Waccamaw Bankshares (WBNK) 10-Q 2006 Q2 Quarterly report

United States Securities and Exchange Commission
Washington, D.C. 20549

FORM 10-Q

(MARK ONE)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
o	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 000-32985
WACCAMAW BANKSHARES, INC.
(Name of Small Business Issuer in its Charter)

NORTH CAROLINA	52-2329563
(State or other Jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
110 N. Powell Boulevard Whiteville, N.C. 28472
(address of Principal Executive Office)
(910) 641-0044
(Issuer’s telephone number, including area code)
Not Applicable
(former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports,) and (2) has been subject to such to filing requirements for the past 90 days.

Yesx Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.)

Large accelerated filer     o Accelerated filer     o Non-accelerated filer     x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yeso Nox

As of August 11, 2006 there were 4,626,959 shares of the issuer’s common stock, no par value, outstanding.

WACCAMAW BANKSHARES, INC.
INDEX

		Page Number
Part I.  FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets June 30, 2006 (Unaudited) and December 31, 2005	1
	Consolidated Statements of Income, Six Months Ended June 30, 2006 and June 30, 2005 (Unaudited)	2
	Consolidated Statements of Income, Quarters Ended June 30, 2006 and June 30, 2005 (Unaudited)	3
	Consolidated Statements of Cash Flows, Six Months Ended June 30, 2006 and June 30, 2005 (Unaudited)	4
	Notes to Consolidated Financial Statements	5-8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	8-13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	13
Item 4.	Controls and Procedures	13
Part II.  OTHER INFORMATION		14
Item 1.	Legal Proceedings	14
Item 1A.	Risk Factors	14
Item 4.	Submission of Matters to a Vote of Security Holders	14
Item 6.	Exhibits	14
SIGNATURES		15

WACCAMAW BANKSHARES, INC.
Consolidated Balance Sheets
June 30, 2006 and December 31, 2005

	(Unaudited) June 30, 2006			December 31, 2005
Assets:
Cash and due from banks	$	10,234,737		$	6,954,425
Interest-bearing deposits with banks		1,474,088			707,708
Federal funds sold		3,389,000			8,281,000
Investment securities, available for sale		47,062,892			33,208,250
Restricted equity securities		2,142,206			2,005,906
Loans, net of allowance for loan losses of $4,601,420 in 2006, and $3,939,002 in 2005		277,806,738			257,574,925
Other real estate owned		87,203			113,886
Property and equipment, net		5,712,456			3,380,179
Intangible assets, net		3,693,935			877,736
Accrued income		1,967,702			1,604,477
Bank owned life insurance		5,315,042			5,208,929
Other assets		2,845,338			2,874,578
Total assets	$	361,731,337		$	322,791,999
Liabilities and Stockholders’ Equity
Liabilities:
Noninterest-bearing deposits	$	38,327,004		$	25,348,916
Interest-bearing deposits		267,823,958			245,686,552
Total deposits		306,150,962			271,035,468
Securities sold under agreements to repurchase		4,725,000			2,736,000
Short-term borrowings		5,000,000			10,000,000
Long-term debt		11,500,000			6,500,000
Guaranteed preferred beneficial interest in the company’s junior subordinated debentures		8,248,000			8,248,000
Accrued interest payable		1,229,502			1,065,996
Other liabilities		418,648			707,891
Total liabilities		337,272,112			300,293,355
Commitments and contingencies		—			—
Stockholders’ equity:
Preferred stock, no par value; 1,000,000 shares authorized; none outstanding		—			—
Common stock, no par value; 25,000,000 shares authorized; 4,593,367 and 4,564,587 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively		13,509,781			13,256,961
Retained earnings		11,298,411			9,564,875
Accumulated other comprehensive income		(348,967	)		(323,192	)
Total stockholders’ equity		24,459,225			22,498,644
Total liabilities and stockholders’ equity	$	361,731,337		$	322,791,999

1

WACCAMAW BANKSHARES, INC.
Consolidated Statements of Income
Six-months ended June 30, 2006 and Six-months ended June 30, 2005 (Unaudited)

	Six-Months Ended June 30, 2006			Six-Months Ended June 30, 2005
Interest income
Loans and fees on loans	$	10,334,175		$	7,220,592
Federal funds sold		192,637			157,732
Investment securities, taxable		956,328			644,621
Investment securities, nontaxable		147,073			45,980
Total interest income		11,630,213			8,068,925
Interest expense
Deposits		4,263,306			2,664,945
Fed funds purchased and securities sold under agreements to repurchase		60,933			35,850
Other borrowed funds		713,078			553,831
Total interest expense		5,037,317			3,254,626
Net interest income		6,592,896			4,814,299
Provision for loan losses		620,000			480,000
Net interest income after provision for loan losses		5,972,896			4,334,299
Noninterest income
Service charges on deposit accounts		553,032			532,955
Mortgage origination income		177,818			125,083
Other operating income		405,783			356,169
Earnings on bank owned life insurance		113,504			87,807
Net realized gains (losses) on sale or maturity of investment securities		(631	)		(111	)
Total noninterest income		1,249,506			1,101,903
Noninterest expense
Salaries and employee benefits		2,417,791			1,771,870
Occupancy expense		505,540			393,327
Data Processing		352,928			312,513
Amortization expense of intangible assets		151,356			126,357
Other expense		904,756			661,351
Total noninterest expense		4,332,371			3,265,418
Income before income taxes		2,890,031			2,170,784
Income tax expense		1,156,495			788,165
Net income	$	1,733,536		$	1,382,619
Basic earnings per share	$	.38		$	.31
Diluted earnings income per share	$	.36		$	.29
Weighted average shares outstanding		4,583,771			4,532,827
Diluted average shares outstanding		4,765,018			4,739,335

2

WACCAMAW BANKSHARES, INC.
Consolidated Statements of Income
Quarter ended June 30, 2006 and Quarter ended June 30, 2005 (Unaudited)

	Quarter Ended June 30, 2006			Quarter Ended June 30, 2005
Interest income
Loans and fees on loans	$	5,411,848		$	3,849,037
Federal funds sold		65,530			92,644
Investment securities, taxable		551,619			345,631
Investment securities, nontaxable		86,890			22,990
Total interest income		6,115,887			4,310,302
Interest expense
Deposits		2,220,108			1,463,850
Federal funds purchased and securities sold under agreements to repurchase		37,593			21,310
Other borrowed funds		367,357			296,130
Total interest expense		2,625,058			1,781,290
Net interest income		3,490,829			2,529,012
Provision for loan losses		515,000			255,000
Net interest income after provision for loan losses		2,975,829			2,274,012
Noninterest income
Service charges on deposit accounts		282,940			273,698
Mortgage origination income		112,449			73,259
Other operating income		145,419			186,288
Earnings on bank owned life insurance		61,451			34,958
Net realized gains (losses) on sale or maturity of investment securities		(631	)		(111	)
Total noninterest income		601,628			568,092
Noninterest expense
Salaries and employee benefits		1,194,172			923,968
Occupancy expense		267,697			201,307
Data processing		189,581			163,976
Amortization expense of intangible assets		88,178			63,178
Other expense		470,062			343,844
Total noninterest expense		2,209,690			1,696,273
Income before income taxes		1,367,767			1,145,831
Income tax expense		479,842			418,877
Net income	$	887,925		$	726,954
Basic earnings income per share	$	.19		$	.16
Diluted earnings income per share	$	.19		$	.15
Weighted average shares outstanding		4,591,232			4,533,738
Diluted average shares outstanding		4,772,409			4,736,970

3

WACCAMAW BANKSHARES, INC.
Consolidated Statements of Cash Flows
Six-months ended June 30, 2006 and Six-months ended June 30, 2005 (Unaudited)

	Six-Months Ended June 30, 2006			Six-Months Ended June 30, 2005
Cash flows from operating activities
Net income	$	1,733,536		$	1,382,619
Adjustments to reconcile net income to net cash used by operations:
Depreciation and amortization		286,717			256,351
Stock-based compensation		24,674			—
Provision for loan losses		620,000			480,000
Accretion of discount on securities, net of amortization of premiums		16,463			48,017
(Gain) loss on sale of investments		631			111
(Gain) loss from sale of other real estate		(1,276	)		—
Changes in assets and liabilities:
Accrued Income		(325,286	)		(87,941	)
Other assets		(63,594	)		(287,839	)
Accrued interest payable		149,126			374,893
Other liabilities		(289,242	)		214,172
Net cash provided (used) by operating activities		2,151,749			2,380,383
Cash flows from investing activities
Net increase/(decrease) in federal funds sold		4,892,000			(9,644,000	)
Purchases of investment securities		(9,571,864	)		(6,683,403	)
Maturities of investments and paydowns of MBS		2,796,549			3,589,155
Net increase in loans		(16,391,234	)		(35,364,299	)
Proceeds from sale of other real estate		83,751			—
Sales of investment securities		935,000			1,361,353
Purchases of property and equipment		(2,203,052	)		(136,251	)
Acquisition of Bank of Heath Springs		(1,591,320	)		—
Net cash used in investing activities		(21,050,170	)		(46,877,445	)
Cash flows from financing activities
Net increase in noninterest-bearing deposits		8,956,643			4,172,846
Net increase in interest-bearing deposits		11,771,325			46,231,073
Net increase in securities sold under agreements to repurchase		1,989,000			123,000
(Repayments) proceeds from short-term borrowings		(5,000,000	)		—
(Repayments) proceeds from long-term debt		5,000,000			(6,000,000	)
Proceeds from exercise of stock options		146,107			10,684
Excess tax benefit from stock-based compensation		82,038			—
Net cash provided by financing activities		22,945,113			44,537,603
Net increase/(decrease) in cash and cash equivalents		4,046,692			40,541
Cash and cash equivalents, beginning		7,662,133			4,725,787
Cash and cash equivalents, ending	$	11,708,825		$	4,766,328
Supplemental disclosure of cash flow information
Interest paid	$	4,873,811		$	2,879,733
Taxes paid	$	1,568,881		$	751,460
Supplemental disclosure of non cash activity
Other real estate acquired in settlement of loans	$	55,792		$	343,068

4

WACCAMAW BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures required by generally accepted accounting principles for a complete presentation of financial statements. In the opinion of the management, the financial statements contain all adjustments necessary to present fairly the financial condition of Waccamaw Bankshares, Inc. (the “Company”) and its subsidiary, Waccamaw Bank (the “Bank”) as of June 30, 2006 and December 31, 2005, and its cash flows for the six months ended June 30, 2006 and 2005. The results of operations for the six months and three months ended June 30, 2006 and 2005 are not necessarily indicative of the results expected for the full year. These consolidated financial statements should be read in conjunction with the Company’s 10-K for the year ended December 31, 2005.

Waccamaw Bankshares, Inc. is located in Whiteville, North Carolina. The accounting and reporting policies of the Company and Bank follow generally accepted accounting principles and general practices within the financial services industry.

PRESENTATION OF CASH FLOWS

For purposes of reporting cash flows, cash and cash equivalents includes cash and amounts due from depository institutions (including cash items in process of collection) and interest-bearing deposits with banks which are considered to be cash equivalents. Federal funds sold are shown separately. Cash flows from demand deposits, NOW accounts and savings accounts are reported net since their original maturities are less than three months. Loans and time deposits are reported net per Financial Accounting Standards Board (“FASB”) Statement No. 104. Federal funds purchased are shown separately.

Investment Securities

Investments classified as available for sale can be held for indefinite periods of time and include those securities that management may employ as part of asset/liability strategy or that may be sold in response to changes in interest rates, prepayments, regulatory capital requirements or similar factors. These securities are carried at fair value and are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Investment securities classified as held to maturity are those debt securities that the Bank has the ability and intent to hold to maturity. Accordingly, these securities are carried at cost adjusted for amortization of premiums and accretion of discount, computed by the interest-method over their contractual lives. At June 30, 2006 and December 31, 2005, the Bank had no investments classified as held to maturity.

Loans

Loans are stated at the amount of unpaid principal, reduced by unearned fees and an allowance for loan losses.

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. The Bank makes continuous credit reviews of the loan portfolio and considers economic conditions, historical loan loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance balance.

Interest on all loans is accrued daily on the outstanding balance. Accrual of interest is discontinued on a loan when management believes, after considering collection efforts and other factors, that the borrower’s financial condition is such that collection of interest is doubtful.

NOTE 2. EARNINGS PER SHARE

Earnings per share for the six months and the quarters ended June 30, 2006 and 2005 were calculated by dividing net income by the weighted average number of shares outstanding during the period. Diluted earnings per share for the six months and the quarters ended June 30, 2006 and 2005 were calculated by dividing net income by the weighted average number of dilutive shares outstanding.

5

NOTE 3. BALANCE SHEETS

The balance sheet at December 31, 2005 has been taken from the audited financial statements at that date.

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing need of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments.  A summary of the Bank’s commitments at June 30, 2006 and December 31, 2005 is as follows:

	June 30, 2006		December 31, 2005
Commitment to extend credit	$	54,685,000	$	52,574,000
Standby letters of credit		1,551,000		1,325,000

NOTE 4.  STOCK OPTION PLAN

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,”  (SFAS No. 123R) which was issued by the Financial Accounting Standards Board (FASB) in December 2004.  SFAS No. 123R revises SFAS No. 123  “Accounting for Stock Based Compensation,” and supersedes APB No. 25,  “Accounting for Stock Issued to Employees,” (APB No. 25) and its related interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period).  SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95 “Statement of Cash Flows,” to require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R.  Accordingly, prior period amounts have not been restated.  Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.

Compensation cost charged to income was approximately $24,674 for the six months ended June 30, 2006.  No income tax benefit was recognized for share-based compensation.

Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the Company’s common stock on the date of grant.

The Company has adopted both the 1998 Incentive Stock Option Plan (Incentive Plan) and the 1998 Nonstatutory Stock Option Plan (Nonstatutory Plan).  Under each plan up to 458,258 shares may be issued for a total of 916,516 shares (adjusted for stock dividends).  Options granted under both plans expire no more than 10 years from date of grant. Option exercise price, under both plans shall be set by the Board of Directors at the date of grant, but shall not be less than 100% of fair market value of the related stock at the date of the grant.  Under both plans, vesting is determined by the specific option agreements.  It is the Company’s policy to issue new shares to satisfy option exercises.

6

The weighted average fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants for the six-months ended June 30, 2006: expected volatility of 8.6%; risk-free interest rate of 6.00%; and expected lives of 10 years.  The weighted average fair value of stock options granted during the six-months was $7.58.

Cash received from option exercises under the plans for the six month period ended June 30, 2006 was $146,107.  The total intrinsic value of options exercised during the six month period ended June 30, 2006 was $373,031.

A summary of option activity under the Plan as of and changes during the six month period ended June 30, 2006 is presented below:

	Options Outstanding		Weighted Average Exercise Price		Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at December 31, 2005		520,072	$	10.60
Granted		6,000	$	16.97
Forfeited		26,900	$	13.53
Exercised		28,780	$	5.08
Outstanding at June 30, 2006		470,392	$	10.86		6.1 years	$	2,653,011
Exercisable at June 30, 2006		403,914	$	10.08		5.8 years	$	2,593,128

The total fair value of shares vested during the six month period ended June 30, 2006 was $24,674.  Total unrecognized compensation cost related to outstanding non-vested stock options will be recognized over the following periods:

July 1 – December 31, 2006	$	62,457
2007		78,896
2008		78,376
2009		61,000
2010		19,195
2011		2,273
Total	$	302,197

The adoption of SFAS No. 123R and its fair value compensation cost recognition provisions had the following effect (increase/ (decrease)) on our financial statements:

	Six-Months Ended June 30, 2006			Three-Months Ended June 30, 2006
Cash flows from operating activities	$	24,674		$	12,337
Income before income taxes	$	(24,674	)	$	(12,337	)
Net income	$	(24,674	)	$	(12,337	)
Net income per share – basic	$	0.00		$	0.00
Net income per share - diluted	$	0.00		$	0.00

The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of SFAS No. 123 with respect to the six-month period ended June 30, 2005.

	Six-Months Ended June 30, 2005			Three-Months Ended June 30, 2005
Net income	$	1,382,619		$	726,954
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(417,163	)		(405,983	)
Proforma net income	$	965,456		$	320,971

7

	Six-Months Ended June 30, 2005		Three-Months Ended June 30, 2005
Earnings per share
Basic	$	0.31	$	0.16
Basic – proforma	$	0.21	$	0.07
Diluted	$	0.29	$	0.15
Diluted – proforma	$	0.20	$	0.07

Note 5.  Immaterial Business Combination

On April 28, 2006, the Company acquired 100 percent of the outstanding common stock of Bank of Heath Springs in Lancaster County, South Carolina in exchange for $8,000,000.  In conjunction with the acquisition, Bank of Heath Springs was merged into Waccamaw Bank, the Company’s subsidiary.

The acquisition was accounted for as a purchase transaction, and accordingly, the results of operations attributable to the acquired company is included in the consolidated financial statements only from the date of acquisition.  The excess purchase price over fair value of net tangible and identified intangible assets acquired will be evaluated annually for impairment and written down as those values become impaired.  Identified intangible assets will be amortized over their expected useful life.

Note 6.  Subsequent Event – Rights Offering

On July 25, 2006, the Company announced a rights offering of 656,196 units consisting of one share of common stock and one warrant to purchase a share of common stock in a rights offering which expires at 5:00 p.m. local time on August 31, 2006.  The units are offered for sale to the holders of record of our common stock at the close of business on July 12, 2006.  Shareholders of record on this record date may subscribe for one unit for each seven shares of common stock beneficially owned by them on such date. 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

This discussion, analysis and related financial information is presented to explain the significant factors which affected the financial condition and results of operations for the six months and three months ending June 30, 2006 and 2005 of Waccamaw Bankshares, Inc. This discussion should be read in conjunction with the financial statements and related notes included in this report.

Waccamaw Bank is a North Carolina state chartered bank, and is located in Whiteville, North Carolina. The Bank began operations on September 2, 1997. Waccamaw Bankshares, Inc. acquired all outstanding shares of Waccamaw Bank on July 1, 2001.

Highlights

Net income for the quarter ended June 30, 2006, was $887,925 or $.19 per weighted average share outstanding compared to a $726,954 net profit or $.16 per weighted average share outstanding for the quarter ended June 30, 2005.

On June 30, 2006, Waccamaw Bankshares, Inc. assets totaled $361,731,337 compared to $322,791,999 on December 31, 2005. Net loans were $277,806,738 compared to $257,574,925 on December 31, 2005. Total deposits on June 30, 2006 were $306,150,962 compared to $271,035,468 at the end of 2005. Stockholders’ equity after adjustments for unrealized losses on securities available for sale as required by FASB 115 increased by  $1,960,581 resulting in a June 30, 2006 book value of $5.32 per share, up from $4.93 on December 31, 2005.

8

Financial Condition, Liquidity and Capital Resources

Investments

The Bank maintains a portfolio of securities as part of its asset/liability and liquidity management programs which emphasize effective yields and maturities to match its needs. The composition of the investment portfolio is examined periodically and appropriate realignments are initiated to meet liquidity and interest rate sensitivity needs for the Bank.

Held to maturity securities are bonds, notes and debentures for which the Bank has the positive intent and ability to hold to maturity and which are reported at cost, adjusted by premiums and discounts that are recognized in interest income using the interest method over the period to maturity or to call dates. The Bank had no “Held to Maturity” securities at June 30, 2006 or December 31, 2005.

Available for sale securities are reported at fair value and consist of bonds, notes, debentures and certain equity securities not classified as trading securities or as held to maturity securities.

Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of stockholders’ equity. Realized gains and losses on the sale of available for sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity or to call dates.

Declines in the fair value of individual held to maturity and available for sale securities below cost that are other than temporary are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses.

Investments in available for sale securities of $47,062,892 consisted of corporate securities, municipal securities, U.S. Governmental agencies and mortgage backed securities (MBS) at June 30, 2006. Included in corporate securities are holdings of Ford Motor Company and General Motors Corporation, which were recently downgraded to junk status. The Company feels this is a temporary impairment and will not be written down due to the strong interest rates associated with these securities and the ability of both companies to turn around their sluggish sales in both the short and long term.

Federal Funds Sold

Federal funds sold consist of short-term loans to other financial institutions. These loans are made to various financial institutions and were $3,389,000 and $8,281,000 on June 30, 2006 and December 31, 2005, respectively. No single loan exceeds Waccamaw Bank’s legal lending limit.

Loans

Net loans outstanding on June 30, 2006, were $277,806,738 compared to $257,574,925 on December 31, 2005.  The Bank maintains a loan portfolio dominated by real estate and commercial loans diversified among various industries. The $20,231,813 increase in loans was due to stronger real estate and commercial demand due to local economies improving in the areas covered by Waccamaw Bank and also the acquisition of $4,500,000 in loans from the Bank of Heath Springs acquisition.  This resulted in increased construction and development during the first six months of 2006.

Deposits

Deposits on June 30, 2006, were $306,150,962 compared to $271,035,468 on December 31, 2005. Interest-bearing accounts represented 87.48% of total deposits at June 30, 2006 and 90.65% of total deposits at December 31, 2005. The significant increase in deposits, necessary to satisfy strong loan demand, was the result of an aggressive marketing and advertising program offering higher deposit rates at the Bank and also the acquisition of $14,400,000 in deposits from the Bank of Heath Springs acquisition. 

9

Liabilities

Securities sold under agreements to repurchase on June 30, 2006, were $4,725,000 compared to $2,736,000 on December 31, 2005. Long-term debt on June 30, 2006 was $11,500,000 compared to $6,500,000 on December 31, 2005 as all long-term debt is funded by the Federal Home Loan Bank of Atlanta. Short-term borrowings on June 30, 2006 were $5,000,000 compared to $10,000,000 on December 31, 2005 as all short-term borrowings are funded by the Federal Home Loan Bank of Atlanta and mature within one year.

Stockholders’ Equity

Waccamaw Bankshares, Inc. maintains a strong capital position which exceeds all capital adequacy requirements of Federal regulatory authorities. Total stockholders’ equity at June 30, 2006 was $24,459,225 compared to $22,498,644 at December 31, 2005. This $1,960,581 increase was largely due to operating profits of $1,733,536. The Bank also exceeds all capital requirements under the leverage guidelines.

For the six months ended June 30, 2006, the operating profit of the Bank was $1,733,536 compared to a $1,382,619 profit for the six months ended June 30, 2005.

Asset Quality

The provision for possible loan losses charged to operations was $620,000 in the first six months of 2006 and $480,000 for the same period of 2005. The reserve for loan losses on June 30, 2006, was $4,601,420 or 1.63% of period end loans.   The increase of $180,000 in loan loss provision was due to the increased loan volume in which the bank increased the loan loss provision adequately to reserve for the increased volume in loans. 

The level of reserve is established based upon management’s evaluation of portfolio composition, current and projected national and local economic conditions and results of independent reviews of the loan portfolio by internal and external examination. Management recognizes the inherent risk associated with commercial and consumer lending, including whether or not a borrower’s actual results of operations will correspond to those projected by the borrower when the loan was funded, economic factors such as the number of housing starts and fluctuations in interest rates, etc., depression of collateral values, and completion of projects within the original cost and time estimates. As a result, management continues to actively monitor the Bank’s asset quality and lending policies. Management believes that its loan portfolio is diversified so that a downturn in a particular market or industry will not have a significant impact on the loan portfolio or the Bank’s financial condition.

Management believes that its provision and reserve offer an adequate allowance for future loan losses and provide a sound reserve for the loan portfolio.

At June 30, 2006 the Bank had $1,609,178 loans in nonaccrual status as compared to $422,813 at June 30, 2005. There were no repossessed assets at June 30, 2006 and at June 30, 2005.  The increase in non-accrual loans of $1,200,000 from June 30, 2005 to June 30, 2006 was the result of a loan of $1,471,000 that was placed under non-accrual status in the third quarter of 2005.  The bank feels this loan is adequately collateralized and reserved against future losses.

Comparison of Results of Operations for the Three Months Ended June 30, 2006 and 2005

The Company reported net income of $887,925 or $.19 per share for the three months ended June 30, 2006, as compared with net income of $726,954 or $.16 per share for the three months ended June 30, 2005, an increase of $160,971 or 22.1% in net income. The Company had significant increases in net interest income in the second quarter of 2006 as compared to the second quarter of 2005, as these increases were due to strong growth in interest earning assets and increases in net interest margin. The Company has incurred additional non-interest expenses both as a result of growth from period to period, and also as a result of additional hiring and other costs incurred as a result of the branch expansion during 2005 and 2006 and the acquisition of the Bank of Heath Springs, located in Heath Springs, SC on April 28, 2006.

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Net Interest Income

Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between the interest earned on loans, the investment portfolio and interest earning deposits and the cost of funds, consisting primarily of the interest paid on deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of non-interest-bearing liabilities and stockholders’ equity.

For the three months ended June 30, 2006, the net interest income of the Bank was $3,490,829 compared to $2,529,012 for the three months ended June 30, 2005. The increase in net interest income can be attributed to strong growth in loans and increases in net interest margin.

Provision for Loan Losses

The Company expensed $515,000 as the provision for loan losses in the second quarter of 2006, as compared to the $255,000 provision for loan losses in the second quarter of 2005. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by Management. Management considers the current level of the loan loss allowance to be satisfactory based on loan volume, the current level of delinquencies, other non-performing assets, prevailing economic conditions and other factors that my affect a borrower’s ability to repay. The increase in the provision for loan losses was due to the increase in real estate and commercial loan demand in the second quarter of 2006 versus the second quarter of 2005.

Non-Interest Income

Non-interest income totaled $602,000 for the three months ended June 30, 2006 as compared with $568,000 for the three months ended June 30, 2005. The principal reason for the increase of $34,000 in total non-interest income for the current quarter was the increase of $39,000 in net servicing fees from mortgage and investments. Increases of $9,000 in services charges on deposit accounts and decreases in other operating income of $41,000 and $27,000 in earnings on bank owned life insurance made up the difference in the three months ended June 30, 2006 compared to the three months ended June 30, 2005.

Non-Interest Expenses

Non-interest expenses totaled $2.2 million for the three months ended June 30, 2006, an increase of $500,000 or 30.3% over the $1.7 million reported for the three months ended June 30, 2005. Substantially all of this increase resulted from the Bank’s growth and development, and reflects the additional expenses in the current quarter associated with new hires and the opening of two new branches and the acquisition of the Bank of Heath Springs, located in Heath Springs, SC on April 28, 2006. For the three months ended June 30, 2006, personnel costs increased by $270,000, or 29.2% to $1,194,000 as compared to $924,000 for the three months ended June 30, 2005.

Provision for Income Taxes

The Company provided $480,000 for income taxes during the three months ended June 30, 2006, compared to a provision for income taxes of $419,000 for the three months ended June 30, 2005.

Comparison of Results of Operations for the Six Months Ended June 30, 2006 and 2005

The Company reported net income of $1,733,536 or $.38 per share for the six months ended June 30, 2006, as compared with net income of $1,382,619 or $.31 per share for the six months ended June 30, 2005, an increase of $350,917 or 25.4% in net income. The Company had significant increases in net interest income in the first six months of 2006 as compared to the first six months of 2005, as these increases were due to strong growth in interest earning assets and increases in net interest margin. The Company has incurred additional non-interest expenses both as a result of growth from period to period, and also as a result of additional hiring and other costs incurred as a result of the branch expansion during 2005 and 2006 and the acquisition of the Bank of Heath Springs located in Heath Springs, SC on April 28, 2006.

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Net Interest Income

Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between the interest earned on loans, the investment portfolio and interest earning deposits and the cost of funds, consisting primarily of the interest paid on deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of non-interest-bearing liabilities and stockholders’ equity.

For the six months ended June 30, 2006, the net interest income of the Bank was $6,592,896 compared to $4,814,299 for the six months ended June 30, 2005. The increase in net interest income can be attributed to strong growth in loans and increases in net interest margin.

Provision for Loan Losses

The Company expensed $620,000 to provision for loan losses in 2006, as compared to the $480,000 provision for loan losses in 2005. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by Management. Management considers the current level of the loan loss allowance to be satisfactory based on loan volume, the current level of delinquencies, other non-performing assets, prevailing economic conditions and other factors that my affect a borrower’s ability to repay. The increase in the provision for loan losses was due to the increase in real estate and commercial loan demand.

Non-Interest Income

Non-interest income totaled $1,250,000 for the six months ended June 30, 2006 as compared with $1,102,000 for the six months ended June 30, 2005. The principal reason for the increase of $148,000 in total non-interest income for the six months ended June 30, 2006 compared to the six months ended June 30, 2005 was an increase of $53,000 in net servicing fees from mortgage and investments. Increases of $50,000 in other operating income, an increase of $26,000 in earnings on bank owned life insurance and an increase of $20,000 in service charges made up the difference in the six months ended June 30, 2006 compared to the six months ended June 30, 2005.

Non-Interest Expenses

Non-interest expenses totaled $4.3 million for the six months ended June 30, 2006, an increase of $1,000,000 or 32.7% over the $3.3 million reported for the six months ended June 30, 2005. Substantially all of this increase resulted from the Bank’s growth and development, and reflects the additional expenses in the current year associated with new hires and the opening of two new branches and the acquisition of the Bank of Heath Springs, located in Heath Springs, SC on April 28, 2006. For the six months ended June 30, 2006, personnel costs increased by $646,000, or 36.5% to $36.5 million as compared to $1.8 million for the six months ended June 30, 2005.

Provision for Income Taxes

The Company provided $1,156,000 for income taxes during the six months ended June 30, 2006, compared to a provision for income taxes of $788,000 for the six months ended June 30, 2005.

Interest Sensitivity and Liquidity

One of the principal duties of the Bank’s Asset/Liability Management Committee (“ALCO”) is management of interest rate risk. The Bank utilizes quarterly asset/liability reports prepared internally to project the impact on net interest income that might occur with hypothetical interest rate changes. The committee monitors and manages asset and liability strategies and pricing.

Another function of ALCO is maintaining adequate liquidity and planning for future liquidity needs. Having adequate liquidity means the ability to meet current needs, including deposit withdrawals and commitments, in an orderly manner without sacrificing earnings. The Bank funds its investing activities, including making loans and purchasing investments, by attracting deposits and utilizing short-term borrowings when necessary.

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At June 30, 2006, the liquidity position of the Bank was strong, with short-term liquid assets of $29,934,000 or 8.26% of total assets.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s profitability is dependent to a large extent upon its net interest income, which is the difference between its interest income on interest-bearing assets, such as loans and investments, and its interest expense on interest-bearing liabilities, such as deposits and borrowings. The Company’s primary market risk is interest rate risk, which is the result of differing maturities or repricing intervals of interest-earning assets and interest-bearing liabilities with the goals of minimizing interest rate fluctuations in its net interest income.

ALCO meets on a monthly basis in order to assess interest rate risk, liquidity, capital and overall balance sheet management through rate shock analysis measuring various interest rate scenarios over the future 12 months. Through ALCO, the Company is able to determine fluctuations to net interest income from changes in the Prime Rate of up to 300 basis points up or down during a 12-month period. ALCO also reviews policies and procedures related to funds management and interest rate risk based on local, national and global economic conditions along with funding strategies and balance sheet management to minimize the potential impact of earnings and liquidity from interest rate movements.

Additional information regarding interest rate risk is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The Company has not had any material changes in the overall interest rate risk since December 31, 2005.

Item 4. Controls and Procedures

Based on their evaluation, as of the end of the period covered by the report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Chief Executive Officer and the Chief Financial Officer of the Company, as appropriate to allow timely decisions regarding required disclosure. There have not been any changes in the Company’s internal control over financial reporting that occurred during the company’s last quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1.	Legal Proceedings
	The Company is not party to, nor is any of its property the subject of, any material pending legal proceeding incidental to the business of the Company or the Bank.
Item 1A.	Risk Factors
	No material changes in the Registrant’s risk factors occurred during the quarter.
Item 4.	Submission of Matters to a Vote of Security Holders
	At the bank’s annual meeting of shareholders held on April 20, 2006, the shareholders (1.) Elected Dr. Maudie M. Davis, James E. Hill, Jr. and Alan W. Thompson to serve as directors of the bank and (2.) Ratified the appointment of Larrowe & Company, P.L.C. as the Company’s independent registered public accounting firm for 2006.
	The following proposals were voted for:

Proposal 1 – Election of  Directors
Dr. Maudie M. Davis	votes for 3,481,173	withheld  10,600	abstain  -0-
James E. Hill, Jr.	votes for 3,481,958	withheld  9,815	abstain - 0-
Alan W. Thompson	votes for 3,485,004	withheld  6,769	abstain - 0-

Proposal 2 – To ratify the selection of Larrowe & Company, P.L.C.  as the Company’s independent registered public accounting firm for 2006.

	Votes for 3,470,189          against 2,206          abstain 19,378
Item 6.	Exhibits
	31.1	Section 302 Certification – CEO
	31.2	Section 302 Certification – CFO
	32	Section 906 Certification

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SIGNATURES

Pursuant to the requirements of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Waccamaw Bankshares, Inc.
Date:   August 11, 2006	By:	/s/   David A. Godwin
		David A. Godwin
		Chief Financial Officer
		(Principal Financial Officer)

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