U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-KSB

þ		ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

o		TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

BANK OF SOUTH CAROLINA CORPORATION

(Name of small business issuer in its charter)

South Carolina		57-1021355
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification Number)
256 Meeting Street, Charleston, SC		29401
(Address of principal executive offices)		(Zip Code)
Issuer’s telephone number: (843) 724-1500

Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:

Common Stock

(Title of Class)

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 þ No o

Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained to the best of the registrant’s knowledge, in definitive proxy information statements incorporated by reference in Part III of this Form 10-KSB or any amendments to this Form 10-KSB.

Not applicable

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No þ

Issuer’s revenues for its most recent fiscal year: $14,769,821

Aggregate market value of the voting stock held by non-affiliates, computed by reference to the closing price of such stock on February 23, 2007 was: $42,078,636

As of February 23, 2007, the Registrant has outstanding 3,929,908 shares of common stock.

Transitional Small Business Disclosure Format (check one): Yes o No þ

 

 

BANK OF SOUTH CAROLINA CORPORATION

AND SUBSIDIARY

Table of Contents

		Page
PART I
Item 1. Description of Business			3
Item 2. Description of Property			5
Item 3. Legal Proceedings			5
Item 4. Submission of Matters to a Vote of Security Holders			5
PART II
Item 5. Market for Common Equity and Related Stockholder Matters			6
Item 6. Management’s Discussion and Analysis or Plan of Operation			9
Item 7. Financial Statements			25
Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure			56
Item 8A. Controls and Procedures			56
Item 8B. Other Information			56
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act			57
Item 10. Executive Compensation			60
Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			66
Item 12. Certain Relationships and Related Transactions			69
Item 13. Exhibits			69
Item 14. Principal Accountant Fees and Services			70

PART I

Item 1. Description of Business

On February 26, 1987, The Bank of South Carolina (the “Bank”), a state-chartered financial institution, opened for business. Organized originally on October 22, 1986, the Bank was reorganized into a wholly-owned subsidiary of Bank of South Carolina Corporation (the “Company”), effective April 17, 1995. At the time of the reorganization, each outstanding share of the Bank was exchanged for two shares of Bank of South Carolina Corporation Stock.

The Company, a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended and as such, is under the supervisory and regulatory authority of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a bank holding company registered under the laws of the South Carolina Bank Holding Company Act, the Company is also subject to regulation by the South Carolina State Board of Financial Institutions. Thus, the Company is required to file annual reports and other information with the Federal Reserve and the South Carolina State Board of Financial Institutions regarding its financial condition, results of operations, management and intercompany relationships and transactions between the Company and its subsidiaries. The Company is publicly traded on the National Association of Securities Dealers Automated Quotations (NASDAQ), and is under the reporting authority of the Securities and Exchange Commission (SEC). Compliance with federal, state and local provisions regulating the discharge of materials into the environment had no material effect on the capital expenditures, earnings and competitive position of the Bank in fiscal year ended December 31, 2006.

The Company’s subsidiary bank, The Bank of South Carolina, is a state chartered financial institution, and as such, is subject to various statutory requirements, supervision and regulation, of which regular bank examinations are a part, promulgated and enforced primarily by the Federal Deposit Insurance Corporation (FDIC), through which the Bank is insured, and the South Carolina State Board of Financial Institutions. Since the primary asset of the Company is its wholly-owned subsidiary, the majority of the following discussion relates to the Bank.

The Bank serves Berkeley, Charleston and Dorchester counties (the “Tri-County Area”) as an independent, community-oriented commercial bank concentrating on individuals and small and medium-sized businesses desiring a high level of personalized services. The four banking house locations of the Bank include; 256 Meeting Street, Charleston, SC, 100 North Main Street, Summerville, SC, 1337 Chuck Dawley Boulevard, Mt. Pleasant, SC and 2027 Sam Rittenberg Boulevard, Charleston, SC.

The Bank offers a full range of deposit services. Checking account services include regular non-interest bearing checking accounts as well as interest bearing negotiable order of withdrawal (“NOW”) accounts. Savings and certificate of deposit accounts include accounts ranging from a daily maturity (regular savings and also money market accounts) to longer term certificates as authorized by regulation. The Bank offers tiered interest to its customers on both money market and NOW accounts. In addition, Individual Retirement Accounts are available. During 2006, the bank added health savings accounts to its deposit services. All deposit accounts are insured by the FDIC to the full amount permitted by law. Deposit accounts are solicited from individuals, businesses, professional organizations and governmental authorities.

Lending services include a full range of commercial, personal and mortgage loans. The Bank’s primary focus is on business lending. The types of commercial loans that are available include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of machinery and equipment. From time to time the Bank may make real estate loans for land acquisition, land development or construction loans. The types of personal loans that are available include secured and unsecured loans for such purposes as financing automobiles, home improvements, education, lot acquisition, construction, home equity loans and personal investments. The Bank offers a personal checking account related line of credit. This line of credit is available for both protection against unexpected overdrafts and also for the convenience of having a pre-arranged loan that can be activated simply by a check drawn on a personal checking account. In the fourth quarter of 1993, a residential mortgage lending department was opened with mortgage loans being provided through correspondent relationships. The Bank originates, processes and closes the loan and sells (each individually) to a correspondent.

The Bank offers credit cards (through correspondent banking services) including MasterCard ™ and Visa ™. The Bank does not have a proprietary automated teller machine but participates in a national ATM network through the Visa Debit Card Program. This service is called “Check Card” by the Bank and also offers purchases by the cardholder where Visa debit cards

are accepted worldwide using a direct charge to their checking account. Other services offered, but not limited to, include safe deposit boxes, letters of credit, travelers checks, direct deposit of payroll, social security and dividend payments and automatic payment of insurance premiums and mortgage loans. The Bank offers a courier service and ACH origination service as part of its deposit services for commercial customers. During 2001, the Bank introduced Internet Banking. This service is called “ESafe” by the Bank and offers twenty-four hour information, up-to-the minute account activity, automatic transfers or onetime transfers between accounts, actual images of customer checks, and statement viewing. The Bank’s website, www.banksc.com, provides direct access to public filings by the Company. In 2006, the Company implemented a direct stock purchase plan and a dividend reinvestment plan through Computershare.

The business of the Bank is not considered to be seasonal nor is the Bank’s business dependent on any one industry.

The Company’s accounting policies are discussed in Item 7, Note 1 to the Consolidated Financial Statements. Of these significant accounting policies, the Company considers its policies regarding the allowance for loan losses to be its most critical accounting policy due to the significant degree of management judgment. For additional discussion concerning the Company’s allowance for loan losses and related matters, see Item 6, “Allowance for Loan Losses”.

The Company was authorized by its Board of Directors at its December 1995, board meeting to repurchase up to 116,462 shares of its common stock on the open market from time to time, and, at its October, 1999 Board meeting, to repurchase up to 37,812 shares of its common stock on the open market from time to time, and, at its September, 2001 Board meeting, to repurchase up to 45,375 shares of its common stock on the open market from time to time. As of this date, 199,501 shares have been repurchased by the Company with 148 shares remaining that are authorized to be repurchased.

Since January 1, 1986, South Carolina law has permitted regional interstate banking. Pursuant to such law, several of the banks in the Tri-County Area have been acquired by banks with headquarters outside the State of South Carolina. In addition, South Carolina laws permit statewide branching by banks and savings and loan associations. During 2006 and 2005 several banks have applied to open offices in the Tri-County Area which will increase competition. In the Bank’s primary service area, there are 20 financial institutions, of which four are considered to have their headquarters in the Bank’s service area. In addition, there are two savings banks and various credit unions with offices in the Tri-County Area. The Bank encounters strong competition from these financial institutions as well as consumer and commercial finance companies, insurance companies, brokerage firms and other financial institutions, some of which are not subject to the same degree of regulation and restrictions as the Bank. Many of these competitors have substantially greater resources and lending limits than the Bank has and offer certain services, such as trust and international banking services, which the Bank is not providing. The Bank does, however, provide a means for clearing international checks and drafts through a third party or correspondent bank.

At year- end 2006, the Bank employed 69 people, 2 of whom are considered part time employees, none of whom are subject to a collective bargaining agreement. Management believes its relationship with its employees is excellent.

Item 2. Description of Property

The Bank leases its headquarters and office facilities at 256 Meeting Street in downtown Charleston. On June 30, 1995, the Bank was successful in renegotiating its lease for one hundred forty (140) months with two additional ten-year terms. Base rent was $26,432 monthly payable in advance for the first twenty (20) months and the remaining one hundred twenty (120) months of the term (which began March 1, 1997) and for the two (2) extensions of the original term is $24,801 per month in advance and is adjustable by 4% of the base rent every two years. The rent, payable in equal monthly installments of $29,014, will increase to $30,175 in March 2007. In addition, the Bank leases adjacent parking facilities at $2,928 per month.

In October of 1993, the Bank opened an office at 100 N. Main Street, Summerville, SC and entered into a lease agreement on August 9, 1993, with an original termination date of June 30, 1999, and two 5-year options to renew. In June of 2004, the bank was successful in renegotiating its 100 N. Main Street facilities lease beginning July 1, 2004 to an annual rent of $30,725 with an increase of $3,582 each year thereafter until July 1, 2009. The lease was a fixed rate of $2,262 through July 1, 2009, however, the new lease was negotiated so that the bank could remain in its current location with the option to expand. At the end of the five year term (June 30, 2009) The Bank of South Carolina will have three (3) ten (10) year options for renewal. During the renewal periods, the annual rent will be adjusted by the current Consumer Price Index (CPI) capped at 3% annually.

On November 1, 1995, the Bank entered into an agreement with an individual to lease property for construction of a new banking facility at 1337 Chuck Dawley Boulevard, Mt. Pleasant, SC. The original term of the lease is for fifteen (15) years with six (6) additional terms of five (5) years each. The base rent for the first ten (10) years was $2,250 per month paid in advance. Rent for years 11 through 15 and each six (6) option periods shall be adjusted to reflect an annualized return determined by multiplying the average yield on five (5) year U.S. Treasury Notes plus 150 basis points times an assumed raw land value of $325,000. The monthly rent, however, shall never be less than the original rent of $2,250 per month. In November 2005 it was determined that there would be no increase in the rent based on the above described formula.

In the first quarter of 1997, the Bank purchased one acre of land for approximately $838,000 in order to construct a full service banking office and operations center in the West Ashley community of Charleston. In March, 1998, the two-story, 12,000 square foot facility was completed at a cost of approximately $1,334,000 representing construction costs and furnishings.

All leased properties are in good order and condition.

Item 3. Legal Proceedings

In the opinion of management, there are no legal proceedings pending other than routine litigation incidental to its business. To the knowledge of management, no proceedings have been instituted or are contemplated by or against any governmental authority against or by the Company or the Bank.

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

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2006.

PART II

Item 5. Market for the Company’s Common Equity and Related Stockholder Matters

There were issued and outstanding 3,929,908 shares of the 6,000,000 authorized shares of common stock of the Company at the close of the Company’s fiscal year ended December 31, 2006. These outstanding shares were held by approximately 1,200 shareholders in nominee names and of record on December 31, 2006. The common stock of the Company is traded in the “capital market” by six market making investment banking firms. These firms are The Robinson-Humphrey Company, Inc., Sterne, Agee & Leach, Inc., Scott and Stringfellow, Inc., Nite Securities LP, Speer, Leeds & Kellogg and Howe Barnes . Stock quotations are available through the National Association of Securities Dealers Automated Quotations (NASDAQ) where the Bank’s shares are listed as BKSC.

According to information supplied by The Nasdaq Stock Market, the range of high and low bid quotations for each quarterly period in the fiscal years 2006, 2005 and 2004 has been as follows:

		2006								2005								2004
		High				Low				High				Low				High				Low
First Quarter			16.79				14.00				10.84				9.56				10.54				9.46
Second Quarter			17.60				15.03				12.79				10.55				10.14				8.98
Third Quarter			17.21				14.80				14.70				11.58				9.99				8.26
Fourth Quarter			17.21				15.63				15.24				13.38				10.18				9.21

The Board of Directors of Bank of South Carolina Corporation declared a quarterly dividend of $.15 per share to shareholders of record March 31, 2006, payable April 28, 2006; a 25% stock dividend to shareholders of record April 28, 2006, payable May 15, 2006; $.14 per share to shareholders of record June 30, 2006, payable July 31, 2006; $.14 per share to shareholders of record October 2, 2006, payable October 31, 2006; $.14 per share and a special $.10 per share to shareholders of record December 29, 2006, payable January 31, 2007.

The Board of Directors of Bank of South Carolina Corporation declared quarterly dividends in 2005 of $.12 per share to shareholders of record March 31, 2005, payable April 29, 2005; 10% stock distribution to shareholders of record April 29, 2005, payable May 16, 2005; $.12 per share to shareholders of record June 30, 2005, payable July 29, 2005; $.12 per share to shareholders of record September 30, 2005, payable October 31, 2005; $.15 per share to shareholders of record December 30, 2005, payable January 31, 2006.

The Board of Directors of Bank of South Carolina Corporation declared quarterly dividends in 2004 of $.11 per share to shareholders of record March 31, 2004, payable April 30, 2004; $.11 per share to shareholders of record June 30, 2004, payable July 30, 2004; $.11 per share to shareholders of record September 30, 2004, payable October 29, 2004; $.11 per share to shareholders of record December 31, 2004, payable January 31, 2005.

As of January 1, 2006, there were approximately 1,200 shareholders of record with shares held by individuals and in nominee names, and on February 23, 2007, the market price for the common stock of the Company was $15.95. It is the intent of the Company to continue paying dividends in the future.

Cash dividends, when declared, are paid by the Bank to the Company for distribution to shareholders of the Company. Certain regulatory requirements restrict the amount of dividends which the Bank can pay to the Company.

Consolidated Financial Highlights

		2006				2005				2004				2003				2002
For December 31:
Net Income		$	3,928,263			$	3,185,006			$	1,845,623			$	1,904,713			$	1,858,319
Selected Year End Balances:
Total Assets			243,472,740				222,517,526				201,235,286				187,342,649				169,480,463
Total Loans (1)			162,557,288				159,338,650				129,107,437				125,235,883				127,887,401
Investment Securities Available for Sale			40,897,855				39,833,240				45,638,694				26,489,162				21,536,340
Federal Funds Sold and Resale Agreements			26,857,657				10,600,904				15,476,959				22,522,973				8,324,145
Interest Bearing Deposits in Other Banks			7,990				7,872				7,783				7,725				7,653
Earning Assets			230,320,790				209,780,666				190,230,873				174,255,743				157,755,539
Deposits			215,316,901				197,847,314				179,070,078				166,142,512				144,448,211
Shareholders’ Equity			23,640,431				21,505,794				19,990,716				19,647,839				19,314,129
Weighted Average Shares Outstanding-Diluted			3,945,928				3,913,119				3,868,448				3,876,687				3,870,879
For the Year:
Selected Average Balances:
Total Assets			232,257,502				225,939,657				192,034,402				174,154,907				162,207,337
Total Loans (1)			159,659,211				147,844,856				123,923,761				130,056,441				117,654,356
Investment Securities Available for Sale			39,330,090				38,596,553				34,808,745				21,202,689				23,316,608
Federal Funds Sold and Resale Agreements			19,893,084				26,109,498				20,431,597				11,275,653				10,412,467
Interest Bearing Deposits in Other Banks			7,931				7,824				7,754				7,693				7,606
Earning Assets			218,890,316				212,558,731				179,171,857				162,542,476				151,391,038
Deposits			207,459,557				203,645,606				171,036,567				152,955,447				138,722,411
Shareholders’ Equity			22,841,402				20,867,968				19,904,862				19,626,907				19,474,929
Performance Ratios:
Return on Average Equity			17.20	%			15.26	%			9.27	%			9.70	%			9.54	%
Return on Average Assets			1.69	%			1.41	%			.96	%			1.09	%			1.15	%
Average Equity to Average Assets			9.83	%			9.24	%			10.37	%			11.27	%			12.01	%
Net Interest Margin			5.24	%			4.58	%			3.93	%			4.36	%			4.76	%
Net (Recoveries) Charge-offs to Average Loans			(0.02)	%			0.03	%			0.02	%			0.15	%			0.03	%
Allowance for Loan Losses as a Percentage of Total Loans (excluding mortgage loans held for sale)			.82	%			.65	%			.82	%			.94	%			1.17	%
Per Share:
Basic Earnings		$	1.01			$	.83			$	0.48			$	0.49			$	0.48
Diluted Earnings			1.00				.81				0.48				0.49				0.48
Year End Book Value			6.02				5.56				5.18				5.09				5.01
Cash Dividends Declared			0.67				0.51				0.44				0.44				0.59
Dividend Payout Ratio			63.76	%			48.39	%			66.89	%			61.87	%			80.98	%
Full Time Employee Equivalents			67				64				64				62				67

All share and per share data have been restated to reflect a 10% stock dividend declared on June 19, 2003, a 10% stock distribution declared on April 12, 2005 and a 25% stock dividend declared on April 11, 2006.

The following tables, as well as the previously presented consolidated financial highlights, set forth certain selected financial information concerning the Company and its wholly owned subsidiary. The information was derived from audited consolidated financial statements. The information should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, which follows, and the audited consolidated financial statements and notes which are presented elsewhere in this report.

		For Years Ended
		December 31,
		2006				2005				2004				2003				2002
Operating Data:
Interest and fee income		$	16,169,958			$	12,383,548			$	7,904,128			$	7,855,161			$	8,565,542
Interest expense			4,696,492				2,646,198				857,801				764,647				1,364,804
Net interest income			11,473,466				9,737,350				7,046,327				7,090,514				7,200,738
(Recovery) provision for loan losses			240,000				12,000				(103,000	)			9,230				195,000
Net interest income after (recovery) provision for loan losses			11,233,466				9,725,350				7,149,327				7,081,284				7,005,738
Other income			1,467,393				1,788,472				1,748,715				2,096,959				1,888,010
Other expense			6,703,716				6,529,267				6,073,609				6,261,182				6,088,861
Income before income taxes			5,997,143				4,984,555				2,824,433				2,917,061				2,804,887
Income tax expense			2,068,880				1,799,549				978,810				1,012,348				946,568
Net income		$	3,928,263			$	3,185,006			$	1,845,623			$	1,904,713			$	1,858,319
Basic income per share		$	1.01			$	0.83			$	0.48			$	0.49			$	0.48
Diluted income per share		$	1.00			$	0.81			$	0.48			$	0.49			$	0.48
Weighted average common shares-basic			3,900,707				3,859,351				3,857,411				3,857,411				3,859,465
Weighted average common shares – diluted			3,945,928				3,913,119				3,868,448				3,876,687				3,870,879
Dividends per common share		$	0.67			$	0.51			$	0.44			$	0.44			$	0.59

		As of
		December 31,
		2006				2005				2004				2003				2002
Balance Sheet Data:
Investment securities available for sale		$	40,897,855			$	39,833,240			$	45,638,694			$	26,489,162			$	21,536,340
Total loans(1)			162,557,288				159,338,650				129,107,437				125,235,883				127,887,401
Allowance for loan losses			1,294,994				1,017,175				1,043,901				1,169,627				1,361,438
Total assets			243,472,740				222,517,526				201,235,286				187,342,649				169,480,463
Total deposits			215,316,901				197,847,314				179,070,078				166,142,512				144,448,211
Shareholders’ equity			23,640,431				21,505,794				19,990,716				19,647,839				19,314,129

All share and per share data have been restated to reflect a 10% stock dividend declared on June 19, 2003, a 10% stock distribution declared on April 12, 2005, and a 25% stock dividend declared on April 11, 2006.

Item 6. Management’s Discussion and Analysis or Plan of Operations

Management’s discussion and analysis is included to provide the shareholders with an expanded narrative of the Company’s results of operations, changes in financial condition, liquidity and capital adequacy. This narrative should be reviewed in conjunction with the audited consolidated financial statements and notes included in this report. Since the primary asset of the Company is its wholly-owned subsidiary, most of the discussion and analysis relates to the Bank.

DISCUSSION OF FORWARD-LOOKING STATEMENTS

Management’s Discussion and Analysis of Financial Condition and Results of Operations and other portions of this annual report contain certain “forward-looking statements” concerning the future operations of the Bank of South Carolina Corporation. Management desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1996 and is including this statement for the express purpose of availing the Company of protections of such safe harbor with respect to all “forward-looking statements” contained in this Form 10-KSB. We have used “forward-looking statements” to describe future plans and strategies including our expectations of the Company’s future financial results. The following are cautionary statements. Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Company’s market area and the country as a whole, the ability of the Company to control costs and expenses, the ability of the Company to successfully address competitive products and pricing, loan delinquency rates, and changes in federal and state regulation. These factors should be considered in evaluating the “forward-looking statements” and undue reliance should not be placed on such statements.

CRITICAL ACCOUNTING POLICIES

The Company’s significant accounting policies are set forth in Note One of the consolidated financial statements. Of these policies, the Company considers its policy regarding the allowance for loan losses to be its most subjective accounting policy due to the significant degree of management judgement. The Company has developed what it believes to be appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company’s assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations and the discovery of information with respect to borrowers which were not known by management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Company’s allowance for loan losses and related matters, see “Allowance for Loan Losses”.

OVERVIEW

Earnings for the year ended December 31, 2006 were $3,928,263 or basic and diluted earnings per share of $1.01 and $1.00, respectively, an increase of 23.34% over 2005’s earnings of $3,185,006 or basic and diluted earnings per share of $.83 and $.81. Earnings for the fourth quarter of 2006 were $1,022,246 or basic and diluted earnings per share of $.26, respectively, up 7.3% from fourth quarter 2005 earnings of $952,671 or basic and diluted earnings per share of $.25 and $.24, respectively. Our return on average equity and return on average assets for the year were 17.20% and 1.69%, respectively, compared to the 2005 return on average equity and return on average assets of 15.26% and 1.41%, respectively.

During the first quarter of 2006, the Company declared a regular quarterly cash dividend of $.15 per share. In addition on April 11, 2006 the Company declared a 25% stock dividend effective May 15, 2006. The Company paid quarterly cash dividends of $.14 per share in the second, third and fourth quarter of 2006. A special cash dividend of $.10 per share was declared in the fourth quarter of 2006, in celebration of the twentieth anniversary of the opening of The Bank.

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2006 TO DECEMBER 31, 2005

Net income increased $743,257 from $3,185,006 in 2005, to $3,928,263 for 2006, an increase of 23.34%. Basic and diluted earnings per share increase to $1.01 and $1.00, respectively for 2006, compared to basic and diluted earnings per share of $.83 and $.81 in 2005. The increase is primarily due to an increase on interest and fees earned on loans as well as an increase in interest and dividends on investment securities. Interest and fees on loans increased $3,068,432 or 29.79% from $10,301,512 for the year ended December 31, 2005, to $13,369,944 for the year ended December 31, 2006. Interest and dividends on investment securities increased from $1,245,105 for the year ended December 31, 2005, to $1,812,842 for the year ended December 31, 2006, an increase of $567,737 or 45.60%.

Net interest and fee income increased 17.83% or $1,736,116, to $11,473,466 in 2006 from $9,737,350 in 2005. Net interest income depends upon the volume of and rates associated with interest earning assets and interest bearing liabilities, which result in the net interest spread. The net interest spread increased from 3.98% for the year ended December 31, 2005 to 4.26% for the year ended December 31, 2006. Average interest earning assets increased $6,331,585 to $218, 890,316 for the year ended December 31, 2006, from $212,558,731 in 2005. This increase is primarily due to an increase in average loans of $11,814,355 offset by a decrease in average federal funds sold of $6,216,414. The yield on average loans increased 141 basis points to 8.38% from 6.97% in 2005. Average investment securities available for sale increased $733,537 with an increase in the yield of 138 basis points to 4.61%. Average interest bearing liabilities increased $6,373,572 from $143,663,987 for the year ended December 31, 2005, to $150,037,559 for the year ended December 31, 2006. This increase is primarily due to an increase in average transaction accounts of $5,300,712 to $100,320,632 for the year ended December 31, 2006, from $95,019,920 in 2005. Average savings accounts also increased by $884,156 to $13,375,943 from $12,491,787. Net interest margin increased from 4.58% in 2005, to 5.24% in 2006.

Total interest and fee income earned on interest bearing assets, increased $3,786,410 or 30.58% to $16,169,958 for the year ended December 31, 2006, from $12,383,548. As noted above, average loans increased $11,814,355. As a result, interest and fees earned on loans increased $3,068,432 or 29.79% to $13,369,944 for the year ended December 31, 2006 from $10,301,512 in 2005. Average investment securities available for sale increased $733,537 to $39,330,090 from $38,596,553. Interest and dividends on investment securities increased $567,737 or 45.60% to $1,812,842 from $1,245,105.

Total interest expense increased $2,050,294 or 77.48% to $4,696,492 from $2,646,198. This increase is primarily due to an increase in rates paid on deposit accounts. Interest on deposits increased $2,035,180 or 77.47% to $4,662,283 for the year ended December 31, 2006 from $2,627,103 in 2005. The average cost of interest bearing liabilities increased 129 basis points from 1.84% in 2005 to 3.13% in 2006.

Total provision for loan losses for 2006 was $240,000 compared to $12,000 for 2005. The allowance for loan losses is based on management’s and the Loan Committee’s review and evaluation of the loan portfolio and general economic conditions on a monthly basis and by the Board of directors on a quarterly basis. Management’s review and evaluation of the allowance for loan losses is based on a historical review of the loan portfolio performance, analysis of the individual loans, and additional risk factors that affect the quality and ultimately the collectibility of the loan portfolio. These risk factors include; loan and credit administration risk, economic conditions, portfolio risk, loan concentration risk and off balance sheet risk which were added to the loan loss model during the first quarter of 2006. Management believes that the allowance for loan losses at December 31, 2006, is adequate to cover probable losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment. Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid. Thus there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required. For further discussion, see “Non accrual and Past Due Loans” and “Allowance for Loan Losses”.

Total non-interest income decreased $321,079 or 17.95% to $1,467,393 for the year ended December 31, 2006, from $1,788,472 in 2005. Mortgage banking income decreased 28.32% or $233,178, from $823,510 for the year ended December 31, 2005 to $590,332 in 2006. The decrease in mortgage income is primarily due to rising interest rates resulting in a slower real estate market. Mortgage loan origination fees, mortgage discount fees and tax and underwriting fees decreased $326,761 or 36.37%. During the second quarter of 2005 a correction was made for an error in a liability

clearing account. This correction was reflected as an increase of $142,971 in mortgage loan discount fees earned in 2005.

Service charge fees earned on business accounts decreased $25,695 or 16.73% between the year ended December 31, 2005 and 2006. There was also a decrease in overdraft fees of $31,813 or 8.61% for the same period. The service charge fees on business accounts decreased due to an increase in the earnings credit and higher average balances, which offset the service charges.

Bank overhead increased $174,449 or 2.67% to $6,703,716 for the year ended December 31, 2006 from $6,529,267 for the year ended December 31, 2005. The increase is primarily due to an increase of 4.61% in salaries and employee benefits as a result of annual merit increases.

Income tax expense increased $269,331 or 14.97% to $2,068,880 for the year ended December 31, 2006 from $1,799,549 for the year ended December 31, 2005. The Company’s effective tax rate was approximately 34.50% for the year ended December 31, 2006 compared to 36.10% for the year ended December 31, 2005.

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2005 TO DECEMBER 31, 2004

Net income increased $1,339,383 from $1,845,623 for 2004, to $3,185,006 for 2005, an increase of 72.57%. Basic and diluted earnings per share increased to $.83 and $.81, respectively for 2005, compared to basic and diluted earnings per share of $.48 for 2004. This increase is primarily due to an increase in interest and fees earned on loans caused by an increase in the volume of loans and an increase in interest rates earned on these loans. The interest and fees on loans increased $3,520,827 to $10,301,512 or 51.92% from $6,780,685 for the year ended December 31, 2004.

Net interest and fee income increased $2,691,023 or 38.19% to $9,737,350 from $7,046,327 for 2004. Net interest income depends upon the volume of and rates associated with interest earning assets and interest bearing liabilities, which result in the net interest spread. The net interest spread increased from 3.68% for the year ended December 31, 2004 to 3.99% for the year ended December 31, 2005. Average interest earning assets increased from $179,171,857 for the year ended December 31, 2004 to $212,558,731 for the year ended December 31, 2005. This increase is primarily due to the increase in average loans of $23,921,095. The yield on average loans increased 150 basis points to 6.97% from 5.47% for the year ended December 31, 2004. The average balance of investment securities available for sale and the average balance of federal funds sold increased $3,787,808 and $5,677,901, respectively. Average interest bearing liabilities increased from $117,834,551 for the year ended December 31, 2004 to $143,663,987 for the year ended December 31, 2005. This increase is primarily due to the increase in average transaction accounts as well as an increase in certificates of deposits of $21,886,912 and $7,018,523, respectively. The increase is offset slightly by a decrease in average saving accounts of $3,119,765. Net interest margin increased from 3.93% to 4.58% for the year ended December 31, 2005.

Total interest and fees earned on interest earning assets increased $4,479,420 or 56.67% to $12,383,548 for the year ended December 31, 2005. This increase is primarily due to the increase in average loans. The interest and fees on loans increased $3,520,827 or 51.92% to $10,301,512 for the year ended December 31, 2005 from $6,780,685 for the year ended December 31, 2004. The average balance of investment securities available for sale and the average balance of federal funds sold increased $9,465,709, collectively, which resulted in an 85.33% increase in the interest earned on these assets. The yield on average interest earning assets increased from 4.41% in 2004, to 5.83% in 2005.

Total interest expense increased $1,788,397 or 208.49% to $2,646,198 for the year ended December 31, 2005 from $857,801 for the year ended December 31, 2004. This increase is primarily due to an increase in average balance of transaction accounts and certificates of deposits. The interest on deposits increased $1,776,050 or 208.69% to $2,627,103 for the year ended December 31, 2005 from $851,053 for the year ended December 31, 2004. The average cost on interest bearing liabilities increased 111 basis points between years to 1.84% for the year ended December 31, 2005 from .73% for the year ended December 31, 2004.

Total provision for loan losses for 2005 was $12,000 compared to a recovery of loan losses of ($103,000) for 2004. The provision for loan losses is recorded in amounts sufficient to bring the allowance for loan losses to a level deemed appropriate by management. Management determines this amount based upon many factors, including its assessment of loan portfolio quality, loan growth, changes in the loan portfolio composition, net loan charge-off levels, and expected economic conditions. Based on these factors management believes that the allowance for loan losses is adequate to absorb probable losses in the loan portfolio based on an evaluation at December 31, 2005; however, the process of assessing adequacy of the allowance is a process that requires considerable judgement. For further discussion, see “Non accrual and Past Due Loans” and “Allowance for Loan Losses”.

Total non interest income increased $39,757 or 2.27% to $1,788,472 for the year ended December 31, 2005 from $1,748,715 for the year ended December 31, 2004. Mortgage banking income increased 30.91% to $823,510 for the year ended December 31, 2005. This increase is primarily due to an increase in both origination fees and the gain on the sale of the mortgage loans in the secondary market. Mortgage loan origination fees increased $132,208 or 49.00% to $402,044 for the year ended December 31, 2005 from $269,836 for the year ended December 31, 2004. Mortgage loans originated totaled $68,662,280 for the year ended December 31, 2005 compared to $58,767,560 for the year ended December 31, 2004. The discount fees earned on mortgage loans sold in the secondary market increased 89.64% to $453,384 for the year ended December 31, 2005 compared to $239,078 for the year ended December 31, 2004. This increase was primarily due to a correction of an error in accounting for a liability clearing account. The Company determined as of June 30, 2005, that the liability clearing account (discount points due investors) was not being properly recorded into mortgage banking income. The account was overstated by $142,971. The $142,971 was recorded as mortgage banking income for the twelve months ended December 31, 2005. Management determined that the error was not material to the financial statements. This increase is offset by a 36.84% increase in commissions paid due to the increase in volume of mortgage loan originations.

The increase in mortgage banking income is offset by a decrease in service charges and fees of $157,563 or 14.45% to $932,832 for the year ended December 31, 2005 from $1,090,395 for the year ended December 31, 2004. The fees earned on business accounts decreased $113,826 or 42.56% to $153,597 for the year ended December 31, 2005 from $267,423 for the year ended December 31, 2004. The decrease in the service charges on business accounts was caused by an increase in the earnings credit and an increase in average balances maintained, which offset the service charges.

Bank overhead increased $455,658 or 7.50% to $6,529,267 for the year ended December 31, 2005 from $6,073,609 for the year ended December 31, 2004. The increase is primarily due to an increase of 9.99% in salaries and employee benefits and an increase of 7.69% in other expenses. Salaries increased 9.97% to $3,067,094 from $2,788,957 as a result of annual merit increases and a one time bonus to all employees totaling $87,000. Health insurance increases as well as an increase in the ESOP contribution, also contributed to the increase in salaries and employee benefits. Although we were able to reduce many of our expenses in 2005, we saw an increase in fees paid for accounting fees and general insurance on the Bank.

Income tax expense increased $820,739 or 83.85% to $1,799,549 for the year ended December 31, 2005 from $978,810 for the year ended December 31, 2004. This increase is due to higher levels of income. The company’s effective tax rate was approximately 36.10% for the year ended December 31, 2005 and 34.66% for the year ended December 31, 2004.

ASSET AND LIABILITY MANAGEMENT

The assets and liabilities of the Company are managed to provide a consistent level of liquidity to accommodate normal fluctuations in loans and deposits. At year end 2006, total assets were $243,472,740 an increase of 9.42% from the end of the previous year, and total deposits were $215,316,901, an increase of 8.83% from the end of the previous year, while short-term borrowings, consisting of Demand Notes Issued to U.S. Treasury, increased $668,433 or 32.70% to $2,712,683 for the year ended December 31, 2006 from $2,044,250 for the year ended December 31, 2005.

At December 31, 2006, approximately 94.60% of the Company’s assets were earning assets composed of U.S. Treasury, Federal Agency and municipal securities in the amount of $40,897,855, Federal Funds Sold and interest bearing deposits in other banks in the amount of $26,865,647, and total loans including mortgage loans held for sale in the amount of $162,557,288.

The yield on a majority of the Company’s earning assets adjusts simultaneously with changes in the general level of interest rates. Some of the Company’s liabilities are issued with fixed terms and can be repriced only at maturity. During 2002 and 2003 loans continued to grow at a faster rate than deposits, however, our net interest margin declined by 29 basis points from January to December 2002 and 40 basis points from January to December 2003 with the decline in interest rates. During 2004 deposits grew at a faster rate than loans and our net interest margin decreased 43 basis points from January to December. In 2005 our loans grew 23.42% compared to an increase of 10.49% in deposits. As a result our net interest margin increased 65 basis points to 4.58% at December 31, 2005 compared to 3.93% for the year ended December 31, 2004. In 2006, deposits increased $17,469,587 or 8.83% with total loans including mortgage loans held for sale increasing $3,218,638 or 2.02%. The Company’s net interest margin increased 66 basis points to 5.24% for the year ended December 31, 2006, from 4.58% at December 31, 2005.

MARKET RISK

Market risk is the risk of loss from adverse changes in market prices and rates. For the Company, this risk is constituted primarily of interest rate risk in its lending and investing activities as they relate to their funding by deposit and borrowing activities.

The Bank’s policy is to minimize interest rate risk between interest bearing assets and liabilities at various maturities and to attempt to maintain an asset positive position over a 6 month period. In adhering to this policy, unless there is a sudden extraordinary drop in the interest rate, it is anticipated that the Bank’s net interest margins will not be materially affected by changes in interest rates. The net interest rate spread for 2006 increased to 4.26% from 3.99% for 2005 and the net interest margin for 2006 increased to 5.24% from 4.58% for 2005. Management will continue to monitor its asset sensitive position.

Since the rates on most of the Bank’s interest bearing liabilities can vary on a daily basis, management continues to maintain a loan portfolio priced predominately on a variable rate basis; however, in an effort to protect future earnings in a declining rate environment, the bank has begun to offer certain fixed rates and terms primarily associated with real estate transactions. The Bank seeks stable, long-term deposit relationships to fund its loan portfolio.

At December 31, 2006, the average maturity of the investment portfolio was 3 years 2.7 months with an average yield of 4.69% compared to 1 year 3.5 months with an average yield of 3.96% at December 31, 2005.

The Company does not take foreign exchange or commodity risks.

The following table summarizes the Bank’s interest sensitivity position as of December 31, 2006:

										3 Months				6 Months				1 Year
						Less				to Less				to Less				to Less												Estimated
Earning Assets						Than 3				Than 6				Than 1				Than 5				5 years								Fair
(in 000’s)		1 Day				Months				Months				Year				Years				or More				Total				Value
Loans (1)		$	117,844			$	8,051			$	8,898			$	7,464			$	18,858			$	1,442			$	162,557			$	166,817
Investment securities			—				—				—				315				37,969				2,580				40,864				40,898
Short term investments			8				—				—				—				—				—				8				8
Federal funds sold			26,858				—				—				—				—				—				26,858				26,858
Total		$	144,710			$	8,051			$	8,898			$	7,779			$	56,827			$	4,022			$	230,287			$	234,581
Interest Bearing Liabilities (in 000’s)
CD’s and other time deposits 100,000 and over		$	—			$	11,096			$	7,416			$	3,556			$	214			$	—			$	22,282			$	22,299
CD’s and other time deposits under 100,000			141				5,412				4,031				3,601				908				—				14,093				14,072
Money market and interest bearing demand accounts			105,844				—				—				—				—				—				105,844				105,844
Savings			15,370				—				—				—				—				—				15,370				15,370
Short term borrowings			2,713				—				—				—				—				—				2,713				2,713
		$	124,068			$	16,508			$	11,447			$	7,157			$	1,122			$	—			$	160,302			$	160,298
Net		$	20,642			$	(8,457	)		$	(2,549	)		$	622			$	55,705			$	4,022			$	69,985			$	74,283
Cumulative						$	12,185			$	9,636			$	10,258			$	65,963			$	69,985

LIQUIDITY

Historically, the Company has maintained its liquidity at levels believed by management to be adequate to meet requirements of normal operations, potential deposit outflows and strong loan demand and still allow for optimal investment of funds and return on assets. The following table summarizes future contractual obligations as of December 31, 2006:

		Payment Due by Period
			Total			Less than				1-5				After 5
						1 Year				Years				Years
Contractual Obligations (in 000’s)
Time deposits		$	36,375			$	35,253			$	1,122			$	—
Short-term borrowings			2,713				2,713				—				—
Operating leases			4,589				463				2,243				1,883
Total contractual cash obligations		$	43,677			$	38,429			$	3,365			$	1,883

The Bank manages its assets and liabilities to ensure that there is sufficient liquidity to enable management to fund deposit withdrawals, loan demand, capital expenditures, reserve requirements, operating expenses and dividends and to manage daily operations on an ongoing basis. Funds are primarily provided by the Bank through customer’s deposits, principal and interest payments on loans, mortgage loan sales, the sale or maturity of securities, temporary investments and earnings.

Proper liquidity management is crucial to ensure that the Company is able to take advantage of new business opportunities as well as meet the demands of its customers. Investment securities are an important tool in the Company’s liquidity management. Securities classified as available for sale may be sold in response to changes in interest rates, liquidity needs and/or significant prepayment risk. All of the securities presently owned by the Bank are classified as Available for Sale. Net cash provided by operations and deposits from customers have been the primary sources of liquidity for the Company. At December 31, 2006, the Bank had unused short-term lines of credit totaling approximately $15,500,000 (which are withdrawable at the lender’s option). Management believes that these sources are adequate to meet its liquidity needs. Liquidity at the parent company level is provided through cash dividends from the Bank and the capacity of the parent company to raise additional borrowed funds as needed.

Composition of Average Assets

		2006				2005				2004				2003				2002
Loans (1)		$	159,659,211			$	147,844,856			$	123,923,761			$	130,056,441			$	117,654,356
Investment securities available for sale			39,330,090				38,596,553				34,808,745				21,202,689				23,316,608
Federal funds sold and other investments			19,901,015				26,117,322				20,439,351				11,283,346				10,420,073
Non-earning assets			13,367,186				13,380,926				12,862,545				11,612,431				10,816,299
Total average assets		$	232,257,502			$	225,939,657			$	192,034,402			$	174,154,907			$	162,207,337

Average earning assets increased by $6,331,585 from 2005 to 2006. Average earning assets increased primarily as a result of an increase in loans and investment securities available for sale offset by a decrease in average federal funds sold. Average loans for 2006 were up $11,814,355 or 7.99% from 2005. Average investment securities available for sale increased $733,537 or 1.90% from 2005. Average federal funds sold decreased $6,216,307 or 23.80% from $26,117,322 at December 31, 2005 to $19,901,015 at December 31, 2005.

ANALYSIS OF CHANGES IN NET INTEREST INCOME

The following table shows changes in interest income and expense based upon changes in volume and changes in rates:

		2006 vs. 2005												2005 vs. 2004												2004 vs. 2003
										Net Dollar												Net Dollar												Net Dollar
		Volume				Rate				Change (1)				Volume				Rate				Change (1)				Volume				Rate				Change (1)
Loans (2)		$	870,323			$	2,198,109			$	3,068,432			$	1,456,982			$	2,063,845			$	3,520,827			$	(325,958	)		$	366,225			$	40,267
Investment securities available for sale			24,094				543,643				567,737				102,841				265,954				368,795				471,317				(603,167	)			(131,850	)
Federal funds sold and and other investments			(232,314	)			382,555				150,241				84,993				504,805				589,798				104,505				36,045				140,550
Interest Income		$	662,103			$	3,124,307			$	3,786,410			$	1,644,816			$	2,834,604			$	4,479,420			$	249,864			$	(200,897	)		$	48,967
Interest-bearing transaction accounts		$	94,708			$	1,133,240			$	1,227,948			$	150,115			$	1,067,146			$	1,217,261			$	43,707			$	96,624			$	140,331
Savings			14,469				162,438				176,907				(23,390	)			139,351				115,961				5,032				8,912				13,944
Certificates of deposit			2,463				627,862				630,325				103,721				339,107				442,828				10,001				(70,978	)			(60,977	)
Federal funds purchased			(825	)			0				(825	)			825				0				825				(268	)			(267	)			(535	)
Securities sold under agreements to repurchase			0				0				0				0				0				0				(176	)			(175	)			(351	)
Demand notes issued to U.S. Treasury			4,052				11,887				15,939				126				11,396				11,522				(969	)			1,711				742
Interest expense		$	114,867			$	1,935,427			$	2,050,294			$	231,397			$	1,557,000			$	1,788,397			$	57,327			$	35,827			$	93,154
Increase (decrease) in net interest income										$	1,736,116											$	2,691,023											$	(44,187	)

YIELDS ON AVERAGE EARNING ASSETS AND RATES ON AVERAGE INTEREST-BEARING LIABILITIES

		2006												2005												2004
						Interest				Average								Interest				Average								Interest				Average
		Average				Paid/				Yield/				Average				Paid/				Yield/				Average				Paid/				Yield/
		Balance				Earned				Rate (1)				Balance				Earned				Rate (1)				Balance				Earned				Rate (1)
Interest-Earning Assets
Loans		$	159,659,211			$	13,369,944				8.38	%		$	147,844,856			$	10,301,512				6.97	%		$	123,923,761			$	6,780,685				5.47	%
Investment securities available for sale			39,330,090				1,812,842				4.61	%			38,596,553				1,245,105				3.23	%			34,808,745				876,310				2.52	%
Investment securities held to maturity			—				—				—				—				—				—				—				—				—
Federal funds sold			19,893,084				987,054				4.96	%			26,109,498				836,842				3.21	%			20,431,597				247,074				1.21	%
Other investments			7,931				118				1.49	%			7,824				89				1.14	%			7,754				59				.76	%
Total earning assets		$	218,890,316			$	16,169,958				7.39	%		$	212,558,731			$	12,383,548				5.83	%		$	179,171,857			$	7,904,128				4.41	%
Interest-Bearing Liabilities:
Interest bearing transaction accounts		$	100,320,632			$	2,842,552				2.83	%		$	95,019,920			$	1,614,604				1.70	%		$	73,133,008			$	397,343				.54	%
Savings			13,375,943				368,861				2.76	%			12,491,787				191,954				1.54	%			15,611,552				99,281				.64	%
Certificates of deposit			35,630,096				1,450,870				4.07	%			35,523,778				820,545				2.31	%			28,505,255				354,429				1.24	%
Federal funds purchased			—				—				—				33,014				825				2.50	%			—				—				—
Securities sold under agreement to repurchase			—				—				—				—				—				—				—				—				—
Demand notes issued to U.S. Treasury			710,888				34,209				4.81	%			595,488				18,270				3.07	%			584,736				6,748				1.15	%
Total interest bearing liabilities		$	150,037,559			$	4,696,492				3.13	%		$	143,663,987			$	2,646,198				1.84	%		$	117,834,551			$	857,801				.73	%
Net interest spread											4.26	%											3.99	%											3.68	%
Net interest margin											5.24	%											4.58	%											3.93	%
Net interest income						$	11,473,466											$	9,737,350											$	7,046,327

INVESTMENT PORTFOLIO

The following is a schedule of the Bank’s investment portfolio as of December 31, 2006, as compared to December 31, 2005, and December 31, 2005 to December 31, 2004:

		DECEMBER 31, 2006
						GROSS				GROSS				ESTIMATED
		AMORTIZED				UNREALIZED				UNREALIZED				FAIR
		COST				GAINS				LOSSES				VALUE
U.S. Treasury Bonds		$	5,968,555			$	8,045			$	—			$	5,976,600
U.S. Treasury Notes			5,869,713				61,287				—				5,931,000
Federal Agency Securities			3,000,000				—				10,200				2,989,800
Government-Sponsored Agencies			20,798,027				64,356				58,883				20,803,500
Municipal Securities			5,228,611				29,344				61,000				5,196,955
Total		$	40,864,906			$	163,032			$	130,083			$	40,897,855

		DECEMBER 31, 2005
						GROSS				GROSS				ESTIMATED
		AMORTIZED				UNREALIZED				UNREALIZED				FAIR
		COST				GAINS				LOSSES				VALUE
U.S. Treasury Bills		$	23,858,701			$	—			$	29,701			$	23,829,000
Other U.S. Treasury Obligations			2,991,648				—				1,248				2,990,400
Federal Agency Securities			3,000,000				—				—				3,000,000
Government-Sponsored Agencies			5,944,483				—				23,683				5,920,800
Municipal Securities			4,120,820				25,753				53,533				4,093,040
Total		$	39,915,652			$	25,753			$	108,165			$	39,833,240

		DECEMBER 31, 2004
						GROSS				GROSS				ESTIMATED
		AMORTIZED				UNREALIZED				UNREALIZED				FAIR
		COST				GAINS				LOSSES				VALUE
U.S. Treasury Bills		$	39,786,310			$	—			$	37,021			$	39,749,289
Other U.S. Treasury Obligations			1,998,258				33,742				—				2,032,000
Federal Agency Securities			—				—				—				—
Government-Sponsored Agencies			1,997,889				40,111				—				2,038,000
Municipal Securities			1,740,000				79,405				—				1,819,405
Total		$	45,522,457			$	153,258			$	37,021			$	45,638,694

The Bank’s investment portfolio had a weighted average yield of 4.69%, 3.96% and 2.53% at December 31, 2006, 2005 and 2004, respectively.

LOAN PORTFOLIO COMPOSITION

The following is a schedule of the Bank’s loan portfolio as of December 31, 2006, as compared to December 31, 2005, 2004, 2003 and 2002:

		Book Value (in 000’s)
Type		2006				2005				2004				2003				2002
Commercial and industrial loans		$	53,609			$	52,373			$	44,829			$	46,687			$	46,908
Real estate loans			99,932				98,619				76,094				69,919				63,372
Loans to individuals for household, family and other personal expenditures			4,872				4,941				6,256				7,045				5,863
All other loans (including overdrafts)			259				170				225				215				63
Total Loans (excluding unearned income)		$	158,672			$	156,103			$	127,404			$	123,866			$	116,206

As a Bank with a mission to serve its community, there is a geographic concentration of loans in Charleston, Dorchester and Berkeley Counties.

The Bank had no foreign loans or loans to fund leveraged buyouts (LBO’s) during 2006, 2005, 2004, 2003 or 2002.

		SELECTED LOAN MATURITY (IN 000 ’S )
						Over one but
		One year				less than five				Over
Type		or less				years				five years				Total
Commercial and industrial loans		$	27,368			$	9,874			$	16,367			$	53,609
Real Estate Loans			30,530				13,825				55,577				99,932
Loans to individuals for household, family and other personal expenditures			2,119				1,111				1,642				4,872
All other loans (including overdrafts)			99				21				139				259
Total Loans (excluding unearned income)		$	60,116			$	24,831			$	73,725			$	158,672

IMPAIRED AND RESTRUCTURED LOANS

The Bank had impaired loans totaling $10,864 as of December 31, 2006 compared to $80,852, $65,751, $128,504 and $198,309 as of December 31, 2005, 2004, 2003 and 2002, respectively. The impaired loans include non-accrual loans with balances at December 31, 2006, 2005, 2004, 2003 and 2002 of $10,864, $80,852, $65,751, $102,588 and $198,309, respectively. The Bank had no restructured loans at December 31, 2006, one restructured loan included in non accrual loans at December 31, 2005 in the amount of $3,394, no restructured loans at December 31, 2004, one restructured loan in the amount of $25,916 at December 31, 2003 and no restructured loans at December 31, 2002. Management does not know of any loans, which will not meet their contractual obligations that are not otherwise discussed herein.

NON-ACCRUAL AND PAST DUE LOANS

The Bank had $10,864 in non-accrual loans as of December 31, 2006, compared to $80,852, $65,751, $102,588 and $198,309 as of December 31, 2005, 2004, 2003 and 2002, respectively. There were two loans over 90 days past due still accruing interest at December 31, 2006 in the amount of $44,534 and no loans over 90 days past due still accruing interest at December 31, 2005.

The accrual of interest is generally discontinued on loans, which become 90 days past due as to principal or interest. The accrual of interest on some loans, however, may continue even though they are 90 days past due if the loans are well secured, in the process of collection, and management deems it appropriate. If non-accrual loans decrease their past due status to 30 days for a period of six months, they are reviewed individually by management to determine if they should be returned to accrual status.

ALLOWANCE FOR LOAN LOSSES

The provision for loan losses is based on management’s and the Loan Committee’s review and evaluation of the loan portfolio and general economic conditions on a monthly basis and by the Board of Directors on a quarterly basis. Management’s review and evaluation of the allowance for loan losses is based on a historical review of the loan portfolio performance, analysis of individual loans, and additional risk factors that affect the quality and ultimately the collectibility of the loan portfolio. These risk factors include; loan and credit administration risk, economic conditions, portfolio risk, loan concentration risk and off balance sheet risk which were added to the loan loss model during the first quarter of 2006. Loans are charged off when, in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance and subsequent recoveries are added to the allowance.

The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustment based upon information that is available at the time of their examination.

All loan relationships are reviewed and classified in accordance with the Company’s loan policy. The Company’s classifications are generally based on regulatory definitions of classified assets for other loans especially mentioned, substandard loans, doubtful loans and loss loans. The Company annually reviews its overall Loan Policy.

The allowance for loan losses consists of an estimated reserve for classified loans and an estimated reserve for unclassified loans. Classified loans are assigned a loss estimate in the allowance for loan loss model based on their risk grade. The loss estimate is based on regulatory guidelines which the Company believes is an appropriate measure of the estimated loss on its classified loans. The loss estimate for classified loans is 5% for other loans especially mentioned and 15% for substandard loans. The loss estimate for doubtful and loss loans is 50% and 100%, respectively. Loans on the Company’s watch list have a loss estimate of 1.5%. Unclassified loans are assigned a loss ratio in the allowance for loan loss model based on the Company’s average historical loss experience for the previous five years, adjusted quarterly. The Company believes the five year historical loss ratio is a reasonable estimate of the existing losses in the unclassified loan portfolio. In addition, the reserve includes unclassified past due loans greater than 30 days at 2.5%. During the quarter ending March, 31, 2006 the Company reviewed its allowance for loan loss model and made changes to better reflect the risk in the portfolio. The changes included adding additional risk factors to the model. Loan and credit administration risk includes collateral documentation, insurance risk and maintenance of borrower’s financial information risks. A risk factor of .0625% was added to the model for each of the loan and credit administration risk. Economic conditions, international, national and local, have

an impact on the bank and the bank’s borrowers. Because the economic conditions are often macroeconomic in nature and cannot be controlled by the bank, a risk factor of .0625% has been added to the model for this risk. Portfolio risk includes portfolio growth and trends as well as over margined real estate lending risk. Loans increased significantly in 2005 and management is concerned about the lack of seasoning of this increase and its potential risk to our asset quality. From time to time the Company extends credit beyond our normal collateral advance percentages in our real estate lending. An excessive level of this lending practice may result in additional examiner scrutiny, competitive disadvantages, and potential losses if the collateral becomes acquired by the Company. Risk factors of .0625% and .25% have been added to the model for portfolio growth and trends and over margined real estate lending risks, respectively. The concentration risk factor includes loan concentration and geographic concentration. As of December 31, 2006, there were only five Standard Industrial Code groups that comprised more than three percent of our total loans outstanding. The market area of the Company is located along the coast and also located on an earthquake fault, increasing the chances of a natural disaster which would impact the Company and the Company’s borrowers. A risk factor of .0625% was added to the model for each of the concentration risk factors. Off balance sheet risk includes off balance sheet items that are unfunded amounts under existing approved lines of credit, letters of credit, Automated Clearing House activity and our potential liability for recourse in the mortgage loans we sell to investors. A risk factor of .025% has been added to the model for off balance sheet risk.

Based on the evaluation described above, the Company recorded a provision for loan losses of $240,000 for the year ended December 31, 2006 compared to a provision for loan losses of $12,000 for the year ended December 31, 2005. The Company believes that the five year historical average is more representative of the loss cycle of their portfolio based on their review of the timing of large losses in their portfolio and the fact that such losses would not be captured in the average loss ratio using a three-year period. Classified assets were $1.1 million at December 31, 2006 compared to $1.9 million at December 31, 2005.

Net recoveries were $37,819 in 2006 or .02% of average loans as compared to net charge-offs of $38,726 in 2005 or .03% of average loans. Uncertainty in the economic outlook still exists, making charge-off levels in future periods less predictable; however, loss exposure in the portfolio is identified, reserved and closely monitored to ensure that changes are promptly addressed in the analysis of reserve adequacy.

The allowance for loan losses increased $277,819 or 27.31% to $1,294,994 or .82% of total loans, excluding mortgage loans held for sale, at December 31, 2006 from $1,017,175 or .65% of total loans at December 31, 2005. Management believes the allowance for a loan loss at December 31, 2006 is adequate to cover probable losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment. Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid. Thus there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of the Company.

Management is currently watching the local real estate market which has had significant price appreciation in the last three years with a corresponding increase in cost and availability of insurance. We are currently seeing a slower real estate market, specifically an increase in days on market and modest price depreciation.

		SUMMARY OF LOAN LOSS EXPERIENCE
		December 31,
		2006				2005				2004				2003				2002
Allowance for loan losses, beginning of year		$	1,017,175			$	1,043,901			$	1,169,627			$	1,361,438			$	1,201,091
Charge-offs:
Commercial			9,164				—				89,308				62,827				51,856
Consumer			15,692				45,982				6,457				153,480				9,632
Real estate			—				—				—				—				—
Other			—				410				2,890				3,104				3,661
Total charge-offs			24,856				46,392				98,655				219,411				65,149
Recoveries:
Commercial			50,227				5,461				63,443				10,520				27,319
Consumer			4,233				2,145				12,486				6,590				2,287
Real estate			—				—				—				—				—
Other			8,215				60				—				1,260				890
Total recoveries			62,675				7,666				75,929				18,370				30,496
Net (recoveries) charge-offs			(37,819	)			38,726				22,726				201,041				34,653
Additions (recovery) to reserve through provision expense			240,000				12,000				(103,000	)			9,230				195,000
Allowance for loan losses, end of year		$	1,294,994			$	1,017,175			$	1,043,901			$	1,169,627			$	1,361,438

		DEPOSITS
										3 Months				6 Months				1 Year
						Less				to Less				to Less				to Less
						Than 3				Than 6				Than 1				Than 5				5 years
(in 000’s)		1 Day				Months				Months				Year				Years				or More				Total
CD’s and other time deposits 100,000 and over		$	—			$	11,096			$	7,416			$	3,556			$	214			$	—			$	22,282
CD’s and other time deposits under 100,000		$	141			$	5,412			$	4,031			$	3,601			$	908			$	—			$	14,093

OFF-BALANCE SHEET ARRANGEMENTS

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used by the Company for general corporate purposes or for customer needs. Corporate purpose transactions are used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customer’s requests for funding.

The Company’s off-balance sheet arrangements, consist principally of commitments to extend credit described below. At December 31, 2006 and 2005, the Company had no interests in non-consolidated special purpose entities.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and real estate. Commitments to extend credit, including unused lines of credit, amounted to $49,060,480 and $45,383,793 at December 31, 2006 and 2005 respectively.

Standby letters of credit represent an obligation of the Company to a third party contingent upon the failure of the Company’s customer to perform under the terms of an underlying contract with the third party or obligates the Company to guarantee or stand as surety for the benefit of the third party. The underlying contract may entail either financial or nonfinancial obligations and may involve such things as the shipment of goods, performance of a contract, or repayment of an obligation. Under the terms of a standby letter, generally drafts will be drawn only when the underlying event fails to occur as intended. The Company can seek recovery of the amounts paid from the borrower. The majority of these standby letters of credit are unsecured. Commitments under standby letters of credit are usually for one year or less. At December 31, 2006 and 2005, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor, as such amounts are not considered material. The maximum potential amount of undiscounted future payments related to standby letters of credit at December 31, 2006 and 2005 was $721,602 and $635,402, respectively.

The Company originates certain fixed rate residential loans and commits these loans for sale. The commitments to originate fixed rate residential loans and the sales commitments are freestanding derivative instruments. The fair value of these commitments was not significant at December 31, 2006 and 2005. The Company had forward sales commitments, totaling $4.0 million at December 31, 2006, to sell loans held for sale of $4.0 million. At December 31, 2005, the Company had forward sales commitments of $3.3 million. The fair value of these commitments was not significant at December 31, 2006 or 2005. The Company has no embedded derivative instruments requiring separate accounting treatment.

Once the Company sells certain fixed rate residential loans, the loans are no longer reportable on the Company’s balance sheet. With most of these sales, the Company has an obligation to repurchase the loan in the event of a default of principal or interest on the loan. This warranty period ranges from three to six months. The unpaid principal balance of loans sold with recourse was $25,441,000 at December 31, 2006 and $42,792,000 at December 31, 2005.

EFFECT OF INFLATION AND CHANGING PRICES

The consolidated financial statements have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and results of operations in terms of historical dollars without consideration of changes in the relative purchasing power over time due to inflation.

Unlike most other industries, the assets and liabilities of financial institutions such as the Bank are primarily monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. The Bank strives to manage the effects of inflation through its asset/liability management.

CAPITAL RESOURCES

The capital needs of the Company have been met to date through the $10,600,000 in capital raised in the Bank’s initial offering, the retention of earnings less dividends paid and the exercising of stock options of $124,000 in 1995, 1996, 1997, 1998, and $603,368 in 2006, for a total shareholders’ equity at December 31, 2006, of $23,640,431. The rate of asset growth from the Bank’s inception has not negatively impacted this capital base. Effective December 31, 1990, regulatory authorities adopted risk based capital guidelines for financial institutions. These risk based guidelines are designed to highlight differences in risk profiles among financial institutions and to account for off balance sheet risk. The guidelines established

require a risk based capital ratio of 8% for bank holding companies and banks. The risk based capital ratio at December 31, 2006, for the Bank was 12.16% and 11.64% at December 31, 2005. The Company’s management does not know of any trends, events or uncertainties that may result in the Company’s capital resources materially increasing or decreasing.

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and to average assets. Management believes, as of December 31, 2006, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

At December 31, 2006 and 2005, the Company and the Bank are categorized as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized” the Company and the Bank must maintain minimum total risk based, Tier 1 risk based and Tier 1 leverage ratios of 10%, 6% and 5% and to be categorized as “adequately capitalized,” the Company and the Bank must maintain minimum total risk based, Tier 1 risk based and Tier 1 leverage ratios of 8%, 4% and 4%, respectively. There are no current conditions or events that management believes would change the Company’s or the Bank’s category.

Please see “Notes to Consolidated Financial Statements” for the Company’s and the Bank’s various capital ratios at December 31, 2006.

THE BANK OF SOUTH CAROLINA EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST

During 1989, the Board of Directors of the Bank adopted an Employee Stock Ownership Plan and Trust Agreement to provide retirement benefits to eligible employees of the Bank for long and faithful service. The Board of Directors of the Bank approved the cash contribution of $330,000 to The Bank of South Carolina Employee Stock Ownership Plan for the fiscal year ended December 31, 2006. The contribution was made during 2006. An amendment and restatement was made to the Employee Stock ownership plan effective January 1, 2007, approved by the Board of Directors January 18, 2007. This amendment was made to comply with the Pension Protection Act of 2006. An application has been filed with the Internal Revenue Service for advance determination of the qualification of the Employee Stock Ownership Plan and Trust Agreement. All employees were notified of their right to express their opinion to Employee Plan Determinations, as to the qualification of the Employee Stock Ownership Plan and Trust Agreement. The Bank is the Plan Administrator. T. Dean Harton, Sheryl G. Sharry and Hugh C. Lane, Jr., currently serve as the Plan Administrative Committee and as Trustees for the Plan. The Plan currently owns 226,823 shares of common stock of Bank of South Carolina Corporation.

		1901 Main Street, Suit 1650 P.O. Box 2227 Columbia, SC 29202-2227
		Phone 803.256.0002 Fax 803.254.4724

Item 7. Financial Statements

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
Bank of South Carolina Corporation and subsidiary
Charleston, South Carolina

We have audited the accompanying consolidated balance sheet of Bank of South Carolina Corporation and subsidiary (the Corporation) as of December 31, 2006 and the related consolidated statement of operations, shareholders’ equity and comprehensive income, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bank of South Carolina Corporation and subsidiary at December 31, 2006, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

Elliott Davis, LLC
Columbia, South Carolina
February 20, 2007

www.elliottdavis.com

Report of Independent Registered Public Accounting Firm

The Board of Directors
Bank of South Carolina Corporation and subsidiary
Charleston, South Carolina

We have audited the accompanying consolidated balance sheet of Bank of South Carolina Corporation and subsidiary (the “Corporation”) as of December 31, 2005, and the related consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows for each of the years in the two-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bank of South Carolina Corporation and subsidiary as of December 31, 2005, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

Raleigh, North
Carolina February 24, 2006

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS

		DECEMBER 31,
		2006				2005
ASSETS
Cash and due from banks		$	9,747,621			$	9,663,790
Interest bearing deposits in other banks			7,990				7,872
Federal funds sold			26,857,657				10,600,904
Investment securities available for sale (amortized cost of $40,864,906 and $39,915,652 in 2006 and 2005, respectively)			40,897,855				39,833,240
Mortgage loans to be sold			3,960,728				3,330,312
Loans			158,596,560				156,008,338
Less: Allowance for loan losses			(1,294,994	)			(1,017,175	)
Net loans			157,301,566				154,991,163
Premises, equipment and leasehold improvements, net			2,662,086				2,741,085
Accrued interest receivable			1,474,703				919,502
Other assets			562,534				429,658
Total assets		$	243,472,740			$	222,517,526
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits:
Non-interest bearing demand		$	58,835,554			$	58,988,930
Interest bearing demand			48,557,628				47,109,142
Money market accounts			56,179,204				45,135,211
Certificates of deposit $100,000 and over			22,281,984				22,528,894
Other time deposits			14,092,859				12,555,221
Other savings deposits			15,369,672				11,529,916
Total deposits			215,316,901				197,847,314
Short-term borrowings			2,712,683				2,044,250
Accrued interest payable and other liabilities			1,802,725				1,120,168
Total liabilities			219,832,309				201,011,732
Shareholders’ equity:
Common stock — No par, 6,000,000 shares authorized; Issued 4,129,409 shares at December 31, 2006 and 4,064,607 at December 31,2005 Shares outstanding 3,929,908 at December 31, 2006 and 3,865,106 at December 31, 2005			—				—
Additional paid in capital			22,719,918				22,077,627
Retained earnings			2,592,719				1,173,050
Treasury stock; 199,501 shares at December 31, 2006 and 2005			(1,692,964	)			(1,692,964	)
Accumulated other comprehensive income (loss), net of income taxes			20,758				(51,919	)
Total shareholders’ equity			23,640,431				21,505,794
Total liabilities and shareholders’ equity		$	243,472,740			$	222,517,526
Commitments and contingencies (note 8)