious activity report and notify the FBI.  The bank has appointed an OFAC complianceofficer to oversee the inspection of its accounts and the filing of anynotifications.  The bank actively checkshigh-risk OFAC areas such as new accounts, wire transfers and customer files.  The bank performs these checks utilizingsoftware, which is updated each time a modification is made to the listsprovided by OFAC and other agencies of Specially Designated Nationals andBlocked Persons.

***Privacy and Credit Reporting*. **Financial institutions are required todisclose their policies for collecting and protecting confidentialinformation.  Customers generally mayprevent financial institutions from sharing nonpublic personal financialinformation with nonaffiliated third parties except under narrow circumstances,such as the processing of transactions requested by the consumer or when thefinancial institution is jointly sponsoring a product or service with anonaffiliated third party.  Additionally,financial institutions generally may not disclose consumer account numbers toany nonaffiliated third party for use in telemarketing, direct mail marketingor other marketing to consumers.  It isthe bank’s policy not to disclose any personal information unless required bylaw.

Like other lendinginstitutions, the bank utilizes credit bureau data in its underwritingactivities.  Use of such data isregulated under the Federal Credit Reporting Act on a uniform, nationwidebasis, including credit reporting, prescreening, sharing of information betweenaffiliates, and the use of credit data. The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”)authorizes states to enact identity theft laws that are not inconsistent withthe conduct required by the provisions of the FACT Act.

***Payment of Dividends.*** A South Carolina state bankmay not pay dividends from its capital. All dividends must be paid out of undivided profits then on hand, afterdeducting expenses, including reserves for losses and bad debts.  The bank is authorized to pay cash dividendsup to 100% of net income in any calendar year without obtaining the priorapproval of the South Carolina Board of Financial Institutions, provided thatthe bank received a composite rating of one or two at the last federal or stateregulatory examination.  The bank mustobtain approval from the South Carolina Board of Financial Institutions priorto the payment of any other cash dividends. In addition, under the FDICIA, the bank may not pay a dividend if, afterpaying the dividend, the bank would be undercapitalized.

***Check 21.*** The Check Clearing for the 21st Century Act gives “substitute checks,”such as a digital image of a check and copies made from that image, the samelegal standing as the original paper check. Some of the major provisions include:

·                                          allowingcheck truncation without making it mandatory;

·                                          demandingthat every financial institution communicate to accountholders in writing adescription of its substitute check processing program and their rights underthe law;

·                                          legalizingsubstitutions for and replacements of paper checks without agreement fromconsumers;

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·                                          retainingin place the previously mandated electronic collection and return of checksbetween financial institutions only when individual agreements are in place;

·                                          requiringthat when accountholders request verification, financial institutions producethe original check (or a copy that accurately represents the original) anddemonstrate that the account debit was accurate and valid; and

·                                          requiringthe re-crediting of funds to an individual’s account on the next business dayafter a consumer proves that the financial institution has erred.

***Effectof Governmental Monetary Policies*.**  Our earnings are affected by domesticeconomic conditions and the monetary and fiscal policies of the United Statesgovernment and its agencies.  The FederalReserve bank’s monetary policies have had, and are likely to continue to have,an important impact on the operating results of commercial banks through itspower to implement national monetary policy in order, among other things, tocurb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effectsupon the levels of bank loans, investments and deposits through its open marketoperations in United States government securities and through its regulation ofthe discount rate on borrowings of member banks and the reserve requirementsagainst member bank deposits.  It is notpossible to predict the nature or impact of future changes in monetary andfiscal policies.

***ProposedLegislation and Regulatory Action*.**  New regulations and statutes are regularlyproposed that contain wide-ranging proposals for altering the structures,regulations, and competitive relationships of the nation’s financialinstitutions.  We cannot predict whetheror in what form any proposed regulation or statute will be adopted or theextent to which our business may be affected by any new regulation or statute.

***Our recent operating results maynot be indicative of our future operating results.***

Wemay not be able to sustain our historical rates of growth of assets andearnings, and we may not be able to grow our business at all.  Although we have plans for continuedexpansion of our company, our historical results of operation will notnecessarily be indicative of our future operations.  Various factors, such as economic conditions,regulatory and legislative considerations, and competition, may also impede ourability to expand our market presence. If we experience a significant decrease in our historical rate ofgrowth, our results of operations and financial condition may be adverselyaffected because a high percentage of our operating costs are fixed expenses.

***Ourdecisions regarding credit risk and reserves for loan losses may materially andadversely affect our business.***

Makingloans and other extensions of credit is an essential element of ourbusiness.  Although we seek to mitigaterisks inherent in lending by adhering to specific underwriting practices, ourloans and other extensions of credit may not be repaid.  The risk of nonpayment is affected by anumber of factors, including:

·                  theduration of the credit;

·                  creditrisks of a particular customer;

·                  changesin economic and industry conditions; and

·                  inthe case of a collateralized loan, risks resulting from uncertainties about thefuture value of the collateral.

Weattempt to maintain an appropriate allowance for loan losses to provide forpotential losses in our loan portfolio. We periodically determine the amount of the allowance based onconsideration of several factors, including:

·                  anongoing review of the quality, mix, and size of our overall loan portfolio;

·                  ourhistorical loan loss experience;

·                  evaluationof economic conditions;

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·                  regularreviews of loan delinquencies and loan portfolio quality; and

·                  theamount and quality of collateral, including guarantees, securing the loans.

Thereis no precise method of predicting credit losses; therefore, we face the riskthat charge-offs in future periods will exceed our allowance for loan lossesand that additional increases in the allowance for loan losses will berequired.  Additions to the allowance forloan losses would result in a decrease of our net income, and possibly ourcapital.

While we generallyunderwrite the loans in our portfolio in accordance with our own internalunderwriting guidelines and regulatory supervisory guidelines, in certaincircumstances we have made loans, which exceed either our internal underwritingguidelines, supervisory guidelines, or both. The aggregate amount of all loansin excess of the supervisory loans-to-value limits should not exceed 100% ofour bank’s capital.  As of December 31,2006, approximately $7 million of our loans, or 24.6% of our bank’s capital,had loan-to-value ratios that exceeded regulatory supervisory guidelines, ofwhich 1 loan totaling approximately $158,000 had a loan-to-value ratio of 100%or more.  In addition, within theaggregate limit noted above, total loans for all commercial, agricultural,multifamily or other non 1-4 family residential properties should not exceed30% of total capital.  At December 31,2006, loans collateralized by commercial, agricultural, multifamily or othernon 1-4 family residential properties that exceeded the supervisory loan tovalue ratio were $5.5 million, or 19.5% of the bank’s capital.  The number of loans in our portfolio withloan-to-value ratios in excess of supervisory guidelines, our internalguidelines, or both could increase the risk of delinquencies and defaults inour portfolio.

**A significant portion of our loanportfolio is secured by real estate, and events that negatively impact the realestate market could hurt our business.**

A significantportion of our loan portfolio is secured by real estate.  As of December 31, 2006, approximately 68.9%of our loans had real estate as a primary or secondary component ofcollateral.  The real estate collateralin each case provides an alternate source of repayment in the event of defaultby the borrower and may deteriorate in value during the time the credit is extended.  A weakening of the real estate market in ourprimary market area could result in an increase in the number of borrowers whodefault on their loans and a reduction in the value of the collateral securingtheir loans, which in turn could have an adverse effect on our profitabilityand asset quality.  If we are required toliquidate the collateral securing a loan to satisfy the debt during a period ofreduced real estate values, our earnings and capital could be adverselyaffected.  Acts of nature, includinghurricanes, tornados, earthquakes, fires and floods, which may cause uninsureddamage and other loss of value to real estate that secures these loans, mayalso negatively impact our financial condition.

**A large percentage of the loansin our portfolio currently include exceptions to our loan policies andsupervisory guidelines.**

All of the loansthat we make are subject to written loan policies adopted by our board ofdirectors and to supervisory guidelines imposed by our regulators.  Our loan policies are designed to reduce therisks associated with the loans that we make by requiring our loan officers totake certain steps that vary depending on the type and amount of the loan,prior to closing a loan.  These stepsinclude, among other things, making sure the proper liens are documented andperfected on property securing a loan, and requiring proof of adequateinsurance coverage on property securing loans. Loans that do not fully comply with our loan policies are known as “exceptions.”  We categorize exceptions as policyexceptions, financial statement exceptions and collateral exceptions.  As a result of these exceptions, such loansmay have a higher risk of loan loss than the other loans in our portfolio thatfully comply with our loan policies.  Inaddition, we may be subject to regulatory action by federal or state bankingauthorities if they believe the number of exceptions in our loan portfoliorepresents an unsafe banking practice. Although we have taken steps to enhance the quality of our loanportfolio, we may not be successful in reducing the number of exceptions.

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***Lackof seasoning of our loan portfolio may increase the risk of credit defaults inthe future.***

Dueto the growth of our bank into new markets over the past several years and ourshort operating history in these communities, a large portion of the loans inour loan portfolio and of our lending relationships are of relatively recentorigin.  In general, loans do not beginto show signs of credit deterioration or default until they have beenoutstanding for some period of time, a process we refer to as “seasoning.”  As a result, a portfolio of older loans willusually behave more predictably than a newer portfolio.  Because a substantial portion of our loanportfolio is relatively new, the current level of delinquencies and defaultsmay not be representative of the level that will prevail when the portfoliobecomes more seasoned, which may be higher than current levels.  If delinquencies and defaults increase, wemay be required to increase our provision for loan losses, which wouldadversely affect our results of operations and financial condition.

***An economic downturn, especiallyone affecting Horry County in South Carolina and Columbus and BrunswickCounties in North Carolina, could reduce our customer base, our level of deposits,and demand for financial products such as loans.***

Oursuccess significantly depends upon the growth in population, income levels,deposits, and housing starts in our markets, especially in Horry County, and toa lesser extent in Columbus and Brunswick Counties in North Carolina.  If the communities in which we operate do notgrow or if prevailing economic conditions locally or nationally areunfavorable, our business may not succeed. An economic downturn would likely contribute to the deterioration of thequality of our loan portfolio and reduce our level of deposits, which in turnwould hurt our business.  If an economicdownturn occurs in the economy as a whole, or especially in Horry County,borrowers may be less likely to repay their loans as scheduled.  Moreover, the value of real estate or othercollateral that may secure our loans could be adversely affected.  Unlike many larger institutions, we are notable to spread the risks of unfavorable local economic conditions across alarge number of diversified economies. An economic downturn could, therefore, result in losses that materiallyand adversely affect our business.

***Changesin prevailing interest rates may reduce our profitability.***

Ourresults of operations depend in large part upon the level of our net interestincome, which is the difference between interest income from interest-earningassets, such as loans and mortgage-backed securities, and interest expense oninterest-bearing liabilities, such as deposits and other borrowings.  Depending on the terms and maturities of ourassets and liabilities, a significant change in interest rates could have amaterial adverse effect on our profitability. Many factors cause changes in interest rates, including governmentalmonetary policies and domestic and international economic and politicalconditions.  While we intend to managethe effects of changes in interest rates by adjusting the terms, maturities,and pricing of our assets and liabilities, our efforts may not be effective andour financial condition and results of operations could suffer.  After operating in a historically lowinterest rate environment, the Federal Reserve began raising short-terminterest rates in the second quarter of 2004. We anticipate that we will benefit from a rising interest rateenvironment.  However, no assurance canbe given that the Federal Reserve will actually continue to raise interestrates or that the results we anticipate will actually occur.

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

**JamesR. Clarkson, our president and chief executive officer, has extensive andlong-standing ties within our primary market area and he has contributedsignificantly to our growth.  If we losethe services of Mr. Clarkson, he would be difficult to replace, and ourbusiness and development could be materially and adversely affected.**

**Oursuccess also depends, in part, on our continued ability to attract and retainexperienced loan originators, as well as other management personnel.  The loss of the services of several of suchkey personnel could adversely affect our growth strategy and prospects to theextent we are unable to replace such personnel.**

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***We are subjectto extensive regulation that could limit or restrict our activities.***

We operate in a highlyregulated industry and are subject to examination, supervision, andcomprehensive regulation by various regulatory agencies.  Our compliance with these regulations iscostly and restricts certain of our activities, including payment of dividends,mergers and acquisitions, investments, loans and interest rates charged,interest rates paid on deposits, and locations of offices.  We are also subject to capitalizationguidelines established by our regulators, which require us to maintain adequatecapital to support our growth.

The laws and regulationsapplicable to the banking industry could change at any time, and we cannotpredict the effects of these changes on our business and profitability.  Because government regulation greatly affectsthe business and financial results of all commercial banks and bank holdingcompanies, our cost of compliance could adversely affect our ability to operateprofitably.

The Sarbanes-Oxley Act of2002, and the related rules and regulations promulgated by the Securities andExchange Commission that are now applicable to us, have increased the scope,complexity, and cost of corporate governance, reporting, and disclosurepractices.  We have experienced, and weexpect to continue to experience, greater compliance costs, including costsrelated to internal controls, as a result of the Sarbanes-Oxley Act.

We are in theprocess of evaluating our internal controls to allow management to report onour internal control for our fiscal year 2007, and for ourindependent registered public accounting firm to attest to our internalcontrols for fiscal year 2008.  We are performing the system and processevaluation and testing (and any necessary remediation) required to comply withthe management certification and auditor attestation requirements of Section404 of the Sarbanes-Oxley Act. While we currently anticipate that we will beable to fully implement the requirements relating to internal controls and allother aspects of Section 404 in a timely manner, as required by Section 404 andthe SEC’s related regulations, we could identify deficiencies that we maynot be able to remediate in time to meet this deadline. If we are not able toimplement or maintain the requirements of Section 404 in a timely manner orwith adequate compliance, we could be subject to scrutiny by regulatoryauthorities and the trading price of our stock coulddecline.  Moreover, effective internal controls are necessaryfor us to produce reliable financial reports and are important to helpingprevent financial fraud. If we cannot provide reliable financial reports orprevent fraud, our business and operating results could be harmed, investorsand regulators could lose confidence in our reported financial information, andthe trading price of our stock could drop significantly.   Wecurrently anticipate that we will fully implement the requirementsrelating to internal controls and all other aspects of Section 404 within the requiredtime frames.

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

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

***Weface strong competition for clients, which could prevent us from obtainingclients and may cause us to pay higher interest rates to attract clients.***

The banking business ishighly competitive, and we experience competition in our market from many otherfinancial institutions.  We compete withcommercial banks, credit unions, savings and loan associations, mortgage bankingfirms, consumer finance companies, securities brokerage firms, insurancecompanies, money market funds, and other mutual funds, as well as othersuper-regional, national, and international financial institutions that operateoffices in our primary market areas and elsewhere.  We compete with these institutions both inattracting deposits and in making loans. In addition, we have to attract our client base from other existingfinancial institutions and from new residents. Many of our 

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competitors arewell-established, larger financial institutions.  These institutions offer some services, suchas extensive and established branch networks, that we do not provide.  There is a risk that we will not be able tocompete successfully with other financial institutions in our market, and thatwe may have to pay higher interest rates to attract deposits, resulting inreduced profitability.  In addition,competitors that are not depository institutions are generally not subject tothe extensive regulations that apply to us.

***We will face risks with respectto future expansion and acquisitions or mergers.***

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

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

·                  the time andcosts of evaluating new markets, hiring or retaining experienced localmanagement, and opening new offices and the time lags between these activitiesand the generation of sufficient assets and deposits to support the costs ofthe expansion;

·                  the incurrenceand possible impairment of goodwill associated with an acquisition and possibleadverse effects on our results of operations; and

·                  the risk of lossof key employees and customers.

**The success of our growthstrategy depends on our ability to identify and retain individuals withexperience and relationships in the markets in which we presently operate aswell as those into which we intend to expand.**

To expand ourcoastal franchise successfully, we must identify and retain experienced keymanagement members with local expertise and relationships in thesemarkets.  We expect that competition forqualified management in the markets in which we now operate and into which wemay expand will be intense and that there will be a limited number of qualifiedpersons with knowledge of and experience in the community banking industry inthese markets.  Even if we identifyindividuals that we believe could assist us in establishing a presence in a newmarket, we may be unable to recruit these individuals away from more establishedfinancial institutions.  In addition, theprocess of identifying and recruiting individuals with the combination ofskills and attributes required to carry out our strategy requires bothmanagement and financial resources and is often lengthy.  Our inability to identify, recruit, and retaintalented personnel to manage new offices effectively would limit our growth andcould materially adversely affect our business, financial condition, andresults of operations.

**Item2.  Description of Property.**

The main office of the bank is located at 5009 BroadStreet, Loris, South Carolina 29569.  Ourexecutive offices are located at 5201 Broad Street, Loris, South Carolina  29569. The bank presently owns ten lots in fee simple on which we have branchbanking facilities and one lot with a facility that houses the bank’s executiveoffices, central deposit operations, central credit operations and computeroperations.  In addition, the bank hasentered into one long-term lease agreement for a lot on which we have built abranch banking facility.  Each of theseproperties is located within Horry County, South Carolina.

InNovember 2006, the Company purchased a 5-acre tract of land in the LorisCommerce Center and expects to begin construction of a Operations Center onthis site in 2007 in order to accommodate its executive offices and all supportservice in this new facility.  TheCompany intends to offer its present Operations Center for sale.

Alsoin 2006 the Company acquired a lot and 25,710 square foot building thereon at1300 Second Avenue, Conway, South Carolina as well as the adjacent lots whichfront on Third Avenue in Conway, South Carolina.  In February 2007 the Company sold an interestin a portion of these properties to TLF 

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Myrtle BeachProperties, LLC, the real estate ownership partnership for the law firm ofThompson & Henry, P.A. and transferred the remaining ownership interest tothe bank subsidiary.   The Companyintends to operate a full service branch bank in the first floor of the SecondAvenue building and construct a drive-up banking facility on two 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.

**Item 3.  Legal Proceedings.**

On March 2, 2007,Horry County State Bank was served with a complaint filed by Coastal FinancialCorporation d/b/a Coastal Federal Bank in the Court of Common Pleas for HorryCounty, South Carolina.  Among other things,the complaint alleges that Horry County State Bank contacted Coastal Federalemployees and customers with the purpose of influencing them to abandon theirrelationships with Coastal Federal.  Thecomplaint also alleges, among other things, that Douglas Schaffer resigned fromCoastal Federal and accepted a position with Horry County State Bank and thathe contacted at least one Coastal Federal customer subsequent to hisresignation from Coastal Federal and misappropriated Coastal Federal tradesecrets.  The complaint alleges variouscauses of action.   The complaint seeksan unspecified amount of attorneys fees and damages, including consequentialand punitive damages, relating to, among other things, Coastal Federal’salleged loss of business and lost reputation, loss of customers banking business,loss of profits, loss of opportunities, loss of employees and alleged unjust enrichment.  The complaint seeks an order that would,among other things, enjoin Horry County State Bank and Mr. Schaffer fromsoliciting Coastal Federal employees, interfering with Coastal Federalrelationships with employees and customers or using alleged Coastal Federaltrade secrets.  We intend to vigorouslydefend this action.

In the ordinary course of operations, we are a party to various legalproceedings.  Except as described above,we are not a party to, nor are any of our properties subject to, any materiallegal proceedings, other than legal proceedings that we believe are routinelitigation incidental to our business.

**Item 4.  Submission of Matters to a Vote of SecurityHolders.**

No matters were submitted during the fourth quarter of the fiscal yearended December 31, 2006 to a vote of security holders, through the solicitationof proxies or otherwise.

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**PART II**

**Item 5. Market for Common Equity and Related Stockholder Matters.**

Theinformation required by Item 5 is hereby incorporated by reference from ourannual report to shareholders for the year ended December 31, 2006.

**Item 6.  Management’s Discussion and Analysis or Planof Operation.**

The information required by Item 6 is hereby incorporated by referencefrom our annual report to shareholders for the year ended December 31, 2006.

**Item 7.  Financial Statements.**

The informationrequired by Item 7 is hereby incorporated by reference from our annual reportto shareholders for the year ended December 31, 2006.

**Item 8.  Changes in and Disagreements with Accountantson Accounting and Financial Disclosure.**

None

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

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our chiefexecutive officer and principal financial officer of the effectiveness of ourdisclosure controls and procedures as defined in Exchange Act Rule13a-15(e).  Based upon that evaluation,our chief executive officer and principal financial officer has concluded thatour current disclosure controls and procedures are effective as of December 31,2005.  There have been no significantchanges in our internal controls over financial reporting during the fourthfiscal quarter ended December 31, 2006 that have materially affected, or arereasonably likely to materially affect, our internal controls over financial reporting.

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

**ITEM 8B.  Other Information.**

None

21

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**PART III**

**Item 9.  Directors, Executive Officers, Promoters andControl Persons; Compliance with Section 16(a) of the Exchange Act**

*Code of Ethics*

Wehave adopted a Code of Ethics that applies to our board of directors, principalexecutive officer, principal financial officer, senior financial officers, andother executive officers in accordance with the Sarbanes-Oxley CorporateResponsibility Act of 2002.  The Code ofEthics is available without charge to shareholders upon request.  Shareholders should contact our chiefexecutive officer, James R. Clarkson, at our main office to obtain a copy.

Additional information required by Item 9 is herebyincorporated by reference from our proxy statement for our 2007 annual meetingof shareholders to be held on April 26, 2007.

**Item10.  Executive Compensation.**

Informationrequired by Item 10 is hereby incorporated by reference from our proxystatement for our 2007 annual meeting of shareholders to be held on April 26,2007.

**Item 11.  Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters.**

The following table sets forth the equity compensation plan informationat December 31, 2006.

**Equity Compensation Plan Information**
| **Plan Category**                                   | ** ** | **Number of securities  to be issued  upon exercise of  outstanding options,  warrants and rights(a)** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights (b)** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (c)  (excluding securities  reflected in column(a)) (1)** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                     |       |                                                                                                                                                |       |                                                                                                                 |       |                                                                                                                                                                                                                     |       |
| Equity compensation  plans approved by  security holders |       | 82,788                                                                                                                                              |       | $                                                                                                                    | 14.94      |                                                                                                                                                                                                                     | 341,572    |   |
|                                                     |       |                                                                                                                                                |       |                                                                                                                 |       |                                                                                                                                                                                                                     |       |
| Total                                                    |       | 82,788                                                                                                                                              |       | $                                                                                                                    | 14.94      |                                                                                                                                                                                                                     | 341,572    |   |

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(1)             TheHCSB Financial Corporation Omnibus Stock Ownership and Long Term Incentive Planauthorizes the grant of options and the award of restricted stock from time totime during the term of the plan.  Theemployees included in the plan include the executive officers of thecorporation as well as certain non-executive officer employees.  This column includes 156,681 options and184,891 shares of restricted stock.

Additionalinformation required by Item 11 is hereby incorporated by reference from ourproxy statement for our 2007 annual meeting of shareholders to be held on April26, 2007.

**Item 12.  Certain Relationships and RelatedTransactions, and Director Independence.**

In response to this Item 12, the information contained onpage 8 of our Proxy Statement for the Annual Meeting of Shareholders to be heldon April 26, 2007 is incorporated herein by reference.

22

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**Item 13.  Exhibits**
| 3.1  |   | Articles  of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s  Form 10-KSB for the fiscal year ended December 31, 1999).                                                          |   |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 3.2  |   | Bylaws  (incorporated by reference to Exhibit 3.2 to the Company’s Form 10-KSB for  the fiscal year ended December 31, 1999).                                                                             |   |
| 10.1 |   | HCSB  Financial Corporation Omnibus Stock Ownership and Long Term Incentive Plan  (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-KSB for  the fiscal year ended December 31, 2003).* |   |
| 10.2 |   | Form  of Restricted Stock Option Agreement (incorporated by reference to Exhibit  10.2 to the Company’s Form 10-KSB for the fiscal year ended December 31,  2004).*                                       |   |
| 10.3 |   | Form  of Incentive Stock Option Agreement (incorporated by reference to Exhibit  10.3 to the Company’s Form 10-KSB for the fiscal year ended December 31,  2004).*                                        |   |
| 10.4 |   | Form  of Director Deferred Compensation Agreement adopted in 1997 by and between  the Board of Directors and Horry County State Bank.*                                                                         |   |
| 13   |   | The  Company’s 2006 Annual Report                                                                                                                                                                         |   |
| 21   |   | Subsidiaries  of Registrant                                                                                                                                                                                    |   |
| 24   |   | Power  of Attorney (contained on signature pages herewith)                                                                                                                                                     |   |
| 31.1 |   | Rule  13a-14(a) Certification of the Chief Executive Officer.                                                                                                                                                  |   |
| 31.2 |   | Rule  13a-14(a) Certification of the Principal Financial Officer.                                                                                                                                              |   |
| 32   |   | Section 1350  Certifications.                                                                                                                                                                                  |   |

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*                                         Management contract of compensatory plan orarrangement required to be filed as an Exhibit to this Annual Report on Form10-KSB.

**Item14.  Principal Accountant Fees and Services.**

Information required by Item 10 is hereby incorporatedby reference from our proxy statement for our 2007 annual meeting ofshareholders to be held on April 26, 2007.

23

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**SIGNATURES**

In accordance with Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.
|                      |                          | **HCSB FINANCIAL CORPORATION** |
|----------------------|-------------------------------|--------------------------------|
|                 |                          |                           |
| Date: March 15, 2007 | By:                           | /s/ James R. Clarkson          |
|                 | James R. Clarkson, President  |
|                 | & Chief Executive Officer |

 

KNOW ALL MEN BYTHESE PRESENTS, that each person whose signature appears below constitutes andappoints James R. Clarkson, his true and lawful attorney-in-fact and agent,with full power of substitution and resubstitution, for him and in his name,place and stead, in any and all capacities, to sign any and all amendments tothis Annual Report on Form 10-KSB, and to file the same, with all exhibitsthereto, and other documents in connection therewith, with the Securities andExchange Commission, granting unto attorney-in-fact and agent full power andauthority to do and perform each and every act and thing requisite or necessaryto be done in and about the premises, as fully to all intents and purposes ashe might or could do in person, hereby ratifying and confirming all thatattorney-in-fact and agent, or his substitute or substitutes, may lawfully door cause to be done by virtue hereof.

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant in thecapacities and on the dates indicated.
| By:    |   /s/ Michael S. Addy                     |   | Date: March 15, 2007        |
|--------|-----------------------------------------------------|--------|-----------------------------|
|   | Michael S. Addy, Director                           |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ Johnny C. Allen                     |   | Date:  March  15, 2007 |
|   | Johnny C. Allen, Director                           |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ Clay D. Brittain, III               |   | Date:  March  15, 2007 |
|   | Clay D. Brittain, III, Director                     |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ Rachel B. Broadhurst                |   | Date:  March  15, 2007 |
|   | Rachel B. Broadhurst, Director                      |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ Russell R. Burgess, Jr.             |   | Date:  March  15, 2007 |
|   | Russell R. Burgess, Jr., Director                   |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ D. Singleton Bailey                 |   | Date:  March  15, 2007 |
|   | D. Singleton Bailey, Director                       |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ Franklin C. Blanton                 |   | Date:  March  15, 2007 |
|   | Franklin C. Blanton, Director                       |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ William H. Caines                   |   | Date:  March  15, 2007 |
|   | William H. Caines, Director                         |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ James R. Clarkson                   |   | Date:  March  15, 2007 |
|   | James R. Clarkson, Director, President,             |   |                        |
|   | Chief Executive Officer, Principal                  |   |                        |
|   | Accounting Officer, and Principal Financial Officer |   |                        |
|   |                                                |   |                        |
| By:    |   /s/ J. Lavelle Coleman                  |   | Date:  March  15, 2007 |
|   | J. Lavelle Coleman, Director                        |   |                        |

 

24

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|        |                                    |   |                        |
|--------|-----------------------------------------|--------|-----------------------------|
| By:    |   /s/ Larry G. Floyd          |   | Date:  March  15, 2007 |
|   | Larry G. Floyd, Director                |   |                        |
|   |                                    |   |                        |
| By:    |   /s/ Boyd R. Ford, Jr.       |   | Date:  March  15, 2007 |
|   | Boyd R. Ford, Jr., Director             |   |                        |
|   |                                    |   |                        |
| By:    |   /s/ Tommie W. Grainger      |   | Date:  March  15, 2007 |
|   | Tommie W. Grainger, Director            |   |                        |
|   |                                    |   |                        |
| By:    |   /s/ Randy B. Hardee         |   | Date:  March  15, 2007 |
|   | Randy B. Hardee, Director               |   |                        |
|   |                                    |   |                        |
| By:    |   /s/ Gwyn G. McCutchen       |   | Date:  March  15, 2007 |
|   | Gwyn G. McCutchen, Director             |   |                        |
|   |                                    |   |                        |
| By:    |   /s/ T. Freddie Moore        |   | Date:  March  15, 2007 |
|   | T. Freddie Moore, Director              |   |                        |
|   |                                    |   |                        |
| By:    |   /s/ Carroll D. Padgett, Jr. |   | Date:  March  15, 2007 |
|   | Carroll D. Padgett, Jr., Director       |   |                        |

 

25

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**EXHIBITINDEX**
| 3.1  |   | Articles  of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s  Form 10-KSB for the fiscal year ended December 31, 1999).                                                          |   |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 3.2  |   | Bylaws  (incorporated by reference to Exhibit 3.2 to the Company’s Form 10-KSB for  the fiscal year ended December 31, 1999).                                                                             |   |
| 10.1 |   | HCSB  Financial Corporation Omnibus Stock Ownership and Long Term Incentive Plan  (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-KSB for  the fiscal year ended December 31, 2003).* |   |
| 10.2 |   | Form  of Restricted Stock Option Agreement (incorporated by reference to Exhibit  10.2 to the Company’s Form 10-KSB for the fiscal year ended December 31,  2004).*                                       |   |
| 10.3 |   | Form  of Incentive Stock Option Agreement (incorporated by reference to Exhibit  10.3 to the Company’s Form 10-KSB for the fiscal year ended December 31,  2004).*                                        |   |
| 10.4 |   | Form  of Director Deferred Compensation Agreement adopted in 1997 by and between  the Board of Directors and Horry County State Bank.*                                                                         |   |
| 13   |   | The  Company’s 2006 Annual Report                                                                                                                                                                         |   |
| 21   |   | Subsidiaries  of Registrant                                                                                                                                                                                    |   |
| 24   |   | Power  of Attorney (contained on signature pages herewith)                                                                                                                                                     |   |
| 31.1 |   | Rule  13a-14(a) Certification of the Chief Executive Officer.                                                                                                                                                  |   |
| 31.2 |   | Rule  13a-14(a) Certification of the Principal Financial Officer.                                                                                                                                              |   |
| 32   |   | Section 1350  Certifications.                                                                                                                                                                                  |   |

 

26

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