Beach First National Bancshares (BFNB) 10-Q 2007 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended: September 30, 2007
___	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from to

Commission file number: 000-22503

BEACH FIRST NATIONAL BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

South Carolina	57-1030117
(State of Incorporation)	(I.R.S. Employer Identification No.)

3751 Grissom Parkway, Suite 100, Myrtle Beach, South Carolina 29577

(Address of principal executive offices)

(843) 626-2265

(Issuer's telephone number)

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 or 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 filing requirements for the past 90 days.    Yes |X|    No [ ]

Indicate by check mark whether the registrant is a large accelerated file, 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 [ ]      Accelerated filer [ ]               Non-accelerated filer |X|

Indicate by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  [ ]    No  |X|

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: On November 1, 2007, 4,842,766 shares of the issuer's common stock, par value $1.00 per share, were issued and outstanding.

Beach First National Bancshares, Inc. and Subsidiaries

INDEX                                                          

PART I. FINANCIAL INFORMATION	Page No.
Item 1. Financial Statements (Unaudited)
Consolidated Condensed Balance Sheets – September 30, 2007, September 30, 2006,
and December 31, 2006		3
Consolidated Condensed Statements of Income –
Nine months ended September 30, 2007 and 2006
Three months ended September 30, 2007 and 2006		4
Consolidated Condensed Statements of Shareholders’ Equity and Comprehensive Income –
Nine months ended September 30, 2007 and 2006		5
Consolidated Condensed Statements of Cash Flows –
Nine months ended September 30, 2007 and 2006		6
Notes to Consolidated Condensed Financial Statements		7-	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		9-	20
Item 3. Quantitative and Qualitative Disclosures about Market Risk		20
Item 4. Controls and Procedures		21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		21
Item 1A. Risk Factors		21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		21
Item 3. Defaults Upon Senior Securities		21
Item 4. Submission of Matters to a Vote of Security Holders		21
Item 5. Other Information		21
Item 6. Exhibits		21

2

Item 1. Financial Statements

Beach First National Bancshares, Inc. and Subsidiaries

Consolidated Condensed Balance Sheets

	September 30,						December 31,
	2007			2006			2006
	(unaudited)			(unaudited)			(audited)
ASSETS
Cash and due from banks	$	5,067,749		$	6,694,944		$	5,198,945
Federal funds sold and short-term investments		359,278			235,866			14,010,667
Investment securities available for sale		69,093,920			62,892,627			68,474,531
Loans
Loans, net of unearned income		465,394,875			395,643,108			398,736,634
Mortgage loans held for sale		6,392,792			8,174,321			12,478,222
Total loans		471,787,667			403,817,429			411,214,856
Allowance for Loan Loss		(6,397,012	)		(5,671,492	)		(5,888,052	)
Loans, net of allowance		465,390,655			398,145,937			405,326,804
Federal Reserve Bank stock		984,000			984,000			984,000
Federal Home Loan Bank stock		3,395,300			2,475,600			2,475,600
Premises and equipment, net		15,458,744			11,197,614			14,344,330
Cash value of life insurance		3,522,501			3,393,144			3,424,586
Investment in BFNB Trusts		310,000			310,000			310,000
Other assets		7,803,341			5,705,823			5,651,876
Total assets	$	571,385,488		$	492,035,555		$	520,201,339
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits
Noninterest bearing deposits	$	40,317,614		$	35,560,935		$	37,194,469
Interest bearing deposits		399,947,404			347,223,536			379,162,660
Total deposits		440,265,018			382,784,471			416,357,129
Advances from Federal Home Loan Bank		55,000,000			37,500,000			37,500,000
Federal funds purchased and other borrowings		9,281,626			14,780,469			7,209,820
Junior subordinated debentures		10,310,000			10,310,000			10,310,000
Other liabilities		5,202,383			3,085,054			3,364,811
Total liabilities		520,059,027			448,459,994			474,741,760
SHAREHOLDERS’ EQUITY:
Common stock, $1 par value; 10,000,000 shares
authorized; 4,842,766 issued and outstanding at
September 30, 2007, 4,768,512 at September 30, 2006,
and 4,768,413 at December 31, 2006		4,842,766			4,768,512			4,768,413
Paid-in capital		29,110,906			28,657,576			28,657,576
Retained earnings		17,839,719			10,878,299			12,706,795
Accumulated other comprehensive loss		(466,930	)		(728,826	)		(673,205	)
Total shareholders’ equity		51,326,461			43,575,561			45,459,579
Total liabilities and shareholders' equity	$	571,385,488		$	492,035,555		$	520,201,339

The accompanying notes are an integral part of these consolidated condensed financial statements.

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Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Condensed Statements of Income

(Unaudited)

	Nine Months Ended				Three Months Ended
	September 30,				September 30,
	2007		2006		2007		2006
INTEREST INCOME
Interest and fees on loans	$	30,643,888	$	23,439,481	$	10,587,658	$	8,816,443
Investment securities		2,783,588		2,048,424		934,016		786,308
Federal funds sold		280,172		313,578		141,795		87,503
Other		17,905		16,915		6,046		6,006
Total interest income		33,725,553		25,818,398		11,669,515		9,696,260
INTEREST EXPENSE
Deposits		13,980,166		9,502,940		4,780,404		3,651,980
Federal funds purchased and other borrowings		1,705,203		1,066,931		734,416		379,518
Junior subordinated debentures		967,591		568,977		327,606		202,150
Total interest expense		16,652,960		11,138,848		5,842,426		4,233,648
Net interest income		17,072,593		14,679,550		5,827,089		5,462,612
PROVISION FOR LOAN LOSSES		950,800		1,778,600		278,800		591,200
Net interest income after provision
for loan losses		16,121,793		12,900,950		5,548,289		4,871,412
NONINTEREST INCOME
Service fees on deposit accounts		426,979		381,611		148,955		119,663
Gain on sale of loans		703,222		319,234		208,389		258,842
Retail mortgage origination income		2,126,300		527,841		493,648		406,968
Income from cash value life insurance		114,150		106,996		39,734		36,469
Miscellaneous loan fees		1,514,357		264,278		354,040		264,277
Other income		1,406,447		909,829		559,428		150,803
Total noninterest income		6,291,455		2,509,789		1,804,194		1,237,022
NONINTEREST EXPENSES
Salaries and wages		5,984,093		4,205,389		1,636,798		1,715,590
Employee benefits		1,230,203		762,497		422,781		328,788
Supplies and printing		150,074		89,542		56,988		30,181
Advertising and public relations		495,967		268,441		178,916		95,658
Professional fees		455,203		350,610		182,379		81,435
Depreciation and amortization		792,982		365,747		266,224		115,621
Occupancy		1,331,458		705,281		469,710		299,392
Data processing fees		528,118		389,333		175,057		142,557
Other operating expenses		3,471,769		1,448,729		1,132,224		589,519
Total noninterest expenses		14,439,867		8,585,569		4,521,077		3,398,741
Income before income taxes		7,973,381		6,825,170		2,831,406		2,709,693
INCOME TAX EXPENSE		2,840,459		2,460,453		1,009,300		979,874
Net income	$	5,132,922	$	4,364,717	$	1,822,106	$	1,729,819
BASIC NET INCOME PER COMMON
SHARE	$	1.07	$	0.92	$	0.38	$	0.36
DILUTED NET INCOME PER COMMON
SHARE	$	1.04	$	0.90	$	0.37	$	0.36
Weighted average common shares outstanding - basic		4,809,546		4,762,576		4,840,145		4,767,705
Weighted average common shares outstanding – diluted		4,942,553		4,877,182		4,939,253		4,882,311

The accompanying notes are an integral part of these consolidated condensed financial statements.

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Beach First National Bancshares, Inc. and Subsidiaries

Consolidated Condensed Statements of Changes in Shareholders’ Equity and Comprehensive Income

(Unaudited)

										Accumulated
										Other			Total
	Common Stock				Paid-in			Retained		Comprehensive			Shareholders'
	Shares		Amount		Capital			Earnings		Income (Loss)			Equity
BALANCE, DECEMBER 31, 2005		3,169,958	$	3,169,958	$	30,157,843		$	6,513,582	$	(715,970	)	$	39,125,413
Net income		--		--		--			4,364,717		--			4,364,717
Other comprehensive income (loss), net of
taxes:
Unrealized loss on investment securities		--		--		--			--		(12,856	)		(12,856	)
Comprehensive income		--		--		--			--		--			4,351,861
Exercise of stock options		9,050		9,050		89,237			--		--			98,287
Stock dividend in the form of a 3 for 2 split		1,589,504		1,589,504		(1,589,504	)		--		--
BALANCE, SEPTEMBER 30, 2006		4,768,512	$	4,768,512	$	28,657,576		$	10,878,299	$	(728,826	)	$	43,575,561

									Accumulated
									Other			Total
	Common Stock				Paid-in		Retained		Comprehensive			Shareholders'
	Shares		Amount		Capital		Earnings		Income (Loss)			Equity
BALANCE, DECEMBER 31, 2006		4,768,413	$	4,768,413	$	28,657,576	$	12,706,797	$	(673,205	)	$	45,459,581
Net income		--		--		--		5,132,922		--			5,132,922
Other comprehensive income, net of taxes:
Unrealized gain on investment securities		--		--		--		--		35,655			35,655
Unrealized gain on interest rate swap		--		--		--		--		170,620			170,620
Comprehensive income													5,339,197
Stock based compensation expense		--		--		6,955		--		--			6,955
Exercise of stock option		74,353		74,353		446,375		--		--			520,728
BALANCE, SEPTEMBER 30, 2007		4,842,766	$	4,842,766	$	29110906	$	17,839,719	$	(466,930	)	$	51,326,461

The accompanying notes are an integral part of these consolidated condensed financial statements.

5

Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Condensed Statements of Cash Flows

	Nine Months Ended
	September 30,
	2007			2006
	(unaudited)			(unaudited)
OPERATING ACTIVITIES:
Net income	$	5,132,922		$	4,364,717
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Deferred income taxes		(250,144	)		(747,736	)
Stock based compensation expense		6,955			--
Provisions for loan losses		950,800			1,778,600
Depreciation and amortization		792,982			365,747
Discount accretion and premium amortization		(103,077	)		56,798
(Gain) on sale of property and equipment		(5,499	)		(581,711	)
(Decrease) in other assets		(1,901,321	)		(1,597,804	)
Increase in other liabilities		1,939,824			1,529,451
Life insurance cash value increase		(97,915	)		(91,727	)
Net cash provided by operating activities		6,465,527			5,076,335
INVESTING ACTIVITIES:
Purchase of investment securities		(462,292	)		(18,993,028	)
Purchase of Federal Home Loan Bank stock		(919,700	)		(464,200	)
Purchase of Federal Reserve stock		--			(450,000	)
Decrease in Federal funds sold		13,651,389			25,285,206
Increase in loans, net		(60,964,646	)		(92,500,102	)
Purchase of premises and equipment		(1,907,827	)		(5,809,143	)
Proceeds from sale of property and equipment		5,930			1,500,000
Net cash used in investing activities		(50,597,146	)		(91,431,267	)
FINANCING ACTIVITIES:
Advances from Federal Home Loan Bank		17,500,000			3,500,000
Net increase in deposits		23,907,889			71,890,261
Proceeds from Federal funds purchased and other borrowings		2,071,806			13,276,460
Exercise of stock options		520,728			98,287
Net cash provided by financing activities		44,000,423			88,765,008
Net increase (decrease) in cash and cash equivalents		(131,196	)		2,410,076
CASH AND DUE FROM BANKS, BEGINNING
OF PERIOD	$	5,198,945		$	4,284,868
CASH AND DUE FROM BANKS, END OF
PERIOD	$	5,067,749		$	6,694,944
CASH PAID FOR:
Income taxes	$	3,195,252		$	4,429,302
Interest	$	16,577,634		$	10,950,800

The accompanying notes are an integral part of these consolidated financial statements.

6

Beach First National Bancshares, Inc.
Notes to Consolidated Condensed Financial Statements (Unaudited)

1.      Basis of Presentation

     The accompanying consolidated condensed financial statements for Beach First National Bancshares, Inc. (“Company”) were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. All adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for fair presentation of the interim consolidated financial statements have been included. Certain previously reported amounts have been reclassified to conform to the current reporting presentation. The results of operations for the nine month period ended September 30, 2007 are not necessarily indicative of the results that may be expected for the entire year. These consolidated financial statements do not include all disclosures required by generally accepted accounting principles and should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the year ended December 31, 2006.

2.      Principles of Consolidation

    The accompanying consolidated condensed financial statements include the accounts of the Company and its subsidiaries, Beach First National Bank and BFNM Building, LLC (“LLC”) (See Note 4 “Investment in LLC” below). The Company also owns two grantor trusts, Beach First National Trust I and Beach First National Trust II. All significant inter-company items and transactions have been eliminated in consolidation. In accordance with current accounting guidance, the financial statements of the trusts have not been included in the Company’s financial statements.

3.      Earnings Per Share

    The Company calculates earnings per share in accordance with Statement of Financial Accounting Standard No. 128, “Earnings per Share” (“SFAS 128”). SFAS 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities, or contingent stock agreements if those securities trade in a public market.
 

    This standard specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS. Basic earnings per share are computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding under the Company’s stock option plan is reflected in diluted earnings per share by application of the treasury stock method.

RECONCILIATION OF THE NUMERATORS AND DENOMINATORS OF THE BASIC AND DILUTED EPS COMPUTATIONS:

	For the Nine Months Ended
	2007		2006
Basic earnings per share:
Net income available to common shareholders	$	5,132,922	$	4,364,717
Average common shares outstanding – basic		4,809,546		4,762,576
Basic earnings per share	$	1.07	$	0.92
Diluted earnings per share:
Net income available to common shareholders	$	5,132,922	$	4,364,717
Average common shares outstanding – basic		4,809,546		4,762,576
Incremental shares from assumed conversion
of stock options		133,007		114,606
Average common shares outstanding – diluted		4,942,553		4,877,182
Diluted earnings per share	$	1.04	$	0.90

7

	For the Three Months Ended
	2007		2006
Basic earnings per share:
Net income available to common shareholders	$	1,822,106	$	1,729,819
Average common shares outstanding – basic		4,840,145		4,767,705
Basic earnings per share	$	0.38	$	0.36
Diluted earnings per share:
Net income available to common shareholders	$	1,822,106	$	1,729,819
Average common shares outstanding – basic		4,840,145		4,767,705
Incremental shares from assumed conversion
of stock options		99,108		114,606
Average common shares outstanding – diluted		4,939,253		4,882,311
Diluted earnings per share	$	0.37	$	0.35

4.   Investment in LLC

     The LLC is in partnership with our legal counsel, Nelson Mullins Riley & Scarborough LLP (NMR&S), for purposes of acquiring a parcel of land and constructing an office building on the property. The Company owns two-thirds of the LLC and NMR&S owns the remaining one-third. The building is a three-story, 46,066 square foot office building located on 3.5 acres at the southwest corner of Robert Grissom Parkway and 38th Avenue North in Myrtle Beach, South Carolina. The Company moved its main office to this location in December 2006. NMR&S also relocated its Myrtle Beach legal office to the building in December 2006. The LLC purchased the land for approximately $1.8 million and financed the construction project through a third-party lender with each of the owners being responsible for their respective interests in the project. The total land and construction project cost approximately $8. 6 million, exclusive of tenant improvements. The Company leases two-thirds of the building (approximately 30,000 square feet) from the LLC. Because the Company occupies approximately 12,500 square feet of space, it intends to lease the other 17,500 square feet of its portion to outside tenants. As of September 30, 2007, the Company has 6,000 square feet available for lease. NMR&S also leases one-third of the building from the LLC.

     Upon completion of construction, the construction financing note from the third-party lender was converted to a term loan payable by the LLC to the third-party bank and is secured by the building. The loan requires 107 installments of principal and interest based on a fifteen year amortization, with all remaining principal and interest due on September 15, 2015. The interest rate on the term loan is variable based on one-month LIBOR plus 1.40%. As a result of the interest rate SWAP discussed below, the LLC has converted this variable rate to a fixed rate of 6.02%. The outstanding balance on the term loan at September 30, 2007 is $7. 0 million and is shown as other borrowings in the accompanying balance sheet.

5.    Interest Rate SWAP - Derivative Financial Instrument

     The LLC entered into an interest rate swap agreement as a risk management tool to hedge the interest rate risk associated with the variable rate building loan discussed above. This swap instrument is a derivative financial instrument designated as a cash flow hedge and is accounted for in accordance with the provisions of Statement of Financial Accounting Standard No. 133 (“SFAS 133”). Under the swap, the LLC pays a fixed rate of 4.62% and receives interest payments that vary based on LIBOR. Through the swap, the LLC has converted the building loan to a fixed effective rate of 6.02%.
 

     In accordance with SFAS 133, the LLC has formally documented the relationship between the building loan and the swap, as well as the risk-management objective and strategy for undertaking the hedge transaction. In connection with this process, the LLC has determined that the swap is highly effective as a cash flow hedge and the entire fair value of the swap was initially recorded in other comprehensive income. Under SFAS 133, any material ineffectiveness must be reclassified to earnings. During the formal documentation process, the LLC also determined that no hedge ineffectiveness is anticipated because the terms of the swap so closely match the terms of the building loan.

8

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is our discussion and analysis of certain significant factors that have affected our financial position and operating results and those of our subsidiary, Beach First National Bank, during the periods included in the accompanying financial statements. This commentary should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.

          This report contains “forward-looking statements” relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “esti mate,” “continue,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties including, without limitation those described in detail in our Annual Report on Form 10-K for the year ended December 31, 2006 under the heading “Risk Factors” with the Securities and Exchange Commission and the following:

·      significant increases in competitive pressure in the banking and financial services industries;

·      changes in the interest rate environment which could reduce anticipated or actual margins;

·      changes in political conditions or the legislative or regulatory environment;

·      general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

·      changes occurring in business conditions and inflation;

·      changes in management;

·      changes in technology;

·      changes in deposit flows;

·      the level of allowance for loan loss;

·      the rate of delinquencies and amounts of charge-offs;

·      the rates of loan growth;

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

·      changes in monetary and tax policies;

·      loss of consumer confidence and economic disruptions resulting from terrorist activities;

·      changes in the securities markets; and

·      other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
 

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our consolidated financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2006 as filed in our 2006 Annual Report on Form 10-K.

Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities. We consider such accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates. These differences could have a material impact on our carrying values of assets and liabilities and our results of operations.

9

We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the subsection entitled “Allowance for Possible Loan Losses” below for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

Overview

The following discussion describes our results of operations for the quarter ended September 30, 2007 as compared to the quarter ended September 30, 2006, as well as results for the nine months ended September 30, 2007 and 2006, and also analyzes our financial condition as of September 30, 2007 as compared to December 31, 2006. Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a detailed discussion of this process.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.

     The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.

Results of Operations

Earnings Review

     Our net income was $5.1 million, or $1.04 per diluted common share, for the nine months ended September 30, 2007 as compared to net income of $4.4 million, or $0.90 per diluted common share, for the nine months ended September 30, 2006. Our net income was $1.8 million, or $0.37 per diluted common share, for the three months ended September 30, 2007 as compared to net income of $1.7 million, or $0. 35 per diluted common share, for the same period of 2006. The increase in net income reflects the bank’s continued growth, as average earning assets increased to $529.3 million during the first nine months of 2007 from $492.0 million during the same period of 2006. The return on average assets for the nine month period ended September 30, 2007 was 1.24% compared to 1.30% for the same period 2006. The return on average equity was 14.34% for the nine month period ended September 30, 2007 versus 13.93% 2006.
 

Net Interest Income

     Our primary source of revenue is net interest income, which represents the difference between the income on interest-earning assets and expense on interest-bearing liabilities. During the nine month period ended September 30, 2007, net interest income increased 16. 3% to $17.1 million from $14.7 million for the same period of 2006. For the three months ended September 30, 2007, net interest income increased 6.7% to $5.8 million from $5.5 million during the comparable period of 2006. The growth in net interest income during the nine month period ended September 30, 2007 resulted from an increase of $7.9 million in interest income, partially offset by

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an increase in interest expense of $5.5 million. Our net interest income is determined by the level of our earning assets and the management of our net interest margin. The continued growth of our loan portfolio is the primary driver of the increase in net interest income. Average total loans increased from $360.8 million in the first nine months of 2006 to $448.4 million in the same period in 2007. In addition, average securities increased to $69.5 million in the first nine months of 2007 compared to $57.4 million for the first nine months of 2006.
     
     Net interest spread, the difference between the rate we earn on interest-earning assets and the rate we pay on interest-bearing liabilities, was 3.74% in the first nine months of 2007 compared to 4.04% during the same period of 2006. The net interest margin was 4.31% for the nine month period ended September 30, 2007 compared to 4.57 % for the same period of 2006. The decline in the net interest spread and the net interest margin are due to the changing interest rate environment and the increased competition in our markets for deposits. With recent declines in key interest rates we expect to continue to see a decline in our net interest margin.

Provision for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our statement of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. The provision for loan losses was $950,800 for the first nine months of 2007 and $1.8 million for the same period of 2006. The provision for loan losses was $278,800 for the three months ended September 30, 2007 and $591,200 for the same period in 2006. The decrease in the provision was the result of management’s assessment of the adequacy of the reserve for loan losses given the size, mix and quality of the current loan portfolio. Please see the discussion below under “Allowance for Loan Losses” for a description of the factors we considered in determining the amount of the provision we expense each period to maintain this allowance.

Noninterest Income

     Noninterest income increased to $6.3 million for the first nine months of 2007 compared to $2.5 million in the same period of 2006. For the three months ended September 30, 2007, noninterest income increased to $1.8 million as compared to $1.2 million in 2006. The increase in noninterest income is related in part to the income from our mortgage operation. The three key components of the revenue from the mortgage operation are retail mortgage origination income, miscellaneous loan fees, and the net gains on the sale of mortgage loans. With the decline in the housing market we expect a slowing in mortgage revenue until the market recovers. As revenue drops from the mortgage operation we will also see a decline in the corresponding expenses. The following table sets forth information related to our noninterest income from the mortgage operation, for the first nine months of 2007 and 2006, as well as, for the three months ended September 30, 2007 and 2006.
 

	For the nine months ended				For the three months ended
	September 30,				September 30,
	2007		2006		2007		2006
Retail Mortgage Origination Income	$	2,126,300	$	527,842	$	493,648	$	406,968
Miscellaneous loan fees		1,514,357		264,278		354,040		264,277
Gain on sale of mortgage loans		567,222		258,842		72,389		258,842
	$	4,207,879	$	1,050,961	$	920,077	$	930,087

 The other income category increased $496,618 to $1,406,447 for the first nine months of 2007. The largest component of this increase includes a $412,324 increase in merchant income, an increase in rental income of $471,941 and a net decrease of $576,562 relating to gain on sale of fixed assets. The rental income increase relates primarily to the BFNB Building, LLC for the period ending September 30, 2007. The BFNB Building, LLC’s expenses of operation are included in the company’s expense base.

Noninterest Expense

     Total noninterest expense increased 68.2% to $14.4 million for the nine months ended September 30, 2007 from $8.6 million for the same period of 2006 and increased 33.0% to $4.5 million for the three months ended September 30, 2007 from $3.4 million in the same period of 2006.
 

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     Salaries and wages and employee benefits, the largest component of noninterest expense, increased $2.2 million to $7.2 million for the nine months ended September 30, 2007 compared to the same period in 2006, and increased $15,201 to $2.1 million for the quarter ended September 30, 2007 compared to the same period in 2006. The mortgage operation had $2.6 million of salary and wages and employee benefit expenses through nine months of 2007. The other increases are the result of personnel additions due to the growth of our bank, normal compensation adjustments, and higher costs associated with group benefits. The drop in wages in the quarter was driven by a drop in mortgage operation staff.

We had 163 full-time equivalent employees at September 30, 2007, a decrease of 17 as compared to the same period in 2006.  This decrease occurred primarily within our mortgage operation , as the housing market has had an impact on our loan origination volume. At September 30, 2007, 7 5 of the full-time equivalent employees work within our mortgage operation. 

Advertising and public relations costs increased $227,526 to $495,967 for the nine months ended September 30, 2007 compared to the same period in 2006, and increased $83,258 to $178,916 for the three months ended September 30, 2007 compared to the same period in 2006. We incurred advertising and public relations costs related to our mortgage operations, special promotions to attract deposits in all markets, as well as contracting with a professional advertising agency. Professional fees increased $104,593 for the nine months ended September 30, 2007 compared to the same period in 2006, and increased $100,944 for the three months ended September 30, 2007 compared to the same period in 2006. The professional fees increased due to our growth, the regulatory fees associated with such growth, and the escalating cost of accounting, auditing, and legal services for a public company, including our expenses directly related to Sarbanes-Oxley (SOX) compliance. We expect these fees to continue to increase as we formally prepare to meet the requirements of these comprehensive regulations.

     Occupancy expenses increased $626,176 during the nine month period ended September 30, 2007 compared to the same period in 2006 and by $170,318 for the three months ended September 30, 2007 compared to the same period in 2006. This increase is related to the addition of the facilities associated with our mortgage operations, increases on leases, and the expense related to the new corporate headquarters. As we continue to expand, we expect that occupancy costs will continue to increase.
 

Data processing fees increased during the nine months ended September 30, 2007 to $528,118 compared to $389,333 for the same period in 2006. For the three months ended September 30, 2007, data processing costs totaled $175,057 compared to $142,557 for September 30, 2006. Data processing costs are primarily related to the volume of loans, deposit accounts, and associated transaction activity. We have expanded the security features of our internet banking product in addition to upgrading all security measures for internal and external systems. We believe our data processing costs are consistent with our expansion. During the quarter we signed a new contract with our data processing provider to upgrade our systems. The conversion is scheduled in the second quarter of 2008.

Total other operating expenses increased 139.6% to $3.5 million during the first nine months of 2007 compared to $1.4 million for the same period in 2006. Other operating expenses increased 92.1%, or $1.1 million, for the three months ended September 30, 2007 compared to the same period in 2006. The following table presents a comparison of other operating expenses by category:

Other Operating Expenses
	For the nine months ended				For the three months ended
	September 30,				September 30,
	2007		2006		2007		2006
Telephone	$	97,076	$	54,898	$	33,514	$	19,543
Postage and freight		73,728		51,421		26,411		23,066
Armored car		67,305		64,856		24,755		23,774
Credit and collection – mortgage operation		1,016,369		80,411		199,991		91,853
Credit and collection – bank		110,090		105,334		23,128		46,145
Dues and subscriptions		103,173		88,231		36,929		30,355
Travel		217,622		138,818		88,219		48,987
Entertainment		226,511		66,091		38,558		15,451
FDIC insurance		94,255		29,522		69,877		10,691
Other insurance		57,801		32,328		32,660		10,855
Debit/ATM		70,623		57,199		24,600		19,053
Merchant		489,920		111,159		209,894		68,278
Credit card processing fees		33,720		44,785		12,969		5,633
Fed charges		32,531		29,078		11,850		10,403
Software maintenance		92,244		43,789		35,263		18,447
Director Supplemental Retirement Plan		83,069		112,671		33,767		24,596
NASDAQ		37,758		18,375		8,182		6,125
Furniture and equipment		226,972		173,809		64,971		79,387
Other Operating Expenses		341,002		145,954		156,686		36,877
Total	$	3,471,769	$	1,448,729	$	1,132,224	$	589,519

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       The $2,023,040 increase for the nine month ended in 2007 was primarily due to an increase of $935,958 for credit and collection expenses of the mortgage operation, $378,760 increase in merchant expenses, a $100,000 increase in the mortgage recourse expense, $160,420 increase in entertainment expenses, $78,804 increase in travel expenses, $53,163 increase furniture and equipment expenses, and various other increases under $50,000. The merchant expense increases are due to the expansion of merchant related activity in the first nine months of 2007.

Balance Sheet Review

General

      We had total assets of $571.4 million at September 30, 2007, an increase of 16.1% from $492.0 million at September 30, 2006 and an increase of 9.8% from $520.2 at December 31, 2006. Total assets consisted primarily of $459.0 million in net loans and $69.1 million in investments. Our liabilities at September 30, 2007 totaled $520.0 million, consisting primarily of $440.3 million in deposits and $55.0 million in Federal Home Loan Bank (FHLB) advances. Our total deposits increased to $440.3 million at September 30, 2007, up 15.0% from $382.8 million at September 30, 2006, and up 5.7% from $416.4 million at December 31, 2006. Shareholder’s equity increased $7.7 million to $51.3 million at September 30, 2007, as compared to $43.6 million at September 30, 2006, and increased $5.8 million from $45.5 million at December 31, 2006.

Investment Securities

     At September 30, 2007, investment securities totaled $69.1 million and averaged $69.5 million during the first nine months of 2007. Total investment securities averaged $57.4 million during the first nine months of 2006 and totaled $66.4 million at September 30, 2006. Total investment securities averaged $60.2 million for the year ended December 31, 2006 and totaled $71.9 million at December 31, 2006. At September 30, 2007, investment securities represented 12.1% of total assets compared to 12.8% at September 30, 2006. All investment securities are classified as available-for-sale and are recorded at fair value. At September 30, 2007, our total investment securities portfolio had a book value of $70.1 million and a fair market value of $69.1 million for a gross unrealized net loss of $1.0 million. We primarily invest in U.S. Government Sponsored Enterprises and Federal Agency securities.

     At September 30, 2007, short-term investments totaled $0.4 million, compared to $0.2 million at September 30, 2006 and $14.0 million at December 31, 2006. These funds are one source of our bank’s liquidity and are generally invested in an earning capacity on an overnight or short-term basis. This increase in short-term investments is primarily due to lower loan demand during this quarter.

Loans

     The following table shows the composition of the loan portfolio by category at September 30, 2007, September 30, 2006, and December 31, 2006.

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	Composition of Loan Portfolio
	September 30, 2007						September 30, 2006						December 31, 2006
				Percent						Percent						Percent
	Amount			of Total			Amount			of Total			Amount			of Total
Commercial	$	52,213,925			11.1	%	$	44,386,968			11.0	%	$	43,974,792			10.7	%
Real estate – construction		51,724,912			10.9	%		40,924,105			10.1	%		44,032,693			10.7	%
Real estate – mortgage (1)		359,454,651			76.1	%		310,748,890			76.9	%		315,689,304			76.7	%
Consumer		8,768,942			1.9	%		8,077,587			2.0	%		7,784,157			1.9	%
		472,162,430			100.0	%		404,137,550			100.0	%		411,480,946			100.0	%
Unearned loan fees and costs, net		(374,763	)					(320,121	)					(266,090	)
Total loans		471,787,667						403,817,429						411,214,856
Allowance for loan losses		(6,397,012	)					(5,671,492	)					(5,888,052	)
Loans, net of allowance	$	465,390,655					$	398,145,937					$	405,326,804

(1)      Includes mortgage loans held for sale

Because loans typically provide higher yields than other types of earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. As of September 30, 2007, loans represented 84.7% of total earning assets compared to 84.4% at September 30, 2006 and 84.2% at December 31, 2006. At September 30, 2007 net loans (total loans less the allowance for loan losses) totaled $465.4 million, an increase of $67.3 million from September 30, 2006 and an increase of $60.1 million from December 31, 2006. Average total loans increased from $360.7 million, with a yield of 8.69%, in the first nine months of 2006 to $448.4 million, with a yield of 9.12%, during the same in 2007. Average total loans were $372.8 million with a yield of 8.88% at December 31, 2006. The interest rates charged on loans vary with the degree of risk and the maturity and amount of the loan. Competitive pressures, money market rates, availability of funds and government regulations also influence interest rates.

Mortgage loans were the principal component of our loan portfolio at September 30, 2007, September 30, 2006, and December 31, 2006, which represented 76.1%, 76.9%, and 76.7% of the portfolio, respectively. In the context of this discussion, a “real estate mortgage loan” is defined as any loan, other than loans for construction purposes, secured by real estate, regardless of the purpose of the loan. We follow the common practice of financial institutions in our market area of obtaining a security interest in real estate whenever possible, in addition to any other available collateral. The security interest in the collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the magnitude of the real estate loan portfolio component. Generally, we limit the loan-to-value ratio to 80%.

Allowance for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of income. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. The evaluation of the allowance is segregated into general allocations and specific allocations. For general allocations, the portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified trends or changes in current portfolio characteristics. Historical loss ratios are calculated by product type for consumer loans (installment and revolving), mortgage loans, and commercial loans and may be adjusted for other risk factors. To allow for modeling error, a range of probable loss ratios is then derived for each segment. The resulting percentages are then applied to the dollar amounts of the loans in each segment to arrive at each segment’s range of probable loss levels. Certain nonperforming loans are individually assessed for impairment under SFAS No. 114 and assigned specific allocations. Other identified high-risk loans or credit relationships based on internal risk ratings are also individually assessed and assigned specific allocations.

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The general allocation also includes a component for probable losses inherent in the portfolio, based on management’s analysis that is not fully captured elsewhere in the allowance. This component serves to address the inherent estimation and imprecision risk in the methodology as well as address management’s evaluation of various factors or conditions not otherwise directly measured in the evaluation of the general and specific allocations. Such factors include the current general economic and business conditions; geographic, collateral, or other concentrations of credit; system, procedural, policy, or underwriting changes; experience of the lending staff; entry into new markets or new product offerings; and results from internal and external portfolio examinations.

Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.

The allocation of the allowance for loan losses to the respective loan segments is an approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio. In addition, the allowance is subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. Such regulatory agencies could require us to adjust the allowance based on information available to them at the time of their examination.

At September 30, 2007, the allowance for loan losses was $6.4 million, or 1.36% of outstanding loans, compared to an allowance for loan losses of $5.7 million, or 1.40% of outstanding loans, at September 30, 2006 and an allowance for possible loan losses of $5.9 million, or 1.43% of outstanding loans, at December 31, 2006. In the first nine months of 2007, we had net charge-offs totaling $0.4 million. During the same period in 2006, we had net charge-offs totaling $0.5 million. For the twelve months ended December 31, 2006, we had net charge-offs totaling $0.7 million. We had non-performing loans totaling $0.6 million at September 30, 2007, $2.6 million at September 30, 2006, and $1.6 million at December 31, 2006. While there can be no assurances, we do not expect significant losses relating to these nonperforming loans because we believe that the collateral supporting these loans is largely sufficient to cover the outstanding loan balances.

The following table sets forth certain information with respect to our allowance for loan losses and the composition of charge-offs and recoveries for the nine months ended September 30, 2007, September 30, 2006, and December 31, 2006.

	Allowance for Loan Losses
	Nine months ended September 30,						December 31,
	2007			2006			2006
Average total loans outstanding	$	448,406,531		$	360,729,338		$	372,791,961
Total loans outstanding at period end		471,787,667			403,817,429			411,214,857
Total nonperforming loans		549,714			2,615,341			1,625,511
Beginning balance of allowance for loan losses	$	5,888,052		$	4,364,287		$	4,364,287
Mortgage recourse reserve		(50,000	)
Loans charged off		(410,174	)		(498,490	)		(792,188	)
Total recoveries		18,334			27,095			141,553
Net loans charged off		(391,840	)		(471,395	)		(650,635	)
Provision for loan losses		950,800			1,778,600			2,174,400
End of period balance of allowance for loan losses	$	6,397,012		$	5,671,492		$	5,888,052
Annualized net charge-offs to average total loans		0.12	%		0.17	%		0.17	%
Allowance as a percent of total loans		1.36	%		1.40	%		1.43	%
Nonperforming loans as a percentage of total loans		0.12	%		0.65	%		0.40	%
Nonperforming loans as a percentage of allowance		8.59	%		46.11	%		27.59	%

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       In 2006, we set up a retail mortgage recourse reserve of $50,000 within the allowance. The reserve is set up for situations where retail mortgage loans, that were sold, may be returned to us under certain circumstances delineated in the sales contract. For 2007, we transferred this amount into a separate liability. For 2007, we have expensed an additional $100,000 and have incurred losses of $47,445. At September 30, 2007, the reserve was $102,555. With the turmoil in the retail mortgage market we are constantly reviewing all loans sold to ensure our reserve is sufficient.

The following table sets forth the breakdown of the allowance for loan losses by loan category and the percentage of loans in each category to gross loans as of September 30, 2007. We believe that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of further losses and does not restrict the use of the allowance to absorb losses in any category.

As of September 30, 2007
Commercial	$	1,179,820	18.5	%
Real estate – construction		666,783	10.4
Real estate – mortgage		4,313,300	67.4
Consumer		192,807	3.0
Unallocated		44,302	0.7	%
Total allowance for loan losses	$	6,397,012	100.0	%

Nonperforming Assets

     We discontinue accrual of interest on a loan when we conclude it is doubtful that we will be able to collect interest from the borrower. We reach this conclusion by taking into account factors such as the borrower's financial condition, economic and business conditions, and the results of our previous collection efforts. Generally, we will place a delinquent loan in nonaccrual status when the loan becomes 90 days or more past due. When we place a loan in nonaccrual status, we reverse all interest which has been accrued on the loan but remains unpaid and we deduct this interest from earnings as a reduction of reported interest income. We do not accrue any additional interest on the loan balance until we conclude the collection of both principal and interest is reasonably certain. At September 30, 2007, there were no loans accruing interest which were 90 days or more past due and we had no restructured loans.

Deposits

     Total deposits were $440. 3 million and represented 77.1% of total assets at September 30, 2007. Average total deposits were $436.0 million and average interest-bearing deposits were $399.9 million for the nine months ended September 30, 2007. Average total deposits were $353.5 million and average interest-bearing deposits were $320.9 million in the same period of 2006. Average total deposits were $367.1 million and average interest-bearing deposits were $333.6 million at December 31, 2006.
 

The following table sets forth our deposits by category as of September 30, 2007, September 30, 2006, and December 31, 2006.

	September 30, 2007					September 30, 2006					December 31, 2006
Deposits			Percent of					Percent of					Percent of
	Amount		Deposits			Amount		Deposits			Amount		Deposit
Demand deposit accounts	$	40,317,614		9.2	%	$	5,560,935		9.3	%	$	37,194,469		8.9	%
Interest bearing checking accounts		23,650,334		5.4	%		20,071,664		5.2	%		21,336,836		5.1	%
Money market accounts		107,480,890		24.4	%		97,421,218		25.5	%		103,056,865		24.8	%
Savings accounts		3,265,956		0.7	%		3,306,161		0.9	%		3,303,763		0.8	%
Time deposits less than $100,000		150,064,341		34.1	%		129,146,950		33.7	%		154,191,755		37.0	%
Time deposits of $100,000 or over		115,485,883		26.2	%		97,277,543		25.4	%		97,273,441		23.4	%
Total deposits	$	440,265,018				$	382,784,471		100.0	%	$	416,357,129		100.0	%

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     Deposit growth was attributable to internal growth and the generation of new deposit accounts due primarily to special promotions and increased advertising. Demand deposit accounts increased as a result of an expanded focus on demand deposit accounts. Interest bearing checking accounts increased primarily due to a change mandated by the South Carolina Bar Association requiring that all lawyer trust accounts be interest bearing. This created a shift from demand deposit accounts to interest bearing checking accounts.

     Core deposits, which exclude certificates of deposit of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $324.8 million at September 30, 2007, compared to $285.5 million at September 30, 2006 and $319.1 million at December 31, 2006. Our brokered deposits were $37.2 million as of September 30, 2007, $27.1 million as of September 30, 2006, and $34.6 million as of December 31, 2006. We expect a stable base of deposits to be our primary source of funding to meet both short-term and long-term liquidity needs. Core deposits as a percentage of total deposits were approximately 73.8% at September 30, 2007, 74.6% at September 30, 2006, and 76.6% at December 31, 2006. Our loan-to-deposit ratio was 107.2% at September 30, 2007 versus 105.5 % at September 30, 2006 and 98.8% at December 31, 2006. The average loan-to-deposit ratio was 102.8% during the first nine months of 2007, 102.1% during the same period of 2006, and 102.0% for the year ended December 31, 2006.
 

Advances from Federal Home Loan Bank (FHLB)

In addition to deposits, we obtained funds from the FHLB to help fund our loan growth, as shown below:

FHLB Description	Balance		Current Rate			Maturity Date
Fixed Rate Hybrid	$	5,000,000		4.76	%		10/21/2010
Fixed Rate		10,000,000		5.358	%		06/04/2010
Convertible		7,500,000		4.51	%		11/23/2010
Convertible		5,000,000		3.68	%		07/13/2015
Convertible		5,000,000		4.06	%		09/29/2015
Convertible		5,000,000		4.16	%		03/13/2017
Convertible		7,500,000		4.385	%		04/13/2017
Prime Based Advance		10,000,000		4.91	%		09/19/2011
	$	55,000,000

Average borrowings from the FHLB were $55.0 million during the third quarter of 2007 and totaled $55.0 million at September 30, 2007.

Junior Subordinated Debentures

     On May 27, 2004 we raised $5.0 million and on March 30, 2005, we raised an additional $5.0 million through the issuance and sale of floating rate trust preferred securities through BFNB Trust I and BFNB Trust II (the “Trusts”). These trust preferred securities are reported on our consolidated balance sheet as junior subordinated debentures. The Trusts loaned these proceeds to our holding company to use for general corporate purposes. Trust preferred securities currently qualify as Tier 1 capital under Federal Reserve Board guidelines.

     Debt issuance costs, net of accumulated amortization, from the junior subordinated debentures totaled $35,194 at September 30, 2007, $44,865 at September 30, 2006, and $41,067 at December 31, 2006. These costs are included in other assets on our consolidated balance sheet. Amortization of debt issuance costs from trust preferred debt totaled $3,754 for the nine month period ended September 30, 2007, $3,337 for the nine month period ended September 30, 2006, and $4,588 for the year ended December 31, 2006. These costs are reported in other noninterest expense on the consolidated statement of income.
 

     The trust preferred securities accrue and pay distributions annually at a rate per annum equal to the three month LIBOR plus 270 and 190 basis points, respectively, which was 8.060 % and 7.594 % at September 30, 2007. The distribution rate payable on these securities is cumulative and payable quarterly in arrears. We have the right, subject to events of default, to defer payments of interest on the trust preferred securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity dates of May 27, 2034 and March 30, 2035, respectively. We have no current intention to exercise our right to defer payments of interest on the trust preferred securities. We have the right to redeem the trust

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preferred securities, in whole or in part, on or after May 27, 2009, and March 30, 2010, respectively. We may also redeem the trust preferred securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium.
 

Capital Resources

The Federal Reserve Board and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio. At both the holding company and bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies. To be considered “well-capitalized,” we must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.

In October 2006, the Company announced a 3-for-2 stock split effected in the form of a 50% stock dividend to shareholders of record on December 1, 2006. The dividend was paid on December 21, 2006. All earnings per share amounts for all periods have been adjusted to reflect this 3-for-2 split.

At September 30, 2007, our total shareholders’ equity was $51.3 million ($51.6 million at the bank level). At September 30, 2007, our Tier 1 capital ratio was 13.4% (11.40 % at the bank level), our total risk-based capital ratio was 14.6% (12.66 % at the bank level), and our Tier 1 leverage ratio was 11.2% (9. 28 % at the bank level). The bank was considered “well capitalized” and the holding company met or exceeded its applicable regulatory capital requirements.

Liquidity Management
 

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

     Our primary sources of liquidity are deposits, scheduled repayments on our loans, and interest on and maturities of our investments. We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits. All of our securities have been classified as available for sale. Occasionally, we might sell investment securities in connection with the management of our interest sensitivity gap or to manage cash availability. We may also utilize our cash and due from banks, security repurchase agreements, and federal funds sold to meet liquidity requirements as needed. In addition, we have the ability, on a short-term basis, to purchase federal funds from other financial institutions. Presently, we have made arrangements with commercial banks for short-term unsecured advances of up to $21.8 million. We maintain a secured line of credit in the amount of $10 .0 million with our primary correspondent. We also have a line of credit with the FHLB to borrow up to 80% of our 1 to 4 family loans, resulting in an availability of funds of $3.8 million at September 30, 2007. The FHLB has approved borrowings up to 15% of the bank’s total assets less advances outstanding. The borrowings are available by pledging additional collateral and purchasing FHLB stock. At September 30, 2007, we had borrowed $55.0 million on this line. We believe that our existing stable base of core deposits, our bond portfolio, borrowings from the FHLB, and short-term federal funds lines will enable us to successfully meet our liquidity needs for the next 12 months.

Interest Rate Sensitivity
 

A significant portion of our assets and liabilities are monetary in nature, and consequently they are very sensitive to changes in interest rates. This interest rate risk is our primary market risk exposure, and it can have a significant effect on our net interest income and cash flows. We review our exposure to market risk on a regular

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basis, and we manage the pricing and maturity of our assets and liabilities to diminish the potential adverse impact that changes in interest rates could have on our net interest income.

We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities, and it is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets. We generally would benefit from increasing market interest rates when we have an asset-sensitive, or a positive, interest rate gap and we would generally benefit from decreasing market interest rates when we have liability-sensitive, or a negative, interest rate gap. When measured on a “gap” basis, we are liability-sensitive over the cumulative one-year time frame and asset-sensitive after one year as of September 30, 2007. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but we believe those rates are significantly less interest-sensitive than market-based rates such as those paid on noncore deposits.

Net interest income is also affected by other significant factors, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities. We perform asset/liability modeling to assess the impact of varying interest rates and the impact that balance sheet mix assumptions will have on net interest income. We attempt to manage interest rate sensitivity by repricing assets or liabilities, selling securities available-for-sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities that reprice in the same time interval helps us to hedge risks and minimize the impact on net interest income of rising or falling interest rates. We evaluate interest sensitivity risk and then formulate guidelines regarding asset generation and repricing, funding sources and pricing, and off-balance sheet commitments in order to decrease interest rate sensitivity risk.

Off Balance Sheet Risk

Through the operations of our bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.

     At September 30, 2007, the bank had issued commitments to extend credit of $53.5 million through various types of lending arrangements, of which $49.2 million was at variable rates. The commitments expire over the next 18 months. Past experience indicates that many of these commitments to extend credit will expire unused. We believe that we have adequate sources of liquidity to fund commitments that are drawn upon by the borrowers.
 

In addition to commitments to extend credit, we also issue standby letters of credit which are assurances to a third party that they will not suffer a loss if our customer fails to meet its contractual obligation to the third party. Standby letters of credit totaled $11.4 million at September 30, 2007. Past experience indicates that many of these standby letters of credit will expire unused. However, through our various sources of liquidity, we believe that we will have the necessary resources to meet these obligations should the need arise.

Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments or significantly impact earnings.

Impact of Inflation
 

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles.

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Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

Recently Issued Accounting Standards
 

     The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by us.
 
     In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements”. SFAS No. 157 provides enhanced guidance for using fair value to measure assets and liabilities. The standard also requires expanded disclosures about the extent to which company’s measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption of Statement 157 to materially impact our consolidated financial statements.
 

In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans”, which amends SFAS No. 87 and SFAS No. 106 to require recognition of the over funded or under funded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS No. 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS No. 87 and SFAS No. 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date, the date at which the benefit obligation and plan assets are measured, is required to be the company's fiscal year end. SFAS No. 158 is effective for publicly-held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company does not have a defined benefit pension plan. Therefore, SFAS No. 158 will not impact our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of SFAS No. 115”. This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains and losses on such instruments in current earnings. This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by -instrument basis with some exceptions, 4) is irrevocable and 5) applies only to entire instruments. One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value. With respect to SFAS No. 115, available for sale and held to maturity securities at the effective date are eligible for the fair value option at that date. If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment and thereafter, such securities will be accounted for as trading securities. SFAS No. 159 will be effective for us on January 1, 2008. Earlier adoption is permitted in 2007 if we also elect to apply the provisions of SFAS No. 157. The Company did not adopt early SFAS No. 159 and believes that it is unlikely that it will expand its use of fair value accounting upon the January 1, 2008 effective date.

In September 2006, The FASB ratified the consensuses reached by the FASB's Emerging Issues Task Force ("EITF") relating to EITF No. 06-4 "Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements". EITF No. 06-4 addresses employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods should recognize a liability for future benefits in accordance with SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions", or Accounting Principles Board ("APB") Opinion No. 12, "Omnibus Opinion-1967". EITF 06-4 is effective for fiscal years beginning after December 15, 2007. Entities should recognize the effects of applying this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. The Board has approved a change in our post retirement benefit program such that EITF No. 06-4 will have no impact on our consolidated financial statements.

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In September 2006, the FASB ratified the consensus reached related to EITF No. 06-5, "Accounting for Purchases of Life Insurance - Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance." EITF No. 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. EITF No. 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF No. 06-5 is effective for fiscal years beginning after December 15, 2007. We do not believe the adoption of EITF No. 06-5 will have a material impact on our consolidated financial statements once adoption.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on our financial position, results of operations, and cash flows.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises principally from interest rate risk inherent in our lending, deposit, and borrowing activities. Management actively monitors and manages its interest rate risk exposure. In addition to other risks that we manage in the normal course of business, such as credit quality and liquidity, management considers interest rate risk to be a significant market risk that could potentially have a material effect on our financial condition and results of operations. The information contained in Item 2 in the section captioned "Interest Rate Sensitivity" is incorporated herein by reference. Other types of market risks, such as foreign currency risk and commodity price risk, do not arise in the normal course of our business activities.
 
     The primary objective of asset and liability management is to manage interest rate risk and achieve reasonable stability in net interest income throughout interest rate cycles. This is achieved by maintaining the proper balance of rate-sensitive earning assets and rate-sensitive interest-bearing liabilities. The relationship of rate-sensitive earning assets to rate-sensitive interest-bearing liabilities is the principal factor in projecting the effect that fluctuating interest rates will have on future net interest income. Rate-sensitive assets and liabilities are those that can be repriced to current market rates within a relatively short time period. Management monitors the rate sensitivity of earning assets and interest-bearing liabilities over the entire life of these instruments, but places particular emphasis on the next twelve months. At September 30, 2007, on a cumulative basis through 12 months, rate-sensitive assets exceeded rate-sensitive liabilities by $19.8 million. This asset -sensitive position is largely attributable to our variable rate loan portfolio.
 

Item 4. Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of September 30, 2007. There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended September 30, 2007, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings.

            There are no material legal proceedings to which the company or any of its subsidiaries is a party or of which any of their property is the subject.
 

Item 1A. Risk Factors.

     
          There were no material changes from the risk factors presented in our annual report on Form 10-K for the year ended December 31, 2006.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

              Not applicable.

Item 3. Defaults Upon Senior Securities.

             Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

       Not Applicable.

Item 5. Other Information.

Not applicable.

Item 6. Exhibits.

Exhibit Description

31.1                Rule 13a-14(a) Certification of the Principal Executive Officer
 

31.2                Rule 13a-14(a) Certification of the Principal Financial Officer

32                   Section 1350 Certifications

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SIGNATURES

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

                                                                                      BEACH FIRST NATIONAL BANCSHARES, INC.

Date: November 9, 2007                                            By:  /s/ Walter E. Standish, III     

                                                                                              Walter E. Standish, III
                                                                                              President and Chief Executive Officer

Date: November 9, 2007  By: /s/ Gary S. Austin

                                                         Gary S. Austin

                                                                                             Chief Financial and Principal Accounting Officer

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INDEX TO EXHIBITS

Exhibit

Number Description

31.1                   Rule 13a-14(a) Certification of the Principal Executive Officer

31.2                   Rule 13a-14(a) Certification of the Principal Financial Officer

32                      Section 1350 Certifications

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