**Exhibit 13**

 

**CommunitySouth**

**2007 Annual Report**

 

 

[Photo of executive management team

in front of CommunitySouth headquartersbuilding]

 

 

**Profitable Growth:**

**A Look Inside CommunitySouthBank& Trust**

 

----

 
| **CommunitySouth** |   | [South Carolina’s fastest  growing |
|--------------------|--------|-----------------------------------------|
| 2007 Annual Report |   | companies seal]                         |

 

CommunitySouth 2007 Annual Report is publishedby CommunitySouth Financial Corporation

6602 Calhoun Memorial Hwy, Easley, SC 29640

communitysouthbankandtrust.com l t: (864)306-2540 l f: (864) 306-3116

 

**CommunitySouth Board of Directors**

 

C. Allan Ducker, III

Chief Executive Officer

CommunitySouth

 

David A. Miller

President

Chief Operating Officer

CommunitySouth

 

John W. Hobbs

Chief Financial Officer

CommunitySouth

 

Daniel E. Youngblood

Board Chairman

Owner

Youngblood Development

 

Dave W. Edwards

Board Vice Chairman

Owner

Dave Edwards Toyota

 

D. Larry Brotherton, Ph.D.

Owner

Ortec, Inc.

 

G. Dial DuBose

Managing Partner

Nalley CommercialProperties

 

R. Wesley Hammond

President

HBJ Home Furnishings

 

Arnold J. Ramsey

Owner

Ramsey Appraisal Service

 

Dr. W. Michael Riddle

Oral and MaxillofacialSurgeon

 

Joanne M. Rogers

President

Lakeview Partners andPalmetto Storage

 

B. Lynn Spencer

Broker

Spencer/Hines Properties

 

J. Neal Workman, Jr.

Owner

Trehel Corporation

 

**CommunitySouth Senior ManagementTeam**

 

C. Allan Ducker, III

Chief Executive Officer

CommunitySouth

 

David A. Miller

President

Chief Operating Officer

CommunitySouth

 

John W. Hobbs

Chief Financial Officer

CommunitySouth

 

Barbra Anderson

Senior Vice President

Marketing Director

 

Tom Hale

Senior Vice President

Chief Credit Officer

 

Lary Heichel

Senior Vice President

Chief Risk Officer

 

Kathy King

Senior Vice President

Branch Coordinator

 

Darlene Nations

Vice President

Human Resources Director

 

Sandy Upton

Senior Vice President

Mortgage DepartmentManager

 

Buddy White

Senior Vice President

Services DepartmentManager

 

----

 

**CommunitySouth CorporateInformation**

 

Headquarters

CommunitySouth Financial Corporation

6602 Calhoun Memorial Hwy

Easley, SC 29640

866.421.CSBT

communitysouthbankandtrust.com

 

Annual Meeting

May 20, 2008 at 11:00 am

Marriott Hotel

One Parkway East

Greenville, SC 29615

 

Counsel

Nelson, Mullins, Riley &Scarborough, LLP 104

South Main Street, Suite 900

Greenville, SC 29601

 

Independent Auditors

Elliott Davis, LLC

200 East Broad Street

Greenville, SC 29601

 

Stock Transfer Agent

Registrar and Transfer Company

10 Commerce Drive

Cranford, NJ 07016

 

CommunitySouth Online

Visit our free investors resource center at

communitysouthbankandtrust.com. Click on“Investors” for SEC filings, financial news,

calculators, corporate information and more.

 

Annual Report & Form 10-KSB

Additional copies of CommunitySouth’s Annual

Report and Form 10-KSB are

available by writing to:

 

Shareholder Relations

CommunitySouth Financial Corporation

PO Box 2849

Easley, SC 29641

 

Stock Information

Symbol: CBSO

Over the Counter Bulletin Board

 

 

[CommunitySouth logo]

 

----

 

**Contents**

**AND FEATURES**

 

[Photo of executive management team in frontof headquarters building]

[Photo of top executives in front of FreeRefreshment Center][Photo of CommunitySouth****wrappedcourier car and wrapped ATM]

 

On the Cover

2  Profitable Growth: A Look Inside CommunitySouth

An in-depth interview with CommunitySouthChief Executive Officer Allan Ducker, President David Miller and ChiefFinancial Officer John Hobbs.

 

6   Bythe Numbers

A snapshot of CommunitySouth’s growth inassets, net income, loans, deposits, earnings per share, and more.

 

8  CommunitySouth Up Close

Profiles of CommunitySouth’s key executivesand its current branch presence.

 

11  Feature: What is Banking Unusual?

CommunitySouth unveiled its new tagline,Banking Unusual, in early 2007. What exactly does Banking Unusual mean and howdoes it reflect CommunitySouth’s brand?

 

13  Financial Review

Management’s discussion and analysis ofCommunitySouth’s financial condition and its results of operations.

 

30  Consolidated Financial Statements and Notes

CommunitySouth’s audited financialstatements.

 

51  Contributors

A full listing of CommunitySouth Bank &Trust employees.

 

----

 

[Photo of Allan Ducker and David Miller]

 

Profitable Growth:

A LOOK INSIDE COMMUNITYSOUTH BANK &TRUST

 

An interview with

CEO Allan Ducker

President David Miller

CFO John Hobbs

 

**Allan, an overview ofCommunitySouth’s 2007 performance seems like a good place to start.**

Allan Ducker, CEO: CommunitySouth had anoutstanding year in 2007, our third year of operation. In arguably the toughestyear for our industry in nearly two decades, CommunitySouth was able to reportsignificant growth in assets and earnings. Total assets for the year grew52.4%, while net earnings grew 35.5%, both top tier performances when comparedto our peers. Additionally, we maintained our focus on excellent creditquality, which we believe is the   reason we had only $65,000 in net loan charge-offs in 2007. Lastly, weopened our newest branch on Laurens Road in Greenville. This gives us a totalof six branches across the Upstate in only three years of operation. I guess it’ssafe to say that all of us at CommunitySouth have been extremely busy growingour franchise and building our brand.

 

**John, what factors were theprimary drivers of CommunitySouth’s performance?**

John Hobbs, CFO: I believe there were fivefactors that contributed to our outstanding performance in 2007. One obviousfactor was our continued focus on strong credit quality. Net charge-offs were0.02% of total loans in 2007. The second factor was growth in our earningassets, primarily loans. Total loans for 2007 grew 39.18%. We also reportedstrong revenue growth in our mortgage division. Mortgage origination fees were$998,111 for the year, which represents a 55% increase over 2006. One of ourkey initiatives in 2007 was to lower our overall funding costs, primarilythrough strategies aimed at increasing our core deposits, which we define aschecking, savings and money market accounts. I’m very pleased to report thatthese accounts grew $28.7 million, or 83.97%, in 2007. Lastly, we continued astrong focus on controlling our non-interest expenses in 2007. Our efficiencyratio for the year was 69%, which compares very favorably to our peers. Infact, we were in the top 16% of our peer group (all banks that opened in 2005)in this regard.

 

[Photo of John Hobbs]

 

----

 

**Allan, John just said creditquality and mortgages were strengths for CommunitySouth last year. Those areissues the banking industry struggled with in 2007. How were you able to turnthose industry negatives into positives?**

Allan: I believe our loan portfolio hasremained solid for several reasons. First and foremost, CommunitySouth was notand is not a subprime lender. Secondly, the majority of our portfolio iscomprised of customers that David or I or one of our community bankers have along-term satisfactory credit history with and have known for an extendedperiod of time. Furthermore, as a result of the softening real estate market,we have taken the proactive step of tightening our credit standards, especiallyin the areas of home equity loans, construction/development lending and realestate development lending in general. It’s true that the Upstate real estatemarket has softened; however, our local market has fared much better than otherareas of the country. While home sales in the Upstate (units) were down 4.5% in2007, total sales volume (dollars) rose 0.8%, the average sales price rose 4%,and our outlook for the commercial market remains optimistic. But the realpromising news is that the Greenville Spartanburg MSA had the lowestforeclosure rate in 2007 among the 100 largest MSAs in the nation.

 

**How do you think the recentdownturn in the economy and the mortgage business will affect CommunitySouth in2008? Did it affect you in 2007?**

Allan: As I mentioned earlier, CommunitySouthwas not and is not a participant in the subprime lending market. However, thecollapse of this segment of the market, along with the general softening of theeconomy, will have an impact on our mortgage business. Our mortgage divisionhad a banner year in 2007; but thus far in 2008, demand for mortgages, consumerand commercial loans has not been as high as it was in 2007.

 

**Core deposits, which you defineas checking, savings and money market accounts, grew $28.7 million in 2007.That was an 83.9% increase. What do you attribute that growth to?**

David Miller, President: The key to oursuccess has been determination and commitment to be the market’s best providerof deposit products and services. This commitment led us to develop a high tech/ high touch philosophy.  We’re high techin that we offer many of the commercial cash management deposit products thatthe big banks offer, but we provide a superior customer service experience andare more high touch than they can be. Many of our smaller bank competitors don’toffer the same high tech product line, which makes us a better choice for manybusinesses and consumers.

 

**Why is CommunitySouth leading somany of its de novo banking peers in asset growth and net income?**

Allan: There are a variety of financialreasons for this, including our significant growth in earning assets and efficientoperations. But I believe the real reason is much deeper and goes back to ourvision and culture. Our vision is real simple - to be the financial servicesprovider of choice in the markets we serve. We execute on this vision throughour culture statement, which hasn’t changed since we started the Bank. Ourfirst culture statement is the customer comes first. Our number one corporategoal always has been and always will be excellence in customer service, andthat is what really sets us apart. We have non-negotiable customer servicestandards, such as greeting customers on their second step in the lobby, ourfree refreshment center, extended hours, our no ATM fee policy, etc. We havetaken our vision and turned it into reality. It’s for this reason I trulybelieve we have outperformed our peers.

 

----

 

**It sounds like CommunitySouthenjoyed a lot of success in 2007. Of everything you accomplished last year,what are you most proud of?**

David: I would have to say I’m most proud ofour employees. The teamwork and cooperation throughout all areas of the bankare better than any other organization I’ve been involved with. I believe thisunique atmosphere is a direct result of our values and overall corporateculture. Our value statement describes the core characteristics we expect fromeach team member; for example, having a positive attitude, excellence,integrity, service, teamwork and leadership. With everyone united we’veachieved extraordinary results: 84% core deposit growth, 53% asset growth, andgrowth in profitability of 35.5%, all of which occurred in 2007.

 

[Photo of David Miller]

 

**Even with all you accomplished in2007, your stock price was down 37.5% in 2007. Why do you think that is?**

Allan: While CommunitySouth continued to growboth assets and earnings at an accelerated rate in 2007, the financial servicesindustry experienced one of its most tumultuous years in two decades. Theindustry is facing a multitude of issues, including continued margincompression, fierce competition, the subprime loan crisis, a declining realestate market, and increased delinquencies and related credit losses. As aresult of these issues, industry earnings were severely lagging in 2007. Infact, net  earnings for the financialservices industry were down in excess of 25% in 2007. For publicly tradedcompanies such as CommunitySouth, this negative news and a cautious outlook hasput negative pressure on the financial services equity markets, which in 2007experienced declines of 25% to greater than 40%. While the value of our stockwas down 37.5% in 2007, our board of directors and management team are verypleased with our growth and overall financial performance.

 

**Do you think the financialmarkets will come back soon?**

Allan: 2008 will continue to be a challengingyear for our industry, as the conditions I just described are expected topersist in 2008. For the financial markets to recover, industry earnings willhave to return to normal levels and we’ll have to demonstrate to the marketthat we have effectively managed through the credit quality issues currentlyplaguing the industry.

 

**David, CommunitySouth opened itsLaurens Road branch in Greenville in 2007. That makes six Upstate offices. Whatis your current branching strategy?**

David: We plan to continue branching acrossthe Upstate. We believe the Upstate market to be attractive due to a growingeconomy, favorable business climate, low cost of living, a talented pool ofcapable bankers, and an attractive cost of real estate to build branches.

 

Ultimately it’s our goal to be the easiestbank to do business with from both a commercial and consumer perspective. Andone of the key factors with consumers is convenience. With our free nationwideATMs and increased branch locations, we aim to  continuously improve our market presence.

 

So far we’ve averaged two branch openings ayear, and have offices in the four largest counties in the Upstate. Now it’stime to fill in the gaps within each county. In 2008 we’ll open on the westside of Spartanburg, but we also have plans to identify another Greenvillelocation.

 

----

 

Another key branching initiative beginningwith our West Spartanburg location is the development of our prototype bankingfacility. Our buildings aren’t just structures; they are an incrediblyimportant part of our brand. We’re working with Greenville-based architecturalfirm Freeman & Major Architects to design a prototype building thatwill reinforce who we are and how we do business. When completed, it will be avisual representation of our brand and will create a unique, welcomingenvironment for our customers.

 

**What are your top priorities for2008?**

Allan: Clearly 2008 will bring manychallenges and opportunities to our Company. To better respond to thesechallenges and opportunities, our board of directors and management planningteams underwent an intense strategic planning process that resulted in acomprehensive five year strategic plan, called Project 2012. This plan outlinesmany of our top priorities for 2008 and is the document by which we will managethe Bank.

 

Project 2012 has five key areas of focus.They are:

1.               Continuous improvement ofthe levels of financial performance that enhance stakeholder value. This areaincludes ensuring that we are, among other things, growing in a profitablemanner, funding and operating the Company as efficiently as possible,maintaining our solid credit quality, and expanding our market presence.

 

2.               Providing the customer withthe Banking Unusual experience to allow us to attract, expand and retaincustomer relationships. Key initiatives include providing our customers with aclearly different WOW level of service and ensuring we offer innovative andcompetitive products and services.

 

3.               Attracting, retaining anddeveloping the right employees. Although the technology has changed, the peopleaspect of banking has not. In this regard, it’s critical that we have the rightpeople in the right positions on the CommunitySouth team.

 

4.               Providing employees with thetools, technology and processes to do the right things to be done right withconsumers. This initiative is all about ensuring we have the technology,processes and procedures to make it easy for our customers to do their businesswith CommunitySouth, and for our employees to execute our customer servicestrategy.

 

5.               Continuing to develop theinfrastructure and maintaining the managing relationships of customers (MRC)culture. Our culture is a key driver of our success; it’s more than just wordson paper. Our culture is shared with every new employee on their first day, andis the way we as an organization collectively act and behave. This initiativeinvolves analyzing our culture to seek creative ways to enhance it and ensureit continues to be embraced by ALL employees.

 

[Photo of Allan Ducker]

 

----

 

**A recent CommunitySouthshareholder newsletter announced the creation of CommunitySouth InvestmentServices. Why did you create this new department?**

David: To be successful in today’senvironment you have to be more than just a bank. CommunitySouth is not just abank; we are a financial services provider. We offer insurance, investments,and cash management services. In order to provide the high touch customer carefor people who need these services, we created an entire department calledCommunitySouth Services. This    departmentis headed by Buddy White, an individual with over 20 years of experience in theindustry. With his expertise, along with additional staff specialists coveringinvestments and cash management, we provide a team approach to total customercare. Instead of just coming to the bank to get a loan, now we take care of allour customers’ needs from IRA rollovers, 401Ks, annuities, stock purchases,insurance and cash management.

 

**What do you think has been thedriving force behind the Bank’s success overall?**

David: I think it’s the unique culture weestablished at the beginning of the bank. When Allan and I first had the ideaof creating a bank, we asked the question, ‘what will make us different fromeveryone else?’ The answer revolved around our core philosophy: we wrote theword ‘customer’ on a piece of paper and circled it, and said everything wecreate from this point on will revolve around the customer. At the end of theday, the customer is what keeps you in business and many banks have driftedfrom this simple reality.

 

The next big difference is our goal ofcovering the entire Upstate. Most banks form in one town. The management team,the board and the shareholders are from that one location, so they tend to havea hard time growing past that one area. However, at CommunitySouth my customerbase has primarily been Spartanburg and Greenville and I’m a native ofSpartanburg. Allan’s primary customer base has been Easley, Anderson andSeneca, or the western region of the Upstate. Together we created a board withties to each Upstate community. We’ve also been fortunate enough to hire someof the best bankers in the Upstate that share our vision and customer servicephilosophy. It takes a total team effort for any company to achieve success. AtCommunitySouth we treat our customers and employees as family, and that hasmade all the difference.

 

**I noticed you introduced a newtagline last year. Tell me about Banking Unusual.**

Allan: I always tell our employees that ournumber one corporate goal always has been and always will be excellence incustomer service. Basically all banks offer the same products and services atgenerally the same price. It’s all about the customer relationships and themanner in which we deliver our products and services. The philosophy of BankingUnusual is to deliver a level of customer service that is clearly differentfrom our competitors.

 

I’ll give you a real life example. You wouldabsolutely not find this at any other bank. We’re known as the cookie bankbecause we bake fresh cookies daily. We don’t import them; we actually bakethem in ovens in our lobbies everyday. Our free refreshment center alsofeatures free coffee, soft drinks and bottled water. We have a customer with asmall business in town. Everyday he comes through the drive-thru and after hemakes his transaction, our teller sends him two chocolate chip cookies and a Dr. Pepperthrough the drive-thru to his truck. First, he won’t find this type of serviceat any other bank and secondly, he’s a loyal customer for life. Now that’sBanking Unusual.****

 

----

 

**By The Numbers – OTCBB: CBSO**

 

 
| Total Assets ($ Millions) |   | Annual Net Income ($ Thousands) |
|--------------------------------|--------|--------------------------------------|
| [Chart]                        |   | [Chart]                              |

 

 
| Total Net Loans/Deposits  ($ Millions) |   | Stock Price (Split  Adjusted) |
|---------------------------------------------|--------|-------------------------------|
| [Chart]                                     |   | (unaudited)                   |
|                                        |   | [Chart]                       |

 

 
| Return on Assets  (Annualized) |   | Return on Equity  (Annualized) |   | Earnings Per Share  (Diluted) |
|--------------------------------|--------|--------------------------------|--------|-------------------------------|
| (unaudited)                    |   | (unaudited)                    |   | [Chart]                       |
| [Chart]                        |   | [Chart]                        |   |                          |

 

----

 

[Full page advertisement]

 

Our customers don’t like paying ATM fees.

So they don’t.

 

That’s right! Use any ATM in the U.S. forfree. We’ll even pay the other bank’s ATM fee for you. Now that’s BankingUnusual!

 

But what else makes us so unusual?

·             FREE NationwideATMs

·             FREECommunitySouth Checks

·             FREE EZ SwitchKit

·             FREE OnlineBanking & Bill Pay

·             FREERefreshment Center with freshly baked cookies, hot coffee and soft drinks!

·             Extendedmorning, evening & Saturday hours

 

Want more information?

Get your FREE Switch Kit today. Stop by anyoffice or visit us online at communitysouthbankandtrust.com. What are youwaiting for?

 

Greenville  |  864-234-5556

2415 Laurens Road

 

Spartanburg  |  864-573-6347

531 East Main Street

 

Anderson  |  864-222-8444

1510 North Main Street

 

Greer  |  864-801-1165

530 W Wade Hampton Blvd

 

Mauldin  |  864-272-0825

787-G East Butler Road

 

Easley  |  864-306-2540

6602 Calhoun Mem’l Hwy

 

 

[CommunitySouth Logo]

 

 

Member FDIC

 

www.communitysouthbankandtrust.com

 

----

 

**COMMUNITYSOUTH:**

**>> Up Close**

 

In operation for just over three years,CommunitySouth Bank & Trust has grown its branch network to sixlocations in four of the largest Upstate counties: Greenville, Spartanburg,Anderson and Pickens Counties. The Bank is also planning on adding its secondbranch in Spartanburg, its seventh overall, in late 2008.

 

[Map of South Carolina]

 

[Branch photo]

Easley Headquarters

6602 Calhoun Memorial Hwy

Easley, SC 29640

Opened January 18, 2005

 

[Branch photo]

Mauldin

787 East Butler Road

Mauldin, SC 29662

Opened December 7, 2005

 

[Branch photo]

Spartanburg

531 East Main Street

Spartanburg, SC 29302

Opened January 30, 2006

 

[Branch photo]

Anderson

1510 North Main Street

Anderson, SC 29621

Opened July 31, 2006

 

[Branch photo]

Greer

530 W. Wade Hampton Boulevard

Greer, SC 29650

Opened November 20, 2006

 

[Branch photo]

Greenville

2415 Laurens Road

Greenville, SC 29607

Opened October 15, 2007

 

----

 

**Up Close**

 

[photo of Daniel Youngblood, David Miller,Allan Ducker and John Hobbs]

From left: Daniel Youngblood, David Miller,Allan Ducker, and John Hobbs.

 

 

**Daniel E. Youngblood**

BOARD CHAIRMAN

Mr. Youngblood, 52, has been the ownerand president of Youngblood Development Corp., a commercial and residentialreal estate development company, since 1983. He is also managing partner ofMainstream Golf, LLC and was owner and president of Century 21 Flynn &Youngblood, Inc. for over 20 years. Mr. Youngblood graduated fromClemson University with a Bachelor of Science degree in AdministrativeManagement.

 

 

**C. Allan Ducker, III**

CHIEF EXECUTIVE OFFICER

Mr. Ducker, 46, has over 24 years ofexperience as a banker. Prior to starting CommunitySouth, he served as seniorvice president and Pickens County executive for Carolina First Bank. Prior tothat, Mr. Ducker served as executive vice president and South Carolinastate president for MountainBank. Before joining MountainBank, Mr. Duckerserved as senior vice president and regional executive for Bank of America. Mr. Duckergraduated from The Citadel with a Bachelor of Science degree in BusinessAdministration.

 

 

**David A. Miller**

PRESIDENT AND CHIEF OPERATING OFFICER

Mr. Miller, 40, has over 18 years ofbanking experience. Prior to starting CommunitySouth, he served as senior vicepresident and city executive of Arthur State Bank. Prior to that, he served asteam leader and vice president of SouthTrust Bank. Prior to that he wascommercial lender and vice president of CCB Financial Corporation. Mr. Millergraduated from the University of South Carolina with a Bachelor of Sciencedegree in Business Administration and the University of Oklahoma NationalCommercial Lending School.

 

 

**John W. Hobbs**

CHIEF FINANCIAL OFFICER

Mr. Hobbs, 45, is a Certified PublicAccountant with over 19 years of banking experience. Prior to joiningCommunitySouth he served as chief financial officer of Carolina National Bank.Prior to joining Carolina National Bank, he served as the chief financialofficer of First National Bank of the Carolinas. Mr. Hobbs graduated fromthe University of South Carolina in 1984 with a Bachelor of Science degree inAccounting.

 

----

 

[Full page advertisement]

 
| “CommunitySouth saves my  business $200-$300 a month!” |
|------------------------------------------------------------------|
|                                                             | - Betty Winslett |
|                                                             | Owner, Winslett’s Produce |

 

[Photo of Betty Winslett]

 

“Our small business is busy in the spring,with lots of checks to deposit. Service fees at our old bank cost $200 to $300a month. But with our new Free Business Checking at CommunitySouth, we get 500items a month free, so we never have service fees. I enjoy CommunitySouth’sfree nationwide ATMs and my husband especially loves the cookies!”

 

Open your Free Business Checking Accounttoday:

·             NO Monthly Fee &No Minimum Balance

·             500 FREEMonthly Transactions

·             FREE BusinessCourier Service*

·             FREE NationwideATMs

·             FREE BusinessVISA Debit Card

·             FREE BusinessOnline Banking with Bill Pay

·             FREERefreshment Center with freshly baked cookies, hot coffee and soft drinks!

 

For more information or to open your FreeBusiness Checking, stop by any office or visit us online atcommunitysouthbankandtrust.com.

 

Greenville  |  864-234-5556

2415 Laurens Road

 

Spartanburg  |  864-573-6347

531 East Main Street

 

Anderson  |  864-222-8444

1510 North Main Street

 

Greer  |  864-801-1165

530 W Wade Hampton Blvd

 

Mauldin  |  864-272-0825

787-G East Butler Road

 

Easley  |  864-306-2540

6602 Calhoun Mem’l Hwy

 

[CommunitySouth Logo]

 

Member FDIC

www.communitysouthbankandtrust.com

 

----

* Not all businesses qualify for courier service. Contact us fordetails.

 

----

 

[Photo of CommunitySouth wrapped courier carin front of wrapped ATM]

 

**What is Banking Unusual?**

 

STEP INTO ANY COMMUNITYSOUTH OFFICE ANDEXPERIENCE THE BANKING UNUSUAL DIFFERENCE.

BUT WHAT EXACTLY IS BANKING UNUSUAL?

 

CommunitySouth Bank & Trust, the11th fastest growing company in South Carolina, unveiled its new tagline - BankingUnusual! - in early 2007. The tagline is definitely a departure from thetraditional bank brand. So what exactly is Banking Unusual?

 

“A tagline captures the essence of a company,and is an important component of the overall branding strategy,” said BarbraAnderson, Senior Vice President and Marketing Director for CommunitySouth Bank &Trust. “We believe that Banking Unusual! conveys the personality of our brandand more accurately describes who we are and how we do business.”

 

[Photo of Chip the Cookie JarTMwith child]

[Photo of CommunitySouth’s Free RefreshmentCenter]

[Photo of Chip the Cookie JarTMwith CommunitySouth employees]

 

The tagline reflects broader marketinginitiatives and branding strategies. CommunitySouth’s marketing department hasbeen working on several other initiatives designed to showcase the new taglineand promote what makes the Bank unique.

 

CommunitySouth’s free business courierservice received a facelift in 2007 in the form of new courier cars. The newChrysler PT Cruisers, loosely referred to as cookie mobiles, received a newpaint job to match the Bank’s new branding strategy. The eye-catching wrapincludes a photo of a large chocolate chip cookie covering the back passengerwindow.

 

“Our courier cars were wrapped to promotewhat makes CommunitySouth unusual,” said Anderson. “We offer more free and lessfee with nationwide free ATMs, free business courier service and our freefreshly baked cookies. It’s not everyday you drive by a car with a giganticchocolate chip cookie painted on it. It’s a real attention getter.”

 

The courier cars were recently joined bymatching ATMs. The Bank, who waives all ATM fees, decided to get theirfree ATM message out by wrapping its ATMs. And of course, included imagesof its freshly baked cookies.

 

“Our wrapped ATMs inform non-customers aboutour nationwide free ATM service and also give people a reason to come insideour branches,” said C. Allan Ducker, III, Chief Executive Officer ofCommunitySouth Bank & Trust. “We want to give customers an incentiveto come inside the office where they can take advantage of our free refreshmentcenter and get to know our friendly bankers. We believe our offices are veryinviting places for our customers to do business.”

 

The branding initiative also included aninterior sprucing up of the Bank’s six branches. Designed to create aconsistent and customer-friendly environment, the mini face-lift includedbranding the Bank’s free refreshment center with colorful signage,CommunitySouth-wrapped soda machines, cookie displays, and inviting welcomemats.

 

----

 

The Bank’s new mascot also made its debut in2007, and  children have been beggingtheir mom to have their photo taken with Chip the Cookie JarTM eversince.

 

“The mascot character is prettyself-explanatory,” said Anderson. “Our branches bake fresh cookies all daylong. We couldn’t have a bear or a squirrel as a mascot, we needed Chip theCookie JarTM. He fits perfectly.”

 

The mascot visits Bank branches and daycarecenters and attends local community events. Recently Chip has been visitinglocal elementary schools as part of a motivational program with Miss Easley,Ambra Yarbrough. “Chip has proven very popular with kids of all ages,” saidDucker. “We think he’s a great ambassador for CommunitySouth.”

 

But CommunitySouth knows that banking is morethan just free cookies and ATMs. Behind this marketing campaign’s cutesyexterior lies a serious purpose.

 

“Banking is a relationship business and atthe core of Banking Unusual is the goal to make banking less of a chore,” saidDucker. “And while we do unusual things like free cookies and free courierservice, the essence and personality of our company is about personalrelationships. For example, we have CommunitySouth umbrellas in the vestibulesof each branch. When it rains, we walk customers to their cars. It’s the littlethings that collectively have a huge importance.”

 

[Illustration of Chip the Cookie JarTM]

 

Learn more about Chip the Cookie JarTMby visiting communitysouthbankandtrust.com!

 

----

 

**Selected Financial Data**

 

The following selected financial data for theyears ended December 31, 2007, 2006 and 2005 was derived from theconsolidated financial statements and other data of CommunitySouth FinancialCorporation and its subsidiary, CommunitySouth Bank and Trust (the “Bank”)(collectively, the “Company”).  Theselected financial data should be read in conjunction with the consolidatedfinancial statements of the Company, including the accompanying notes, includedelsewhere herein.

 

On January 16, 2006, the Companyeffected a 5-for-4 stock split in the form of a stock dividend for shareholdersof record as of December 15, 2005. On January 16, 2007, the Companyeffected a 5-for-4 stock split in the form of a stock dividend for shareholdersof record as of December 15, 2006. All share and per share data has beenadjusted for all periods prior to the splits.

 
| **(Dollars in thousands except per share data)** | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Income Statement Data:**                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income – loans                                                   |       | $          | 21,403     |       | $          | 13,644     |       | $ | 4,544 |   |
| Interest income – investments                                             |       | 1,813      |       | 1,041      |       | 441        |       |
| Total interest income                                                          |       | 23,216     |       | 14,685     |       | 4,985      |       |
| Interest expense – deposits                                               |       | (13,069    | )          | (7,281     | )          | (1,863     | )          |
| Net interest income                                                            |       | 10,147     |       | 7,404      |       | 3,122      |       |
| Provision for loan losses                                                      |       | (1,188     | )          | (1,532     | )          | (1,558     | )          |
| Net interest income after provision for loan losses                            |       | 8,959      |       | 5,872      |       | 1,564      |       |
| Non-interest income                                                            |       | 1,575      |       | 842        |       | 321        |       |
| Non-interest expense                                                           |       | (8,184     | )          | (5,197     | )          | (2,680     | )          |
| Income (loss) before income taxes                                              |       | 2,350      |       | 1,517      |       | (795       | )          |
| Income tax (expense) benefit                                                   |       | (782       | )          | (360       | )          | 179        |       |
| Net income (loss)                                                              | ** ** | **$**      | **1,568**  | ** ** | **$**      | **1,157**  | ** ** | **$** | **(616** | **)** |
| ** **                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balance Sheet Data:**                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total assets                                                                   |       | $          | 377,867    |       | $          | 248,273    |       | $ | 136,826 |   |
| Earning assets                                                                 |       | 361,890    |       | 235,959    |       | 132,969    |       |
| Investment securities, available for sale (1)                                  |       | 24,844     |       | 100        |       | —     |       |
| Other investments (2)                                                          |       | 447        |       | 271        |       | 83         |       |
| Loans (3)                                                                      |       | 302,934    |       | 217,664    |       | 115,704    |       |
| Allowance for loan losses                                                      |       | (4,214     | )          | (3,091     | )          | (1,558     | )          |
| Deposits                                                                       |       | 327,664    |       | 217,031    |       | 106,972    |       |
| Shareholders’ equity                                                      |       | 31,471     |       | 29,695     |       | 28,286     |       |
| ** **                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Per-Share Data:**                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss) – basic                                                 |       | $          | 0.33       |       | $          | 0.25       |       | $ | (0.13 | ) |
| Net income (loss) – diluted                                               |       | 0.31       |       | 0.22       |       | (0.13      | )          |
| Book value                                                                     |       | 6.70       |       | 6.32       |       | 6.04       |       |
|                                                                           |       |       |       |       |       |       |       |
| **Return on Equity and Assets:**                                               |       |       |       |       |       |       |       |
| Return on average assets                                                       |       | 0.50       | %          | 0.59       | %          | (0.77      | )%         |
| Return on average equity                                                       |       | 5.12       | %          | 4.08       | %          | (2.24      | )%         |
| Average equity to average assets ratio                                         |       | 9.76       | %          | 14.53      | %          | 34.55      | %          |

 

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(1)   Marketablesecurities are stated at fair value.

(2)   Non-marketablesecurities are stated at cost.

(3)   Loans arestated at gross amounts before allowance for loan losses.

 

----

 

**Forward Looking Statements**

 

This report contains “forward-lookingstatements” within the meaning of the securities laws.  All statements that are not historical factsare “forward-looking statements.”  Youcan identify these forward-looking statements through our use of words such as “may,”“will,” “expect,” “anticipate,” “believe,” “intend,” “estimate,” “project,” “continue,”or other similar words.  Forward-lookingstatements include, but are not limited to, statements regarding our futurebusiness prospects, revenues, working capital, liquidity, capital needs,interest costs, income, business operations and proposed services.

 

These forward-looking statements arebased on current expectations, estimates and projections about our industry,management’s beliefs, and assumptions made by management.  Such information includes, withoutlimitation, discussions as to estimates, expectations, beliefs, plans,strategies, and objectives concerning our future financial and operatingperformance.  These statements are notguarantees of future performance and are subject to risks, uncertainties andassumptions that are difficult to predict, particularly in light of the factthat we are a new company with limited operating history. Therefore, actualresults may differ materially from those expressed or forecasted in suchforward-looking statements.  The risksand uncertainties include, but are not limited to:

 

·      our rapid growth to date andshort operating history;

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

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

·      changes in politicalconditions 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, adeterioration in credit quality;

·      changes occurring inbusiness conditions and inflation;

·      changes in technology;

·      changes in monetary and taxpolicies;

·      the lack of seasoning of ourloan portfolio, especially given our rapid loan growth;

·      the level of allowance forloan losses;

·      the rate of delinquenciesand amounts of charge-offs;

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

·      loss of consumer confidenceand economic disruptions resulting from terrorist activities;

·      changes in the securitiesmarkets; and

·      other risks anduncertainties detailed from time to time in our filings with the Securities andExchange Commission.

 

We undertake no obligation to publiclyupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise. In light of these risks, uncertainties, and assumptions, theforward-looking events discussed in this report may not occur.

 

*A copy of the our Annual Reporton Form 10-KSB for the fiscal year ended December 31, 2007, as filedwith the Securities and Exchange Commission, which contains a discussion ofcertain risks and uncertainties that could affect our forward-lookingstatements, will be sent to any shareholder without charge upon written requestto: CommunitySouth Financial Corporation, Attn: John W. Hobbs, Chief FinancialOfficer, 6602 Calhoun Memorial Highway, Easley, South Carolina 29640.*

 

**Market for Common Stock andDividends**

 

Since March 15, 2006, our common stock has been quoted on the OTCBulletin Board under the symbol “CBSO.” Quotations on the OTC Bulletin Boardreflect inter-dealer prices, without retail mark-up, mark-down, or commissions,and may not represent actual transactions. Transactions of our common stock did not begin to occur on the OTCBulletin Board until March 16, 2006.

 

The following is a summary of the high and low bidprices for our common stock reported by the OTC Bulletin Board for the periodsindicated (the bids prices have been adjusted for all stock splits):

 
| **2007**       | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| Fourth Quarter |       | $        | 11.40      |    | $          | 8.55 |   |
| Third Quarter  |       | 13.50    |       | 11.00   |       |
| Second Quarter |       | 15.90    |       | 12.75   |       |
| First Quarter  |       | 18.00    |       | 13.68   |       |
|                |            |          |            |         |            |  |  |

 

----

 
| **2006**       | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| Fourth Quarter |       | $        | 15.36      |    | $          | 10.80 |   |
| Third Quarter  |       | 14.40    |       | 12.00   |       |
| Second Quarter |       | 17.60    |       | 13.60   |       |
| First Quarter  |       | 15.60    |       | 15.20   |       |
|                |            |          |            |         |            |  |  |

 

As of December 31, 2007, there were 4,698,697 shares of commonstock outstanding held by approximately 945 shareholders of record.

 

We have not declared or paid any cash dividends on our common stocksince our inception.  For the foreseeablefuture we do not intend to declare cash dividends.  We intend to retain earnings to grow ourbusiness and strengthen our capital base. Our ability to pay dividends depends on the ability of our subsidiary,CommunitySouth Bank and Trust, to pay dividends to us.  As a South Carolina state bank,CommunitySouth Bank and Trust may only pay dividends out of its net profits,after deducting expenses, including losses and bad debts. In addition, the Bankis prohibited from declaring a dividend on its shares of common stock unlessits surplus equals or exceeds its stated capital. At December 31, 2007,the Bank’s surplus exceeded its stated capital by $1,970,050.

 

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**COMMUNITYSOUTH FINANCIAL CORPORATION**

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

 

**Basis of Presentation**

 

The following discussion should be read in conjunction with the Company’sFinancial Statements and the Notes thereto and the other financial dataincluded elsewhere in this Annual Report. The financial information provided below has been rounded in order tosimplify its presentation.  However, theratios and percentages provided below are calculated using the detailedfinancial information contained in the Consolidated Financial Statements, theNotes thereto and the other financial data included elsewhere in this AnnualReport.

 

# **General**

 

CommunitySouth Financial Corporation is a bank holding companyheadquartered in Easley, South Carolina. Its subsidiary, CommunitySouth Bankand Trust, opened for business on January 18, 2005.  The principal business activity of the Bankis to provide banking services to domestic markets, principally in the upstateof South Carolina.  The deposits of theBank are insured by the Federal Deposit Insurance Corporation (the “FDIC”). TheCompany completed an initial public offering of its common stock in which itsold a total of 4,681,069 shares at $6.40 per share (as adjusted for allprevious stock splits).  Proceeds of theoffering were used to pay organizational costs and provide the initial capitalfor the Bank.

 

# **Overview**

 

The following discussion describes our results of operations for theyears ended December 31, 2007 and 2006 and also analyzes our financialcondition as of December 31, 2007 and 2006.  We received approvals from the FDIC, theFederal Reserve Board (“FRB”) and the State Board of Financial Institutionsduring January 2005, and commenced business on January 18, 2005.

 

Like most community banks, we derive most of our income from interestwe receive on our loans and investments. Our primary source of funds for makingthese loans and investments is our deposits, on which we pay interest.Consequently, one of the key measures of our success is our amount of netinterest income, or the difference between the income on our interest-earningassets, such as loans and investments, and the expense on our interest-bearingliabilities, such as deposits. Another key measure is the spread between theyield we earn on these interest-earning assets and the rate we pay on ourinterest-bearing liabilities.

 

Of course, there are risks inherent in all loans, so we maintain anallowance for loan losses to absorb probable losses on existing loans that maybecome uncollectible. We establish and maintain this allowance by charging aprovision for loan losses against our operating earnings. We have included adetailed discussion of this process in the following section.

 

In addition to earning interest on our loans and investments, we earnincome through fees and other expenses we charge to our customers. We describethe various components of this non-interest income, as well as our non-interestexpense, in the discussion below.

 

# **Results of Operations**

 

***Results of operations are only presented for the years ended December 31,2007 and 2006.***

 

Net interest income increased $2.7 million, or 37.0%, to $10.1 millionin 2007, up from $7.4 million in 2006. The primary component of interest incomein 2007 was interest on loans, including fees, of $21.4 million, as compared to$13.6 million in 2006. The increase in net interest income was due primarily toan increase in average earning assets, which increased by $111.1 million, or58.8%, in 2007 due to continued growth in the loan portfolio during this thirdyear of operation.

 

The Company’s net interest spreads were 2.75% and 3.05% in 2007 and2006, respectively. The Company’s net interest margins were 3.38% and 3.92% in2007 and 2006, respectively.  Thisdecline of 54 basis points in the net interest margin was due to the increasedleveraging of our capital.  Yields onaverage earning assets decreased from 7.79% in 2006 to 7.74% in 2007. Rates onaverage interest bearing liabilities increased from 4.74% in 2006 to 4.99% in2007. These changes in yields and rates resulted in a net decrease in netinterest spread of 30 basis points. Average shareholder equity was 11.7% ofaverage interest bearing liabilities in 2007 and 18.4% of average interestbearing liabilities in 2006.

 

----

 

The provision for loan losses was $1.2 million in 2007, compared to$1.5 million in 2006.  The charges to theprovision were to maintain the allowance for loan losses at a level sufficientto cover estimated losses inherent in the loan portfolio.

 

Non-interest income increased $731,710, or 86.8%, to $1.6 million in2007, up from non-interest income of $842,510 in 2006. The increase is attributableto the $356,045 increase, or 55.5%, in mortgage loan origination fees, whichwas $998,111 for the year ended December 31, 2007 due to our increasedvolume in mortgage loan originations, and to the $222,048 increase inbank-owned life insurance. Service charges on deposit accounts increased$59,512, or 67.0%, to $148,338 in 2007, as compared to service charges ondeposit accounts of $88,826 in 2006, due to the increased volume in depositaccounts.

 

Non-interest expense increased $3.0 million, or 57.5%, to $8.2 millionin 2007, compared to non-interest expense of $5.2 million in 2006. Non-interestexpense increased in all categories as a result of our continued growth.Salaries and employee benefits increased $1.5 million to $4.3 million for theyear ended December 31, 2007. This increase is attributable to normal payincreases, hiring of additional staff to meet the needs associated with ourgrowth, including the opening of a full service branch during 2007, andincentive compensation for commercial lenders and branch managers. The Company’sefficiency ratio was 69.8% in 2007 compared to 63.0% in 2006. The efficiencyratio is defined as non-interest expense divided by the sum of net interestincome and non-interest income, net of gains and losses on sales ofassets.  The deterioration in ourefficiency ratio is primarily attributable to the increased expenses describedabove, which we incurred to position our Bank for anticipated growth

 

The Company’s net income was $1.57 million in 2007, compared to a netincome of $1.16 million in 2006. The net income for the year reflects ourcontinued growth, as average earning assets increased from $188.8 million in2006 to $299.8 million in 2007. Return on average assets during 2007 was 0.50%compared to a return of 0.59% in 2006. Net income was after an income taxexpense of $781,656 in 2007 and an income tax expense of $360,420 in 2006. Theincome tax expenses for 2007 and 2006 resulted in effective tax rates of 33.3%and 23.8%, respectively. See Notes 1 and 6 to the consolidated financialstatements for additional information about income taxes.

 

# **Net Interest Income**

 

***General****.* The largest component of the Company’s net income is its net interestincome, which is the difference between the income earned on assets andinterest paid on deposits and borrowings used to support such assets.  Net interest income is determined by theyields earned on the Company’s interest-earning assets and the rates paid onits interest-bearing liabilities, as well as the relative amounts ofinterest-earning assets and interest-bearing liabilities.  Net interest income divided by averageinterest-earning assets represents the Company’s net interest margin.  The net interest spread is the differencebetween the yield we earn on our interest-earning assets and the rate we pay onour interest-bearing liabilities.

 

***Rate/Volume Analysis****.* Net interest income can be analyzed in terms of the impact of changinginterest rates and changing volumes.  Thefollowing tables set forth the effect which the varying levels ofinterest-earning assets and interest-bearing liabilities and the applicablerates have had on changes in the net interest income for the periods presented.

 
| ** **                           | ** ** | **December 31, 2007 vs. 2006** | ** ** | **December 31, 2006 vs. 2005** | ** ** |
|--------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                           | ** ** | **Increase (decrease) Due to**      | ** ** | **Increase (decrease) Due to**      | ** ** |
| ** **                           | ** ** | ** **                                         | ** ** | ** **                                         | ** ** | **Rate /** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Rate /** | ** ** | ** ** | ** ** |
| **(Dollars in thousands)** | ** ** | **Volume**                                         | ** ** | **Rate**                                           | ** ** | **Volume** | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Total** | ** ** |
| Interest Income                      |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                |       | $                                                  | 7,852      |                                               | $          | (59 | ) | $ | (34 | ) | $ | 7,759 |   | $ | 7,395 |   | $ | 649 |   | $ | 1,056 |   | $ | 9,100 |   |
| Investment securities (1)            |       | 463                                                |       | 5                                                  |       | 182 |   | 650 |   | 10 |   | — |   | 2 |   | 12 |   |
| Federal funds                        |       | 131                                                |       | (8                                                 | )          | (1 | ) | 122 |   | 403 |   | 97 |   | 88 |   | 588 |   |
| Total Interest Income                | ** ** | **$**                                              | **8,446**  | ** **                                         | **$**      | **(62** | **)** | **$** | **147** | ** ** | **$** | **8,531** | ** ** | **$** | **7,808** | ** ** | **$** | **746** | ** ** | **$** | **1,146** | ** ** | **$** | **9,700** | ** ** |
|                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Expense                     |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                             |       | $                                                  | 5,001      |                                               | $          | 429 |   | $ | 295 |   | $ | 5,725 |   | $ | 4,175 |   | $ | 384 |   | $ | 860 |   | $ | 5,419 |   |
| Other borrowings                     |       | —                                             |       | —                                             |       | 63 |   | 63 |   | (1 | ) | (1 | ) | 1 |   | (1 | ) |
| Total Interest Expense               | ** ** | **$**                                              | **5,001**  | ** **                                         | **$**      | **429** | ** ** | **$** | **358** | ** ** | **$** | **5,788** | ** ** | **$** | **4,174** | ** ** | **$** | **383** | ** ** | **$** | **861** | ** ** | **$** | **5,418** | ** ** |
|                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net Interest Income                  | ** ** | **$**                                              | **3,445**  | ** **                                         | **$**      | **(491** | **)** | **$** | **(211** | **)** | **$** | **2,743** | ** ** | **$** | **3,634** | ** ** | **$** | **363** | ** ** | **$** | **285** | ** ** | **$** | **4,282** | ** ** |

 

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(1)          For the purpose of thistable, the investment securities include marketable and non-marketablesecurities.

 

----

 

***Average Balances, Income andExpenses and Rates****.*  The followingtable sets forth, for the years ended December 31, 2007 and 2006,information related to the Company’s average balance sheet and its averageyields on earning assets and average costs of interest-bearingliabilities.  Such yields are derived bydividing income or expense by the average balance of the corresponding earningassets or interest-bearing liabilities. Average balances have been derived from the daily balances throughoutthe periods indicated.

 
| ** **                                      | ** ** | **2007**    | ** **  | **2006**          | ** ** |
|-------------------------------------------------|------------|-------------|-------------|-------------------|------------|
| ** **                                      | ** ** | **Average** | ** **  | **Income /** | ** ** | **Yield /** | ** ** | **Average** | ** ** | **Income /** | ** ** | **Yield /** | ** ** |
| **(Dollars in thousands)**            | ** ** | **Balance** | ** **  | **Expense**       | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                      |       |        |        |              |       |   |   |   |   |   |   |   |   |
| Earning assets:                                 |       |        |        |              |       |   |   |   |   |   |   |   |   |
| Loans (1)                                       |       | $           | 264,844     |              | $          | 21,403 |   | 8.08 | % | $ | 168,107 |   | $ | 13,644 |   | 8.12 | % |
| Investment securities (2)                       |       | 12,067      |        | 663               |       | 5.49 | % | 330 |   | 13 |   | 3.94 | % |
| Federal funds sold and other                    |       | 22,914      |        | 1,150             |       | 5.02 | % | 20,325 |   | 1,028 |   | 5.06 | % |
| Total earning assets                            |       | 299,825     |        | 23,216            |       | 7.74 | % | 188,762 |   | 14,685 |   | 7.79 | % |
| Cash and due from banks                         |       | 4,720       |        |              |       |   |   | 2,984 |   |   |   |   |   |
| Premises and equipment                          |       | 4,953       |        |              |       |   |   | 4,031 |   |   |   |   |   |
| Other assets                                    |       | 7,856       |        |              |       |   |   | 1,694 |   |   |   |   |   |
| Allowance for loan losses                       |       | (3,686      | )           |              |       |   |   | (2,294 | ) |   |   |   |   |
| Total assets                                    | ** ** | **$**       | **313,668** | ** **        | ** ** |   |   |   | **$** | **195,177** |   |   |   |   |   |
|                                            |       |        |        |              |       |   |   |   |   |   |   |   |   |
| **Liabilities**                                 |       |        |        |              |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                   |       |        |        |              |       |   |   |   |   |   |   |   |   |
| Repurchase agreements                           |       | $           | 2,315       |              | $          | 63 |   | 2.72 | % | $ | — |   | $ | — |   | — | % |
| Interest-bearing transaction accounts           |       | 11,520      |        | 196               |       | 1.70 | % | 3,991 |   | 59 |   | 1.47 | % |
| Savings deposits                                |       | 19,107      |        | 648               |       | 3.39 | % | 10,234 |   | 363 |   | 3.55 | % |
| Time deposits                                   |       | 228,748     |        | 12,162            |       | 5.32 | % | 139,535 |   | 6,859 |   | 4.92 | % |
| Total interest-bearing liabilities              |       | 261,690     |        | 13,069            |       | 4.99 | % | 153,760 |   | 7,281 |   | 4.74 | % |
| Demand deposits                                 |       | 18,864      |        |              |       |   |   | 11,429 |   |   |   |   |   |
| Accrued interest and other liabilities          |       | 2,492       |        |              |       |   |   | 1,627 |   |   |   |   |   |
| Total liabilities                               |       | 283,046     |        |              |       |   |   | 166,816 |   |   |   |   |   |
| Shareholders’ equity                       |       | 30,622      |        |              |       |   |   | 28,361 |   |   |   |   |   |
| Total liabilities and shareholders’ equity | ** ** | **$**       | **313,668** | ** **        | ** ** |   |   |   | **$** | **195,177** |   |   |   |   |   |
|                                            |       |        |        |              |       |   |   |   |   |   |   |   |   |
| Net interest income                             | ** ** | ** **  | ** **  | **$**             | **10,147** |   |   |   |   |   | **$** | **7,404** |   |   |   |
| Net interest spread                             | ** ** | ** **  | ** **  | ** **        | ** ** | **2.75** | **%** | ** ** | ** ** | ** ** | ** ** | **3.05** | **%** |
| Net interest margin                             | ** ** | ** **  | ** **  | ** **        |       | **3.38** | **%** |   |   |   |   | **3.92** | **%** |

 

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(1)          There were $35,172 and$283,934 of loans in non-accrual status as of December 31, 2007 and 2006,respectively.  The effect of feescollected on loans in 2007 and 2006 totaled $654,596 and $527,248,respectively, and increased the annualized yield on loans by 25 basis pointsfrom 7.83% for 2007 and by 32 basis points from 7.80% for 2006.  The effect of such fees on the annualizedyield on earning assets was an increase of 22 basis points from 7.52% in 2007and an increase of 28 basis points from 7.51% in 2006.  The effects of such fees on net interest spreadwere an increase of 22 basis points from 2.53% for 2007 and an increase of 28basis points from 2.77% for 2006.  Theeffects of such fees on net interest margin were an increase of 21 basis pointsfrom 3.17% for 2007 and an increase of 27 basis points from 3.65% for 2006.

 

(2)          For the purpose of thistable, the investment securities include marketable and non-marketablesecurities.

 

----

 

***InterestSensitivity****.*  The Company monitors and manages the pricingand maturity of its assets and liabilities in order to diminish the potentialadverse impact that changes in interest rates could have on its net interestincome.  The principal monitoringtechnique employed by the Company is the measurement of the Company’s interestsensitivity “gap”, which is the positive or negative dollar difference betweenassets and liabilities that are subject to interest rate repricing within agiven period of time.  Interest ratesensitivity can be managed by repricing assets or liabilities, sellingsecurities available for sale, replacing an asset or liability at maturity, oradjusting the interest rate during the life of an asset or liability. Managingthe amount of assets and liabilities repricing in this same time interval helpsto hedge the risk and minimize the impact on net interest income of rising orfalling interest rates.

 

The following table setsforth the Company’s interest rate sensitivity at December 31, 2007.

 
| ** **                                      | ** ** | ** ** | ** **  | **After**   | ** ** | ** **   | ** ** | ** **  | ** **  | ** ** | ** ** |
|-------------------------------------------------|------------|------------|-------------|-------------|------------|--------------|------------|-------------|-------------|------------|------------|
| ** **                                      | ** ** | ** ** | ** **  | **Three**   | ** ** | **One**      | ** ** | **Greater** | ** **  | ** ** | ** ** |
| ** **                                      | ** ** | **Within** | ** **  | **Through** | ** ** | **Through**  | ** ** | **Than**    | ** **  | ** ** | ** ** |
| ** **                                      | ** ** | **Three**  | ** **  | **Twelve**  | ** ** | **Five**     | ** ** | **Five**    | ** **  | ** ** | ** ** |
| **(Dollars in thousands)**            | ** ** | **Months** | ** **  | **Months**  | ** ** | **Years**    | ** ** | **Years**   | ** **  | **Total**  | ** ** |
| **Assets**                                      | ** ** | ** ** | ** **  | ** **  | ** ** | ** **   | ** ** | ** **  | ** **  | ** ** | ** ** |
| Earning assets:                                 |       |       |        |        |       |         |       |        |        |       |       |
| Loans, gross                                    |       | $          | 155,755     |        | $          | 22,856       |       | $           | 112,450     |       | $          | 11,873 |   | $ | 302,934 |   |
| Investment securities, available for sale       |       | 2,001      |        | 2,001       |       | 11,621       |       | 9,221       |        | 24,844     |       |
| Other investments                               |       | —     |        | —      |       | —       |       | 447         |        | 447        |       |
| Fed Funds                                       |       | 33,665     |        | —      |       | —       |       | —      |        | 33,665     |       |
| Total earning assets                            |       | 191,421    |        | 24,857      |       | 124,071      |       | 21,541      |        | 361,890    |       |
|                                            |       |       |        |        |       |         |       |        |        |       |       |
| **Liabilities**                                 |       |       |        |        |       |         |       |        |        |       |       |
| Interest-bearing liabilities:                   |       |       |        |        |       |         |       |        |        |       |       |
| Interest-bearing deposits:                      |       |       |        |        |       |         |       |        |        |       |       |
| Repurchase agreements                           |       | —     |        | 15,000      |       | —       |       | —      |        | 15,000     |       |
| Demand deposits                                 |       | 13,721     |        | —      |       | —       |       | —      |        | 13,721     |       |
| Savings deposits                                |       | 24,634     |        | —      |       | —       |       | —      |        | 24,634     |       |
| Time deposits                                   |       | 31,712     |        | 215,262     |       | 17,871       |       | —      |        | 264,845    |       |
| Total interest-bearing liabilities              |       | 70,067     |        | 230,262     |       | 17,871       |       | —      |        | 318,200    |       |
| Period gap                                      | ** ** | **$**      | **121,354** | ** **  | **$**      | **(205,405** | **)**      | **$**       | **106,200** | ** ** | **$**      | **21,541** | ** ** | **$** | **43,690** | ** ** |
| Cumulative gap                                  | ** ** | **$**      | **121,354** | ** **  | **$**      | **(84,050**  | **)**      | **$**       | **22,150**  | ** ** | **$**      | **43,691** | ** ** | **$** | **43,690** | ** ** |
| Ratio of cumulative gap to total earning assets | ** ** | **33.53**  | **%**       | **(23.23**  | **)%**     | **6.12**     | **%**      | **12.07**   | **%**       | **12.07**  | **%**      |

 

The above table reflects the balances of interest-earning assets andinterest-bearing liabilities at the earlier of their repricing or maturitydates.  Overnight federal funds arereflected at the earliest pricing interval due to the immediately availablenature of the instruments.  Scheduledpayment amounts of fixed rate amortizing loans are reflected at each scheduledpayment date.  Scheduled payment amountsof variable rate amortizing loans are reflected at each scheduled payment dateuntil the loan may be repriced contractually; the unamortized balance isreflected at that point. Interest-bearing liabilities with no contractual maturity, such as savingsdeposits and interest-bearing transaction accounts, are reflected in theearliest repricing period due to contractual arrangements which give theCompany the opportunity to vary the rates paid on those deposits within athirty-day or shorter period.  Fixed ratetime deposits, principally certificates of deposit, are reflected at theircontractual maturity date.

 

The Company generally would benefit from increasingmarket rates of interest when it has an asset-sensitive gap position andgenerally would benefit from decreasing market rates of interest when it isliability-sensitive.  The Company iscumulatively liability sensitive over the three-month to twelve-month periodand asset sensitive over all periods**greaterthan one year.  However, the Company’s gapanalysis is not a precise indicator of its interest sensitivity position.  The analysis presents only a static view ofthe timing of maturities and repricing opportunities, without taking intoconsideration that changes in interest rates do not affect all assets andliabilities equally.  Net interest incomemay be impacted by other significant factors in a given interest rateenvironment, including changes in the volume and mix of earning assets andinterest-bearing liabilities.

 

----

# ** **

# **Provision and Allowance forLoan Losses**

 

***General****.*  TheCompany has developed policies and procedures for evaluating the overallquality of its credit portfolio and the timely identification of potentialproblem loans.  On a quarterly basis, theCompany’s Board of Directors reviews and approves the appropriate level for theCompany’s allowance for loan losses based upon management’s recommendations,the results of the internal monitoring and reporting system, and an analysis ofeconomic conditions in its market.

 

Additions to the allowance for loan losses,which are expensed through the provision for loan losses on the Company’sincome statement, are made periodically to maintain the allowance at anappropriate level based on management’s analysis of the estimated lossesinherent in the loan portfolio.  Loanlosses and recoveries are charged or credited directly to the allowance.  The amount of the provision is a function ofthe level of loans outstanding, the level of non-performing loans, historicalloan loss experience, the amount of loan losses actually charged against thereserve during a given period, and current and anticipated economic conditions.

 

The Company’s allowance for loan losses isbased upon judgments and assumptions about risk elements in the portfolio,future economic conditions, and other factors affecting borrowers.  The process includes identification andanalysis of loss potential in various portfolio segments utilizing a creditrisk grading process and specific reviews and evaluations of significantproblem credits.  However, there is noprecise method of estimating credit losses, since any estimate of loan lossesis necessarily subjective and the accuracy depends on the outcome of futureevents.  In addition, due to our rapidgrowth over the past several years and our limited operating history, a largeportion of the loans in our loan portfolio was originated recently.  In general, loans do not begin to show signsof credit deterioration or default until they have been outstanding for someperiod of time, a process referred to as seasoning.  As a result, a portfolio of more mature loanswill usually behave more predictably than a newer portfolio.  Because our loan portfolio is relatively new,the current level of delinquencies and defaults may not be representative ofthe level that will prevail when the portfolio becomes more seasoned, which maybe higher than current levels.  Ifcharge-offs in future periods increase, we may be required to increase ourprovision for loan losses, which would decrease our net income and possibly ourcapital.

 

Based on present information and an ongoingevaluation, management considers the allowance for loan losses to be adequateto meet presently known and inherent losses in the loan portfolio.  Management’s judgment about the adequacy ofthe allowance is based upon a number of assumptions about future events whichit believes to be reasonable but which may or may not be accurate.  Thus, there can be no assurance that charge-offsin future periods will not exceed the allowance for loan losses or thatadditional increases in the allowance for loan losses will not berequired.  The Company does not allocatethe allowance for loan losses to specific categories of loans but evaluates theadequacy on an overall portfolio basis utilizing a risk grading system.

 

The following table sets forth certaininformation with respect to the Company’s allowance for loan losses and thecomposition of charge-offs and recoveries for the year ended December 31,2007 and 2006.

 

# **Allowance for Loan Losses**

 
| **(Dollars in thousands)**                       | ** ** | **2007** | ** **  | **2006**   | ** ** |
|------------------------------------------------------------|------------|----------|-------------|------------|------------|
| Total loans outstanding at end of period                   | ** ** | **$**    | **302,934** | ** ** | **$**      | **217,664** | ** ** |
| Average loans outstanding                                  | ** ** | **$**    | **264,844** | ** ** | **$**      | **168,107** | ** ** |
| Balance of allowance for loan losses at  beginning of year |       | $        | 3,091       |       | $          | 1,558 |   |
| Provision for loan losses                                  |       | 1,188    |        | 1,533      |       |
| Charge-offs                                                |       | (65      | )           | —     |       |
| Balance of allowance for loan losses at end  of year       | ** ** | **$**    | **4,214**   | ** ** | **$**      | **3,091** | ** ** |
| Allowance for loan losses to period end  loans             | ** ** | **1.39** | **%**       | **1.42**   | **%**      |

 

**Non-performing Assets**

 

***Non-performingAssets****.* Therewere $35,172 and $283,934 of non-accrual loans at December 31, 2007 and December 31,2006, respectively. There were no loans past due 90 days or more and stillaccruing interest, or restructured loans at December 31, 2007 or December 31,2006.

 

----

 

The Company’s policy with respect to non-performing assets is asfollows.  Accrual of interest will bediscontinued on a loan when management believes, after considering economic andbusiness conditions and collection efforts that the borrower’s financial conditionis such that the collection of interest is doubtful.  A delinquent loan will generally be placed innon-accrual status when it becomes 90 days or more past due unless theestimated net realizable value of collateral exceeds the principal balance andaccrued interest.  When a loan is placedin non-accrual status, all interest which has been accrued on the loan butremains unpaid is reversed and deducted from current earnings as a reduction ofreported interest income.  No additionalinterest will be accrued on the loan balance until the collection of bothprincipal and interest becomes reasonably certain.  When a problem loan is finally resolved,there may ultimately be an actual write-down or charge-off of the principalbalance of the loan to the allowance for loan losses.

 

***Potential Problem Loans****.* Potential problem loans are loans that are not included in impairedloans (non-accrual loans or loans past due 90 days or more and still accruing),but about which management has become aware of information about possiblecredit problems of the borrowers that causes doubt about their ability tocomply with current repayment terms. At December 31, 2007 and December 31,2006, the Company had identified $1,625,150 and $0, respectively, of potentialproblem loans through its internal review procedures.  The results of this internal review processare considered in determining management’s assessment of the adequacy of theallowance for loan losses.

 

# **Non-interest Income and Expense**

 

***Non-interestIncome****.*  The largest component of non-interest incomewas mortgage origination fees which totaled $998,111 and $642,066 for the yearsended December 31, 2007 and 2006, respectively.

 

The following table sets forth the principal components of non-interestincome for the years ended December 31, 2007 and 2006.

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006**   | ** ** |
|--------------------------------------|------------|----------|------------|------------|------------|
| Mortgage origination fees            |       | $        | 998        |       | $          | 642 |   |
| Service charges on deposit accounts  |       | 148      |       | 89         |       |
| Bank-owned life insurance            |       | 222      |       | —     |       |
| Other income                         |       | 207      |       | 112        |       |
| Total non-interest income            | ** ** | **$**    | **1,575**  | ** ** | **$**      | **843** | ** ** |

 

***Non-interest Expense****. *Salaries and employee benefits comprised the largest component ofnon-interest expense which totaled $4.3 million and $2.8 million for the yearsended December 31, 2007 and 2006, respectively.  All of the other categories of non-interestexpense totaled $3.9 million and $2.4 million for the years ended December 31,2007 and 2006, respectively.

# ** **

The following table sets forth the primary components of non-interestexpense for the years ended December 31, 2007 and 2006.

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006**   | ** ** |
|--------------------------------------|------------|----------|------------|------------|------------|
| Salaries and benefits                |       | $        | 4,336      |       | $          | 2,845 |   |
| Net occupancy                        |       | 500      |       | 273        |       |
| Depreciation                         |       | 601      |       | 365        |       |
| Equipment maintenance and rental     |       | 109      |       | 57         |       |
| Advertising                          |       | 270      |       | 240        |       |
| Professional fees                    |       | 335      |       | 172        |       |
| Office supplies                      |       | 146      |       | 172        |       |
| Telephone                            |       | 145      |       | 111        |       |
| Data processing                      |       | 603      |       | 341        |       |
| Other                                |       | 1,139    |       | 621        |       |
| Total non-interest expense           | ** ** | **$**    | **8,184**  | ** ** | **$**      | **5,197** | ** ** |

 

----

 

**Earning Assets**

 

***Loans****.*Loansare the largest category of earning assets and typically provide higher yieldsthan the other types of earning assets. Loans also entail greater credit and liquidity risks than most of theCompany’s other investments and short-term interest-earning cash and cashequivalents, which management attempts to control and counterbalance.  Loans averaged $264.8 million and $168.1million in 2007 and 2006, respectively. Total loans were $302.9 million and$217.7 million at December 31, 2007 and 2006, respectively.

 

The following table sets forth the composition of the loan portfolio bycategory at December 31, 2007 and 2006 and highlights the Company’sgeneral emphasis on mortgage lending.

 
| ** **                           | ** ** | **2007**   | ** **  | **2006**          | ** ** |
|--------------------------------------|------------|------------|-------------|-------------------|------------|
| ** **                           | ** ** | ** ** | ** **  | **Percent**       | ** ** | ** ** | ** ** | **Percent** | ** ** |
| **(Dollars in thousands)** | ** ** | **Amount** | ** **  | **Of Total** | ** ** | **Amount** | ** ** | **Of Total** | ** ** |
| Real estate – construction      |       | $          | 124,016     |              | 40.94      | % | $ | 69,021 |   | 31.71 | % |
| Real estate – mortgage          |       | 149,369    |        | 49.31             | %          | 128,709 |   | 59.13 | % |
| Commercial and industrial            |       | 26,095     |        | 8.61              | %          | 17,239 |   | 7.92 | % |
| Consumer                             |       | 3,454      |        | 1.14              | %          | 2,695 |   | 1.24 | % |
| Total loans, gross                   |       | 302,934    | ** **  | **100.00**        | **%**      | 217,664 | ** ** | **100.00** | **%** |
| Allowance for loan losses            |       | (4,214     | )           |              |       | (3,091 | ) |   |   |
| Net loans                            | ** ** | **$**      | **298,720** | ** **        | ** ** |   | **$** | **214,573** |   |   |   |

 

The largest component of loans in the Company’s loan portfolio is realestate mortgage loans.  At December 31,2007 and 2006, real estate mortgage loans, which consist of first and secondmortgages on single or multi-family residential dwellings, loans secured bycommercial and industrial real estate and other loans secured by multi-familyproperties and farmland, totaled $149.4 million and $128.7 million,respectively and represented 49.31% and 59.13%, respectively of the total loanportfolio.  In the context of thisdiscussion, a “real estate mortgage loan” is defined as any loan, other than aloan for construction purposes, secured by real estate, regardless of thepurpose of the loan.  It is commonpractice for financial institutions in the Company’s market area to obtain asecurity interest in real estate whenever possible, in addition to any otheravailable collateral.  This collateral istaken to reinforce the likelihood of the ultimate repayment of the loan andtends to increase the magnitude of the real estate loan portfolio component.

 

The demand for residential and commercial real estate loans in theupstate South Carolina market is strong due to the historically low interestrate environment.  Commercial real estateloans are generally viewed as having more risk of default than residential realestate loans.  They are also typicallylarger than residential real estate loans and consumer loans and depend on cashflows from the owner’s business or the property to service the debt.  Cash flows may be affected significantly bygeneral economic conditions (including rising interest rates) and a downturn inthe local economy or in occupancy rates in the local economy where the propertyis located could increase the likelihood of default.  Because our loan portfolio contains a numberof commercial real estate loans with relatively large balances, thedeterioration of one or a few of these loans could cause a significant increasein our level of non-performing loans.  Anincrease in non-performing loans could result in a loss of earnings from theseloans, an increase in the related provision for loan losses and an increase incharge-offs, all of which could have a material adverse effect on our financialcondition and results of operations.

 

Real estate construction loans totaled $124.0 million and $69.0 millionat December 31, 2007 and 2006, respectively. In the context of thisdiscussion, a “real estate construction loan” is defined as any loan forconstruction purposes, secured by real estate.

 

Commercial and industrial loans totaled $26.1 million and $17.2 millionat December 31, 2007 and 2006, respectively and comprised 8.61% and 7.92%,respectively of the total portfolio. In the context of this discussion, a “commercialand industrial loan” is defined as any loan for a non-consumer purpose, notsecured by real estate.

 

The Company’s loan portfolio also includes consumer loans.  At December 31, 2007 and 2006, consumerloans totaled $3.5 million and $2.7 million, respectively and represented 1.14%and 1.24%, respectively of the total loan portfolio.

 

The Company’s loan portfolio reflects the diversity of its upstateSouth Carolina market.  The Company’soffices are located in Easley, Spartanburg, Mauldin, Greer, Anderson andGreenville, South Carolina.  Managementexpects the area to remain stable with continued growth in the nearfuture.  The diversity of the economycreates opportunities for all types of lending. The Company does not engage in foreign lending.

 

----

 

The repayment of loans in the loan portfolio as they mature is also asource of liquidity for the Company.  Thefollowing tables set forth the Company’s loans maturing within specifiedintervals at December 31, 2007 and 2006.

 

**2007**

 
| ** **                           | ** ** | ** **        | ** **  | **Over One** | ** ** | ** **  | ** ** | ** ** | ** **  |
|--------------------------------------|------------|-------------------|-------------|-------------------|------------|-------------|------------|------------|-------------|
| ** **                           | ** ** | ** **        | ** **  | **Year**          | ** ** | ** **  | ** ** | ** ** | ** **  |
| ** **                           | ** ** | ** **        | ** **  | **Through**       | ** ** | **Over**    | ** ** | ** ** | ** **  |
| ** **                           | ** ** | **One Year** | ** **  | **Five**          | ** ** | **Five**    | ** ** | ** ** | ** **  |
| **(Dollars in thousands)** | ** ** | **or Less**  | ** **  | **Years**         | ** ** | **Years**   | ** ** | **Total**  | ** **  |
| Real estate – construction      |       | $                 | 66,972      |              | $          | 49,908      |       | $          | 7,136       |   | $ | 124,016 |   |
| Real estate – mortgage          |       | 34,964            |        | 93,976            |       | 20,429      |       | 149,369    |        |
| Commercial and industrial            |       | 13,351            |        | 11,313            |       | 1,431       |       | 26,095     |        |
| Consumer                             |       | 1,408             |        | 1,262             |       | 784         |       | 3,454      |        |
| ** **                           | ** ** | **$**             | **116,695** | ** **        | **$**      | **156,459** | ** ** | **$**      | **29,780**  | ** ** | **$** | **302,934** | ** ** |
|                                 |       |              |        |              |       |        |       |       |        |
| Loans maturing after one year with:  |       |              |        |              |       |        |       |       |        |
| Fixed interest rates                 |       |              |        |              |       |        |       | $          | 132,590     |   |
| Floating interest rates              |       |              |        |              |       |        |       | 53,649     |        |
| ** **                           | ** ** | ** **        | ** **  | ** **        | ** ** | ** **  | ** ** | **$**      | **186,239** | ** ** |

 

**2006**

 
| ** **                           | ** ** | ** **        | ** ** | **Over One** | ** ** | ** **  | ** ** | ** ** | ** **  |
|--------------------------------------|------------|-------------------|------------|-------------------|------------|-------------|------------|------------|-------------|
| ** **                           | ** ** | ** **        | ** ** | **Year**          | ** ** | ** **  | ** ** | ** ** | ** **  |
| ** **                           | ** ** | ** **        | ** ** | **Through**       | ** ** | **Over**    | ** ** | ** ** | ** **  |
| ** **                           | ** ** | **One Year** | ** ** | **Five**          | ** ** | **Five**    | ** ** | ** ** | ** **  |
| **(Dollars in thousands)** | ** ** | **or Less**  | ** ** | **Years**         | ** ** | **Years**   | ** ** | **Total**  | ** **  |
| Real estate – construction      |       | $                 | 38,797     |              | $          | 27,406      |       | $          | 2,818       |   | $ | 69,021 |   |
| Real estate – mortgage          |       | 28,676            |       | 86,726            |       | 13,307      |       | 128,709    |        |
| Commercial and industrial            |       | 7,215             |       | 9,579             |       | 445         |       | 17,239     |        |
| Consumer                             |       | 740               |       | 1,292             |       | 663         |       | 2,695      |        |
| ** **                           | ** ** | **$**             | **75,428** | ** **        | **$**      | **125,003** | ** ** | **$**      | **17,233**  | ** ** | **$** | **217,664** | ** ** |
|                                 |       |              |       |              |       |        |       |       |        |
| Loans maturing after one year with:  |       |              |       |              |       |        |       |       |        |
| Fixed interest rates                 |       |              |       |              |       |        |       | $          | 101,126     |   |
| Floating interest rates              |       |              |       |              |       |        |       | 41,110     |        |
| ** **                           | ** ** | ** **        | ** ** | ** **        | ** ** | ** **  | ** ** | **$**      | **142,236** | ** ** |

 

The information presented in the above table is based on the contractualmaturities of the individual loans, including loans which may be subject torenewal at their contractual maturity. Renewal of such loans is subject to review and credit approval as wellas modification of terms upon their maturity. Consequently, management believes this treatment presents fairly thematurity and repricing structure of the loan portfolio shown in the abovetable.

 

***Investment Securities and Other Investments****.* The investment securities portfolio, whichaveraged $12.0 million and $0.3 million in 2007 and 2006, respectively, is acomponent of the Company’s total earning assets.  At December 31, 2007 and 2006, the totalinvestment securities portfolio was $25.3 million and $0.4 million,respectively.  Investment securities wereprimarily marketable investments recorded at their fair value. Otherinvestments consisted of Federal Home Loan Bank of Atlanta (“FHLB”) stock recorded at cost.

 

The following table sets forth the fair value of the securities held bythe Company at December 31, 2007 and 2006.

 
| **(Dollars in thousands)**  | ** ** | **2007** | ** ** | **2006**   | ** ** |
|---------------------------------------|------------|----------|------------|------------|------------|
| Investment securities                 |       | $        | 24,844     |       | $          | 100 |   |
| Other investments                     |       | 447      |       | 271        |       |
| Total investment securities portfolio | ** ** | **$**    | **25,291** | ** ** | **$**      | **371** | ** ** |

 

***Short-Term Investments****.* Short-term investments, which consistprimarily of federal funds sold, averaged $22.9 million and $20.3 million in2007 and 2006, respectively with a weighted average yield of 5.02% and 5.06% in2007 and 2006, respectively.  These fundsare an important source of the Company’s liquidity. Federal funds are generallyinvested in an earning capacity on an overnight basis. At December 31,2007 and 2006, federal funds were $33.7 million and $17.9 million at anannualized overnight rate of 4.15% and 5.12%, respectively. The maximumoutstanding balance of federal funds sold at any month end during the years2007 and 2006 was $40.8 million and $30.3 million, respectively.

 

# ****

# ** **

# **Deposits**

 

***General. ***Average interest-bearing liabilities totaled$261.7 million and $153.8 million in 2007 and 2006, respectively.  Average total deposits totaled $278.2 millionand $165.2 million during 2007 and 2006, respectively.  At December 31, 2007 and 2006 totaldeposits were $327.7 million and $217.0 million, respectively.

 

The following table sets forth the average deposits of the Company bycategory for the year ended December 31, 2007 and 2006.

 
| ** **                           | ** ** | **2007**   | ** **  | **2006**    | ** ** |
|--------------------------------------|------------|------------|-------------|-------------|------------|
| ** **                           | ** ** | ** ** | ** **  | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(Dollars in thousands)** | ** ** | **Amount** | ** **  | **Rate**    | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| Non-interest bearing demand          |       | $          | 18,864      |        | —     | % | $ | 11,429 |   | — | % |
| Interest bearing demand              |       | 11,520     |        | 1.70        | %          | 3,991 |   | 1.47 | % |
| Savings                              |       | 19,107     |        | 3.39        | %          | 10,234 |   | 3.55 | % |
| Time                                 |       | 228,748    |        | 5.32        | %          | 139,535 |   | 4.92 | % |
| Total                                | ** ** | **$**      | **278,239** | ** **  | ** ** |   | **$** | **165,189** |   |   |   |

 

The following table setsforth the deposits of the Company by category as of December 31, 2007 and2006.

 
| ** **                           | ** ** | **2007**   | ** **  | **2006**      | ** ** |
|--------------------------------------|------------|------------|-------------|---------------|------------|
| ** **                           | ** ** | ** ** | ** **  | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| **(Dollars in thousands)** | ** ** | **Amount** | ** **  | **Deposits**  | ** ** | **Amount** | ** ** | **Deposits** | ** ** |
| Non-interest bearing demand          |       | $          | 24,464      |          | 7.46       | % | $ | 14,784 |   | 6.81 | % |
| Interest bearing demand              |       | 13,721     |        | 4.19          | %          | 5,508 |   | 2.54 | % |
| Savings                              |       | 24,634     |        | 7.52          | %          | 13,868 |   | 6.39 | % |
| Time deposits less than $100         |       | 59,528     |        | 18.17         | %          | 64,457 |   | 29.70 | % |
| Time deposits of $100 or over        |       | 47,118     |        | 14.38         | %          | 46,606 |   | 21.47 | % |
| Brokered deposits                    |       | 158,199    |        | 48.28         | %          | 71,808 |   | 33.09 | % |
| Total                                | ** ** | **$**      | **327,664** | ** **    | **100.00** | **%** | **$** | **217,031** | ** ** | **100.00** | **%** |

 

Core deposits, which excludecertificates of deposit of $100,000 or more and brokered deposits, provide arelatively stable funding source for the Company’s loan portfolio and otherearning assets.  The Company’s coredeposits were $122.3 million and $98.6 million at December 31, 2007 and2006, respectively, or 37.3% and 45.4%, respectively of total deposits.  Certificates of deposit of $100,000 or moreand brokered deposits are not considered core deposits because their retentioncan be expected to be heavily influenced by rates offered at renewal.  Due to the developed national market forcertificates of deposit, we anticipate being able to either renew or replacethese deposits when they renew; however, no assurance can be given that we willbe able to replace them with deposits with the same terms.

 

For the years ended December 31,2007 and 2006, our non-core deposits included wholesale funding in the form ofbrokered CDs of $158.2 million and $71.8 million, respectively.  We generally obtain out-of-market timedeposits of $100,000 or more through brokers with whom we maintain ongoingrelationships.  The guidelines governingour participation in brokered CD programs are part of our Asset LiabilityManagement Program Policy, which is reviewed, revised and approved annually bythe Asset Liability Committee.  Theseguidelines limit our brokered CDs to 60% of total deposits, dictate that ourcurrent interest rate risk profile determines the terms and that we only acceptbrokered CDs from approved correspondents. In addition, we do not obtain time deposits through the Internet.  These guidelines allow us to take advantageof the attractive terms that wholesale funding can offer while mitigating theinherent related risk.

 

Deposits have been a primarysource of funding.  Management anticipatesthat deposits will continue to be the Company’s primary source of funding inthe future.  The Company’sloan-to-deposit ratio was 92.45% and 100.29% at December 31, 2007 and2006, respectively.  The maturitydistribution of the Company’s time deposits of $100,000 or over at December 31,2007 and 2006, is set forth in the following tables.

 

----

 

**Maturitiesof Certificates of Deposit of $100,000 or More (Including Brokered Deposits)**

 
| ** **                                  | ** ** | ** ** | ** ** | **After**   | ** ** | **After**   | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|------------|------------|------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | **Three**   | ** ** | **Six**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **Within** | ** ** | **Through** | ** ** | **Through** | ** ** | **After**  | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **Three**  | ** ** | **Six**     | ** ** | **Twelve**  | ** ** | **Twelve** | ** ** | ** ** | ** ** |
| **(Dollars in thousands)**        | ** ** | **Months** | ** ** | **Months**  | ** ** | **Months**  | ** ** | **Months** | ** ** | **Total**  | ** ** |
| **December 31, 2007**                  | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Certificates of deposit of $100,000 or more |       | $          | 17,479     |        | $          | 81,361      |       | $          | 98,331     |       | $          | 8,146 |   | $ | 205,317 |   |
|                                        |       |       |       |        |       |        |       |       |       |       |       |
| **December 31, 2006**                  | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Certificates of deposit of $100,000 or more |       | $          | 22,282     |        | $          | 50,247      |       | $          | 40,762     |       | $          | 5,123 |   | $ | 118,414 |   |

 

Of the Company’s time deposits of $100,000 or over as of December 31,2007 and 2006, 8.51% and 18.82% are scheduled maturities within three months,respectively. As of December 31, 2007 and 2006, 96.03% and 95.67%,respectively, of the Company’s time deposits of $100,000 or over had maturitieswithin twelve months.

 

# **Other Borrowings**

 

The following table outlinesour various sources of borrowed funds during the years ended December 31,2007, the amounts outstanding at the end of each period and theweighted-average interest rates paid for each borrowing source. During and asof the year-ended December 31, 2006, the Bank had no borrowed funds from any of these varioussources.

 
| ** **                                     | ** ** | ** **  | ** ** | **Period-** | ** ** |
|------------------------------------------------|------------|-------------|------------|-------------|------------|
| ** **                                     | ** ** | **Ending**  | ** ** | **End**     | ** ** |
| **(Dollars in thousands)**           | ** ** | **Balance** | ** ** | **Rate**    | ** ** |
| **December 31, 2007**                     |       |        |       |        |       |
| Federal Home Loan Bank advances                |       | $           | —     |        | —     | % |
| Federal funds purchased                        |       | —      |       | —      | %          |
| Securities sold under agreement to  repurchase |       | 15,000      |       | 2.58        | %          |
|                                                |            |             |            |             |            |  |

 

# **Capital**

 

The FRB and bank regulatory agencies requirebank holding companies and financial institutions to maintain capital atadequate levels based on a percentage of assets and off-balance sheetexposures, adjusted for risk weights ranging from 0% to 100%.

 

The FRB guidelines contain an exemption fromthe capital requirements for “small bank holding companies” which in 2006 wereamended to cover most bank holding companies with less than $500 million intotal assets that do not have a material amount of debt or equity securitiesoutstanding registered with the SEC. Although our class of common stock is registered under Section 12of the Securities Exchange Act, we believe that because our stock is not listedon any exchange the FRB will interpret its new guidelines to mean that wequalify as a small bank holding company. Nevertheless, our Bank remains subject to these capitalrequirements.  Failure to meet minimumcapital requirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the Bank’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance sheet items as calculated under regulatoryaccounting practices.  The Bank’s capitalamounts and classifications are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.  Regardless, our Bank is “well capitalized”under these minimum capital requirements as set per bank regulatory agencies.

 

Under the capital adequacy guidelines,regulatory capital is classified into two tiers.  These guidelines require an institution tomaintain a certain level of Tier 1 and Tier 2 capital to risk-weightedassets.  Tier 1 capital consists ofcommon shareholders’ equity, excluding the unrealized gain or loss onsecurities available for sale, minus certain intangible assets.  In determining the amount of risk-weightedassets, all assets, including certain off-balance sheet assets, are multipliedby a risk-weight factor of 0% to 100% based on the risks believed to beinherent in the type of asset.  Tier 2capital consists of Tier 1 capital plus the general reserve for loan losses,subject to certain limitations.  We arealso required to maintain capital at a minimum level based on total averageassets, which is known as the Tier 1 leverage ratio.

 

----

 

At the bank level, we are subject to variousregulatory capital requirements administered by the federal bankingagencies.  To be considered “adequatelycapitalized” under these capital guidelines, we must maintain a minimum totalrisk-based capital of 8%, with at least 4% being Tier 1 capital.  In addition, we must maintain a minimum Tier1 leverage ratio of at least 4%.  To beconsidered “well-capitalized,” we must maintain total risk-based capital of atleast 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.

 

Failure to meet minimum capital requirementscan initiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a material effect on the Bank’sfinancial statements.  Under capitaladequacy guidelines and the regulatory framework for prompt corrective action,the Bank must meet specific capital guidelines that involve quantitativemeasures of the Bank’s assets, liabilities, and certain off-balance sheet itemsas calculated under regulatory accounting practices.  The Bank’s capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

The Bank exceeded the regulatory capitalrequirements at December 31, 2007 and 2006 as set forth in the followingtable.

 

**Analysisof Capital and Capital Ratios**

** **
| **(Dollars in thousands)**                                | ** ** | **2007**   | ** **  | **2006**   | ** ** |
|---------------------------------------------------------------------|------------|------------|-------------|------------|------------|
| Tier 1 capital                                                      |       | $          | 30,102      |       | $          | 27,528 |   |
| Tier 2 capital                                                      |       | 4,214      |        | 2,993      |       |
| Total qualifying capital                                            | ** ** | **$**      | **34,316**  | ** ** | **$**      | **30,521** | ** ** |
| ** **                                                          | ** ** | ** ** | ** **  | ** ** | ** ** |
| Risk-adjusted total assets (including  off-balance sheet exposures) | ** ** | **$**      | **337,586** | ** ** | **$**      | **239,344** | ** ** |
|                                                                |       |       |        |       |       |
| Total risk-based capital ratio                                      |       | 10.17      | %           | 12.75      | %          |
| Tier 1 risk-based capital ratio                                     |       | 8.92       | %           | 11.50      | %          |
| Tier 1 leverage ratio                                               |       | 8.26       | %           | 11.49      | %          |

 

**Off-Balance Sheet Risk**

 

Throughits operations, the Bank has made contractual commitments to extend credit inthe ordinary course of its business activities. These commitments are legallybinding agreements to lend money to the Bank’s customers at predeterminedinterest rates for a specified period of time. At December 31, 2007 and 2006, the Bank had issued commitments,including standby letters of credit, to extend credit of $52.5 million and$40.7 million, respectively through various types of commercial lendingarrangements.

 

The following tables set forth the length of timeuntil maturity for unused commitments to extend credit at December 31,2007 and 2006.

** **
| ** **                           | ** ** | ** ** | ** ** | **After**   | ** ** | **After**   | ** ** | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|------------|------------|-------------|------------|------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **One**     | ** ** | **Three**   | ** ** | ** ** | ** ** | **Greater** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Within** | ** ** | **Through** | ** ** | **Through** | ** ** | **Within** | ** ** | **Than**    | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **One**    | ** ** | **Three**   | ** ** | **Twelve**  | ** ** | **One**    | ** ** | **One**     | ** ** | ** ** | ** ** |
| **(Dollars in thousands)** | ** ** | **Month**  | ** ** | **Months**  | ** ** | **Months**  | ** ** | **Year**   | ** ** | **Year**    | ** ** | **Total**  | ** ** |
| **December 31, 2007**           | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** |
| Unused commitments to extend credit  |       | $          | 2,479      |        | $          | 891         |       | $          | 17,370     |        | $          | 20,740     |       | $ | 28,603 |   | $ | 49,343 |   |
| Standby letters of credit            |       | 578        |       | 833         |       | —      |       | 1,411      |       | 1,766       |       | 3,177      |       |
| ** **                           | ** ** | **$**      | **3,057**  | ** **  | **$**      | **1,724**   | ** ** | **$**      | **17,370** | ** **  | **$**      | **22,151** | ** ** | **$** | **30,369** | ** ** | **$** | **52,520** | ** ** |
|                                 |       |       |       |        |       |        |       |       |       |        |       |       |       |
| **December 31, 2006**           | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** |
| Unused commitments to extend credit  |       | $          | 1,224      |        | $          | 1,677       |       | $          | 10,527     |        | $          | 13,428     |       | $ | 24,500 |   | $ | 37,928 |   |
| Standby letters of credit            |       | 321        |       | —      |       | 2,414       |       | 2,735      |       | 45          |       | 2,780      |       |
| ** **                           | ** ** | **$**      | **1,545**  | ** **  | **$**      | **1,677**   | ** ** | **$**      | **12,941** | ** **  | **$**      | **16,163** | ** ** | **$** | **24,545** | ** ** | **$** | **40,708** | ** ** |

 

Approximately$37.6 million and $23.5 million of these commitments to extend credit hadvariable rates as of December 31, 2007 and 2006, respectively.

 

----

 

TheBank evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemednecessary by the Bank upon extension of credit, is based on its creditevaluation of the borrower.  Collateralvaries but may include accounts receivable, inventory, property, plant andequipment, commercial and residential real estate.

 

**CriticalAccounting Policies**

 

TheCompany has adopted various accounting policies which govern the application ofaccounting principles generally accepted in the United States of America in thepreparation of its financial statements. Significant accounting policies are described in the footnotes to theconsolidated financial statements at December 31, 2007, included in thisAnnual Report to Shareholders, and as filed with the Company’s Annual Report onForm 10-KSB.  Certain accountingpolicies involve significant judgments and assumptions which have a materialimpact on the carrying value of certain assets and liabilities. Theseaccounting policies are considered to be critical accounting policies.  The judgments and assumptions used are basedon historical experience and other factors, which are believed to be reasonableunder the circumstances.  Because of thenature of the judgments and assumptions, actual results could differ from thesejudgments and estimates which could have a material impact on the carryingvalues of assets and liabilities and results of operations.

 

Management believes the allowance for loan losses is a criticalaccounting policy that requires the most significant judgments and estimatesused in preparation of the consolidated financial statements.  Refer to the portion of this discussion thataddresses the allowance for loan losses for a description of our processes andmethodology for determining our allowance for loan losses.

 

**Liquidity Management**

 

Liquidity management involves monitoring the Company’s sources and usesof funds in order to meet its day-to-day cash flow requirements whilemaximizing profits.  Liquidity representsthe ability of a Company to convert assets into cash or cash equivalentswithout significant loss and to raise additional funds by increasingliabilities.  Without proper liquiditymanagement, the Company would not be able to perform the primary function of afinancial intermediary and would, therefore, not be able to meet the needs ofthe communities it serves.

 

Liquidity management is made more complexbecause different balance sheet components are subject to varying degrees ofmanagement control.  For example, thetiming of maturities of the investment portfolio is very predictable and subjectto a high degree of control at the time investment decisions are made.  However, net deposit inflows and outflows arefar less predictable and are not subject to nearly the same degree ofcontrol.  The Company also has theability to obtain funds from various financial institutions should the needarise.

 

**Impact ofInflation**

 

Unlike most industrial companies, the assets and liabilities offinancial institutions such as the Bank are primarily monetary in nature.  Therefore, interest rates have a moresignificant effect on the Bank’s performance than do the effects of changes inthe general rate of inflation and change in prices.  In addition, interest rates do notnecessarily move in the same direction or in the same magnitude as the pricesof goods and services.  As discussedpreviously, management seeks to manage the relationships between interestsensitive assets and liabilities in order to protect against wide interest ratefluctuations, including those resulting from inflation.

 

**Recently Issued Accounting Standards**

 

Accounting standards and pronouncements of a recent nature arediscussed in Notes to Consolidated Financial Statements, Note 1 – Summary ofSignificant Accounting Policies.  Otheraccounting standards that have been issued or proposed by authoritativestandards-setting bodies that do not require adoption until a future date arenot expected to have a material impact on the consolidated financial statementsupon adoption.

 

----

 

**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

 
| To the Shareholders and Board of Directors           |
|------------------------------------------------------|
| CommunitySouth  Financial Corporation and Subsidiary |
| Easley,  South Carolina                              |

 

We haveaudited the accompanying consolidated balance sheets of CommunitySouthFinancial Corporation (formerly known as CommunitySouth Bancshares, Inc.) andSubsidiary (the “Company”) as of December 31, 2007 and 2006, and therelated consolidated statements of income, changes in shareholders’ equity andcomprehensive income, and cash flows for the years then ended.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of CommunitySouth FinancialCorporation and Subsidiary as of December 31, 2007 and 2006 and theresults of their operations and their cash flows for the years then ended inconformity with accounting principles generally accepted in the United Statesof America.

 

We werenot engaged to examine management’s assertion about the effectiveness of theCompany’s internal control over financial reporting as of December 31,2007 included in the accompanying Management’s Report on Internal Controls OverFinancial Reporting and, accordingly, we do not express an opinion thereon.

 

 
| /s/ Elliott Davis          |   |
|----------------------------|--------|
|                       |   |
|                            |   |
| Elliott Davis              |
| Greenville, South Carolina |
| March 27, 2008        |

 

----

 

**COMMUNITYSOUTH FINANCIAL CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

** **
| ** **                                                                                                                                                                 | ** ** | **December 31,** | ** **  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|
| ** **                                                                                                                                                                 | ** ** | **2007**              | ** **  | **2006** | ** ** |
|                                                                                                                                                                       |       |                  |        |   |   |
| **Assets**                                                                                                                                                                 |       |                  |        |   |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| Cash and cash equivalents                                                                                                                                                  |       |                  |        |   |   |
| Cash and due from bank                                                                                                                                                     |       | $                     | 6,486,676   |   | $ | 3,116,070 |   |
| Federal funds sold                                                                                                                                                         |       | 33,665,005            |        | 17,925,000 |   |
| Total cash and cash equivalents                                                                                                                                            |       | 40,151,681            |        | 21,041,070 |   |
| Investment securities, available for sale                                                                                                                                  |       | 24,844,007            |        | 100,000 |   |
| Other investments, at cost                                                                                                                                                 |       | 446,800               |        | 270,800 |   |
| Loans, net                                                                                                                                                                 |       | 298,720,357           |        | 214,573,046 |   |
| Accrued interest receivable                                                                                                                                                |       | 2,092,066             |        | 1,177,802 |   |
| Property and equipment, net                                                                                                                                                |       | 5,073,685             |        | 4,743,166 |   |
| Bank-owned life insurance                                                                                                                                                  |       | 5,226,806             |        | 5,004,758 |   |
| Other assets                                                                                                                                                               |       | 1,311,799             |        | 1,362,641 |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| Total assets                                                                                                                                                               |       | $                     | 377,867,201 |   | $ | 248,273,283 |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| **Liabilities and Shareholders’ Equity**                                                                                                                              |       |                  |        |   |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| **Liabilities**                                                                                                                                                            |       |                  |        |   |   |
| Deposit                                                                                                                                                                    |       |                  |        |   |   |
| Non-interest bearing                                                                                                                                                       |       | $                     | 24,464,433  |   | $ | 14,784,450 |   |
| Interest bearing                                                                                                                                                           |       | 303,199,212           |        | 202,246,738 |   |
| Total deposits                                                                                                                                                             |       | 327,663,645           |        | 217,031,188 |   |
| Repurchase agreements                                                                                                                                                      |       | 15,000,000            |        | — |   |
| Accrued expenses                                                                                                                                                           |       | 427,380               |        | 100,330 |   |
| Accrued interest payable                                                                                                                                                   |       | 3,238,298             |        | 1,425,106 |   |
| Other liabilities                                                                                                                                                          |       | 66,742                |        | 21,704 |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| Total liabilities                                                                                                                                                          |       | 346,396,065           |        | 218,578,328 |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| Commitments and contingencies                                                                                                                                              |       | —                |        | — |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| **Shareholders’ Equity**                                                                                                                                              |       |                  |        |   |   |
| Preferred stock, par value $.01 per share 10,000,000  shares authorized, no shares issued                                                                                  |       | —                |        | — |   |
| Common stock, par value $.01 per share 10,000,000  shares authorized; 4,698,697 and 4,697,697 issued and outstanding at  December 31, 2007 and December 31, 2006 |       | 46,987                |        | 46,977 |   |
| Additional paid-in capital                                                                                                                                                 |       | 29,691,467            |        | 29,635,458 |   |
| Accumulated other comprehensive income                                                                                                                                     |       | 152,050               |        | — |   |
| Retained earnings                                                                                                                                                          |       | 1,580,632             |        | 12,520 |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| Total shareholders’ equity                                                                                                                                            |       | 31,471,136            |        | 29,694,955 |   |
|                                                                                                                                                                       |       |                  |        |   |   |
| Total liabilities and shareholders’ equity                                                                                                                            |       | $                     | 377,867,201 |   | $ | 248,273,283 |   |
|                                                                                                                                                                            |            |                       |             |  |  |  |  |  |  |

 

The accompanying notes are an integral part ofthe consolidated financial statements.

 

43

----

 

**COMMUNITYSOUTH FINANCIAL CORPORATION**

**CONSOLIDATED STATEMENTS OF INCOME**

** **
| ** **                                           | ** ** | **For the years ended December 31,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                      | ** ** | **2006** | ** ** |
| **Interest income**                                  |       |                                                          |       |   |   |
| Interest and fees on loans                           |       | $                                                             | 21,402,981 |   | $ | 13,643,910 |   |
| Interest and dividends on investments                |       | 1,813,059                                                     |       | 1,041,379 |   |
| Total interest income                                |       | 23,216,040                                                    |       | 14,685,289 |   |
|                                                 |       |                                                          |       |   |   |
| **Interest expense - deposits**                      |       | 13,068,585                                                    |       | 7,281,015 |   |
|                                                 |       |                                                          |       |   |   |
| Net interest income                                  |       | 10,147,455                                                    |       | 7,404,274 |   |
|                                                 |       |                                                          |       |   |   |
| **Provision for loan losses**                        |       | 1,188,000                                                     |       | 1,532,500 |   |
|                                                 |       |                                                          |       |   |   |
| Net interest income after provision for  loan losses |       | 8,959,455                                                     |       | 5,871,774 |   |
|                                                 |       |                                                          |       |   |   |
| **Non-interest income**                              |       |                                                          |       |   |   |
| Mortgage origination fees                            |       | 998,111                                                       |       | 642,066 |   |
| Other                                                |       | 576,109                                                       |       | 200,444 |   |
| Total non-interest income                            |       | 1,574,220                                                     |       | 842,510 |   |
|                                                 |       |                                                          |       |   |   |
| **Non-interest expense**                             |       |                                                          |       |   |   |
| Salaries and benefits                                |       | 4,336,105                                                     |       | 2,844,483 |   |
| Occupancy                                            |       | 500,458                                                       |       | 272,919 |   |
| Depreciation                                         |       | 601,017                                                       |       | 365,122 |   |
| Equipment maintenance and rental                     |       | 108,856                                                       |       | 56,662 |   |
| Advertising                                          |       | 269,860                                                       |       | 239,865 |   |
| Professional fees                                    |       | 334,978                                                       |       | 172,228 |   |
| Office supplies                                      |       | 145,633                                                       |       | 172,364 |   |
| Telephone                                            |       | 144,771                                                       |       | 111,272 |   |
| Data processing                                      |       | 602,975                                                       |       | 341,369 |   |
| Other                                                |       | 1,139,254                                                     |       | 620,560 |   |
| Total non-interest expense                           |       | 8,183,907                                                     |       | 5,196,844 |   |
|                                                 |       |                                                          |       |   |   |
| **Income before income taxes**                       |       | 2,349,768                                                     |       | 1,517,440 |   |
|                                                 |       |                                                          |       |   |   |
| **Income tax expense**                               |       | 781,656                                                       |       | 360,420 |   |
|                                                 |       |                                                          |       |   |   |
| **Net income**                                       |       | $                                                             | 1,568,112  |   | $ | 1,157,020 |   |
|                                                 |       |                                                          |       |   |   |
| **Earnings per share**(1)                            |       |                                                          |       |   |   |
| **Basic**                                            |       | $                                                             | 0.33       |   | $ | 0.25 |   |
| **Diluted**                                          |       | $                                                             | 0.31       |   | $ | 0.22 |   |
| Weighted average basic shares outstanding (1)        |       | 4,698,634                                                     |       | 4,686,807 |   |
| Weighted average diluted shares outstanding  (1)     |       | 5,126,601                                                     |       | 5,144,536 |   |

 

----

(1)   Adjustedfor 5-for-4 stock splits effective January 16, 2007 and January 16,2006.

 

The accompanying notes are an integral part ofthe consolidated financial statements.

 

44

----

 

**COMMUNITYSOUTH FINANCIAL CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN**

**SHAREHOLDERS’EQUITY AND COMPREHENSIVE INCOME**

**For theyears ended December 31, 2007 and December 31, 2006**

** **
| ** **                                                        | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained  Earnings /** | ** ** | **Total  Shareholders’ ** | ** **  | **Total  Comprehensive** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------------------|------------|--------------------------|------------|-------------------------------------|-------------|--------------------------|------------|
| ** **                                                        | ** ** | **Shares(1)**         | ** ** | **Amount(1)**           | ** ** | **Capital**                           | ** ** | **Income**               | ** ** | **(Deficit)**                       | ** **  | **Equity**               | ** ** | **Income** | ** ** |
| **Balance  at December 31, 2005**                            |       | 4,681,069             |       | $                       | 46,811     |                                  | $          | 29,383,999               |       | $                                   | —      |                     | $          | (1,144,500 | ) | $ | 28,286,310 |   |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Net income                                                        |       | —                |       | —                  |       | —                                |       | —                   |       | 1,157,020                           |        | 1,157,020                |       | $ | 1,157,020 |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Other  comprehensive income:                                      |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Unrealized gains  on securities                                   |       | —                |       | —                  |       | —                                |       | —                   |       | —                              |        | —                   |       | — |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Total  comprehensive income                                       |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       | $ | 1,157,020 |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Stock option  compensation                                        |       | —                |       | —                  |       | 140,400                               |       | —                   |       | —                              |        | 140,400                  |       |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Cash paid for  fractional shares                                  |       | (417                  | )          | (5                      | )          | (1,097                                | )          | —                   |       | —                              |        | (1,102                   | )          |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Stock options  exercised, including income tax benefit of $27,200 |       | 17,045                |       | 171                     |       | 112,156                               |       | —                   |       | —                              |        | 112,327                  |       |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| **Balance  at December 31, 2006**                            | ** ** | **4,697,697**         | ** ** | **46,977**              | ** ** | **29,635,458**                        | ** ** | **—**               | ** ** | **12,520**                          | ** **  | **29,694,955**           |       |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Net income                                                        |       | —                |       | —                  |       | —                                |       | —                   |       | 1,568,112                           |        | 1,568,112                |       | $ | 1,568,112 |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Other  comprehensive income:                                      |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Unrealized gains  on securities, net of income taxes of $89,200   |       | —                |       | —                  |       | —                                |       | 152,050                  |       | —                              |        | 152,050                  |       | 152,050 |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Total  comprehensive income                                       |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       | $ | 1,720,162 |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Stock option  compensation                                        |       | —                |       | —                  |       | 55,320                                |       | —                   |       | —                              |        | 55,320                   |       |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Cash paid for  fractional shares                                  |       | —                |       | —                  |       | (5,701                                | )          | —                   |       | —                              |        | (5,701                   | )          |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| Stock options  exercised                                          |       | 1,000                 |       | 10                      |       | 6,390                                 |       | —                   |       | —                              |        | 6,400                    |       |   |   |
|                                                              |       |                  |       |                    |       |                                  |       |                     |       |                                |        |                     |       |   |   |
| **Balance  at December 31, 2007**                            | ** ** | **4,698,697**         | ** ** | **$**                   | **46,987** | ** **                            | **$**      | **29,691,467**           | ** ** | **$**                               | **152,050** | ** **               | **$**      | **1,580,632** | ** ** | **$** | **31,471,136** |   |   |   |

 

----

(1)   Adjusted for 5-for-4 stock splits effective January 16,2007 and January 16, 2006.

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

45

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**COMMUNITYSOUTHFINANCIAL CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

*** ***
| ** **                                                                         | ** ** | **For the years ended December 31,** | ** **     |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|----------------|
| ** **                                                                         | ** ** | **2007**                                                      | ** **     | **2006** | ** ** |
| **Operating  activities**                                                          |       |                                                          |           |   |   |
| Net income                                                                         |       | $                                                             | 1,568,112      |   | $ | 1,157,020 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                                          |           |   |   |
| Provision for loan losses                                                          |       | 1,188,000                                                     |           | 1,532,500 |   |
| Stock based compensation                                                           |       | 55,320                                                        |           | 140,400 |   |
| Depreciation                                                                       |       | 601,017                                                       |           | 365,122 |   |
| Appreciation of bank-owned life insurance                                          |       | (222,048                                                      | )              | — |   |
| Deferred income tax benefit                                                        |       | (275,892                                                      | )              | (412,072 | ) |
| Increase in accrued interest receivable                                            |       | (914,264                                                      | )              | (733,416 | ) |
| Increase in accrued interest payable                                               |       | 1,813,192                                                     |           | 227,520 |   |
| Increase (decrease) in accrued expenses                                            |       | 327,050                                                       |           | (102,063 | ) |
| Decrease (increase) in other assets                                                |       | 237,534                                                       |           | (614,426 | ) |
| Increase (decrease) in other liabilities                                           |       | 45,038                                                        |           | (146,026 | ) |
| Net cash provided by operating activities                                          |       | 4,423,059                                                     |           | 1,414,559 |   |
|                                                                               |       |                                                          |           |   |   |
| **Investing  activities**                                                          |       |                                                          |           |   |   |
| Net increase in loans outstanding                                                  |       | (85,335,311                                                   | )              | (101,959,915 | ) |
| Purchase of bank owned life insurance                                              |       | —                                                        |           | (5,004,758 | ) |
| Purchase of investments and FHLB stock                                             |       | (24,678,757                                                   | )              | (288,100 | ) |
| Purchase of property and equipment                                                 |       | (931,536                                                      | )              | (2,450,160 | ) |
| Net cash used in investing activities                                              |       | (110,945,604                                                  | )              | (109,702,933 | ) |
|                                                                               |       |                                                          |           |   |   |
| **Financing****activities**                                                        |       |                                                          |           |   |   |
| Net increase in deposit accounts                                                   |       | 110,632,457                                                   |           | 110,058,886 |   |
| Increase in repurchase agreements                                                  |       | 15,000,000                                                    |           | — |   |
| Cash paid for fractional shares                                                    |       | (5,701                                                        | )              | (1,102 | ) |
| Stock options exercised                                                            |       | 6,400                                                         |           | 112,327 |   |
| Net cash provided by financing activities                                          |       | 125,633,156                                                   |           | 110,170,111 |   |
|                                                                               |       |                                                          |           |   |   |
| Net increase in cash and cash equivalents                                          |       | 19,110,611                                                    |           | 1,881,737 |   |
|                                                                               |       |                                                          |           |   |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF  YEAR**                                  |       | 21,041,070                                                    |           | 19,159,333 |   |
|                                                                               |       |                                                          |           |   |   |
| **CASH AND CASH EQUIVALENTS, END OF YEAR**                                         | ** ** | **$**                                                         | **40,151,681** | ** ** | **$** | **21,041,070** | ** ** |
|                                                                               |       |                                                          |           |   |   |
| **SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION**                              |       |                                                          |           |   |   |
| Cash paid for:                                                                     |       |                                                          |           |   |   |
| Interest                                                                           | ** ** | **$**                                                         | **11,255,393** | ** ** | **$** | **7,053,495** | ** ** |
| Income taxes                                                                       | ** ** | **$**                                                         | **900,197**    | ** ** | **$** | **1,254,146** | ** ** |
|                                                                               |       |                                                          |           |   |   |
| **SCHEDULE OF NON-CASH TRANSACTIONS:**                                             |       |                                                          |           |   |   |
| Unrealized gain on investment securities,  net of income taxes                     | ** ** | **$**                                                         | **152,050**    | ** ** | **$** | **—** | ** ** |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

46

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### **NOTE 1 – SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**BusinessActivity and Organization -**CommunitySouth FinancialCorporation (the “Company”) is a South Carolina corporation organized for thepurpose of owning and controlling all of the capital stock of CommunitySouthBank and Trust (the “Bank”).  The Bank isa state chartered bank organized under the laws of South Carolina.  From inception on March 20, 2004 throughJanuary 18, 2005, the Company engaged in organizational and pre-openingactivities necessary to obtain regulatory approvals and to prepare itssubsidiary, the Bank, to commence business as a financial institution.  The Company received approval from theFederal Deposit Insurance Corporation (“FDIC”), the Federal Reserve Board (“FRB”)and the State Board of Financial Institutions in January 2005.

 

The Bank began operations on January 18,2005. The Bank primarily is engaged in the business of accepting depositsinsured by the FDIC, and providing commercial, consumer and mortgage loans tothe general public.

 

The Company sold 4,681,069shares of common stock at $6.40 per share in an initial public offering thatwas completed on February 15, 2005 (as adjusted for all stocksplits).  The offering raised$29,430,810, net of offering costs.  Thedirectors and officers of the Company purchased 659,531 shares at $6.40 pershare for a total of $4,221,000.

 

**Basis ofPresentation -**The accounting and reporting policiesconform to accounting principles generally accepted in the United States ofAmerica and to general practices in the banking industry. The Company uses theaccrual basis of accounting.

 

**Principles of Consolidation -**The consolidated financial statements include the accounts of CommunitySouth Financial Corporation, the parent company, and CommunitySouth Bank and Trust, its wholly owned subsidiary. All significant intercompany items have been eliminated in the consolidated financial statements.

 

**Management’sEstimates** - The preparation of consolidated financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of income andexpenses during the reporting period. Actual results could differ from those estimates.

 

**Disclosure Regarding Segments**- The Company reports as one operating segment, as management reviews theresults of operations of the Company as a single enterprise.

 

**Cash and Cash Equivalents**-For purposes of reporting cash flows, cash and cash equivalents include cash onhand, amounts due from banks, short-term interest bearing deposits and federalfunds sold. Cash and cash equivalents have an original maturity of three monthsor less.

 

**Concentrationsof Credit Risk** - Financial instruments, whichpotentially subject the Company to concentrations of credit risk, consistprincipally of loans receivable, investment securities, federal funds sold andamounts due from banks.

 

The Company makes loans toindividuals and small businesses for various personal and commercial purposesprimarily in the upstate region of South Carolina.  The Company’s loan portfolio is notconcentrated in loans to any single borrower or to a relatively small number ofborrowers.  Additionally, management isnot aware of any concentrations of loans to classes of borrowers or industriesthat would be similarly affected by economic conditions.

 

In addition to monitoringpotential concentrations of loans to particular borrowers or groups ofborrowers, industries and geographic regions, management monitors exposure tocredit risk that could arise from potential concentrations of lending productsand practices such as loans that subject borrowers to substantial paymentincreases (e.g. principal deferral periods, loans with initial interest-onlyperiods, etc), and loans with high loan-to-value ratios.  Additionally, there are industry practicesthat could subject the Company to increased credit risk should economic conditionschange over the course of a loan’s life. For example, the Company makes variable rate loans and fixed rateprincipal-amortizing loans with maturities prior to the loan being fully paid(i.e. balloon payment loans).  Theseloans are underwritten and monitored to manage the associated risks.  Management has determined that there is noconcentration of credit risk associated with its lending policies or practices.

 

The Company’s investmentportfolio consists of both marketable and non-marketable equitysecurities.  Management believes creditrisk associated with the equity securities is not significant. The Companyplaces its deposits and correspondent accounts with and sells its federal fundsto high quality institutions.  Managementbelieves credit risk associated with correspondent accounts is not significant.

 

47

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**Investment Securities** – The Company accounts for investment securities in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”).  The statement requires investments in equity and debt securities to be classified into three categories:

 

1.               *Availablefor sale securities*: These are securities that are not classified aseither held to maturity or as trading securities.  These securities arereported at fair market value.  Unrealized gains and losses are reported,net of income taxes, as separate components of shareholders’ equity(accumulated other comprehensive income).

2.               *Held to maturity securities*: These are investment securities that thecompany has the ability and intent to hold until maturity.  Thesesecurities are stated at cost, adjusted for amortization of premiums and theaccretion of discounts.

3.               *Trading securities*: These are securities that are bought andheld principally for the purpose of selling in the near future.  Tradingsecurities are reported at fair market value, and related unrealized gains andlosses are recognized in the income statement.  The company has no tradingsecurities.

 

Gains or losses on dispositionsof investment securities are based on the differences between the net proceedsand the adjusted carrying amount of the securities sold, using the specificidentification method.   Premiums and discounts are amortized oraccrued into interest income by a method that approximates a level yield.

 

**OtherInvestments –**CommunitySouth Bank and Trust, as amember institution, is required to own stock investments in the FHLB.  Investment in the FHLB is a condition ofborrowing from the FHLB, and the stock is pledged to collateralize suchborrowings.  No ready market exists forthe stock and it has no quoted market value. However, redemption of thesestocks has historically been at par value. At December 31, 2007 and 2006, the Company’s investment in FHLBstock was $446,800 and $270,800, respectively. The dividend received on thisstock is included in interest and dividends on investments.

 

**LoansReceivable** - Loans are stated at their unpaidprincipal balance less an allowance for loan losses and net deferred loanorigination fees.  Interest income iscomputed using the simple interest method and is recorded in the period earned.Loan origination fees collected and certain loan origination costs are deferredand the net amount is accreted as income using a method that approximates thelevel yield method over the life of the related loans.

 

In accordance with SFAS No. 114,“Accounting by Creditors for Impairment of a Loan,” (“SFAS 114”) loans areconsidered to be impaired when, in management’s judgment and based on currentinformation, the full collection of principal and interest becomesdoubtful.  A loan is also consideredimpaired if its terms are modified in a troubled debt restructuring.  Impaired loans are placed in non-performingstatus, and future payments are applied to principal until such time ascollection of the obligation is no longer doubtful. Interest accrual resumesonly when loans return to performing status. To return to performing status, loans must be fully current, andcontinued timely payments must be a reasonable expectation.  Loans are generally placed on non-accrualstatus when principal or interest becomes ninety days past due, or when paymentin full is not anticipated.  When a loan is placed on non-accrual status,interest accrued but not received is generally reversed against interestincome.  Cash receipts on non-accrual loans are not recorded as interestincome, but are used to reduce principal.

 

The Company identifies impairedloans through its normal internal loan review process.  Loans on the Company’s potential problem loanlist are considered potentially impaired loans. These loans are evaluated in determining whether all outstandingprincipal and interest are expected to be collected.  Loans are not considered impaired if aminimal payment delay occurs and all amounts due, including accrued interest atthe contractual interest rate for the period of delay, are expected to becollected.  Management has determinedthat the Company had $35,172 and $283,934 in impaired loans at December 31,2007 and 2006, respectively.

 

**Allowance for Loan Losses**– The allowance for loan losses is established as losses are estimated to haveoccurred through a provision for loan losses charged to earnings. Loan lossesare charged against the allowance when management believes the uncollectabilityof a loan balance is confirmed. Subsequent recoveries, if any, are credited tothe allowance.

 

The allowance for loan lossesis evaluated on a regular basis by management and is based upon management’speriodic review of the collectability of the loans in light of historicalexperiences, the nature and volume of the loan portfolio, adverse situationsthat may affect the borrower’s ability to repay, estimated value of anyunderlying collateral and prevailing economic conditions. This evaluation isinherently subjective as it requires estimates that are susceptible tosignificant revision as more information becomes available.

 

48

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The allowance consists ofspecific, general and unallocated components. The specific component relates toloans that are classified as either doubtful, substandard or special mention.For such loans that are also classified as impaired, an allowance isestablished when the discounted cash flows (or collateral value or observablemarket price) of the impaired loan is lower than the carrying value of theloan. The general component covers non-classified loans and is based onhistorical loss experience adjusted for qualitative factors. An unallocatedcomponent is maintained to cover uncertainties that could affect management’sestimate of probable losses. The unallocated component of the allowancereflects the margin of imprecision inherent in the underlying assumptions usedin the methodologies for estimating specific and general losses in theportfolio.

 

A loan is considered impairedwhen, based on current information and events, it is probable that the Companywill be unable to collect the scheduled payments of principal or interest whendue according to the contractual terms of the loan agreement. Factorsconsidered by management in determining impairment include payment status,collateral value, and the probability of collecting scheduled principal andinterest payments due. Loans that experience insignificant payment delays andpayment shortfalls generally are not classified as impaired. Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record and the amount ofthe shortfall in relation to the principal and interest owed. Impairment ismeasured on a loan by loan basis for commercial and construction loans byeither the present value of expected future cash flows discounted at the loan’seffective interest rate, the loan’s obtainable market price, or the fair valueof the collateral if the loan is collateral dependent.

 

Large groups of smaller balancehomogeneous loans are collectively evaluated for impairment. Accordingly, theCompany does not separately identify individual consumer and residential loansfor impairment disclosures, unless such loans are the subject of arestructuring agreement.

 

**Bank-OwnedLife Insurance**- The Company has purchased life insurance policies on certain keyemployees.  These policies are recordedin other assets at their cash surrender value, or the amount that can berealized.  Income from these policies andchanges in the net cash surrender value are recorded in non-interest income.

 

**Advertising -**Advertising, promotional, and other business development costs generally areexpensed as incurred. External costs incurred in producing media advertisingare expensed the first time the advertising takes place. External costsrelating to direct mailing costs are expensed in the period in which the directmailings are sent.

 

**Propertyand Equipment** - Premises, furniture and equipment arestated at cost, less accumulated depreciation. Depreciation expense is computed using the straight-line method, basedon the estimated useful lives for furniture and equipment of 5 to 10 years.  Leasehold improvements are amortized over thelife of the lease.  Maintenance andrepairs are charged to current expense. The costs of major renewals and improvements are capitalized.

 

**ResidentialLoan Origination Fees** - The Company offers residential loan origination services to itscustomers in its immediate market area. The loans are offered on terms and prices offered by the Company’scorrespondents and are closed in the name of the correspondents. The Companyreceives fees for services it provides in conjunction with the originationservices it provides.  The fees arerecognized at the time the loans are closed by the Company’s correspondent.

 

**Income Taxes** - The consolidated financial statements have been prepared on the accrual basis.  When income and expenses are recognized in different periods for financial reporting purposes versus for the purposes of computing income taxes currently payable, deferred taxes are provided on such temporary differences.  The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”).

 

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) to clarify the accounting and disclosure for uncertainty in tax positions, as defined. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. The Company implemented the provisions of FIN 48 as of January 1, 2007, and has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The Company believes that its income tax filing positions taken or expected to be taken in an its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flow. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN 48. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.

 

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Under SFAS 109 and FIN 48, deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns.  Income taxes are the sum of amounts currently payable to taxing authorities and the net changes in income taxes payable or refundable in future years.  Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled.  Income taxes deferred to future years are determined utilizing an asset and liability approach.  This method gives consideration to the future tax consequences associated with differences between financial accounting and tax bases of certain assets and liabilities which are principally the allowance for loan losses, depreciable premises and equipment, and net operating loss carry-forwards.

 

**EarningsPer Share** - Basic earnings per share represents thenet income allocated to shareholders divided by the weighted-average number ofcommon shares outstanding during the period. Diluted earnings per share reflect the impact of additional commonshares that would have been outstanding if dilutive potential common shares hadbeen issued.  Potential common sharesthat may be issued by the Company relate to both outstanding warrants and stockoptions, and are determined using the treasury stock method.

 

**Stock–basedCompensation** - On January 1, 2006, the Companyadopted the fair value recognition provisions of the Financial AccountingStandards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123(R),*Share-Based Payment*, which is a revisionof SFAS No. 123, *Accounting for Stock-BasedCompensation*, to account for compensation costs under its stockoption plans.  The Company previouslyutilized the intrinsic value method under Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees (asamended)* (“APB 25”).  Underthe intrinsic value method prescribed by APB 25, no compensation costs wererecognized for the Company’s stock options because the option exercise price inits plans equaled the market price on the date of grant.  Prior to January 1, 2006, the Company onlydisclosed the pro forma effects on net income and earnings per share as if thefair value recognition provisions of SFAS No. 123(R) had beenutilized.

 

# **In adopting SFAS No. 123, the Company elected to usethe modified prospective method to account for the transition from theintrinsic value method to the fair value recognition method.  Under the modified prospective method,compensation cost is recognized from the adoption date forward for all newstock options granted and for any outstanding unvested awards as if the fairvalue method had been applied to those awards as of the date of grant.**

 

**Off-BalanceSheet Financial Instruments** - In the ordinary courseof business, the Company enters into off-balance sheet financial instrumentsconsisting of commitments to extend credit and letters of credit.  These financial instruments are recorded inthe financial statements when they become payable by the customer.

 

**RecentlyIssued Accounting Standards -**The following is asummary of recent authoritative pronouncements that could impact theaccounting, reporting, and / or disclosure of financial information by theCompany.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard eliminates inconsistencies found in various prior pronouncements but does not require any new fair value measurements. SFAS 157 is effective for the Company on January 1, 2008 and will not impact the Company’s accounting measurements but it is expected to result in additional disclosures.

 

In September 2006, the FASB ratified the consensus reached on EITF 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 06-5”).  EITF 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 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 06-5 is effective for the Company on January 1, 2008.  The Company does not believe the adoption of EITF 06-5 will have a material impact on its financial position, results of operations or cash flows.

 

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In September 2006, The FASB ratified the consensuses reached by the FASB’s Emerging Issues Task Force (“EITF”) relating to EITF 06-4, “Accounting for the Deferred Compensation and Post-retirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (“EITF 06-4”).  Entities purchase life insurance for various reasons including protection against loss of key employees and to fund postretirement benefits. The two most common types of life insurance arrangements are endorsement split dollar life and collateral assignment split dollar life. EITF 06-4 covers the former and EITF 06-10 (discussed below) covers the latter. EITF 06-4 states that entities with 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,” (if, in substance, a postretirement benefit plan exists)**or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus Opinion–1967” (if the arrangement is, in substance, an individual deferred compensation contract).* *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. EITF 06-4 is effective for the Company on January 1, 2008. The Company does not believe the adoption of EITF 06-4 will have a material impact on its financial position, results of operations or cash flows.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (“SFAS 159”). 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 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 159 is effective for the Company on January 1, 2008. The Company is currently analyzing the fair value option that is permitted, but not required, under SFAS 159.

 

In March 2007, the FASB ratified the consensus reached on EITF 06-10, “Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements” (“EITF 06-10”). The postretirement aspect of this EITF is substantially similar to EITF 06-4 discussed above and requires that an employer recognize a liability for the postretirement benefit related to a collateral assignment split-dollar life insurance arrangement in accordance with either FASB Statement No. 106 or APB Opinion No. 12, as appropriate, if the employer has agreed to maintain a life insurance policy during the employee’s retirement or provide the employee with a death benefit based on the substantive agreement with the employee.  In addition, a consensus was reached that an employer should recognize and measure an asset based on the nature and substance of the collateral assignment split-dollar life insurance arrangement. EITF 06-10 is effective for the Company on January 1, 2008. The Company does not believe the adoption of EITF 06-10 will have a material impact on its financial position, results of operations or cash flows.

 

In November 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (“SAB 109”). SAB 109 expresses the current view of the SEC staff that the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings.  SEC registrants are expected to apply this guidance on a prospective basis to derivative loan commitments issued or modified in the first quarter of 2008 and thereafter. The Company is currently analyzing the impact of this guidance, which relates to the Company’s mortgage loans held for sale.

 

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In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (“SFAS 141(R)”) which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141(R) is effective for acquisitions by the Company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations following existing accounting guidance until January 1, 2009. The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.

 

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting non-controlling interests (minority interest). As a result, diversity in practice exists. In some cases minority interest is reported as a liability and in others it is reported in the mezzanine section between liabilities and equity. Specifically, SFAS 160 requires the recognition of a non-controlling interest (minority interest) as equity in the consolidated financials statements and separate from the parent’s equity. The amount of net income attributable to the non-controlling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the non-controlling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interests. SFAS 160 is effective for the Company on January 1, 2009.  Earlier adoption is prohibited. The Company is currently evaluating the impact, if any, the adoption of SFAS 160 will have on its consolidated financial statements.

 

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 the Company’s financial position, results of operations or cash flows.

 

**Risks andUncertainties** - In the normal course of its business,the Company encounters two significant types of risk: economic andregulatory.  There are three maincomponents of economic risk:  interestrate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that itsinterest-bearing liabilities mature or reprice at different speeds, or ondifferent bases, than its interest-earning assets.  Credit risk is the risk of default on theCompany’s loan portfolio that results from borrower’s inability orunwillingness to make contractually required payments.  Market risk reflects changes in the value ofcollateral underlying loans receivable and the valuation of real estate held bythe Company.

 

The Company is subject to theregulations of various governmental agencies. These regulations can and do change significantly from period toperiod.  The Company also undergoes periodicexaminations by the regulatory agencies, which may subject it to furtherchanges with respect to asset valuations, amounts of required loss allowancesand operating restrictions from the regulators’ judgments based on informationavailable to them at the time of their examination.

 

**Reclassifications**- Certain captions and amounts in the prior financial statements werereclassified to conform with the 2007 presentation. Such reclassifications hadno effect on previously reported net income or shareholders’ equity.

 

**NOTE 2 – RESTRICTIONSON CASH AND DUE FROM BANKS**

 

The Bank is required tomaintain average reserve balances, computed by applying prescribed percentagesto its various types of deposits, either at the Bank or on deposit with theFRB. At December 31, 2007 and 2006, these required reserves were met byvault cash.

 

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### **NOTE 3 – INVESTMENTSECURITIES**

 

# **The amortized costs and fair valuesof investment securities are as follows:**

 
| ** **                                      | ** ** | **Amortized** | ** **     | **Gross Unrealized** | ** ** | **Fair**    | ** ** |
|-------------------------------------------------|------------|---------------|----------------|---------------------------|------------|-------------|------------|
| ** **                                      | ** ** | **Cost**      | ** **     | **Gains**                 | ** ** | **Losses**  | ** ** | **Value** | ** ** |
| **As of December 31, 2007** |       |          |           |                      |       |        |       |   |   |
| **Available for sale**                          |       |          |           |                      |       |        |       |   |   |
| Government sponsored enterprises                |       | $             | 15,488,584     |                      | $          | 136,049     |       | $ | — |   | $ | 15,624,633 |   |
| Mortgage-backed                                 |       | 9,014,173     |           | 115,428                   |       | 10,227      |       | 9,119,374 |   |
| Marketable securities                           |       | 100,000       |           | —                    |       | —      |       | 100,000 |   |
| Total Available for sale                        | ** ** | **$**         | **24,602,757** | ** **                | **$**      | **251,477** | ** ** | **$** | **10,227** | ** ** | **$** | **24,844,007** | ** ** |
|                                            |       |          |           |                      |       |        |       |   |   |
| **As of December 31, 2006**                |       |          |           |                      |       |        |       |   |   |
| **Available for sale**                          |       |          |           |                      |       |        |       |   |   |
| Marketable securities                           |       | $             | 100,000        |                      | $          | —      |       | $ | — |   | $ | 100,000 |   |
| Total Available for sale                        | ** ** | **$**         | **100,000**    | ** **                | **$**      | **—**  | ** ** | **$** | **—** | ** ** | **$** | **100,000** | ** ** |

 

# **The amortized costs and fair valuesof investment securities available for sale at December 31, 2007, bycontractual maturity, are shown below.**

 
| ** **                       | ** ** | **December 31, 2007** | ** **     |
|----------------------------------|------------|---------------------------------|----------------|
| ** **                       | ** ** | **Amortized**                   | ** **     | **Fair** | ** ** |
| ** **                       | ** ** | **Cost**                        | ** **     | **Value** | ** ** |
| **Available for sale**           |       |                            |           |   |   |
| Due within one year(1)           |       | $                               | 4,093,646      |   | $ | 3,555,000 |   |
| Due after one through five years |       | 11,494,940                      |           | 11,622,834 |   |
| Due after five through ten years |       | 6,755,981                       |           | 6,293,676 |   |
| Due after ten years              |       | 2,258,190                       |           | 3,372,497 |   |
| Total Available for sale         | ** ** | **$**                           | **24,602,757** | ** ** | **$** | **24,844,007** | ** ** |

----

(1)   Marketable securities are included as due within one year.

 

The table below summarizes gross unrealizedlosses on investment securities and the fair market value of the relatedsecurities, aggregated by investment category and length of time thatindividual securities have been in a continuous unrealized loss position, at December 31,2007.

 
| ** **                  | ** ** | **Less than 12 months** | ** **    | **12 months or longer** | ** ** | **Total**  | ** ** |
|-----------------------------|------------|----------------------------------------|---------------|----------------------------------------|------------|------------|------------|
| ** **                  | ** ** | **Fair**                               | ** **    | **Unrealized**                         | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                  | ** ** | **Value**                              | ** **    | **Loss**                               | ** ** | **Value**  | ** ** | **Gain/(Loss)** | ** ** | **Value** | ** ** | **Gain/(Loss)** | ** ** |
| **As of December 31, 2007** |       |                                   |          |                                   |       |       |       |   |   |   |   |   |   |
| **Available for sale**      |       |                                   |          |                                   |       |       |       |   |   |   |   |   |   |
| Mortgage-backed             |       | $                                      | 9,119,374     |                                   | $          | 10,227     |       | $ | — |   | $ | — |   | $ | 9,119,374 |   | $ | 10,227 |   |
| Total Available for sale    | ** ** | **$**                                  | **9,119,374** | ** **                             | **$**      | **10,227** | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **9,119,374** | ** ** | **$** | **10,227** | ** ** |

 

At December 31, 2007, the Company hadmortgage-backed securities in an unrealized loss position.  The Company believes, based on industryanalyst reports and credit ratings that the deterioration in value isattributed to changes in market interest rates and not in the credit quality ofthe issuer and therefore, these losses are not consideredother-than-temporary.  The Company hasthe ability and intent to hold these securities until such time as the valuerecovers or the securities mature.

 

# **No investment securities were soldduring 2007 or 2006. Accordingly, no gains or losses were recorded. At December 31,2007, there were $16.0 million of securities pledged as collateral forrepurchase agreements from brokers. There were no securities pledged ascollateral for repurchase agreements from brokers at December 31, 2006.**

 

Management limits its credit risk bygenerally investing its portfolio principally in obligations of the UnitedStates of America, its agencies or it corporations. Included in the investmentportfolio at December 31, 2007, are mortgage-backed securities issued bythe Federal National Mortgage Association and the Federal Home Loan MortgageCorporation totaling $5.7 million and $3.3 million, respectively.

 

53

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### **NOTE 4 – OTHERINVESTMENTS**

 

Other investments consisted of FHLB stockwith a cost of $446,800 and $270,800 at December 31, 2007 and 2006,respectively.  All of the FHLB stock isused to collateralize advances with the FHLB.

 

### **NOTE 5 – LOANS RECEIVABLE**

 

Majorclassifications of loans receivable for the years ended December 31, 2007and 2006 are summarized as follows:

 
| ** **                     | ** ** | **December 31,** | ** **      |
|--------------------------------|------------|-----------------------|-----------------|
| ** **                     | ** ** | **2007**              | ** **      | **2006** | ** ** |
| Real estate - construction     |       | $                     | 124,016,089     |   | $ | 69,020,976 |   |
| Real estate - mortgage         |       | 149,369,530           |            | 128,708,578 |   |
| Commercial and industrial      |       | 26,094,711            |            | 17,238,551 |   |
| Consumer and other             |       | 3,453,574             |            | 2,695,441 |   |
| Total loans, gross             |       | 302,933,904           |            | 217,663,546 |   |
| Less allowance for loan losses |       | (4,213,547            | )               | (3,090,500 | ) |
| Total loans, net               | ** ** | **$**                 | **298,720,357** | ** ** | **$** | **214,573,046** | ** ** |

 

Loans are stated net ofdeferred fees and costs.

 

The Bank had $35,172 and$283,934 of loans classified as non-accrual status as of December 31, 2007and 2006, respectively.  At December 31,2007 and 2006, loans past due 90 days or more amounted to $10,644 and $0,respectively. See additional disclosures regarding Loans Receivable andAllowance for Loan Losses in Note 1.

 

Activity in the allowance for loan lossesduring the years ended December 31, 2007 and 2006 is summarized below:

 
| ** **                      | ** ** | **Year ended December 31,** | ** **    |
|---------------------------------|------------|--------------------------------------------|---------------|
| ** **                      | ** ** | **2007**                                   | ** **    | **2006** | ** ** |
| Balance, beginning of year      |       | $                                          | 3,090,500     |   | $ | 1,558,000 |   |
| Provision charged to operations |       | 1,188,000                                  |          | 1,532,500 |   |
| Charge-offs                     |       | (64,953                                    | )             | — |   |
| Balance, end of year            | ** ** | **$**                                      | **4,213,547** | ** ** | **$** | **3,090,500** | ** ** |

 

### **NOTE 6 – PROPERTYAND EQUIPMENT**

 

Property and equipmentconsisted of the following:

 
| ** **                           | ** ** | **December 31,** | ** **    |
|--------------------------------------|------------|-----------------------|---------------|
| ** **                           | ** ** | **2007**              | ** **    | **2006** | ** ** |
| Land                                 |       | $                     | 785,811       |   | $ | 785,811 |   |
| Buildings and leasehold improvements |       | 2,837,874             |          | 2,594,269 |   |
| Property and equipment               |       | 2,562,922             |          | 1,889,284 |   |
| Construction in progress             |       | —                |          | 1,028 |   |
| Total                                |       | 6,186,607             |          | 5,270,392 |   |
| Less, accumulated depreciation       |       | (1,112,922            | )             | (527,226 | ) |
| Property and equipment, net          | ** ** | **$**                 | **5,073,685** | ** ** | **$** | **4,743,166** | ** ** |

 

The Companyrecorded $601,017 and $365,122 in depreciation expense of property and equipmentfor the years ended December 31, 2007 and 2006, respectively.

 

54

----

 

### **NOTE 7 – DEPOSITS**

 

The following table sets forth the depositsof the Company by category as of December 31, 2007 and 2006.

 
| ** **                        | ** ** | **December 31,** | ** **      |
|-----------------------------------|------------|-----------------------|-----------------|
| ** **                        | ** ** | **2007**              | ** **      | **2006** | ** ** |
| Non-interest bearing demand       |       | $                     | 24,463,939      |   | $ | 14,784,450 |   |
| Interest bearing demand           |       | 13,720,505            |            | 5,508,164 |   |
| Savings                           |       | 24,634,385            |            | 13,867,588 |   |
| Time deposits less than $100,000  |       | 59,528,027            |            | 64,456,550 |   |
| Time deposits of $100,000 or over |       | 47,117,789            |            | 46,606,436 |   |
| Brokered deposits                 |       | 158,199,000           |            | 71,808,000 |   |
| Total deposits                    | ** ** | **$**                 | **327,663,645** | ** ** | **$** | **217,031,188** | ** ** |

 

Deposits from outside theCompany’s market area obtained through brokers amounted to 48.28% and 33.09% oftotal deposits at December 31, 2007 and 2006, respectively.

 

At December 31, 2007, thescheduled maturities of certificates of deposit were as follows:

 
| **Maturing In:** | ** ** | **Amount** | ** **      | ** ** | ** ** |
|-----------------------|------------|------------|-----------------|------------|------------|
| 2008                  |       | $          | 246,973,881     |       |       |   |
| 2009                  |       | 17,848,513 |            |       |       |
| 2010                  |       | —     |            |       |       |
| 2011                  |       | 16,904     |            |       |       |
| 2012                  |       | 5,518      |            |       |       |
| Thereafter            |       | —     |            |       |       |
| Total                 | ** ** | **$**      | **264,844,816** | ** ** | ** ** | ** ** |

 

### **NOTE 8 – REPURCHASE AGREEMENTS**

 

At December 31, 2007, theBank had sold $15.0 million of securities under agreements to repurchase withbrokers with a weighted average rate of 2.58% and an average maturity of 82months.  The maximum amountoutstanding at any month-end was $15.0 million.  These agreements were secured withapproximately $16.0 million of investment securities.

 

As of and for the year-ended December 31,2006, the Bank had no securities under agreements to repurchase with brokers.

 

### **NOTE 9 – INCOME TAXES**

 

Income tax expense for the yearended December 31, 2007 and 2006 is summarized as follows:

 
| ** **                            | ** ** | **2007**  | ** **  | **2006**   | ** ** |
|---------------------------------------|------------|-----------|-------------|------------|------------|
| Current portion:                      |       |      |        |       |       |
| Federal                               |       | $         | 984,495     |       | $          | 719,826 |   |
| State                                 |       | 73,053    |        | 52,666     |       |
| Total current income tax expense      |       | 1,057,548 |        | 772,492    |       |
| Deferred income tax expense (benefit) |       | (275,892  | )           | (412,072   | )          |
| Income tax expense                    | ** ** | **$**     | **781,656** | ** ** | **$**      | **360,420** | ** ** |

 

A reconciliationbetween the income tax expense and the amount is computed by applying theFederal statutory rate of 34% for 2007 and 2006 to income before income taxesfollows:

 
| ** **                                    | ** ** | **2007** | ** **  | **2006**   | ** ** |
|-----------------------------------------------|------------|----------|-------------|------------|------------|
| Federal income tax expense at statutory  rate |       | $        | 798,921     |       | $          | 515,930 |   |
| State income taxes, net of federal benefit    |       | 48,216   |        | 34,760     |       |
| Valuation allowance change                    |       | —   |        | (272,884   | )          |
| Other                                         |       | (65,481  | )           | 82,614     |       |
| Income tax expense                            | ** ** | **$**    | **781,656** | ** ** | **$**      | **360,420** | ** ** |

 

55

----

 

The grossamounts of deferred tax assets and deferred tax liabilities are as follows:

 
| ** **                                  | ** ** | **December 31,** | ** **  |
|---------------------------------------------|------------|-----------------------|-------------|
| ** **                                  | ** ** | **2007**              | ** **  | **2006** | ** ** |
| **Deferred tax assets**           |       |                  |        |   |   |
| Allowance for loan losses                   |       | $                     | 1,122,861   |   | $ | 765,087 |   |
| Organization and start-up costs             |       | 114,168               |        | 143,904 |   |
| Accrued interest on non-accrual loans       |       | 1,552                 |        | 6,527 |   |
| Other                                       |       | 33,497                |        | — |   |
| Total deferred tax assets                   |       | 1,272,078             |        | 915,518 |   |
|                                        |       |                  |        |   |   |
| **Deferred tax liabilities**                | ** ** | ** **            | ** **  | ** ** | ** ** |
| Loan origination costs                      |       | (88,236               | )           | (79,579 | ) |
| SFAS No. 115 mark-to-market adjustment |       | (89,200               | )           | — |   |
| Depreciation                                |       | (89,512               | )           | (27,371 | ) |
| Prepaid expenses                            |       | (67,238               | )           | (57,348 | ) |
| Total deferred tax liabilities              |       | (334,186              | )           | (164,298 | ) |
| Net deferred tax asset                      | ** ** | **$**                 | **937,892** | ** ** | **$** | **751,220** | ** ** |

 

Deferred taxassets represent the future tax benefit of deductible differences and, if it ismore likely than not that a tax asset will not be realized, a valuationallowance is required to reduce the recorded deferred tax assets to netrealizable value.  As of December 31,2007 and 2006, management has determined that no valuation allowance isrequired as it is more likely than not that the recorded net deferred taxassets will be realized in full. The net deferred tax asset is included in thecaption “other assets” on the balance sheet.

 

The Company hasanalyzed the tax positions taken or expected to be taken in its tax returns andconcluded it has no liability related to uncertain tax positions in accordancewith FIN 48.

 

### **NOTE 10 – LEASES**

 

The Company leases branchlocations in Spartanburg, Mauldin, Anderson, Greer and Greenville as well asthe loan operations center in Easley. The initial lease terms range from threeto ten years with various renewal options. The minimum future rental paymentsunder non-cancelable operating leases having remaining terms in excess of oneyear, for each of the next five years and in the aggregate are:

 
| 2008                                 |       | $         | 337,457       |       |       |       |
|--------------------------------------|------------|-----------|---------------|------------|------------|------------|
| 2009                                 |       | 353,771   |          |       |       |
| 2010                                 |       | 332,364   |          |       |       |
| 2011                                 |       | 331,862   |          |       |       |
| 2012                                 |       | 345,471   |          |       |       |
| Thereafter                           |       | 1,288,756 |          |       |       |
| Total minimum future rental payments | ** ** | **$**     | **2,989,681** | ** ** | ** ** | ** ** |

 

### **NOTE 11 – COMMITMENTS AND CONTINGENCIES**

 

The Company is subject toclaims and lawsuits which arise primarily in the ordinary course ofbusiness.  Management is not aware of anylegal proceedings which would have a material adverse effect on the financialposition or operating results of the Company.

 

### **NOTE 12 – RELATED PARTY TRANSACTIONS**

 

Certain parties (principallycertain directors and executive officers of the Company, their immediatefamilies and business interests) (“affiliates”) are loan customers in thenormal course of business with the Bank. These loans are made on substantially the same terms, including interestrates and collateral, as those prevailing at the time for comparable transactionswith unrelated persons and do not involve more than the normal risk ofcollectability.  As of December 31,2007 and 2006 the Bank had related party loans totaling $21,946,890 and$15,250,850, respectively.  During 2007,advances on related party loans totaled $11,026,237 and repayments were$4,330,197. During 2006, advances on related party loans totaled $9,435,115 andrepayments were $4,886,549.

 

56

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Both at December 31, 2007and 2006, affiliates had deposits with the Bank in the amount of $3.7 million.

 

The Company also enters intoother transactions in the ordinary course of business with affiliates.  Company policy requires transactions withaffiliates to be on terms no more favorable than could be obtained from anunaffiliated third party and to be approved by a majority of disinteresteddirectors.  The following aretransactions entered into with affiliates during the years ended December 31,2007 and 2006:

 
| · |   | The Spartanburg branch location was leased from a partnership in  which two Company directors have a partnership interest. Lease payments on  that office totaled $80,000 and $78,000 for the years ended December 31,  2007 and 2006, respectively.                                                                        |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · |   | The loan operations center in Easley was leased from a partnership in  which a Company director has a partnership interest. Lease payments on that  office totaled $24,000 for the year ended December 31, 2007. There were  no lease payments on the loan operations center during the year ended  December 31, 2006. |
| · |   | The Company leased the site for its temporary headquarters and  banking facility in Easley from a director. Lease payments under this lease  totaled $20,658 for the year ended December 31, 2006.                                                                                                                          |
| · |   | The permanent headquarters and branch office in Easley was completed  as of May 19, 2006 by a company owned by one of our directors at a  contract cost of $1,974,059, which Management concluded was the fair market  price.                                                                                               |

 

### **NOTE 13 – SHARES OUTSTANDING AND EARNINGS PER SHARE**

 

On January 16,2006, the Company effected a 5-for-4 stock split in the form of a stockdividend for shareholders of record as of December 15, 2005. On January 16,2007, the Company effected a 5-for-4 stock split in the form of a stockdividend for shareholders of record as of December 15, 2006. All share andper share data has been adjusted for all periods prior to the splits.

 

Basic earnings pershare is computed by dividing the net income by the weighted-average number ofcommon shares outstanding.  Dilutedearnings per share is computed by dividing the net income by the sum of theweighted-average number of common shares outstanding and dilutive common shareequivalents using the treasury stock method. Dilutive common share equivalents include common shares issuable uponexercise of outstanding stock warrants and stock options.

 

The following isthe basic and diluted income per share computation:

 
| ** **                                                 | ** ** | **December 31,** | ** **    |
|------------------------------------------------------------|------------|-----------------------|---------------|
| ** **                                                 | ** ** | **2007**              | ** **    | **2006** | ** ** |
| Net income to common shareholders                          | ** ** | **$**                 | **1,568,112** | ** ** | **$** | **1,157,020** | ** ** |
|                                                       |       |                  |          |   |   |
| Weighted-average common shares outstanding –  basic   | ** ** | **4,698,634**         | ** **    | **4,686,807** | ** ** |
|                                                       |       |                  |          |   |   |
| Weighted-average common shares outstanding –  diluted | ** ** | **5,126,601**         | ** **    | **5,144,536** | ** ** |
|                                                       |       |                  |          |   |   |
| Earnings per share – basic                            | ** ** | **$**                 | **0.33**      | ** ** | **$** | **0.25** | ** ** |
|                                                       | ** ** | ** **            | ** **    | ** ** | ** ** |
| Earnings per share – diluted                          | ** ** | **$**                 | **0.31**      | ** ** | **$** | **0.22** | ** ** |

 

**NOTE 14 – STOCK COMPENSATION PLANS**

 

Upon completion of theoffering, the Company agreed to issue warrants to the organizing directors forthe purchase of one share of common stock at $6.40 per share for every twoshares purchased in the stock offering, up to a maximum of 15,625 warrants perdirector. The warrants were fully vested 120 days after January 18, 2005and will expire on January 18, 2015. Warrants held by directors of the Company will expire 90 days after thedirector ceases to be a director or officer of the Company (365 days if due todeath or disability). The Company issued a total of 171,404 warrants.  In addition, the Company has adopted a stock optionplan.  As of December 31, 2007 theCompany has 761,493 outstanding options to employees and directors. On January 16,2006 the company adopted a resolution that terminated the “evergreen” provisionof the Company 2005 Stock Incentive Plan. As a result, the number of shares ofcommon stock issuable under the plan shall not be further increased inconnection with any future share issuances by the company. The exerciseprice of each option is equal to the market price of the Company’s stock on thedate of grant. The maximum term is ten years, and they vest in no greater thanfive years. When necessary, the Company may purchase shares on the open marketto satisfy share option exercises. During the ensuing year, the Company isexpected to acquire no shares.

 

57

----

 

The table set forth belowsummarizes stock option activity for the Company’s stock compensation plans forthe years ended December 31, 2007 and 2006 as adjusted for all stocksplits.

 
| ** **                                | ** ** | **Stock Options** | ** ** | **Warrants**  | ** ** |
|-------------------------------------------|------------|------------------------|------------|---------------|------------|
| ** **                                | ** ** | ** **             | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                | ** ** | ** **             | ** ** | **Average**   | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                | ** ** | ** **             | ** ** | **Exercise**  | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                | ** ** | **Number**             | ** ** | **Price**     | ** ** | **Number** | ** ** | **Price** | ** ** |
| **Outstanding at December 31, 2005** |       | 721,672                |       | $             | 6.54       |   | 171,404 |   | $ | 6.40 |   |
| Granted                                   |       | 34,038                 |       | 13.99         |       | — |   | — |   |
| Forfeited                                 |       | (887                   | )          | 11.18         |       | — |   | — |   |
| Exercised                                 |       | (16,810                | )          | 6.59          |       | — |   | — |   |
| **Outstanding at December 31, 2006** | ** ** | **738,013**            | ** ** | **6.87**      | ** ** | **171,404** | ** ** | **6.40** | ** ** |
| Granted                                   |       | 37,173                 |       | 15.33         |       | — |   | — |   |
| Forfeited                                 |       | (12,693                | )          | 13.31         |       | — |   | — |   |
| Exercised                                 |       | (1,000                 | )          | 6.40          |       | — |   | — |   |
| **Outstanding at December 31, 2007** | ** ** | **761,493**            | ** ** | **7.17**      | ** ** | **171,404** | ** ** | **6.40** | ** ** |
|                                           |            |                        |            |               |            |  |  |  |  |  |  |

 

The table set forth belowsummarizes non-vested stock options as of December 31, 2007 and 2006.

 
| ** **                                | ** ** | **Weighted-Average** | ** ** | **Fair**  | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|----------------------|------------|-----------|------------|------------|------------|
| ** **                                | ** ** | **Number**           | ** ** | **Value** | ** ** | ** ** | ** ** |
| **Outstanding at December 31, 2005** |       | 7,343                |       | $         | 4.97       |       |       |   |
| Granted                                   |       | 34,038               |       | 5.93      |       |       |       |
| Vested during the year                    |       | (29,431              | )          | 5.84      |       |       |       |
| Forfeited during the year                 |       | (450                 | )          | 6.39      |       |       |       |
| **Outstanding at December 31, 2006** | ** ** | **11,500**           | ** ** | **6.47**  | ** ** | ** ** | ** ** |
| Granted                                   |       | 37,173               |       | 6.88      |       |       |       |
| Vested during the year                    |       | (2,300               | )          | 6.44      |       |       |       |
| Forfeited during the year                 |       | (4,100               | )          | 7.06      |       |       |       |
| **Outstanding at December 31, 2007** | ** ** | **42,273**           | ** ** | **6.79**  | ** ** | ** ** | ** ** |
|                                           |            |                      |            |           |            |            |            |  |

 

As of December 31, 2007,there was $255,917 in total unrecognized compensation cost related tonon-vested share-based compensation arrangements, which is expected to berecognized over a weighted average period of 49 months. As of December 31,2006, there was $62,627 in total unrecognized compensation cost related tonon-vested share-based compensation arrangements, which is expected to berecognized over a weighted average period of 56 months.

 

The fair value of each optiongranted is estimated on the grant date using the Black-Scholes option-pricingmodel with the following assumptions for 2007 and 2006:  dividend yield of 0%, expected term of 10years, risk-free interest rate of 5.0%, expected life of 10 years, and expectedvolatility of 20%.

 

The following table summarizesinformation about stock options outstanding under the Company’s plans at December 31,2007 and 2006 as adjusted for the 5-for-4 stock splits effective January 16,2006 and January 16, 2007.

 
| **2007**                        | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|---------------------------------|------------|-----------------|------------|-----------------|------------|
| Number of options     |       | 761,493         |       | 719,220         |       |
| Weighted average remaining life |       | 7.35 years      |       | 7.25 years      |       |
| Weighted average exercise price |       | $               | 7.17       |            | $          | 6.71 |   |
| High exercise price             |       | $               | 16.80      |            | $          | 16.80 |   |
| Low exercise price              |       | $               | 6.40       |            | $          | 6.40 |   |
|                            |       |            |       |            |       |
| **2006**                        | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
| Number of options               |       | 738,013         |       | 726,513         |       |
| Weighted average remaining life |       | 8.27 years      |       | 8.26 years      |       |
| Weighted average exercise price |       | $               | 6.87       |            | $          | 6.75 |   |
| High exercise price             |       | $               | 16.80      |            | $          | 16.80 |   |
| Low exercise price              |       | $               | 6.40       |            | $          | 6.40 |   |

 

58

----

 

Cash received from the exerciseof options during the year was $6,400. The intrinsic value of options exercisedduring 2007 and 2006 was $2,880 and $50,480, respectively.

 

At December 31, 2007, allof the 171,404 warrants were exercisable and had an average remaining life of7.05 years. At December 31, 2006, all of the 171,404 warrants wereexercisable and had an average remaining life of 8.05 years.

 

### **NOTE 15 – EMPLOYEE BENEFIT PLAN**

 

The Bank maintains an employeebenefit plan for all eligible employees of the Bank under the provisions ofInternal Revenue Code Section 401(k).  The CommunitySouth 401(k) Plan(the “Plan”), adopted in 2006, allows for employee contributions.  TheBank matches 25% of employee contributions up to a maximum of 1.25% of annualcompensation.  A total of $31,495 and $28,539 was charged to operations in2007 and 2006, respectively, for the Company’s matching contribution. Employees are immediately vested in their contributions to the Plan and becomefully vested in the employer matching contribution after five years of service.

 

### **NOTE 16 – REGULATORY MATTERS**

 

The Bank is subject to variousregulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial adverse effect on the Bank’s financial condition.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance sheet items as calculated under regulatoryaccounting practices.  The Bank’s capitalamounts and classification are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum ratios of Tier 1 and total capital as a percentage of assetsand off-balance sheet exposures, adjusted for risk weights ranging from 0% to100%.  Tier 1 capital consists of commonshareholders’ equity, excluding the unrealized gain or loss on securitiesavailable-for-sale, minus certain intangible assets.  Tier 2 capital consists of the allowance forloan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists ofthe sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 and 8% for totalrisk-based capital.

 

The Bank is also required tomaintain capital at a minimum level based on total assets, which is known asthe leverage ratio.  Only the strongestbanks are allowed to maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios1% to 2% above the minimum.

 

As of December 31,2007, the most recent notification from the Bank’s primary regulatorcategorized it as well-capitalized under the regulatory framework for promptcorrective action.  There are noconditions or events that management believes have changed the Bank’s category.

 

The following tablesummarizes the capital amounts and ratios of the Bank and the regulatoryminimum requirements at December 31, 2007.

 
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well-**  | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| **December 31, 2007**               |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 capital (to risk-weighted assets) |       | $          | 30,102,000 |                       | 8.92       | %                          | $          | 13,503,000                 |       | 4.00                       | %          | $ | 20,255,000 |   | 6.00 | % |
| Total capital (to risk-weighted assets)  |       | 34,316,000 |       | 10.17                      |       | 27,007,000                 |       | 8.00                       |       | 33,759,000                 |       | 10.00 |   |
| Tier 1 capital (to average assets)       |       | 30,102,000 |       | 8.26                       |       | 14,573,000                 |       | 4.00                       |       | 18,217,000                 |       | 5.00 |   |
| **December 31, 2006**               |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 capital (to risk-weighted assets) |       | $          | 27,528,000 |                       | 11.50      | %                          | $          | 9,574,000                  |       | 4.00                       | %          | $ | 14,361,000 |   | 6.00 | % |
| Total capital (to risk-weighted assets)  |       | 30,521,000 |       | 12.75                      |       | 19,148,000                 |       | 8.00                       |       | 23,934,000                 |       | 10.00 |   |
| Tier 1 capital (to average assets)       |       | 27,528,000 |       | 11.49                      |       | 9,582,000                  |       | 4.00                       |       | 11,978,000                 |       | 5.00 |   |

 

59

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The FRB has similarrequirements for bank holding companies. The Company currently is not subjectto these requirements because the FRB applies its guidelines on a bank-onlybasis for bank holding companies with less than $500 million in consolidatedassets.

 

### **NOTE 17 – UNUSED LINES OF CREDIT**

 

As of December 31, 2007and 2006, the Bank had unused lines of credit to purchase federal funds fromunrelated banks totaling $15,000,000 and $11,125,000, respectively.  These lines of credit are available on a oneto fourteen day basis for general corporate purposes.  As of December 31, 2007 and 2006, theBank has no funds drawn from these lines. The Company also has a line of creditto borrow funds from the FHLB up to 10% of the Bank’s total assets subject toavailable collateral; availability under this facility totaled $34,670,000 and$20,292,000 as of December 31, 2007 and 2006, respectively.  As of December 31, 2007 and 2006, theBank had not drawn any advances on this line.

 

**NOTE18 – RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS, OR ADVANCES**

 

The ability of CommunitySouthFinancial Corporation to pay cash dividends is dependent upon receiving cash inthe form of dividends from the Bank. However, there are restrictions on the ability of the Bank to transferfunds to CommunitySouth Financial Corporation in the form of cash dividends,loans, or advances.  As a South Carolinastate bank, the Bank may only pay dividends out of its net profits, afterdeducting expenses, including losses and bad debts.  In addition, the Bank is prohibited fromdeclaring a dividend on its shares of common stock until its surplus equals itsstated capital.  At December 31,2006, the Bank was no longer prohibited from declaring a dividend because ithad a surplus of $105,369. At December 31, 2007, the Bank’s surplusexceeded its stated capital by $1,970,050.

 

### **NOTE 19 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEETRISK**

 

The Company is a party tofinancial instruments with off-balance sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  These financial instruments consist ofcommitments to extend credit and standby letters of credit.  Commitments to extend credit are agreementsto lend to a customer as long as there is no violation of any conditionestablished in the contract.  Commitmentsgenerally have fixed expiration dates or other termination clauses and mayrequire payment of a fee.  A commitmentinvolves, to varying degrees, elements of credit and interest rate risk inexcess of the amount recognized in the balance sheet.  The Company’s exposure to credit loss in theevent of non-performance by the other party to the instrument is represented bythe contractual notional amount of the instrument.  Since certain commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future cash requirements. The Company uses the same credit policies in making commitments toextend credit as it does for on-balance-sheet instruments.  Letters of credit are conditional commitmentsissued to guarantee a customer’s performance to a third party and haveessentially the same credit risk as other lending facilities.  The Company has not recorded a liability forthe current carrying amount of the obligation to perform as a guarantor and nocontingent liability was considered necessary, as such amounts were notconsidered material.

 

Collateral held for commitmentsto extend credit and letters of credit varies but may include accountsreceivable, inventory, property, plant, equipment and income-producingcommercial properties.

 

The following table summarizesthe Company’s off-balance sheet financial instruments whose contract amountsrepresent credit risk:

 
| ** **                   | ** ** | **December 31,** | ** **     |
|------------------------------|------------|-----------------------|----------------|
| ** **                   | ** ** | **2007**              | ** **     | **2006** | ** ** |
|                         | ** ** | ** **            | ** **     | ** ** | ** ** |
| Commitments to extend credit | ** ** | **$**                 | **49,342,960** | ** ** | **$** | **37,928,398** | ** ** |
|                         |       |                  |           |   |   |
| Standby letters of credit    | ** ** | **$**                 | **3,176,854**  | ** ** | **$** | **2,780,068** | ** ** |

 

60

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### **NOTE 20 – FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

SFAS No. 107, “Disclosuresabout Fair Value of Financial Instruments” (“SFAS 107”), requires disclosure offair value information, whether or not recognized in the consolidatedbalance sheets, when it is practical to estimate the fair value.  SFAS 107 defines a financial instrument ascash, evidence of an ownership interest in an entity or contractualobligations, which require the exchange of cash, or other financialinstruments.  Certain items arespecifically excluded from the disclosure requirements, including the Company’scommon stock, premises and equipment, accrued interest receivable and payable,and other assets and liabilities.

 

The fair value of a financialinstrument is the amount at which the asset or obligation could be exchanged ina current transaction between willing parties, other than in a forced orliquidation sale.  Fair value estimates aremade at a specific point in time based on relevant market information andinformation about the financial instruments. Because no market value exists for a significant portion of thefinancial instruments, fair value estimates are based on judgments regardingfuture expected loss experience, current economic conditions, riskcharacteristics of various financial instruments, and other factors.

 

The Company has used management’sbest estimate of fair value based on the above assumptions.  Thus, the fair values presented may not bethe amounts, which could be realized, in an immediate sale or settlement of theinstrument. In addition, any income taxes or other expenses, which would beincurred in an actual sale or settlement, are not taken into consideration inthe fair values presented.

 

The following methods andassumptions were used to estimate the fair value of significant financialinstruments:

 

***Cash and Due from Banks*** - The carryingamount is a reasonable estimate of fair value.

 

***Federal Funds Sold*** - Federal funds soldare for a term of one day, and the carrying amount approximates the fair value.

 

***Investment Securities*** - The fair values ofmarketable equity securities are valuedusing quoted fair market prices.

 

***Other Investments*** - The carrying value ofnon-marketable equity securities approximates the fair value since no readymarket exists for the stocks.

 

***Bank-owned Life Insurance*** - The cash surrender value of life insurancepolicies held by the Bank approximates fair values of the policies.

 

# ***Loans receivable***- For certain categories of loans,such as variable rate loans which are repriced frequently and have nosignificant change in credit risk, fair values are based on the carryingamounts.  The fair value of other typesof loans is estimated by discounting the future cash flows using the currentrates at which similar loans would be made to borrowers with similar creditratings and for the same remaining maturities.

 

***Deposits*****- The fair value of demand deposits, savings, and money marketaccounts is the amount payable on demand at the reporting date.  The fair values of certificates of depositare estimated using a discounted cash flow calculation that applies currentinterest rates to a schedule of aggregated expected maturities.

 

***Repurchase Agreements*** - The carrying valueof these instruments is a reasonable estimate of fair value.

 

The carrying values andestimated fair values of the Company’s financial instruments at December 31,2007 and 2006 are shown in the following table.

 
| ** **                                                          | ** ** | **Carrying** | ** ** | **Estimated**       | ** ** |
|---------------------------------------------------------------------|------------|--------------|------------|---------------------|------------|
| ** **                                                          | ** ** | **Amount**   | ** ** | **Fair Value** | ** ** |
| **December 31, 2007**                                     | ** ** | ** **   | ** ** | ** **          | ** ** |
| **Financial Assets**                                                |       |         |       |                |       |
| Cash and due from banks                                             |       | $            | 6,486,676  |                | $          | 6,486,676 |   |
| Federal funds sold                                                  |       | 33,665,005   |       | 33,665,005          |       |
| Investment securities, available for sale                           |       | 24,844,007   |       | 24,884,007          |       |
| Other investments                                                   |       | 446,800      |       | 446,800             |       |
| Loans, gross                                                        |       | 302,933,904  |       | 302,838,045         |       |
| Bank-owned life insurance                                           |       | 5,226,806    |       | 5,226,806           |       |
|                                                                |       |         |       |                |       |
| **Financial Liabilities**                                           |       |         |       |                |       |
| Demand deposit, interest-bearing  transaction, and savings accounts |       | $            | 62,819,326 |                | $          | 62,819,326 |   |
| Certificates of deposit and other time  deposits                    |       | 264,844,319  |       | 265,698,742         |       |
| Repurchase agreements                                               |       | 15,000,000   |       | 15,041,667          |       |
|                                                                |       |         |       |                |       |
| **December 31, 2006**                                     |       |         |       |                |       |
| **Financial Assets**                                                |       |         |       |                |       |
| Cash and due from banks                                             |       | $            | 3,116,070  |                | $          | 3,116,070 |   |
| Federal funds sold                                                  |       | 17,925,000   |       | 17,925,000          |       |
| Investment securities, available for sale                           |       | 100,000      |       | 100,000             |       |
| Other investments                                                   |       | 270,800      |       | 270,800             |       |
| Loans, gross                                                        |       | 217,663,546  |       | 207,171,479         |       |
| Bank-owned life insurance                                           |       | 5,004,758    |       | 5,004,758           |       |
|                                                                |       |         |       |                |       |
| **Financial Liabilities**                                           |       |         |       |                |       |
| Demand deposit, interest-bearing  transaction, and savings accounts |       | $            | 34,160,201 |                | $          | 34,160,201 |   |
| Certificates of deposit and other time  deposits                    |       | 182,870,987  |       | 182,652,496         |       |

 

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# **NOTE 21 –COMMUNITYSOUTH FINANCIAL CORPORATION (PARENT COMPANY ONLY)**

 

Presented below are thecondensed financial statements for CommunitySouth Financial Corporation (ParentCompany only).

 

**Condensed Balance Sheets**

** **
| ** **                                      | ** ** | **December 31,** | ** **     |
|-------------------------------------------------|------------|-----------------------|----------------|
| ** **                                      | ** ** | **2007**              | ** **     | **2006** | ** ** |
| **Assets**                                      |       |                  |           |   |   |
| Cash                                            |       | $                     | 94,125         |   | $ | 993,426 |   |
| Investment securities, available for sale       |       | 100,000               |           | 100,000 |   |
| Investment in the Bank                          |       | 31,280,850            |           | 28,605,368 |   |
| Other assets                                    |       | 6,692                 |           | 6,692 |   |
| Total assets                                    | ** ** | **$**                 | **31,481,667** | ** ** | **$** | **29,705,486** | ** ** |
| ** **                                      | ** ** | ** **            | ** **     | ** ** | ** ** |
| **Liabilities and shareholders’ equity**   |       |                  |           |   |   |
| Other liabilities                               |       | $                     | 10,531         |   | $ | 10,531 |   |
| Shareholders’ equity                       |       | 31,471,136            |           | 29,694,955 |   |
| Total liabilities and shareholders’ equity | ** ** | **$**                 | **31,481,667** | ** ** | **$** | **29,705,486** | ** ** |

 

**Condensed Statements of Income**

**For the years ended December 31, 2007and December 31, 2006**

 
| ** **                                                                            | ** ** | **2007**  | ** **    | **2006**   | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------|---------------|------------|------------|
| **Income**                                                                            |       | $         | —        |       | $          | 289 |   |
|                                                                                  |       |      |          |       |       |
| **Expenses**                                                                          |       | (55,320   | )             | (140,399   | )          |
|                                                                                  |       |      |          |       |       |
| **Income (loss) before income taxes and  equity in undistributed income of the Bank** |       | (55,320   | )             | (140,110   | )          |
| ** **                                                                            |       |      |          |       |       |
| **Equity in undistributed income of the Bank**                                        |       | 1,623,432 |          | 1,170,353  |       |
|                                                                                  |       |      |          |       |       |
| **Net income before taxes**                                                           |       | 1,568,112 |          | 1,030,243  |       |
|                                                                                  |       |      |          |       |       |
| **Income tax expense (benefit)**                                                      |       | —    |          | (126,777   | )          |
|                                                                                  |       |      |          |       |       |
| **Net income**                                                                        | ** ** | **$**     | **1,568,112** | ** ** | **$**      | **1,157,020** | ** ** |

 

62

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** **

**CondensedStatements of Cash Flows**

**For the year ended December 31, 2007 andDecember 31, 2006**

** **
| ** **                                                                         | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Cash flows from operating activities**                                           |       |       |       |       |       |
| Net income                                                                         |       | $          | 1,568,112  |       | $          | 1,157,020 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |       |       |       |       |
| Increase in other assets                                                           |       | —     |       | 124,837    |       |
| Stock based compensation                                                           |       | 55,320     |       | 140,400    |       |
| Equity in undistributed income of the Bank                                         |       | (1,623,432 | )          | (1,170,353 | )          |
| Decrease in other liabilities                                                      |       | —     |       | (140,527   | )          |
| Net cash provided by operating activities                                          |       | —     |       | 111,377    |       |
|                                                                               |       |       |       |       |       |
| **Cash flows from investing activities**                                           |       |       |       |       |       |
| Purchase of investments                                                            |       | —     |       | (100,000   | )          |
| Transfer of property and equipment                                                 |       | —     |       | 1,444,910  |       |
| Investments in Bank subsidiary                                                     |       | (900,000   | )          | (8,000,000 | )          |
| Net cash used in investing activities                                              |       | (900,000   | )          | (6,655,090 | )          |
|                                                                               |       |       |       |       |       |
| **Cash flows from financing activities**                                           |       |       |       |       |       |
| Cash paid for fractional shares                                                    |       | (5,701     | )          | (1,102     | )          |
| Stock options exercised                                                            |       | 6,400      |       | 112,327    |       |
| Net cash provided by financing activities                                          |       | 699        |       | 111,225    |       |
|                                                                               |       |       |       |       |       |
| **Net decrease in cash and cash equivalents**                                      |       | (899,301   | )          | (6,432,488 | )          |
|                                                                               |       |       |       |       |       |
| **Cash and cash equivalents, beginning of  year**                                  |       | 993,426    |       | 7,425,914  |       |
|                                                                               |       |       |       |       |       |
| **Cash and cash equivalents, end of year**                                         | ** ** | **$**      | **94,125** | ** ** | **$**      | **993,426** | ** ** |

 

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**Contributors**

**CommunitySouth Bank &Trust Employees**

 
| Brenda Adkins     |   | Jennifer Kennedy |
|-------------------|--------|------------------|
| Crystal Alexander |   | Kathy King       |
| Barbra Anderson   |   | Jeff Kirby       |
| Brandi Anderson   |   | Gayle Lee        |
| Diane Auletti     |   | Barbara Marcy    |
| Greg Bailey       |   | Tracy Martin     |
| Kyle Baker        |   | Wayne McKinney   |
| Sherry Beasley    |   | Selena McLeroy   |
| Linda Bindewald   |   | Casey McPeters   |
| Kim Blanton       |   | Joy Merck        |
| Beth Brewer       |   | Cathy Merrell    |
| Erica Brewton     |   | David Miller     |
| Toniette Brooks   |   | Shane Miller     |
| Rose Buonomo      |   | Pat Moody        |
| Mike Burkett      |   | Shannon Moody    |
| Tammy Byars       |   | Priscilla Moore  |
| Essie Clark       |   | Darlene Nations  |
| Cindy Coleman     |   | Mary Neely       |
| Gail Cook         |   | Shana Owens      |
| Cindy Cooper      |   | Rebecca Parker   |
| Abby Copeland     |   | Toni Pearson     |
| Beth Couch        |   | Jennifer Polson  |
| Lisa Crowe        |   | Beth Pruitt      |
| Jay Davis         |   | Joyce Pugsley    |
| Derrell Dean      |   | Marisol Rivera   |
| Marti Donato      |   | Jan Sartor       |
| Allan Ducker      |   | Homer Simuel     |
| Mike Easler       |   | Dee Smith        |
| Sam Engel         |   | Dwayne Stickler  |
| Nikki Farr        |   | David Swank      |
| Roger Foster      |   | Art Tompkins     |
| Julie Gathings    |   | Shana Tucker     |
| Jeff Gilstrap     |   | Sandy Upton      |
| Lori Greene       |   | Brandon Watson   |
| Rod Greene        |   | Buddy White      |
| Leigh Gregory     |   | Leigh Ann White  |
| Tom Hale          |   | Myles Wilkes     |
| Sherry Hall       |   | Andrew Winkler   |
| Sharon Hamilton   |   | Ron Young        |
| Lary Heichel      |   |             |
| Ashley Herlihy    |   |             |
| John Hobbs        |   |             |
| Mac Hogan         |   |             |
| Susan Hooper      |   |             |
| David Jackson     |   |             |
| Lisa Jackson      |   |             |
| Pam Keenan        |   |             |
| Cynthia Kelly     |   |             |

 

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