Waccamaw Bankshares (WBNK) 10-Q 2006 Q3 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 SEPTEMBER 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.

YES  x NO  o

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).    

YES  o NO  x

As of November 14, 2006 there were 4,837,666 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 September 30, 2006 (Unaudited) and December 31, 2005	1
	Consolidated Statements of Income, Nine Months Ended September 30, 2006 and September 30, 2005 (Unaudited)	2
	Consolidated Statements of Income, Quarters Ended September 30, 2006 and September 30, 2005 (Unaudited)	3
	Consolidated Statements of Cash Flows, Nine Months Ended September 30, 2006 and September 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 6	Exhibits	14
SIGNATURES		15

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

	September 30, 2006			December 31, 2005
	(Unaudited)
Assets:
Cash and due from banks	$	7,002,333			6,954,425
Interest-bearing deposits with banks		1,413,048			707,708
Federal funds sold		856,000			8,281,000
Investment securities, available for sale		49,684,559			33,208,250
Restricted equity securities		2,142,206			2,005,906
Loans, net of allowance for loan losses of $5,031,748 in 2006, and $3,939,002 in 2005		289,789,176			257,574,925
Other real estate owned		87,203			113,886
Property and equipment, net		6,062,072			3,380,179
Goodwill		2,665,602			—
Intangible assets, net		994,850			877,736
Accrued income		2,363,974			1,604,477
Bank owned life insurance		5,366,311			5,208,929
Other assets		3,038,812			2,874,578
Total assets	$	371,466,146		$	322,791,999
Liabilities and Stockholders’ Equity
Liabilities:
Demand deposits	$	34,667,291		$	25,348,916
Interest-bearing deposits		275,977,704			245,686,552
Total deposits		310,644,995			271,035,468
Securities sold under agreements to repurchase		4,920,000			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		1,258,829			1,065,996
Other liabilities		308,557			707,891
Total liabilities		341,880,381			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; 4,837,666 and 4,564,587 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively		17,369,282			13,256,961
Retained earnings		12,226,191			9,564,875
Accumulated other comprehensive income		(9,708	)		(323,192	)
Total stockholders’ equity		29,585,765			22,498,644
Total liabilities and stockholders’ equity	$	371,466,146		$	322,791,999

1

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

	Nine Months Ended Sept 30, 2006			Nine Months Ended Sept 30, 2005
Interest income
Loans and fees on loans	$	16,313,438		$	11,638,840
Federal funds sold		211,262			296,428
Investment securities, taxable		1,586,118			990,963
Investment securities, nontaxable		237,886			68,971
Total interest income		18,348,704			12,995,202
Interest expense
Deposits		6,745,731			4,386,808
Federal funds purchased and securities sold under agreements to repurchase		138,015			57,615
Other borrowed funds		1,097,035			817,892
Total interest expense		7,980,781			5,262,315
Net interest income		10,367,923			7,732,887
Provision for loan losses		1,090,000			1,180,000
Net interest income after provision for loan losses		9,277,923			6,552,887
Noninterest income
Service charges on deposit accounts		821,772			818,760
Mortgage origination income		278,709			215,901
Other operating income		647,007			517,498
Earnings on bank owned life insurance		179,676			141,097
Net realized gains (losses) on sale or maturity of investment securities		(753	)		(909	)
Total noninterest income		1,926,411			1,692,347
Noninterest expense
Salaries and employee benefits		3,859,166			2,693,528
Occupancy and equipment		797,421			598,161
Data processing		558,207			463,396
Amortization expense of intangible assets		202,034			189,534
Other expense		1,465,722			1,101,790
Total noninterest expense		6,882,550			5,046,409
Income (loss) before income taxes		4,321,784			3,198,825
Income Tax Expense		1,660,468			1,070,615
Net income	$	2,661,316		$	2,128,210
Basic earnings income per share	$	.58		$	.47
Diluted earnings income per share	$	.56		$	.45
Weighted average shares outstanding		4,602,318			4,537,367
Diluted average shares outstanding		4,743,168			4,737,050

2

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

	Quarter Ended Sept 30, 2006			Quarter Ended Sept 30, 2005
Interest income
Loans and fees on loans	$	5,979,263		$	4,418,248
Federal funds sold		18,625			138,696
Investment securities, taxable		629,790			346,342
Investment securities, nontaxable		90,813			22,991
Total interest income		6,718,491			4,926,277
Interest expense
Deposits		2,482,425			1,721,863
Fed funds purchased and securities sold under agreements to repurchase		77,082			21,765
Other borrowed funds		383,957			264,061
Total interest expense		2,943,464			2,007,689
Net interest income		3,775,027			2,918,588
Provision for loan losses		470,000			700,000
Net interest income after provision for loan losses		3,305,027			2,218,588
Noninterest income
Service charges on deposit accounts		268,740			285,805
Mortgage origination income		100,891			90,818
Other operating income		241,224			161,329
Earnings on bank owned life insurance		66,172			53,290
Net realized gains (losses) on sale or maturity of investment securities		(122	)		(798	)
Total noninterest income		676,905			590,444
Noninterest expense
Salaries and employee benefits		1,441,375			921,658
Occupancy and equipment		291,881			204,834
Data processing		205,279			150,883
Amortization expense of intangible assets		50,678			63,177
Other expense		560,966			440,439
Total noninterest expense		2,550,179			1,780,991
Net income		1,431,753			1,028,041
Income Tax Expense		503,973			282,450
Net income	$	927,780		$	745,591
Basic earnings income per share	$	.20		$	.16
Diluted earnings income per share	$	.20		$	.16
Weighted average shares outstanding		4,639,074			4,546,312
Diluted average shares outstanding		4,755,309			4,753,358

3

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

	Nine-Months Ended Sept 30, 2006			Nine-Months Ended Sept 30, 2005
Cash flows from operating activities
Net income	$	2,661,316		$	2,128,210
Adjustments to reconcile net income to net cash used by operations:
Depreciation and amortization		462,179			387,068
Stock-based compensation		73,490			—
Provision for loan losses		1,090,000			1,180,000
Accretion of discount on securities, net of amortization of premiums		44,308			69,066
(Gain) loss on sale of investment securities		753			909
(Gain) loss from sale of other real estate		(1,276	)		—
Changes in assets and liabilities:
Accrued income		(721,558	)		(275,313	)
Other assets		(483,107	)		(524,944	)
Accrued interest payable		192,833			279,322
Other liabilities		(399,334	)		(238,222	)
Net cash provided (used) by operating activities		2,919,604			3,006,096
Cash flows from investing activities
Net (increase) decrease in federal funds sold		7,425,000			(5,726,000	)
Purchases of investment securities		(13,281,605	)		(9,412,917	)
Maturities of investment securities		4,370,685			5,412,987
Net increase in loans		(28,843,672	)		(49,758,719	)
Proceeds from sale of other real estate		83,751			—
Sales of investment securities		935,000			1,371,150
Purchases of property and equipment		(2,658,835	)		(194,685	)
Acquisition of Bank of Heath Springs		(1,641,512	)		—
Net cash used in investing activities		(33,611,188	)		(58,308,184	)
Cash flows from financing activities
Net increase in noninterest-bearing deposits		5,296,930			8,083,739
Net increase in interest-bearing deposits		19,925,071			53,337,532
Net increase in securities sold under agreements to repurchase		2,184,000			(558,000	)
(Repayments) proceeds from short-term borrowings		(5,000,000	)		—
(Repayments) proceeds from long-term debt		5,000,000			(2,000,000	)
Proceeds from exercise of stock options		255,655			80,429
Excess tax benefit from stock-based compensation		201,151			—
Proceeds from issuance of common stock		3,582,025			—
Net cash provided by financing activities		31,444,832			58,943,700
Increase (decrease) in cash and cash equivalents		753,248			3,641,612
Cash and cash equivalents, beginning		7,662,133			4,725,787
Cash and cash equivalents, ending	$	8,415,381		$	8,367,399
Supplemental disclosure of cash flow information
Interest paid	$	7,787,948		$	4,982,993
Taxes paid	$	2,271,194		$	1,523,480
Supplemental disclosure of non cash activity
Other real estate acquired in settlement of loans	$	55,792		$	117,872

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 September 30, 2006 and December 31, 2005, and its cash flows for the nine months ended September 30, 2006 and 2005. The results of operations for the nine months and three months ended September 30, 2006 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 polices 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 September 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.

5

NOTE 2. EARNINGS PER SHARE

Earnings per share for the nine months and quarters ended September 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 nine months and the quarters ended September 30, 2006 and 2005 were calculated by dividing net income by the weighted average number of dilutive shares outstanding.

At September 30, 2006, the Bank had 210,707 warrants outstanding. These warrants were not included in the diluted earnings per share calculation as the effect would have been anti-dilutive. No warrants were outstanding at September 30, 2005.

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 September 30, 2006 and December 31, 2005 is as follows:

	September 30, 2006		December 31, 2005
Commitment to extend credit	$	60,702,000	$	52,574,000
Standby letters of credit		1,125,000		1,325,000

NOTE 4.  STOCK OPTION PLANS

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 $73,490 for the nine months ended September 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.

6

The Company’s Board of Directors 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 must be set by the Board of Directors at the date of grant and cannot 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.

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 nine-months ended September 30, 2006: expected volatility of 8.7%; risk-free interest rate of 6.00%; and expected lives of 10 years.  The weighted average fair value of stock options granted during the nine-months was $7.52.

Cash received from option exercises under the plans for the nine month period ended September 30, 2006 was $255,656.  The total intrinsic value of options exercised during the nine month period ended September 30, 2006 was $773,746.

A summary of option activity under the Plan as of and changes during the nine month period ended September 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		7,000	$	16.83
Forfeited		34,900	$	14.73
Exercised		62,372	$	4.10
Outstanding at September 30, 2006		429,800	$	11.31		6.1 years	$	2,978,514
Exercisable at September 30, 2006		373,449	$	10.40		5.7 years	$	3,047,344

The total fair value of shares vested during the nine month period ended September 30, 2006 was $73,490.  Total unrecognized compensation cost related to outstanding non-vested stock options will be recognized over the following periods:

October 1 – December 31, 2006	$	14,377
2007		80,368
2008		79,848
2009		62,472
2010		20,667
2011		3,009
Total	$	260,741

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

	Nine-Months Ended Sept 30, 2006			Three-Months Ended Sept 30, 2006
Cash flows from operating activities	$	73,490		$	48,816
Income before income taxes	$	(73,490	)	$	(48,816	)
Net income	$	(73,490	)	$	(48,816	)
Net income per share – basic	$	(0.02	)	$	(0.01	)
Net income per share - diluted	$	(0.02	)	$	(0.01	)

7

The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of SFAS No. 123R with respect to the nine and three-month periods ended September 30, 2005.

	Nine-Months Ended Sept 30, 2005			Three-Months Ended Sept 30, 2005
Net income	$	2,128,210		$	745,591
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(693,606	)		(276,443	)
Proforma net income	$	1,434,604		$	469,148

	Nine-Months Ended Sept 30, 2005		Three-Months Ended Sept 30, 2005
Earnings per share
Basic	$	0.47	$	0.16
Basic – proforma	$	0.32	$	0.10
Diluted	$	0.45	$	0.16
Diluted – proforma	$	0.30	$	0.10

NOTE 5.  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 are 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 – UNIT OFFERING

On September 29, 2006, the Company commenced a private placement of up to 400,000 units consisting of one share of convertible preferred stock and one warrant to purchase a share of common stock in a unit offering which expired at 5:00 p.m. local time on October 31, 2006.  The units were offered for sale in a private placement as the Bank sold 59,192 shares of preferred stock and 59,192 warrants. Each warrant entitles the holder to purchase one share of common stock for $24.00 on or before September 30, 2009. 

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 nine months and three months ending September 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.

8

Highlights

Net income for the quarter ended September 30, 2006, was $927,780 or $.20 per weighted average basic share outstanding compared to a $745,591 net profit or $.16 per weighted average basic share outstanding for the quarter ended September 30, 2005.

On September 30, 2006, Waccamaw Bankshares, Inc. assets totaled $371,466,146 compared to $322,791,999 on December 31, 2005. Net loans were $289,789,176 compared to $257,574,925 on December 31, 2005. Total deposits on September 30, 2006 were $310,644,995 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  $7,087,121  resulting in a September 30, 2006 book value of $6.12 per share, up from $4.93 on December 31, 2005.

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 September 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 $49,684,559 consisted of corporate securities, municipal securities, U.S. Governmental agencies and mortgage backed securities (MBS) at September 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 $856,000 and $8,281,000 on September 30, 2006 and December 31, 2005, respectively. No single loan exceeds Waccamaw Bank’s legal lending limit.

9

Loans

Net loans outstanding on September 30, 2006, were $289,789,176 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 $32,214,251 increase in loans was due to stronger real estate and commercial demand due to local economies improving in Waccamaw Bank’s market areas 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 nine months of 2006.

Deposits

Deposits on September 30, 2006, were $310,644,995 compared to $271,035,468 on December 31, 2005. Interest-bearing accounts represented 88.84% of total deposits at September 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. 

Liabilities

Securities sold under agreements to repurchase on September 30, 2006, was $4,920,000 compared to $2,736,000 on December 31, 2005. Long-term debt at September 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 at September 30, 2006 was $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 September 30, 2006 was $29,585,765 compared to $22,498,644 at December 31, 2005. This $7,087,121 increase was largely due to operating profits of $2,661,316 and the sale of $3,582,025 of common stock through a rights offering to shareholders pursuant to a prospectus dated July 25, 2006. The Bank sold 210,707 shares of common stock and 210,707 warrants. Each warrant entitles the holder to purchase one share of common stock for $24.00 on or before September 30, 2009. The Bank exceeds all capital requirements under the leverage guidelines.

For the nine months ended September 30, 2006, the operating profit of the Bank was $2,661,316 compared to a $2,128,210  profit for the nine months ended  September 30, 2005.

Asset Quality

The provision for possible loan losses charged to operations was $1,090,000 in the first nine months of 2006 and $1,180,000 for the same period of 2005. The allowance for loan losses on September 30, 2006, was $5,031,748 or 1.71% of period end loans compared to 1.51% for December 31, 2005.  The increase in the allowance for loan losses was due to loan growth.  

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.

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At September 30, 2006 the Bank had $2,085,042 loans in nonaccrual status as compared to $1,685,042 at September 30, 2005. There were no repossessed assets at September 30, 2006 or at September 30, 2005.

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

The Company reported net income of $927,780 or $.20 per basic share and $.20 per diluted share for the three months ended September 30, 2006, as compared with net income of $745,591 or $.16 per basic share and $.16 per diluted share for the three months ended September 30, 2005, an increase of $182,189 or 24.4% in net income. The Company had significant increases in net interest income in the third quarter of 2006 as compared to the third 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.

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 September 30, 2006, the net interest income of the Bank was $3,775,027 compared to $2,918,588 for the three months ended September 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 $470,000 as the provision for loan losses in the third quarter of 2006, as compared to the $700,000 provision for loan losses in the third 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 may affect a borrower’s ability to repay. The decrease in the provision for loan losses was due to the decline in loan demand in the third quarter of 2006 compared to the loan demand in the third quarter of 2005.

Non-Interest Income

Non-interest income totaled $677,000 for the three months ended September 30, 2006 as compared with $590,000 for the three months ended September 30, 2005. The principal reason for the increase of $87,000 in total non-interest income for the current quarter was increases of $80,000 in other operating income, $10,000 in net servicing fees from mortgage origination income and increases in earnings on bank owned life insurance of $13,000 and a decrease of $17,000 in service charges on deposit accounts.

Non-Interest Expenses

Non-interest expenses totaled $2,600,000 for the three months ended September 30, 2006, an increase of $800,000 or 43.2% over the $1,800,000  reported for the three months ended September 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 new branches. For the three months ended September 30, 2006, personnel costs increased by $519,000, or 56.4% to $1,441,000 as compared to $922,000 for the three months ended September 30, 2005.

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Provision for Income Taxes

The Company provided $504,000 for income taxes during the three months ended September 30, 2006, at an effective tax rate of 35% compared to a provision for income taxes of $283,000 for the three months ended September 30, 2005 at an effective tax rate of 27%.

Comparison of Results of Operations for the Nine Months Ended September 30, 2006 and 2005

The Company reported net income of $2,661,316 or $.58 per basic share and $.56 per diluted share for the nine months ended September 30, 2006, as compared with net income of $2,128,210 or $.47 per basic share and $.45 per diluted share for the nine months ended September 30, 2005, an increase of $533,106 or 25.0% in net income. The Company had significant increases in net interest income in the first nine months of 2006 as compared to the first nine 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 2004, 2005 and 2006 and the acquisition of the Bank of Heath Springs located in Heath Springs, SC on April 28, 2006.

Net Interest Income

For the nine months ended September 30, 2006, the net interest income of the Bank was $10,367,923 compared to $7,732,887 for the nine months ended September 30, 2005. The increase in net interest income can be attributed to increases in net interest margin.

Provision for Loan Losses

The Company expensed $1,090,000 to the provision for loan losses in the first nine months of 2006, as compared to the $1,180,000 provision for loan losses in the first nine months 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 may affect a borrower’s ability to repay. The decrease in the provision for loan losses was due to the decline in loan demand in the third quarter of 2006 compared to the loan demand in the third quarter of 2005.

Non-Interest Income

Non-interest income totaled $1,926,000 for the nine months ended September 30, 2006 as compared with $1,692,000 for the nine months ended September 30, 2005. The principal reason for the increase of $234,000 in total non-interest income for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 was the increases of $130,000 in other operating income, $63,000 in net servicing fees from mortgage origination income and increases in earnings on bank owned life insurance of $38,000.

Non-Interest Expenses

Non-interest expenses totaled $6,900,000  for the nine months ended September 30, 2006, an increase of $1,800,000 or 36.4% over the $5,100,000  reported for the nine months ended September 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 new branches. For the nine months ended September 30, 2006, personnel costs increased by $1,200,000, or 43.3% to $3,900,000 as compared to $2,700,000 for the nine months ended September 30, 2005.

Provision for Income Taxes

The Company provided $1,660,000 for income taxes during the nine months ended September 30, 2006, at a tax rate of 38% compared to a provision for income taxes of $1,071,000 for the nine months ended September 30, 2005 at a tax rate of 34%.

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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 by a regional correspondent bank 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 the 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.

At September 30, 2006, the liquidity position of the Bank was strong, with short-term liquid assets of $26,680,413 or 7.18% 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.

The Company’s 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 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:  November 14, 2006	By:	/s/ David A. Godwin
		David A. Godwin
		Chief Financial Officer
		(Principle Financial Officer)

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