GRANDSOUTH BANCORPORATON

                                   EXHIBIT 13

                   Portions of Annual Report to Shareholders
                           Incorporated by Reference
                             into December 31, 2005
                                  Form 10-KSB
























<PAGE>

                           Forward-Looking Statements

          This report contains  "forward-looking  statements" within the meaning
of the  securities  laws.  All  statements  that are not  historical  facts  are
"forward-looking  statements." You can 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-looking statements include, but are not limited to, statements regarding
our future business prospects,  revenues,  working capital,  liquidity,  capital
needs, interest costs, income, business operations and proposed services.

         These  forward-looking  statements  are based on current  expectations,
estimates  and  projections  about  our  industry,   management's  beliefs,  and
assumptions made by management.  Such information includes,  without limitation,
discussions  as to estimates,  expectations,  beliefs,  plans,  strategies,  and
objectives  concerning  our future  financial and operating  performance.  These
statements  are not guarantees of future  performance  and are subject to risks,
uncertainties  and  assumptions  that are difficult to predict,  particularly in
light of the fact that we are a relatively  new company  with limited  operating
history. Therefore, actual results may differ materially from those expressed or
forecasted  in such  forward-looking  statements.  The risks  and  uncertainties
include, but are not limited to:

     o    our growth and our ability to maintain growth;

     o    governmental  monetary and fiscal policies, as well as legislative and
          regulatory changes;

     o    the effect of interest  rate changes on our level and  composition  of
          deposits,  loan  demand  and the  value  of our  loan  collateral  and
          securities;

     o    the effects of competition from other financial institutions operating
          in our market area and  elsewhere,  including  institutions  operating
          locally,  regionally,  nationally and  internationally,  together with
          competitors   that  offer  banking  products  and  services  by  mail,
          telephone and computer and/or the Internet;

     o    potential losses arising from failure of customers to repay loans;

     o    failure of assumptions  underlying the  establishment of our allowance
          for loan losses, including the value of collateral securing loans; and

     o    loss of consumer  confidence and economic  disruptions  resulting from
          terrorist activities.

          We  undertake  no  obligation   to  publicly   update  or  revise  any
forward-looking  statements,  whether  as a result  of new  information,  future
events or otherwise.  In light of these risks,  uncertainties,  and assumptions,
the forward-looking events discussed in this report might not occur.

           MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

General

         This  discussion is intended to assist in  understanding  the financial
condition  and  results  of  operations  of the  Company,  and should be read in
conjunction  with the Company's  consolidated  financial  statements and related
notes contained elsewhere herein. Because the Bank is responsible for all of the
Company's operations,  the discussion will refer to the results of operations of
the Bank.  Dollars are in thousands except for per share data,  unless otherwise
noted.

Critical Accounting Policies

         The Company has adopted various accounting  policies,  which govern the
application of accounting  principles generally accepted in the United States of


<PAGE>

America  in  the  preparation  of  the  Company's  financial   statements.   The
significant accounting policies of the Company are described in the footnotes to
the consolidated financial statements.

         Certain   accounting   policies  involve   significant   judgments  and
assumptions by management, which have a material impact on the carrying value of
certain assets and liabilities.  Management  considers these accounting policies
to be critical  accounting  policies.  The  judgments  and  assumptions  used by
management  are based on  historical  experience  and other  factors,  which are
believed to be reasonable under the circumstances.  Because of the nature of the
judgments and  assumptions  made by  management,  however,  actual results could
differ from these judgments and estimates, which could have a material impact on
the carrying  values of assets and  liabilities and the results of operations of
the Company.

         The  Company  believes  the  allowance  for loan  losses is a  critical
accounting  policy that  requires the most  significant  judgments and estimates
used in  preparation  of its  consolidated  financial  statements.  Refer to the
"Provision for Loan Losses" and "Allowance for Loan Losses" sections below for a
detailed description of the Company's estimation process and methodology related
to the allowance for loan losses.

Financial Condition

         In May 2005,  the Company  acquired  an  auto-financing  business  with
assets  valued at $3,236 and  recorded  $737 in  goodwill.  This  auto-financing
business had $2,413 in specialty commercial lines of credit with the Bank. These
loans are now on the Bank's books in the auto dealers' names.

         In  2001,  the  Company  issued  ten-year   variable  rate  convertible
subordinated  debentures  (the  "Debentures").   The  Debentures  paid  interest
quarterly at prime minus 2 percent.  Under the original  terms of the  Debenture
agreement  (the  "Terms"),  the  holders of the  Debentures  could  convert  the
principal  amount of each  Debenture  into  common  stock of the  Company at the
conversion  rate of $5.12  (which  was based on the  approximate  fair  value at
issuance of $6.50, as adjusted for the 2003,  2004 and 2005 stock  dividends) of
Debenture  principal for one share of the Company's stock.  Under the Terms, the
Company had the option of redeeming the  Debentures  at any time after  December
31, 2005 as a whole or in part and from time to time at predetermined prices. At
the Company's request,  during the third and fourth quarters of 2005, holders of
$3,500 of the Company's  Debentures  converted  their principal to common stock.
This conversion was made in advance of the earliest contractual  redemption date
of January 1, 2006,  provided for by the Terms.  The Company paid the holders an
amount  equal  to the  interest  income  that  would  have  been  earned  on the
Debentures through January 1, 2006. This interest was paid based on the interest
rate in  effect  at the time of  conversion:  4.25%  and 4.75% for the third and
fourth quarters of 2005, respectively.

         At December 31, 2005 the Company had total assets of $251,948  composed
primarily of net loans of $197,312,  investment  securities,  other investments,
and  Federal  Funds sold of  $35,270  and cash and due from  banks  balances  of
$6,628.  At December 31, 2004 the Company had total assets of $207,930  composed
primarily of net loans of $174,165,  investment  securities,  other investments,
and  Federal  Funds sold of $20,730  and cash and due from banks of $2,544.  The
increase  in net loans of  $23,147  is the  result of  acquiring  the  specialty
commercial  loans  described  above and strong  loan  demand  during  2005.  The
increase of $14,540 in investment  securities,  other  investments,  and Federal
Funds sold is the result of the Company's  management of the liquidity  needs of
the  institution.  Liabilities  were  $235,820 at December  31,  2005,  composed
primarily of deposits of $221,661,  Federal Home Loan Bank ("FHLB")  advances of
$8,500,  and other  borrowings of $3,900.  Liabilities were $197,133 at December
31, 2004, composed primarily of deposits of $176,146,  FHLB advances of $13,500,
subordinated  debentures of $3,500, and other borrowings of $2,500. The increase
of $45,515 in deposits is the result of new certificates of deposit accounts and
money market  accounts  opened during the period.  The net increase of $1,400 in
other borrowings is the result of paying off an old line of credit of $2,500 and
obtaining  a new line of credit in the  amount of  $3,900.  This  agreement  was
executed  during  the  second  quarter  of  2005  in  order  to  facilitate  the
acquisition  described above.  Shareholders'  equity was $16,128 at December 31,
2005  compared to $10,797 at December  31,  2004.  The increase of $5,331 is the
result of $2,361 in earnings generated by the Company and $3,500 of subordinated
debt  converted  into  common  stock,  offset  by  dividends  paid of $210 and a
decrease in accumulated other comprehensive income of $318.

         The Company's loan  portfolio at December 31, 2005 consisted  primarily
of $41,915 of commercial loans,  $110,694 of real estate mortgage loans, $39,895
of real estate  construction  loans and $7,858 of consumer loans.  The allowance
for loan losses  totaled $3,050 at December 31, 2005.  Management  believes that
the allowance for loan losses is adequate to absorb losses  inherent in the loan
portfolio as of December 31, 2005.

Earnings Performance

         The Company had net income from  operations for the year ended December
31,  2005 of  $2,361,  or $0.91  basic and $0.76  diluted  earnings  per  share,

                                       2
<PAGE>

compared to $1,319 or $0.55 basic earnings per share and $0.43 diluted  earnings
per share for the year ended  December  31,  2004.  Diluted  earnings  per share
reflect the effect of the exercise of stock options as well as the conversion of
subordinated  debentures.  The  Bank had net  interest  income  (the  difference
between  interest  earned  on  interest-earning  assets  and  interest  paid  on
interest-bearing  liabilities) of $9,623 in 2005 compared to $6,674 in 2004. The
Bank also had other operating  income  (principally  service  charges,  fees and
commissions,  and gains on sales of investment  securities)  of $580 in 2005 and
$401 in 2004.  The Bank  provided  $1,125 and $1,000 to its  allowance  for loan
losses  in  2005  and  2004  respectively,  and  had  other  operating  expenses
(principally  salaries and benefits,  occupancy and equipment  expenses and data
processing expenses) of $5,562 in 2005 and $3,987 in 2004.

Net Interest Income

         Net   interest   income   is  the   amount   of   interest   earned  on
interest-earning  assets (loans,  investment securities,  time deposits in other
banks  and  federal  funds  sold),   less  the  interest  expenses  incurred  on
interest-bearing liabilities (interest-bearing deposits and borrowed money), and
is the principal source of the Bank's earnings.  Net interest income is affected
by the level of interest rates,  volume and mix of  interest-earning  assets and
interest-bearing liabilities and the relative funding of these assets.

        During the year ended December 31, 2005, net interest income was $9,623.
For the year ended  December 31,  2004,  net  interest  income was $6,674.  This
increase  was  primarily  attributable  to an  increase  in  volume  of  average
interest-earning  assets,  which  increased to $217,014 in 2005 from $185,167 in
2004. The average yield on  interest-earning  assets  increased to 7.43% in 2005
from  5.68% in 2004,  while the  average  cost of  interest-bearing  liabilities
increased  to  3.17%  in 2005  from  2.23% in  2004.  The net  yield on  average
interest-earning  assets  increased  to  4.43%  in  2005  from  3.60%  in  2004,
increasing the benefit of the increased volume of interest-earning assets.



                                       3
<PAGE>

The table "Average Balances,  Yields and Rates," provides a detailed analysis of
the  average   yields  and  average   effective   rates  on  the  categories  of
interest-earning  assets and  interest-bearing  liabilities  for the years ended
December 31, 2005, 2004 and 2003.
<TABLE>
<CAPTION>
                                                                      Average Balances, Yields and Rates
                                                                      ----------------------------------
                                          Year ended December 31, 2005   Year ended December 31, 2004  Year ended December 31, 2003
                                          ----------------------------   ----------------------------  ----------------------------
                                                      Interest                      Interest                       Interest
                                            Average  Income(2)/  Yields/  Average  Income(2)/  Yields/  Average   Income/(2) Yields/
                                          Balances(1) Expense    Rates  Balances(1) Expense     Rates  Balances(1) Expense    Rates
                                          ----------- -------    -----  ----------- -------     -----  -----------  -------   -----
Assets
<S>                                         <C>       <C>        <C>     <C>        <C>         <C>      <C>        <C>       <C>
Federal funds sold and interest-bearing
 deposits ...............................   $  9,253  $   311    3.36%   $  6,494   $    83     1.29%    $  4,291   $   55    1.28%
Investment securities ...................     24,185      895    3.70      16,629       525     3.16       16,246      557    3.43
Loans (3) ...............................    183,576   14,917    8.13     162,044     9,901     6.11      130,448    7,992    6.13
                                            --------  -------    ----    --------   -------     ----     --------   ------    ----
  Total interest-earning assets .........    217,014   16,123    7.43     185,167    10,509     5.68      150,985    8,604    5.70
Cash and due from banks .................      3,737                        2,504                           2,149
Allowance for loan losses ...............     (2,503)                      (2,214)                         (1,642)
Premises and equipment ..................      3,979                        3,774                           3,958
Other assets ............................      9,848                        5,445                           2,014
                                            --------                     --------                        --------
  Total assets ..........................   $232,075                     $194,676                        $157,464
                                            ========                     ========                        ========
Liabilities and shareholders' equity
      NOW accounts ......................      3,022        7     0.24      2,849         8     0.28        2,580        3    0.13
      Savings and money market accounts .     54,602    1,423     2.61     60,003     1,213     2.02       42,314      817    1.93
      Time deposits .....................    130,419    4,290     3.29     92,410     2,029     2.20       80,555    1,973    2.45
                                            --------  -------     ----   --------   -------     ----     --------   ------    ----
  Interest-bearing deposits .............    188,043    5,720     3.04    155,262     3,250     2.09      125,449    2,793    2.23
  FHLB advances .........................     11,392      459     4.03     11,498       425     3.70        9,588      382    3.98
  Other borrowings ......................      3,232      205     6.33      2,067        81     3.92            -        -       -
  Subordinated debentures ...............      2,460      116     4.70      3,500        79     2.25        3,500       74    2.11
                                            --------  -------     ----   --------   -------     ----     --------   ------    ----
    Total interest-bearing liabilities ..    205,127    6,500     3.17    172,327     3,835     2.23      138,537    3,249    2.35
Noninterest-bearing demand deposits .....     12,107                        9,853                           8,361
Other liabilities .......................      1,965                        2,777                           1,121
                                            --------                     --------                        --------
    Total liabilities ...................    219,199                      184,957                         148,019
Shareholders' equity ....................     12,876                        9,719                           9,445
                                            --------                     --------                        --------
  Total liabilities and
    shareholders' equity ................   $232,075                     $194,676                        $157,464
                                            ========                     ========                        ========
Interest rate spread (4) ................                         4.26                          3.45                          3.35
                                                                  ----                          ----                          ----
Net interest income and net yield
 on earning assets (5) ..................             $ 9,623     4.43              $6,674      3.60                $5,355    3.55
                                                      =======     ----              =======     ----                ======    ----
Interest free funds supporting
 earning assets (6) .....................   $ 11,887                     $ 12,840                        $ 12,448
                                            ========                     ========                        ========
</TABLE>
(1)  Average balances are computed on a daily basis.
(2)  Interest income is not stated on a fully tax-equivalent basis.
(3)  Nonaccruing  loans are included in the average loan  balances and income on
     such loans is recognized on a cash basis.  Income includes loan fees, which
     are immaterial to the calculation.
(4)  Total  interest-earnings  assets  yield  less  the  total  interest-bearing
     liabilities rate.
(5)  Net interest income divided by total interest earning assets.
(6)  Total interest-earnings assets less total interest-bearing liabilities.



                                       4
<PAGE>

Rate/Volume Analysis of Net Interest Income

            The  effect of changes in  average  balances  (volume)  and rates on
interest  income,  interest  expense and net  interest  income,  for the periods
indicated,  is shown below.  The effect of a change in average  balance has been
determined  by applying the average rate in the earlier  period to the change in
average balance in the later period,  as compared with the earlier  period.  The
effect of a change in the  average  rate has been  determined  by  applying  the
average  balance in the earlier  period to the change in the average rate in the
later  period,  as compared  with the earlier  period.  The effect of changes in
volume/rate  has been determined by applying the amount of the change in average
rates to the amount of the change in average  volumes,  and  allocated to volume
and rate based on their proportions to the absolute value of each.

<TABLE>
<CAPTION>
                                                           Year ended December 31, 2005              Year Ended December 31, 2004
                                                               Compared to 2004                          Compared to 2003
                                                          Increase (Decrease) Due to                Increase (Decrease) Due to
                                                          --------------------------                --------------------------
                                                     Volume          Rate      Rate/Volume      Volume        Rate       Rate/Volume
                                                     ------          ----      -----------      ------        ----       -----------
Interest earned on:
<S>                                                 <C>            <C>           <C>           <C>           <C>            <C>
       Federal  funds  sold and
       interest-bearing deposits ............       $    36        $   192       $   228       $    28       $     1        $    29
       Investment securities (1) ............           239            131           370            12           (45)           (33)
       Gross Loans (2) ......................         1,314          3,702         5,016         1,935           (26)         1,909
                                                    -------        -------       -------       -------       -------        -------

Total Interest Income .......................         1,589          4,025         5,614         1,975           (70)         1,905
Interest paid on:
       Deposits .............................           685          1,785         2,470           620          (163)           457
       FHLB advances ........................            (4)            38            34            70           (27)            43
       Other borrowings .....................            46             78           124            81             -             81
       Subordinated debentures ..............           (23)            60            37             -             5              5
                                                    -------        -------       -------       -------       -------        -------

Total Interest Expense ......................           704          1,961         2,665           771          (185)           586

Change in Net Interest Income ...............       $   885        $ 2,064       $ 2,949       $ 1,204       $   115        $ 1,319
                                                    =======        =======       =======       =======       =======        =======
</TABLE>

Notes to rate/volume table:

(1)  The changes in rate are not calculated on a fully tax-equivalent basis.
(2)  Interest  income on nonaccruing  loans is recognized on a cash basis.  Loan
     income includes loan fees, which are immaterial to the calculation.

         During 2006,  management  expects that  short-term  interest rates will
continue to increase  during the entire year, but at a slower pace than in 2005.
The Company does not expect these increases to have a significant  impact on the
company's  earnings due to similar  repricing  intervals in the interest earning
asset and  liability  portfolio.  Therefore,  any  improvements  in net interest
income for 2005 are expected to be largely the result of increases in the volume
and  changes  in  the  mix  of  interest-earning   assets  and  interest-bearing
liabilities.   Management  expects  to  continue  to  use  aggressive  marketing
strategies  to increase the Bank's  market  share for both  deposits and quality
loans within the  Greenville,  South Carolina  area.  These  strategies  involve
offering  attractive  interest  rates and  continuing  the Bank's  commitment to
providing outstanding customer service.

Interest Rate Sensitivity

         Interest rate  sensitivity  management is concerned with the timing and
magnitude of repricing  assets  compared to liabilities and is an important part
of asset/liability  management. It is the objective of interest rate sensitivity
management to generate stable growth in net interest income,  and to control the
risks  associated  with interest rate movement.  Management  constantly  reviews
interest rate risk exposure and the expected  interest rate  environment so that
adjustments in interest rate sensitivity can be timely made.



                                       5
<PAGE>

         The  table,  "Interest  Sensitivity  Analysis,"  indicates  that,  on a
cumulative  basis through twelve  months,  rate-sensitive  liabilities  exceeded
rate-sensitive assets, resulting in an liability-sensitive  position at December
31, 2005 of $31,798 for a cumulative gap ratio of (13.4)%.

         When interest-sensitive  assets exceed  interest-sensitive  liabilities
for a specific repricing period, a positive interest sensitive gap results.  The
gap is negative when  interest-sensitive  liabilities exceed  interest-sensitive
assets.  For a bank  with a  negative  gap,  such as the  Bank  over a one  year
horizon,  rising  interest rates would be expected to have a negative  effect on
net  interest  income and falling  rates would be expected to have the  opposite
effect.  However,  gap  analysis,  such as the table  below,  does not take into
account  actions by a bank or its customers  during  periods of changing  rates,
which  could  significantly  change  the  effects  of rate  changes  than  would
otherwise be expected.

         The table below  reflects the balances of  interest-earning  assets and
interest-bearing  liabilities  at the  earlier of their  repricing  or  maturity
dates.  Amounts  of fixed  rate  loans are  reflected  at the  earlier  of their
contractual  maturity  date or the  date at  which  the  loans  may be  repriced
contractually.  Other  borrowings  are  reflected  in the  earliest  contractual
repricing  interval  due to the  immediately  available  nature of these  funds.
Interest-bearing   liabilities   with   no   contractual   maturity,   such   as
interest-bearing transaction accounts and savings deposits, are reflected in the
earliest  repricing   interval  due  to  contractual   arrangements  which  give
management the  opportunity  to vary the rates paid on these  deposits  within a
thirty day or shorter period.  However,  the Bank is under no obligation to vary
the rates  paid on those  deposits  within  any given  period.  Fixed  rate time
deposits are reflected at their contractual  maturity dates. Fixed rate advances
are reflected at their  contractual  maturity dates,  and variable rate advances
are reflected in the earliest  repricing interval since they were borrowed under
the adjustable rate credit option.

                          Interest Sensitivity Analysis

<TABLE>
<CAPTION>
                                                                                      December 31, 2005
                                                                                      -----------------
                                                                     Within    Over 3 to 12    Over 1 to 5    Over 5
                                                                    3 Months      Months          Years        Years        Total
                                                                    --------      ------          -----        -----        -----

Interest-earning assets
<S>                                                               <C>           <C>            <C>           <C>           <C>
   Federal funds sold and interest-bearing deposits ..........    $   8,464     $       -      $       -     $       -     $   8,464
   Investment Securities and other investments ...............          798         2,967         13,307        11,886        28,958
   Loans .....................................................      142,002        22,224         35,207           929       200,362
                                                                  ---------     ---------      ---------     ---------     ---------

        Total interest-earning assets ........................      151,264        25,191         48,514        12,815       237,784
Interest-bearing liabilities
   Interest-bearing deposits
      Interest-bearing transaction accounts ..................        2,941             -              -             -         2,941
      Savings and money market accounts ......................       51,656             -              -             -        51,656
      Time deposits over $100M ...............................       13,915        60,764              -             -        74,679
      Other time deposits ....................................       15,781        56,696          7,587             -        80,064
                                                                  ---------     ---------      ---------     ---------     ---------
        Total interest-bearing deposits ......................       84,293       117,460          7,587             -       209,340

   Other borrowings ..........................................            -         6,500              -         5,900        12,400
                                                                  ---------     ---------      ---------     ---------     ---------
        Total interest-bearing liabilities ...................    $  84,293     $ 123,960      $   7,587     $   5,900     $ 221,740

Period interest-sensitive gap ................................    $  66,971     $ (98,769)     $  40,927     $   6,915
Cumulative interest-sensitive gap ............................    $  66,971     $ (31,798)     $   9,129     $  16,044

Gap ratio as a percentage of earning assets ..................        28.2%         (41.5)%         17.2%          2.9%
Cumulative gap ratio as a percentage of earning assets .......        28.2%         (13.4)%          3.8%          6.7%
</TABLE>



                                       6
<PAGE>

Provision for Loan Losses

         The allowance for loan losses,  established  through charges to expense
in the form of a provision for loan losses,  allows for loan losses  inherent in
the Bank's loan  portfolio.  Loan losses or  recoveries  are charged or credited
directly to the  allowance.  The level of the allowance for loan losses is based
on  management's  judgment as to the amount  required  to maintain an  allowance
adequate to provide for estimated  inherent  losses in the loan  portfolio.  The
Bank provided $1,125 and $1,000 to the allowance during the years ended December
31, 2005 and 2004,  respectively.  The increase in the provision for loan losses
for 2005 versus  2004 was the result of a  significant  increase  in  nonaccrual
loans.  See  "Allowance for Loan Losses" for further  information  about factors
considered by management in setting the amount of the allowance.

Other Income

         In 2005,  the Bank had other  income of $580  compared to $401 in 2004.
The increase was primarily the result of gains on sales of investment securities
of $18 and income on bank-owned life insurance of $161.

Other Expenses

         Salaries and employee  benefits  totaled $3,095 and $2,163 for 2005 and
2004,  respectively.  The  increase was  primarily  due to the  acquisition  and
expansion of the specialty auto-financing business and the addition of staff for
the Anderson branch. At December 31, 2005, the bank had 54 full-time  equivalent
employees,  compared to 33 at December 31, 2004. Professional services increased
$97 due to the  increased  cost of the  human  resource  consultant,  which is a
direct result of additional employees. In 2005, the Bank recorded write-downs of
assets acquired in settlement of loans of $251, compared to $68 in 2004.

Income Taxes

         During the years ended  December 31, 2005 and 2004,  the Bank  recorded
income tax  expense  of $1,155 and $769,  respectively.  The Bank  accounts  for
income taxes under SFAS No. 109, "Accounting for Income Taxes." Certain items of
income and expense (principally  provision for loan losses and depreciation) are
included in one reporting period for financial  accounting  purposes and another
for income tax purposes.

Investment Portfolio

         As of December 31, 2005,  the Bank's  investment  portfolio,  excluding
investments required for membership in the FHLB,  comprised  approximately 11.2%
of total assets.  The following  table  summarizes the carrying value amounts of
securities   held  by  the  Bank  at   December   31,   2005,   2004  and  2003.
Available-for-sale  securities are stated at estimated fair value.  The Bank had
no  held-to-maturity  securities at December 31, 2005. The unrealized  losses on
investment  securities are not considered to be other than temporary because the
Company has the ability and intent to hold the securities until such time as the
value recovers or the securities mature.

Securities Portfolio Composition

<TABLE>
<CAPTION>
                                         December 31, 2005               December 31, 2004                December 31, 2003
                                         -----------------               -----------------                -----------------
                                             Net                                Net                               Net
                                          Unrealized                         Unrealized                        Unrealized
                                 Book      Holding     Fair        Book       Holding     Fair        Book       Holding     Fair
                                Value       Loss       Value       Value       Loss       Value       Value       Loss       Value
                                -----       ----       -----       -----       ----       -----       -----       ----       -----
<S>                           <C>         <C>         <C>        <C>         <C>         <C>        <C>         <C>         <C>
U.S. Government
Agencies  .................   $ 14,498    $   (209)   $ 14,289   $  7,496    $    (34)   $  7,462   $  3,014    $    (38)   $  2,976
State and Municipals ......        463          (2)        461         --          --          --         --          --          --
Mortgage-backed ...........     13,772        (362)     13,410      8,924         (35)      8,889     10,901         (48)     10,853
                              --------    --------    --------   --------    --------    --------   --------    --------    --------
                              $ 28,733    $   (573)   $ 28,160   $ 16,420    $    (69)   $ 16,351   $ 13,915    $    (86)   $ 13,829
                              ========    ========    ========   ========    ========    ========   ========    ========    ========
</TABLE>

         The Bank also holds  stock in the FHLB.  This stock was  recorded  at a
cost of $798 at December  31, 2005,  and $955 at December  31, 2004,  and has no
quoted market value. However,  redemption of this stock has historically been at
par value.


                                       7
<PAGE>

         The following table presents  maturities and weighted average yields of
debt  securities  available for sale at December 31, 2005. All of the securities
are stated at estimated fair value.

Securities Portfolio Maturities and Yields

                                                    December 31, 2005
                                                    -----------------
                                                  Fair        Tax Equivalent
                                                  Value           Yield
                                                  -----           -----
Federal agencies

Due within one year ..........................   $ 2,967           3.05%
Due from one to five years ...................    11,322           3.82%
Due from five to ten years ...................         -              -
Due after ten years ..........................         -              -

State and municipals

Due within one year ..........................         -              -
Due from one to five years ...................         -              -
Due from five to ten years ...................         -              -
Due after ten years ..........................       461           5.69%

Mortgage-backed securities

Due within one year ..........................         -              -
Due from one to five years ...................     1,985           3.78%
Due from five to ten years ...................     9,907           4.14%
Due after ten years ..........................     1,518           4.83%
                                                 -------           ----

Total ........................................   $28,160           3.93%
                                                 =======           ====

Loan Portfolio

         Management believes the loan portfolio is adequately diversified. There
are no  significant  concentrations  of loans to any  particular  individuals or
industry or group of related individuals or industries, and there are no foreign
loans.

         The amount of loans  outstanding at December 31, 2005, 2004, 2003, 2002
and 2001 is shown in the following table according to type of loan:

                           Loan Portfolio Composition

<TABLE>
<CAPTION>
                                                                                            December 31,
                                                                                            ------------
                                                                      2005        2004         2003         2002          2001
                                                                      ----        ----         ----         ----          ----
<S>                                                               <C>          <C>          <C>          <C>          <C>
Commercial ....................................................   $  41,915    $  33,644    $  30,500    $  45,122    $  36,800
Real estate - Construction ....................................      39,895       39,170       15,814       13,627        6,846
Real estate - Mortgage ........................................     110,694       96,984       94,391       44,840       41,924
Consumer ......................................................       7,858        6,660        9,691        7,350        7,120
                                                                  ---------    ---------    ---------    ---------    ---------
    Total loans ...............................................     200,362      176,458      150,396      110,939       92,690
Less allowance for loan losses ................................      (3,050)      (2,293)      (2,345)      (1,395)      (1,176)
                                                                  ---------    ---------    ---------    ---------    ---------
                                                                  $ 197,312    $ 174,165    $ 148,051    $ 109,544    $  91,514
                                                                  =========    =========    =========    =========    =========
</TABLE>


                                       8
<PAGE>

         A  certain  degree  of risk is  inherent  in the  extension  of  credit
Management has established loan and credit policies designed to control both the
types and  amounts of risks  assumed and to  ultimately  minimize  losses.  Such
policies include limitations on  loan-to-collateral  values for various types of
collateral,  requirements for appraisals of real estate collateral, problem loan
management  practices and collection  procedures,  and nonaccrual and charge-off
guidelines.

Commercial Loans

         Commercial loans primarily represent loans made to businesses,  and may
be made on  either a secured  or an  unsecured  basis.  When  taken,  collateral
usually consists of liens on receivables,  equipment, inventories, furniture and
fixtures.  Unsecured  business loans are generally  short-term  with emphasis on
repayment  strengths and low debt-to-worth  ratios.  Commercial lending involves
significant risk because  repayment  usually depends on the cash flows generated
by a  borrower's  business,  and the debt  service  capacity  of a business  can
deteriorate because of downturns in national and local economic  conditions.  To
control  risk,  initial  and  continuing  financial  analysis  of  a  borrower's
financial information is required.

Real Estate Construction Loans

         Real estate  construction  loans  generally  consist of  financing  the
construction of 1-4 family  dwellings and nonfarm,  nonresidential  real estate.
Generally,  loan-to-cost  ratios  are  limited to 80% and the Bank  reviews  the
financial ability of the borrower to meet the guidelines of permanent  financing
prior to the advancement of the construction loan proceeds.

Real Estate Mortgage Loans

         Loans secured by real estate  mortgages  (residential  and  commercial)
comprised  75.2% of the Bank's loan  portfolio at December 31, 2005  compared to
55.0% at December 31, 2004. The repayment of both  residential and business real
estate  loans  is  dependent  primarily  on the  income  and  cash  flows of the
borrowers,  with the real estate serving as a secondary or liquidation source of
repayment.

         Residential real estate loans, which make up $38,469 of the $110,694 at
December 31, 2005, consist mainly of first and second mortgages on single-family
homes,  with some  multifamily  loans.  Loan-to-value  ratios  ("LTV") for these
instruments are generally limited to 80%.  Occasionally  loans with greater than
100% LTV will be originated to refinance  previously unsecured consumer debt, on
the  assumption  that it is better to have some  collateral  than none. The Bank
does not require purchased  mortgage  insurance (PMI) on loans with greater than
an 80% LTV. The Bank monitors key factors on loans,  including LTV, with monthly
reports  to senior  management.  At  December  31,  2005,  the Bank had one loan
amounting to $184 in loans with LTV greater than 100%.

         The Bank offers a variety of  fixed-rate  residential  real estate loan
products. Generally, the residential loans that are kept in-house are fixed-rate
balloons with  maturities  up to 5 years.  The  underwriting  for these loans is
performed  in-house  within an  officer's  lending  authority.  These  loans are
re-negotiated  near  the  end of the  term.  Conventional,  fixed-rate  mortgage
products can be originated  by the Bank in the  secondary  market in the name of
another  financial  institution.  Because  these  loans are  closed in the other
bank's name,  they are not recorded on the Bank's  books.  The Bank  receives an
origination  fee for  its  role  in the  process.  Currently,  the  Bank  offers
conventional adjustable-rate-mortgage products for the secondary market.

         Nonfarm,  nonresidential  loans (i.e.,  commercial real estate mortgage
loans) are secured by business  and  commercial  properties  with LTV  generally
limited to 80%.  These loans  consist of $72,225 of the  $110,694 in real estate
loans reported at December 31, 2005.


                                       9
<PAGE>

Maturity and Interest Sensitivity Distribution of Loans

         The  following  table  sets  forth  the  maturity  distribution  of the
Company's  loans,  by type, at December 31, 2005, as well as the amount of fixed
and variable rate loans outstanding.

<TABLE>
<CAPTION>
                                                                                           December 31, 2005
                                                                                           -----------------
                                                                    One Year         Over One to        Over Five
                                                                     Or Less         Five Years            Years              Total
                                                                     -------         ----------            -----              -----
<S>                                                                <C>                <C>                <C>                <C>
Commercial, financial and industrial ...................           $ 27,831           $ 13,630           $    454           $ 41,915
Real estate - construction .............................             36,080              2,857                958             39,895
Real estate - mortgage .................................             76,243             24,905              9,546            110,694
Consumer installment ...................................              4,176              3,188                494              7,858
                                                                   --------           --------           --------           --------
         Total loans ...................................           $144,330           $ 44,580           $ 11,452           $200,362
                                                                   ========           ========           ========           ========

Fixed rate .............................................                                                                    $ 59,190

Variable rate ..........................................                                                                    $141,172
</TABLE>

Nonperforming Loans; Other Problem Assets

         When a loan is 90 days past due as to interest or principal or there is
serious doubt as to collectibility,  the accrual of interest income is generally
discontinued  unless  the  estimated  net  realizable  value  of  collateral  is
sufficient to assure  collection of the principal  balance and accrued interest.
When the  collectibility  of a  significant  amount of  principal  is in serious
doubt,  the  principal  balance  is  reduced  to the  estimated  fair  value  of
collateral by  charge-off  to the  allowance for loan losses and any  subsequent
collections  are credited first to the remaining  principal  balance and then to
the  allowance  for loan  losses as a  recovery  of the  amount  charged-off.  A
nonaccrual loan is not returned to accrual status unless  principal and interest
are current and the borrower  has  demonstrated  the ability to continue  making
payments as agreed.

         At  December  31,  2005  and  2004,  the Bank had  $2,551  and  $1,497,
respectively,   of  nonaccrual   loans.  The  increase  in  2005  was  primarily
attributable  to one large loan  being  placed on  nonaccrual  during the fourth
quarter.  Gross  interest  income that would have been  recorded with respect to
nonaccrual  loans in 2005 and 2004 under the original terms of the loans was $96
and $168,  respectively.  No interest income on nonaccrual loans was included in
net income for the years ended  December 31, 2005 or 2004.  At December 31, 2005
and  2004,  there  were no loans  that  were 90 days or more  past due and still
accruing interest, and no restructured loans.


                                       10
<PAGE>

Nonperforming Assets

         Nonperforming assets,  percentages of net charge-offs,  and the related
percentage of allowance for loan losses are shown in the following table:

<TABLE>
<CAPTION>
                                                                                        Year Ended December 31,
                                                                                        -----------------------
                                                                   2005           2004           2003           2002           2001
                                                                   ----           ----           ----           ----           ----
<S>                                                              <C>            <C>            <C>            <C>            <C>
Loans over 90 days past due and still
accruing ................................................        $    -         $    -         $  393         $    -         $  628

Loans on non-accrual
   Real estate - mortgage ...............................         2,210          1,394          1,052            789            645
   Real estate - construction ...........................             -             10             16              -            300
   Commercial ...........................................           329              -             56              7            351
   Consumer .............................................            12             93            107             59             66
                                                                 ------         ------         ------         ------         ------
      Total non-accrual loans ...........................         2,551          1,497          1,231            855          1,362

Troubled debt restructurings ............................             -              -              -              -              -
                                                                 ------         ------         ------         ------         ------
      Total nonperforming loans .........................         2,551          1,497          1,624            855          1,990

Other nonperforming assets ..............................           630            881            411            243            574
                                                                 ------         ------         ------         ------         ------
      Total nonperforming assets ........................        $3,181         $2,378         $2,035         $1,098         $2,564
                                                                 ======         ======         ======         ======         ======
Nonperforming assets to total assets ....................          1.26%          1.14%          1.18%          0.78%          2.18%

Percentage of nonperforming assets to
    total loans and other nonperforming
    assets ..............................................          1.58           1.34           1.35           0.99           2.75
</TABLE>

Potential Problem Loans

         Management  has  identified  and maintains a list of potential  problem
loans. These are loans that are not included in nonaccrual status, or loans that
are  past  due 90  days or more  and  still  accruing.  A loan is  added  to the
potential  problem  list when  management  becomes  aware of  information  about
possible  credit  problems of  borrowers  that causes  serious  doubts as to the
ability of such  borrowers to comply with the current loan repayment  terms.  At
December 31, 2005,  loans in the amount of $885 were determined by management to
be potential problem loans.

Assets Acquired in Settlement of Loans

         At  December  31,  2005  and  2004,  the Bank had  assets  acquired  in
settlements  of loans of  approximately  $630 and $881,  respectively.  For both
years, those amounts  represented 100% of real estate owned. Two properties were
acquired,  and two properties  were sold in 2005. Real estate owned is initially
recorded at the lower of net loan principal balance or its estimated fair market
value less estimated  selling  costs.  The estimated fair value is determined by
appraisal  at the time of  acquisition,  and written  down  periodically  if the
appraised value is deemed not to be realizable.

Allowance for Loan Losses

         The  allowance  for loan  losses  is  increased  by direct  charges  to
operating  expense.  Losses on loans are charged  against the  allowance  in the
period in which  management has determined  that it is more likely than not that
the loans have become uncollectible.  Recoveries of previously charged-off loans
are credited to the  allowance.  The table,  "Analysis of the Allowance for Loan
Losses," summarizes loan balances at the end of each period indicated,  averages
for  each  period,  changes  in  the  allowance  arising  from  charge-offs  and
recoveries by loan  category,  and  additions to the  allowance  which have been
charged to expense.


                                       11
<PAGE>

         In  reviewing  the  adequacy of the  allowance  for loan losses at each
year-end,  management  considers the historical  loan losses  experienced by the
Bank, current economic conditions affecting the borrowers' ability to repay, the
volume of  loans,  and the  trends in  delinquent,  nonaccruing,  and  potential
problem loans, and the quality of collateral securing  nonperforming and problem
loans.  The increase in the allowance at December 31, 2005, is mostly due to one
large loan being  placed on  nonaccrual  during the fourth  quarter.  Management
believes this loan will not be charged-off,  but ultimately be collected.  After
charging off all known  losses,  management  considers  the  allowance  for loan
losses  adequate  to cover its  estimate  of loan  losses  inherent  in the loan
portfolio as of December 31, 2005.

         In  calculating  the amount  required in the allowance for loan losses,
management  applies a  consistent  methodology  that is updated  quarterly.  The
methodology  utilizes a loan  risk-grading  system and detailed  loan reviews to
assess credit risks and the overall  quality of the loan  portfolio,  as well as
other  off-balance-sheet  credit  risks  such as loan  commitments  and  standby
letters of credit. Also, the calculation provides for management's assessment of
trends in national and local economic  conditions  that might affect the general
quality  of the loan  portfolio.  Regulators  also  review the  adequacy  of the
allowance  for  loan  losses  as part of their  examination  of the Bank and may
require adjustments to the allowance based upon information available to them at
the time of the examination.

         During 2005, the Bank  experienced net charge-offs of $368.  Management
believes that it has adequately  provided for losses  considering its assessment
of collateral values and other factors affecting collectibility.

         The allowance is not allocated to different  segments of the portfolio.
The Bank  charges  losses from any  segment of the  portfolio  to the  allowance
without any allocation.

                    Analysis of the Allowance for Loan Losses

<TABLE>
<CAPTION>
                                                                                     Year Ended December 31,
                                                                                     -----------------------
                                                                 2005           2004           2003           2002           2001
                                                                 ----           ----           ----           ----           ----
<S>                                                           <C>            <C>            <C>            <C>            <C>
Total gross loans outstanding at end of period ..........     $ 200,362      $ 176,458      $ 150,396      $ 110,939      $  92,690
Average amount of loans outstanding, gross ..............       183,576        162,044        130,448         99,820         78,318
                                                              ---------      ---------      ---------      ---------      ---------
Balance of allowance for loan losses -
    beginning ...........................................         2,293          2,345          1,395          1,176            958
                                                              ---------      ---------      ---------      ---------      ---------
Loans charged off:
    Real estate-construction ............................             -              -            (82)             -             (6)
    Real estate-mortgage ................................          (347)          (466)          (120)          (529)          (241)
    Consumer loans ......................................           (13)          (475)           (97)           (54)           (95)
    Commercial and other loans ..........................          (123)          (135)           (90)           (25)          (163)
                                                              ---------      ---------      ---------      ---------      ---------
           Total charge-offs ............................          (483)        (1,076)          (389)          (608)          (505)
                                                              ---------      ---------      ---------      ---------      ---------

Recoveries of loans previously charged-off:
    Real estate-mortgage ................................            76              1              -              6              -
    Consumer loans ......................................            14             23              -              -              -
    Commercial and other loans ..........................            25              -              -             16              -
                                                              ---------      ---------      ---------      ---------      ---------
          Total recoveries ..............................           115             24              -             22              -
                                                              ---------      ---------      ---------      ---------      ---------

           Net charge-offs ..............................          (368)        (1,052)          (389)          (586)          (505)

Additions to allowance for loan losses-ending ...........         1,125          1,000          1,339            805            723
                                                              ---------      ---------      ---------      ---------      ---------

Balance of allowance for loan losses-ending .............     $   3,050      $   2,293      $   2,345      $   1,395      $   1,176
                                                              =========      =========      =========      =========      =========
</TABLE>


                                       12
<PAGE>

<TABLE>
<CAPTION>
                                                                                            Year Ended December 31,
                                                                                            -----------------------
                                                                          2005          2004         2003         2002         2001
                                                                          ----          ----         ----         ----         ----
Ratios
<S>                                                                       <C>          <C>           <C>          <C>          <C>
   Net charge-offs during period to average
       loans outstanding during period ...........................        0.20%         0.65%        0.30%        0.59%        0.64%
   Net charge-offs to loans at end of period .....................        0.18          0.60         0.26         0.53         0.54
   Allowance for loan losses to average loans ....................        1.66          1.42         1.80         1.40         1.50
   Allowance for loan losses to loans at end of period ...........        1.52          1.30         1.56         1.26         1.27
   Net charge-offs to allowance for loan losses ..................        12.1          45.9         16.6         42.0         42.9
   Net charge-offs to provision for loan losses ..................        32.7         105.2         29.1         72.8         69.8
</TABLE>

Deposits

         The amounts and  composition  of total deposits as of December 31, 2005
and 2004 were as follows:

<TABLE>
<CAPTION>
                                                                                      December 31,
                                                                                      ------------
                                                                        2005                                 2004
                                                                        ----                                 ----
                                                           Amount                Percent             Amount            Percent
                                                           ------                -------             ------            -------
<S>                                                       <C>                     <C>              <C>                 <C>
Noninterest-bearing ..............................        $ 12,321                  5.6%           $  8,818               5.0%
NOW accounts .....................................           2,941                  1.3               2,914               1.7
Money market accounts ............................          50,905                 23.0              61,240              34.8
Savings ..........................................             751                  0.3                 742               0.4
Time, less than $100,000 .........................          80,064                 36.1              50,222              28.5
Time, $100,000 and over ..........................          74,679                 33.7              52,210              29.6
                                                          --------                -----            --------             -----
                                                          $221,661                100.0%           $176,146             100.0%
                                                          ========                =====            ========             =====
</TABLE>

         The average amounts and average rates paid on deposits held by the Bank
for the years ended December 31, 2005, 2004 and 2003 are summarized below:

<TABLE>
<CAPTION>
                                                                                          Deposits

                                                             December 31, 2005         December 31, 2004          December 31, 2003
                                                             -----------------         -----------------          -----------------
                                                                       Average                   Average                    Average
                                                            Amount     Rate (%)       Amount     Rate (%)        Amount     Rate (%)
                                                            ------     --------       ------     --------        ------     --------

<S>                                                       <C>                     <C>                        <C>
Noninterest-bearing demand ........................       $ 12,107          -     $  9,853             -     $  8,361             -
Interest-bearing transaction accounts .............          3,022       0.24        2,849          0.26        2,580          0.11
Savings ...........................................            765       0.50          813          0.49          628          0.48
Money market accounts .............................         53,837       2.64       59,190          2.04       41,686          1.95
Certificates of deposit and
Individual retirement accounts ....................        130,419       3.29       92,410          2.20       80,555          2.45
                                                          --------       ----     --------          ----     --------          ----
         Total average deposits ...................       $200,150       2.86%    $165,115          2.09%    $133,810          2.23%
                                                          ========       ====     ========          ====     ========          ====
</TABLE>

                                       13
<PAGE>

         As of December  31,  2005,  the Bank held  $74,679 in time  deposits of
$100,000 or more,  with  approximately  $13,916  maturing  within three  months,
$23,340 with maturities  over three through six months,  $26,685 with maturities
over six through twelve months and $10,738 with  maturities  over twelve months.
Brokered deposits as of December 31, 2005 amounted to $30,774. Brokered deposits
are generally more interest rate sensitive  and,  therefore,  more volatile than
deposits obtained from the Bank's local market areas.

Return on Equity and Assets

         The following  table shows the return on assets (net income  divided by
average  assets),  return on equity  (net  income  divided by  average  equity),
dividend  payout ratio  (dividends  declared per share divided by net income per
share),  and equity to assets ratio  (average  equity  divided by average  total
assets) for the years ended December 31, 2005, 2004 and 2003.

                                                     December 31,
                                                     ------------
                                           2005           2004           2003
                                           ----           ----           ----
        Return on average assets ......    1.02%          0.68%          0.41%
        Return on average equity ......   18.34%         13.57%          6.88%
        Dividend payout ratio .........    8.89%         13.12%         12.15%
        Average equity to average
          asset ratio .................    5.55%          4.99%          6.00%

Liquidity

         Liquidity is the ability to meet current and future obligations through
liquidation  or maturity of existing  assets or the  acquisition  of  additional
liabilities.  Adequate  liquidity  is  necessary  to meet  the  requirements  of
customers for loans and deposit  withdrawals  in the most timely and  economical
manner.  Some  liquidity  is  ensured  by  maintaining  assets,   which  may  be
immediately  converted  into cash at minimal  cost  (amounts  due from banks and
federal  funds sold).  However,  the most  manageable  sources of liquidity  are
composed of liabilities,  with the primary focus on liquidity  management  being
the ability to obtain  deposits  within the Bank's  service area.  Core deposits
(total  deposits  less time  deposits  greater than  $100,000 and less  brokered
deposits)  provide a relatively  stable funding base, and were equal to 57.7% of
total  assets at December  31, 2005.  Asset  liquidity is provided  from several
sources, including amounts due from banks and federal funds sold, and funds from
maturing  loans.  The Bank is a member of the FHLB of Atlanta and, as such,  has
the ability to borrow  against  the  security of its  investment  portfolio  and
qualifying  mortgage  loans.  At December 31, 2005,  the Bank had the ability to
borrow up to 15% of assets  from the FHLB.  The $8,500 of  borrowings  that were
outstanding  from the FHLB at  December  31,  2005 are  secured  by 1 - 4 family
residential  mortgage loans and commercial loans. These borrowings bear interest
at rates ranging from 4.33% to 4.38%. The $6,500 advance matures in 2006 and the
$2,000  advance  matures in 2011. The $2,000 advance is callable and may reprice
prior to its final maturity date.

         The unused borrowing capacity currently available from the FHLB assumes
that the Bank's $798 investment in FHLB stock as well as certain  securities and
qualifying  mortgages  would be pledged to secure  any  future  borrowings.  The
maximum  amount of FHLB  borrowings  outstanding at the end of any month in 2005
was  $16,500.  The Bank  believes  that it  could  obtain  additional  borrowing
capacity from the FHLB by  identifying  additional  qualifying  collateral  that
could be pledged.


         The Bank also has $7,400  available  through lines of credit with other
banks as an additional source of liquidity funding. Management believes that the
Bank's overall liquidity sources are adequate to meet its operating needs in the
ordinary course of business.


                                       14
<PAGE>

Off-Balance Sheet Arrangements

         The Company,  through the  operations  of the Bank,  makes  contractual
commitments to extend credit in the ordinary course of its business  activities.
These instruments  represent  unfunded  commitments,  not outstanding  balances,
therefore,  the risk associated with these financial  instruments is referred to
as "off-balance  sheet risk." The Bank's financial  instruments with off-balance
sheet risk consist of 1) commitments to extend credit and 2) standby  letters of
credit.  Both involve elements of credit and interest rate risk not reflected on
the  balance  sheet.  We use the same credit and  collateral  policies in making
these commitments as we do for on-balance sheet instruments.

         Commitments  to extend  credit are legally  binding  agreements to lend
money to customers of the Bank at  predetermined  interest rates for a specified
period of time. At December 31, 2005, the Bank had issued  commitments to extend
credit of $45,968  through  various  types of lending.  Commitments  at variable
rates of  interest  totaled  $29,853  and  commitments  at fixed  rates  totaled
$16,115.  The  commitments  generally  expire  over one  year.  Past  experience
indicates  that many of these  commitments  to extend credit will expire unused.
However,  as described in "Liquidity," the Company believes that it has adequate
sources of liquidity to fund commitments that are drawn upon by the borrower.

         In  addition  to  commitments  to extend  credit,  the Bank also issues
standby  letters of credit which are  assurances to a third party that they will
not  suffer  a loss  if the  Bank's  customer  fails  to  meet  its  contractual
obligation  to the  third  party.  Standby  letters  of credit  totaled  $332 at
December 31, 2005. Past experience  indicates that many of these standby letters
of credit will expire unused. However, through its various sources of liquidity,
the Bank  believes  that it will  have the  necessary  resources  to meet  these
obligations should the need arise.

         Neither the Company nor its subsidiary is involved in other off-balance
sheet  contractual  relationships,  unconsolidated  related  entities  that have
off-balance  sheet  arrangements or transactions  that could result in liquidity
needs or other commitments or significantly  impact earnings.  Obligations under
noncancelable  operating lease agreements totaled approximately $356 at December
31, 2005.  These  obligations are payable over several years as shown in Note 10
to the Company's consolidated financial statements.


Capital Resources

         Shareholders'  equity increased $5,331 during 2005. Major components of
the change in  shareholders'  equity  included net  operating  income of $2,361,
conversion of subordinated debentures of $3,500, partially offset by an increase
in unrealized losses on investment securities available for sale, net of tax, of
$318, and a cash dividend of $.08 per share,  or $210. The unrealized  losses on
investment  securities are not considered to be other than temporary because the
Company has the ability and intent to hold the securities until such time as the
value recovers or the securities mature.

         The  Company and the Bank are subject to  regulatory  capital  adequacy
standards.  Under these standards,  financial institutions and holding companies
are  required to maintain  certain  minimum  ratios of capital to  risk-weighted
assets and average total  assets.  Under the  provisions of the Federal  Deposit
Insurance  Corporation  Improvements Act of 1991, federal financial  institution
regulatory  authorities are required to implement  prescribed "prompt corrective
actions"  upon the  deterioration  of the  capital  position  of a bank.  If the
capital  position of an  institution  falls below certain  levels,  increasingly
stringent regulatory corrective actions are mandated.

         It is  management's  objective to maintain the capital levels such that
the Bank will continue to be considered well capitalized.  However, no assurance
can be given that this objective will be achieved.  The Company anticipates that
it will  maintain  capital at levels that will allow the Company and the Bank to
qualify as being  adequately  capitalized  as defined by  regulation,  and as of
December 31, 2005,  the Company and the Bank exceed the capital  levels that are
required to be maintained.  However,  the Company does not  sufficiently  exceed
minimum capital adequacy levels, and the Bank does not sufficiently  exceed well
capitalized levels by a great enough margin to continue to grow at recent rates.

         In connection with the Company's  acquisition of a specialty  lender in
2005, the Company committed to the Federal Reserve to increase the amount of its
Tier 1 capital to the well capitalized level by June 30, 2006. The conversion of
subordinated  debentures  to  common  stock in 2005 was in  furtherance  of this
commitment.  The Company plans to raise additional Tier 1 capital in 2006 and is
exploring several avenues to do so.

         Company and Bank capital  ratios at December 31, 2005 are  presented in
the following  table,  compared with the "well  capitalized"  and minimum ratios
under the Federal Reserve and FDIC regulatory definitions and guidelines:


                                       15
<PAGE>

<TABLE>
<CAPTION>
                                                                                                            To be well capitalized
                                                                                        For capital         under prompt corrective
                                                                                      adequacy purposes      action provisions
                                                                    Actual                 Minimum                 Minimum
                                                                    ------                 -------                 -------
                                                            Amount         Ratio    Amount         Ratio       Amount     Ratio
                                                            ------         -----    ------         -----       ------     -----
Company (consolidated):
As of December 31, 2005
<S>                                                        <C>              <C>    <C>              <C>
Total capital (to risk weighted  assets) ...............   $18,374          8.8%   $16,787          8.0%         N/A        N/A
Tier 1 capital (to risk weighted assets) ...............    15,747          7.5      8,393          4.0          N/A        N/A
Tier 1 capital (to average assets) .....................    15,747          6.7      9,416          4.0          N/A        N/A

Company (consolidated):
As of December 31, 2004
Total capital (to risk weighted  assets) ...............   $16,577          9.3%   $14,331          8.0%         N/A        N/A
Tier 1 capital (to risk weighted assets) ...............    10,840          6.1      7,166          4.0          N/A        N/A
Tier 1 capital (to average assets) .....................    10,840          5.6      8,196          4.0          N/A        N/A
<CAPTION>
                                                                                                            To be well capitalized
                                                                                        For capital         under prompt corrective
                                                                                      adequacy purposes      action provisions
                                                                    Actual                 Minimum                 Minimum
                                                                    ------                 -------                 -------
                                                            Amount         Ratio    Amount         Ratio       Amount     Ratio
                                                            ------         -----    ------         -----       ------     -----
Bank:
As of December 31, 2005
<S>                                                         <C>           <C>       <C>             <C>        <C>         <C>
Total capital (to risk weighted assets) ...............     $21,145       10.1%     $16,778         8.0%       $20,972     10.0%
Tier 1 capital (to risk weighted assets) ..............      18,518        8.8        8,389         4.0         12,583      6.0
Tier 1 capital (to average assets) ....................      18,518        8.0        9,230         4.0         11,538      5.0

As of December 31, 2004
Total capital (to risk weighted assets) ...............     $18,715       10.5%     $14,312         8.0%       $17,891     10.0%
Tier 1 capital (to risk weighted assets) ..............      16,478        9.2        7,156         4.0         10,734      6.0
Tier 1 capital (to average assets) ....................      16,478        8.5        8,196         4.0         10,246      5.0
</TABLE>

Inflation

         Since the assets and  liabilities  of a bank are primarily  monetary in
nature (payable in fixed,  determinable  amounts),  the performance of a bank is
affected  more by changes in interest  rates than by inflation.  Interest  rates
generally increase as the rate of inflation increases,  but the magnitude of the
change in rates may not be the same.

         While the effect of inflation  on banks is normally not as  significant
as is its influence on those  businesses,  which have large investments in plant
and inventories, it does have an effect. During periods of high inflation, there
are  normally  corresponding  increases  in the money  supply,  and  banks  will
normally experience  above-average  growth in assets,  loans and deposits.  Also
general  increases in the prices of goods and services  will result in increased
operating expenses.

Recently Issued Accounting Standards

        Recently issued accounting standards and pronouncements are discussed in
Note 1, Summary of Significant Accounting Policies and Activities, in our Report
on  Consolidated   Financial   Statements  included  herein.   Other  accounting
standards,  which  have been  issued or  proposed  by the  Financial  Accounting
Standards  Board  ("FASB") that do not require  adoption until a future date are
not expected to have a material impact on the consolidated  financial statements
upon adoption.


                                       16
<PAGE>











                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY

                   REPORT ON CONSOLIDATED FINANCIAL STATEMENTS

              FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003





















                                       17
<PAGE>











             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the Board of Directors
GrandSouth Bancorporation and Subsidiary
Greenville, South Carolina


         We  have  audited  the  accompanying  consolidated  balance  sheets  of
GrandSouth  Bancorporation  and Subsidiary as of December 31, 2005 and 2004, and
the  related  consolidated  statements  of  income,   shareholders'  equity  and
comprehensive  income,  and cash  flows for each of the years in the  three-year
period ended December 31, 2005. These consolidated  financial statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material  respects,  the financial position of GrandSouth
Bancorporation  and  Subsidiary as of December 31, 2005 and 2004 and the results
of their operations and their cash flows for each of the years in the three-year
period  ended  December 31,  2005,  in  conformity  with  accounting  principles
generally accepted in the United States of America.





                                        s/Elliott Davis LLC
Greenville, South Carolina
February 10, 2006



                                       18
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                                                DECEMBER 31,
                                                                                                                ------------
                                                                                                          2005                2004
                                                                                                          ----                ----
                                                          ASSETS
<S>                                                                                                    <C>                <C>
Cash and due from banks ......................................................................         $   6,628          $   2,544
Federal funds sold ...........................................................................             6,312              3,424
                                                                                                       ---------          ---------
           Cash and cash equivalents .........................................................            12,940              5,968

Investment securities available for sale .....................................................            28,160             16,351
Other investments, at cost ...................................................................               798                955
Loans, net ...................................................................................           197,312            174,165
Property and equipment, net ..................................................................             4,380              3,629
Bank owned life insurance ....................................................................             4,408              4,247
Assets acquired in settlement of loans .......................................................               630                881
Other assets .................................................................................             3,320              1,734
                                                                                                       ---------          ---------
           Total assets ......................................................................         $ 251,948          $ 207,930
                                                                                                       =========          =========

                                           LIABILITIES AND SHAREHOLDERS' EQUITY

Deposits
     Noninterest bearing .....................................................................         $  12,321          $   8,818
     Interest bearing ........................................................................           209,340            167,328
                                                                                                       ---------          ---------
           Total deposits ....................................................................           221,661            176,146

Federal Home Loan Bank advances ..............................................................             8,500             13,500
Other borrowings .............................................................................             3,900              2,500
Subordinated debentures ......................................................................                 -              3,500
Other liabilities ............................................................................             1,759              1,487
                                                                                                       ---------          ---------
           Total liabilities .................................................................           235,820            197,133
                                                                                                       ---------          ---------

COMMITMENTS AND CONTINGENCIES - Notes 10 and 14

SHAREHOLDERS' EQUITY
     Common stock, no par value, 20,000,000 shares authorized,
        3,065,726 and 2,382,357 shares issued and outstanding
        at December 31, 2005 and 2004 respectively ...........................................            14,340             10,840
     Retained earnings .......................................................................             2,149                  -
     Accumulated other comprehensive income (loss) ...........................................              (361)               (43)
                                                                                                       ---------          ---------
           Total shareholders' equity ........................................................            16,128             10,797
                                                                                                       ---------          ---------
           Total liabilities and shareholders' equity ........................................         $ 251,948          $ 207,930
                                                                                                       =========          =========
</TABLE>

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




                                       19
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                        CONSOLIDATED STATEMENTS OF INCOME
             (Dollars in thousands except share and per share data)

<TABLE>
<CAPTION>
                                                                                             For the years ended December 31,
                                                                                             --------------------------------
                                                                                       2005               2004               2003
                                                                                       ----               ----               ----
INTEREST INCOME
<S>                                                                                 <C>                <C>                <C>
   Loans and fees on loans ................................................         $   14,917         $    9,901         $    7,992
   Investment securities ..................................................                895                525                557
   Federal funds sold and due from banks ..................................                311                 83                 55
                                                                                    ----------         ----------         ----------
        Total interest income .............................................             16,123             10,509              8,604
                                                                                    ----------         ----------         ----------
INTEREST EXPENSE
   Deposits ...............................................................              5,720              3,250              2,793
   Federal Home Loan Bank advances and other borrowings ...................                664                506                382
   Subordinated debentures ................................................                116                 79                 74
                                                                                    ----------         ----------         ----------
        Total interest expense ............................................              6,500              3,835              3,249
                                                                                    ----------         ----------         ----------
        Net interest income ...............................................              9,623              6,674              5,355

PROVISION FOR POSSIBLE LOAN LOSSES ........................................              1,125              1,000              1,339
                                                                                    ----------         ----------         ----------
        Net interest income after provision for
           possible loan losses ...........................................              8,498              5,674              4,016
                                                                                    ----------         ----------         ----------
NONINTEREST INCOME
   Service fees on deposit accounts .......................................                311                266                289
   Gain on sale of investment securities available for sale ...............                 18                  -                 90
   Other ..................................................................                251                135                132
                                                                                    ----------         ----------         ----------
        Total noninterest income ..........................................                580                401                511
                                                                                    ----------         ----------         ----------
NONINTEREST EXPENSES
   Salaries and benefits ..................................................              3,095              2,163              1,895
   Data processing ........................................................                335                321                351
   Insurance ..............................................................                200                 85                 49
   Occupancy and equipment ................................................                579                579                517
   Printing and supplies ..................................................                 92                 76                 71
   Professional services ..................................................                290                193                152
   Writedowns on assets acquired in settlement of loans ...................                251                 68                 24
   Other operating ........................................................                720                502                436
                                                                                    ----------         ----------         ----------
        Total noninterest expenses ........................................              5,562              3,987              3,495
                                                                                    ----------         ----------         ----------
        Income before income taxes ........................................              3,516              2,088              1,032

INCOME TAX PROVISION ......................................................              1,155                769                382
                                                                                    ----------         ----------         ----------
        Net income ........................................................         $    2,361         $    1,319         $      650
                                                                                    ==========         ==========         ==========
NET INCOME PER COMMON SHARE
     Basic ................................................................         $     0.91         $     0.55         $     0.27
                                                                                    ==========         ==========         ==========
     Diluted ..............................................................         $     0.76         $     0.43         $     0.22
                                                                                    ==========         ==========         ==========
WEIGHTED AVERAGE NUMBER OF COMMON
   SHARES OUTSTANDING
     Basic ................................................................          2,582,298          2,382,357          2,382,567
                                                                                    ==========         ==========         ==========
     Diluted ..............................................................          3,218,986          3,200,558          3,162,300
                                                                                    ==========         ==========         ==========
</TABLE>

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


                                       20
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
    CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
              For the years ended December 31, 2005, 2004 and 2003
                    (Dollars in thousands except share data)

<TABLE>
<CAPTION>
                                                                      Common stock                       Accumulated
                                                                      ------------                          other         Total
                                                                                            Retained    comprehensive  shareholders'
                                                                Shares         Amount       earnings    income (loss)     equity
                                                                ------         ------       --------    -------------     ------
<S>                                                           <C>           <C>            <C>            <C>            <C>
Balance, December 31, 2002 ..............................     1,875,329     $    8,464     $      660     $      187     $    9,311
                                                                                                                         ----------
     Net income .........................................             -              -            650              -            650
     Other comprehensive income -
       Unrealized holding losses on
       investment securities (net of
       income tax benefit of $108) ......................             -              -              -           (184)          (184)

       Less reclassification adjustment for
       gains included in net income (net of
       income tax expense of $33) .......................             -              -              -            (57)           (57)
                                                                                                                         ----------
     Comprehensive income ...............................             -              -              -              -            409
     Stock dividend (5%) ................................        93,731            625           (625)             -              -
     Cash dividend ($.04) per share .....................             -              -            (79)             -            (79)
     Stock dividend (10%) ...............................       196,910            606           (606)             -              -
                                                             ----------     ----------     ----------     ----------     ----------

Balance, December 31, 2003 ..............................     2,165,970          9,695              -            (54)         9,641
                                                                                                                         ----------
     Net income .........................................             -              -          1,319              -          1,319
     Other comprehensive income -
       Unrealized holding gain on
       investment securities (net of
       income tax expense of $5) ........................             -              -              -             11             11
                                                                                                                         ----------
     Comprehensive income ...............................             -              -              -              -          1,330
     Cash in lieu of fractional shares ..................          (191)            (1)             -              -             (1)
     Cash dividend ($.08) per share .....................             -              -           (173)             -           (173)
     Stock dividend (10%) ...............................       216,578          1,146         (1,146)             -              -
                                                             ----------     ----------     ----------     ----------     ----------

Balance, December 31, 2004 ..............................     2,382,357         10,840              -            (43)        10,797
                                                                                                                         ----------
     Net income .........................................             -              -          2,361              -          2,361
     Other comprehensive income -
       Unrealized holding losses on
       investment securities (net of
       income tax effect of $180) .......................             -              -              -           (307)          (307)

     Less reclassification adjustment for
     gains included in net income (net of
     income tax expense of $7) ..........................             -              -              -            (11)           (11)
                                                                                                                         ----------
     Comprehensive income ...............................             -              -              -              -          2,043
     Conversion of subordinated debentures into
     common stock .......................................       683,581          3,500              -              -          3,500
     Cash in lieu of fractional shares ..................          (212)             -             (2)             -             (2)
     Cash dividend ($.08) per share .....................             -              -           (210)             -           (210)
                                                             ----------     ----------     ----------     ----------     ----------

Balance, December 31, 2005 ..............................     3,065,726     $   14,340     $    2,149     $     (361)    $   16,128
                                                             ==========     ==========     ==========     ==========     ==========
</TABLE>


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


                                       21
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                                For the years ended December 31,
                                                                                                --------------------------------
                                                                                               2005           2004           2003
                                                                                               ----           ----           ----
OPERATING ACTIVITIES
<S>                                                                                          <C>            <C>            <C>
     Net income .......................................................................      $  2,361       $  1,319       $    650
     Adjustments to reconcile net income to net cash
        provided by operating activities
        Deferred income tax expense (benefit) .........................................          (361)            55           (194)
        Provision for possible loan losses ............................................         1,125          1,000          1,339
        Depreciation ..................................................................           329            385            334
        Amortization and accretion (net) of securities available for sale .............            19            114            127
        Gain on sale of investment securities available for sale ......................           (18)             -            (90)
        Gain on sale of property and equipment ........................................            (1)            (4)           (11)
        (Gain) loss on sale of assets acquired in settlement of loans .................             1             13            (10)
        Accretion of bank owned life insurance ........................................          (161)             -              -
        Write-down of assets acquired in settlement of loans ..........................           251             68             24
        Increase in other assets ......................................................          (232)          (534)          (291)
        Increase in other liabilities .................................................           203            276            592
                                                                                             --------       --------       --------
              Net cash provided by operating activities ...............................         3,516          2,692          2,470
                                                                                             --------       --------       --------
INVESTING ACTIVITIES
     Purchase of investment securities ................................................       (16,046)       (11,027)        (9,796)
     Redemption (purchase) of Federal Home Loan Bank stock ............................           157           (375)          (155)
     Proceeds from principal paydowns on investment securities ........................         2,769          2,908          5,160
     Proceeds from sales and calls of investment securities ...........................           962          5,500          7,187
     Proceeds from maturity of investment securities ..................................             -              -          1,000
     Increase in loans, net ...........................................................       (24,582)       (28,271)       (40,295)
     Purchase of bank owned life insurance ............................................             -         (3,357)             -
     Increase in cash surrender value of life insurance ...............................             -            (63)           (42)
     Proceeds from sale of assets acquired in settlement of loans .....................           309            606            267
     Cash equivalents acquired, net of payment for purchase acquisition ...............          (737)             -              -
     Proceeds from sale of property and equipment .....................................            22             16             23
     Purchase of property and equipment ...............................................        (1,101)          (132)          (246)
                                                                                             --------       --------       --------
              Net cash used for investing activities ..................................       (38,247)       (34,195)       (36,897)
                                                                                             --------       --------       --------
FINANCING ACTIVITIES
      Proceeds from Federal Home Loan Bank advances ...................................        11,000          5,000          3,100
      Repayment of Federal Home Loan Bank advances ....................................       (16,000)        (3,100)             -
      Proceeds from other borrowings ..................................................         3,900          2,500              -
      Repayment of other borrowings ...................................................        (2,500)             -              -
      Net increase in deposits ........................................................        45,515         29,637         27,148
      Dividends paid ..................................................................          (210)          (173)           (79)
      Cash paid in lieu of fractional shares ..........................................            (2)            (1)             -
                                                                                             --------       --------       --------
              Net cash provided by financing activities ...............................        41,703         33,863         30,169
                                                                                             --------       --------       --------
              Net (decrease) increase in cash and cash equivalents ....................         6,972          2,360         (4,258)

CASH AND CASH EQUIVALENTS, BEGINNING
      OF YEAR .........................................................................         5,968          3,608          7,866
                                                                                             --------       --------       --------
CASH AND CASH EQUIVALENTS, END OF YEAR ................................................      $ 12,940       $  5,968       $  3,608
                                                                                             ========       ========       ========
SUPPLEMENTAL INFORMATION
      Cash paid for:
         Income taxes .................................................................      $  1,225       $    238       $    148
                                                                                             ========       ========       ========
         Interest .....................................................................      $  6,632       $  3,811       $  3,383
                                                                                             ========       ========       ========
</TABLE>

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


                                       22
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
                             (Dollars in thousands)

<TABLE>
<CAPTION>

                                                                                               For the years ended December 31,
SUPPLEMENTAL SCHEDULE OF NON-CASH                                                              --------------------------------
INVESTING AND FINANCING ACTIVITIES                                                          2005             2004              2003
                                                                                            ----             ----              ----
<S>                                                                                       <C>               <C>             <C>
Change in unrealized gain (loss) on investment securities
available for sale, before tax .................................................          $  (505)          $   16          $  (382)
                                                                                          =======           ======          =======

Loans charged-off, net of recoveries ...........................................          $   368           $1,052          $   389
                                                                                          =======           ======          =======

Loans transferred to assets acquired in settlement of loans ....................          $   310           $1,157          $   449
                                                                                          =======           ======          =======

Subordinated debentures converted into common stock ............................          $ 3,500                -                -
                                                                                          =======           ======          =======
</TABLE>

























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


                                       23
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES

         GrandSouth   Bancorporation   (the   "Company")  is  a  South  Carolina
corporation  organized  in 2000 for the  purpose of being a holding  company for
GrandSouth Bank (the "Bank"). On October 2, 2000, pursuant to a Plan of Exchange
approved by the shareholders,  all of the outstanding  shares of $2.50 par value
common stock of the Bank were  exchanged for shares of no par value common stock
of the Company.  The Company presently engages in no business other than that of
owning the Bank,  has no employees,  and operates as one business  segment.  The
Company is regulated by the Federal Reserve Board.  The  consolidated  financial
statements  include the  accounts of the Company and the Bank.  All  significant
intercompany accounts and transactions have been eliminated in consolidation.

         The Bank was  incorporated  in 1998 and  operates  as a South  Carolina
chartered  bank providing  full banking  services to its customers.  The Bank is
subject  to  regulation  by  the  South   Carolina   State  Board  of  Financial
Institutions and the Federal Deposit Insurance Corporation.

   Basis of presentation
     The  accounting  and reporting  policies  conform to accounting  principles
     generally accepted in the United States of America and to general practices
     in the banking industry. The Company uses the accrual basis of accounting.

   Reclassifications
     Certain prior year amounts have been reclassified to conform to the current
     presentation. These reclassifications have no effect on previously reported
     shareholders' equity or net income.

   Acquisition
     In May 2005, the Company  acquired an  auto-financing  business with assets
     valued  at  $3,236  and  recorded  $737 in  goodwill.  This  auto-financing
     business had $2,413 in specialty  commercial lines of credit with the Bank.
     These loans are now on the Bank's books in the auto dealers' names.

   Estimates
     The  preparation of  consolidated  financial  statements in conformity with
     accounting  principles  generally  accepted in the United States of America
     requires  management  to make  estimates  and  assumptions  that affect the
     reported  amounts of assets and  liabilities  and  disclosure of contingent
     assets  and  liabilities  as of  the  date  of the  consolidated  financial
     statements  and the  reported  amount of income  and  expenses  during  the
     reporting periods. Actual results could differ from those estimates.

   Concentrations of credit risk
     The Company makes loans to  individuals  and small  businesses  for various
     personal and commercial  purposes  primarily in the upstate region of South
     Carolina.  The Company's loan portfolio is not concentrated in loans to any
     single borrower or in a relatively small number of borrowers. Additionally,
     management  is not  aware of any  concentrations  of loans  to  classes  of
     borrowers  or  industries  that would be  similarly  affected  by  economic
     conditions.

     In addition to monitoring  potential  concentrations of loans to particular
     borrowers  or groups  of  borrowers,  industries  and  geographic  regions,
     Management monitors exposure to credit risk that could arise from potential
     concentrations of lending products and practices such as loans that subject
     borrowers  to  substantial  payment  increases  (e.g.   principal  deferral
     periods,  loans with initial  interest-only  periods,  etc), and loans with
     high loan-to-value ratios. Additionally,  there are industry practices that
     could  subject  the  Company  to  increased  credit  risk  should  economic
     conditions  change  over the  course of a loan's  life.  For  example,  the
     Company makes variable rate loans and fixed rate principal-amortizing loans
     with  maturities  prior to the loan being fully paid (i.e.  balloon payment
     loans). These loans are underwritten and monitored to manage



                                       24
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES,    Continued

     the  associated   risks.   Management  has  determined  that  there  is  no
     concentration  of credit  risk  associated  with its  lending  policies  or
     practices

     The Company's  investment  portfolio consists principally of obligations of
     the United States of America,  its agencies or its corporations and general
     obligation municipal securities. In the opinion of management,  there is no
     concentration  of credit  risk in its  investment  portfolio.  The  Company
     places its deposits and  correspondent  accounts with and sells its federal
     funds  to  high  quality  institutions.  Management  believes  credit  risk
     associated with correspondent accounts is not significant.

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

1.      Available  for sale:  These are  securities  that are not  classified as
        either held to maturity or as trading  securities.  These securities are
        reported at fair market value which is  determined  using quoted  market
        prices.  Unrealized gains and losses are reported,  net of income taxes,
        as  separate  components  of  shareholders'  equity  (accumulated  other
        comprehensive  income  (loss)).  Gains  or  losses  on  dispositions  of
        securities are based on the difference  between the net proceeds and the
        adjusted  carrying  amounts of the  securities  sold using the  specific
        identification  method.   Premiums  and  discounts  are  amortized  into
        interest income by a method that approximates a level yield.

2.      Held to maturity:  These are securities that the Company has the ability
        and intent to hold until maturity.  These securities are stated at cost,
        adjusted for  amortization  of premiums and the  accretion of discounts.
        Premiums and discounts are  amortized  into interest  income by a method
        that  approximates  a level  yield.  The Company has no held to maturity
        securities.

3.      Trading:  These are securities that are bought and held  principally for
        the  purpose of  selling  in the near  future.  Trading  securities  are
        reported at fair market value,  and related  unrealized gains and losses
        are  recognized  in the income  statement.  The  Company  has no trading
        securities.

   Loans and interest income on loans

     Loans are stated at the principal  balance  outstanding.  The allowance for
     possible  loan  losses is  deducted  from total  loans in the  consolidated
     balance sheet.  Interest  income is recognized on an accrual basis over the
     term of the loan based on the principal amount outstanding.

     Loans are generally placed on non-accrual status when principal or interest
     becomes  ninety days past due, or when payment in full is not  anticipated.
     When a loan is placed  on  non-accrual  status,  interest  accrued  but not
     received is generally  reversed against interest income.  If collectibility
     is in  doubt,  cash  receipts  on  non-accrual  loans are not  recorded  as
     interest income,  but are used to reduce principal.  Loans are not returned
     to  accrual  status  until the  borrower  demonstrates  the  ability to pay
     principal and interest.  Loans on non-accrual status as well as real estate
     acquired  through  foreclosure  or deed  taken in lieu of  foreclosure  are
     included in non-performing assets.


                                       25
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

   Allowance for possible loan losses

     The  provision  for  possible  loan  losses  charged to  operating  expense
     reflects  the amount  deemed  appropriate  by  management  to  establish an
     adequate reserve to meet the present estimated loss  characteristics of the
     current  loan  portfolio.  Management's  estimate is based on periodic  and
     regular evaluation of individual loans, the overall risk characteristics of
     the various portfolio segments, past experience with losses, and prevailing
     and  anticipated  economic  conditions.  Loans  that are  determined  to be
     uncollectible  are charged  against the  allowance.  Provision for possible
     loan losses and recoveries on loans previously charged off are added to the
     allowance.

     The Company  accounts for impaired  loans in accordance  with SFAS No. 114,
     "Accounting by Creditors for Impairment of a Loan." This standard  requires
     that all  lenders  value  loans at the loan's  fair value if it is probable
     that the lender will be unable to collect all amounts due  according to the
     terms of the loan  agreement.  Fair value may be determined  based upon the
     present  value  of  expected  cash  flows,  market  price of the  loan,  if
     available,  or value of the underlying collateral.  Expected cash flows are
     required to be discounted at the loan's effective interest rate.

     Under  SFAS No.  114,  as  amended  by SFAS  No.  118,  when  the  ultimate
     collectibility  of an  impaired  loan's  principal  is in doubt,  wholly or
     partially,  all cash receipts are applied to  principal.  Once the reported
     principal  balance  has been  reduced to zero,  future  cash  receipts  are
     applied to  interest  income,  to the  extent  that any  interest  has been
     foregone.  Further cash  receipts are recorded as recoveries of any amounts
     previously charged off.

     A loan is also considered  impaired if its terms are modified in a troubled
     debt  restructuring.  For these accruing  impaired loans, cash receipts are
     typically  applied to principal and interest  receivable in accordance with
     the terms of the restructured loan agreement. Interest income is recognized
     on these loans using the accrual method of accounting.

   Property and equipment

     Property and equipment are stated at cost, net of accumulated depreciation.
     Depreciation is computed using the straight-line  method over the estimated
     useful lives of the related assets.  Maintenance and repairs are charged to
     operations, while major improvements are capitalized. Upon retirement, sale
     or other  disposition of property and equipment,  the cost and  accumulated
     depreciation are eliminated from the accounts, and gain or loss is included
     in income from operations.

   Assets acquired in settlement of loans

     Assets acquired in settlement of loans include real estate acquired through
     foreclosure or deed taken in lieu of foreclosure,  and repossessed  assets.
     These assets are  recorded at the lower of the carrying  value of the loans
     or the estimated fair value of the related asset, net of estimated  selling
     costs.  The excess  carrying value, if any, is charged to the allowance for
     possible loan losses upon transfer.  If further  reduction in value occurs,
     charges are included in income from operations.

   Goodwill

     Goodwill  is  evaluated  for  impairment  on at  least an  annual  basis by
     comparing the fair value of its reporting  units to their related  carrying
     value.  If the carrying  value of a reporting  unit exceeds its fair value,
     the Company  determines  whether the  implied  fair value of the  goodwill,
     using a discounted  cash flow  analysis,  exceeds the carrying value of the
     goodwill.  If the carrying  value of the goodwill  exceeds the implied fair
     value of the goodwill, an impairment loss is recorded in an amount equal to
     that  excess.  To date,  the Company  has not had to record any  impairment
     write downs of its goodwill.


                                       26
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

   Income taxes

     The  financial  statements  have been prepared on the accrual  basis.  When
     income and  expenses are  recognized  in  different  periods for  financial
     reporting  purposes versus for 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." Under SFAS No. 109,  deferred tax assets and
     liabilities  are recognized  for the expected  future tax  consequences  of
     events that have been recognized in the financial statements or tax return.
     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.

   Advertising and public relations expense

     Advertising,   promotional,   and  other  business  development  costs  are
     generally expensed as incurred.  External costs incurred in producing media
     advertising  are  expensed  the first  time the  advertising  takes  place.
     External  costs  relating to direct  mailings are expensed in the period in
     which the direct mailings are sent.

   Net income per common share

     Net  income  per  common  share is  computed  on the basis of the  weighted
     average  number of common shares  outstanding  in accordance  with SFAS No.
     128, "Earnings per Share." The treasury stock method is used to compute the
     effect of stock  options and  convertible  subordinated  debentures  on the
     weighted  average number of common shares  outstanding for diluted earnings
     per share.  On January 21, 2003, the Company  declared a five percent stock
     dividend and on January 22, 2004 and February 28, 2005 the Company declared
     ten  percent  stock  dividends.  Per  share  and  share  amounts  have been
     retroactively  restated  to reflect the stock  dividends  declared in 2003,
     2004 and 2005.  The 2005 stock dividend was reflected in the 2004 financial
     statements.

   Statement of cash flows

     For purposes of reporting cash flows, cash and cash equivalents are defined
     as those  amounts  included in the  balance  sheet  caption  "Cash and cash
     equivalents."  Cash and cash equivalents have an original maturity of three
     months or less.

   Fair values of financial instruments

     SFAS No. 107,  "Disclosures About Fair Value of Financial  Instruments," as
     amended by SFAS No. 119, requires  disclosure of fair value information for
     financial  instruments,  whether  or not  recognized  in  the  consolidated
     balance sheet,  when it is practicable to estimate the fair value. SFAS No.
     107  defines a  financial  instrument  as cash,  evidence  of an  ownership
     interest  in an  entity  or  contractual  obligations,  which  require  the
     exchange  of  cash  or  other  financial  instruments.  Certain  items  are
     specifically  excluded  from the  disclosure  requirements,  including  the
     Company's common stock. In addition, other nonfinancial instruments such as
     property and equipment and other assets and  liabilities are not subject to
     the disclosure requirements.

   Risks and uncertainties

     In the normal course of its business the Company encounters two significant
     types of risks: economic and regulatory. There are three main components of
     economic risk: interest rate risk, credit risk and market risk. The Company
     is subject to interest  rate risk to the degree  that its  interest-bearing
     liabilities  mature or reprice at different  times, or on different  bases,
     than its interest-earning assets. Credit risk is the risk of default on the
     Company's loan and  investment  securities  portfolios  that results from a
     borrower's  inability  or  unwillingness  to  make  contractually  required
     payments.   Market  risk  reflects  changes  in  the  value  of  collateral
     underlying  loans  receivable  and the valuation of real estate held by the
     Company.


                                       27
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES,   Continued

     The Company is subject to the regulations of various governmental agencies.
     These  regulations can and do change  significantly  from period to period.
     The  Company  also  undergoes  periodic   examinations  by  the  regulatory
     agencies,  which may subject it to further  changes  with  respect to asset
     valuations,  amounts of required loss allowances and operating restrictions
     from the regulators'  judgments  based on information  available to them at
     the time of their examination.

Stock-based compensation

     The Company has a stock-based employee  compensation plan, which is further
     described  in Note  16.  The  Company  accounts  for  the  plan  under  the
     recognition  and  measurement  principles  of Accounting  Principles  Board
     ("APB")  Opinion No. 25,  "Accounting  for Stock Issued to Employees,"  and
     related  Interpretations.  No  stock-based  employee  compensation  cost is
     reflected in net income, as all stock options granted under the plan had an
     exercise price equal to the market value of the underlying  common stock on
     the date of grant. The following table illustrates the effect on net income
     and net income per common  share as if the  Company  had  applied  the fair
     value recognition  provisions of SFAS No. 123,  "Accounting for Stock-Based
     Compensation," to stock-based employee compensation. Per share and weighted
     average  shares  outstanding  have been restated to reflect the ten percent
     stock  dividends  declared on January 22, 2004 and February  28, 2005.  The
     2005 stock dividend was reflected in the 2004 financial statements.

<TABLE>
<CAPTION>
                                                                                                    Years ended December 31,
                                                                                                    ------------------------
                                                                                           2005              2004             2003
                                                                                           ----              ----             ----
<S>                                                                                       <C>               <C>               <C>
Net income, as reported ......................................................            $2,361            $1,319            $  650
Deduct:  Total stock-based employee compensation
     expense determined under fair value based
     method for all awards, net of related tax effects .......................               124                54                20
                                                                                          ------            ------            ------
Pro forma net income - basic .................................................             2,237             1,265               630

Add: Interest savings, net of tax/weighted average
     incremental shares assumed on conversion of
     subordinated debentures .................................................                73                50                47
                                                                                          ------            ------            ------
Pro forma net income - diluted ...............................................            $2,310            $1,315            $  677
                                                                                          ======            ======            ======
Net income per common share:
     Basic - as reported .....................................................            $ 0.91            $ 0.55            $ 0.27
                                                                                          ======            ======            ======
     Basic - pro forma .......................................................            $ 0.87            $ 0.53            $ 0.26
                                                                                          ======            ======            ======
     Diluted - as reported ...................................................            $ 0.76            $ 0.43            $ 0.22
                                                                                          ======            ======            ======
     Diluted - pro forma .....................................................            $ 0.72            $ 0.41            $ 0.21
                                                                                          ======            ======            ======
</TABLE>

   The fair values at date of grant range from $1.38 to $3.56. The fair value of
   the option grant is  estimated  on the date of grant using the  Black-Scholes
   option  pricing model with the following  weighted  average  assumptions  for
   grants:  the risk free  interest  rate used ranged  from 4.00% to 5.89%,  the
   expected volatility ranged from 5.00% to 20.09%, the expected option life was
   10 years and the assumed dividend yields ranged from zero to $0.08 per share.


                                       28
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

Recently issued accounting standards

   The following is a summary of recent authoritative pronouncements that affect
   accounting,  reporting,  and  disclosure  of  financial  information  by  the
   Company:

              In December  2004,  the FASB issued SFAS No. 123  (revised  2004),
     "Share-Based  Payment" ("SFAS No.  123(R)").  SFAS No.123(R)  covers a wide
     range of stock-based  compensation  arrangements  including  stock options,
     restricted  stock  plans,   performance-based  awards,  stock  appreciation
     rights,  and employee  stock purchase  plans.  SFAS No. 123(R) will require
     companies to measure all employee  stock-based  compensation awards using a
     fair value method and record such expense in their financial statements. In
     addition,  the adoption of SFAS No. 123(R) requires  additional  accounting
     and  disclosure  related to the income tax and cash flow effects  resulting
     from stock-based payment arrangements. SFAS No. 123(R) is effective for the
     Company  beginning  with the first interim  reporting  period in 2006.  The
     Company is  currently  evaluating  the impact that the adoption of SFAS No.
     123(R) will have on its financial position,  results of operations and cash
     flows.  The  cumulative  effect of adoption,  if any,  will be measured and
     recognized in the statement of income on the date of adoption.

              In April 2005, the Securities and Exchange  Commission's Office of
     the Chief Accountant and its Division of Corporation Finance released Staff
     Accounting  Bulletin  ("SAB")  No.107 to  provide  guidance  regarding  the
     application of SFAS No. 123(R). SAB No. 107 provides  interpretive guidance
     related to the interaction between SFAS No.123(R) and certain SEC rules and
     regulations,  as well as the  staff's  views  regarding  the  valuation  of
     stock-based  payment  arrangements for public  companies.  SAB No. 107 also
     reminds public companies of the importance of including  disclosures within
     filings  made  with the SEC  relating  to the  accounting  for  stock-based
     payment transactions, particularly during the transition to SFAS No.123(R).

              In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
     Error  Corrections--a  replacement of APB Opinion No. 20 and FASB Statement
     No. 3". SFAS No. 154 establishes  retrospective application as the required
     method  for  reporting  a change  in  accounting  principle,  unless  it is
     impracticable,  in which case the  changes  should be applied to the latest
     practicable date presented. SFAS No. 154 also requires that a correction of
     an error be reported as a prior period adjustment by restating prior period
     financial statements.  SFAS No. 154 is effective for accounting changes and
     corrections  of errors made in fiscal years  beginning  after  December 15,
     2005.

           Other  accounting  standards that have been issued or proposed by the
     FASB or other standards-setting bodies that do not require adoption until a
     future date are not expected to have a material impact on the  consolidated
     financial statements upon adoption.


NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS

           The Bank is required to maintain average reserve  balances,  computed
by applying prescribed  percentages to its various types of deposits,  either at
the Bank or on deposit with the Federal  Reserve  Bank. At December 31, 2005 and
2004 these required reserves were met by vault cash.


                                       29
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 3 - INVESTMENT SECURITIES

           The amortized cost and fair value of investment  securities available
for sale are as follows:

<TABLE>
<CAPTION>
                                                                                           December 31, 2005
                                                                                           -----------------
                                                                                            Gross unrealized
                                                                        Amortized           ----------------                  Fair
                                                                           Cost          Gains            Losses              Value
                                                                           ----          -----            ------              -----
<S>                                                                      <C>             <C>              <C>                <C>
U.S. Government Agencies ....................................            $14,498         $   -            $   209            $14,289
State and municipals ........................................                463             -                  2                461
Mortgage backed .............................................             13,772             -                362             13,410
                                                                         -------         -----            -------            -------
       Total investment securities ..........................            $28,733         $   -            $   573            $28,160
                                                                         =======         =====            =======            =======

<CAPTION>
                                                                                           December 31, 2004
                                                                                           -----------------
                                                                                            Gross unrealized
                                                                        Amortized           ----------------                  Fair
                                                                           Cost          Gains            Losses              Value
                                                                           ----          -----            ------              -----
<S>                                                                      <C>            <C>                <C>               <C>
U.S. Government Agencies ...................................             $ 7,496        $     -            $    34           $ 7,462
Mortgage backed ............................................               8,924             44                 79             8,889
                                                                         -------        -------            -------           -------

       Total investment securities .........................             $16,420        $    44            $   113           $16,351
                                                                         =======        =======            =======           =======
</TABLE>

           The amortized costs and fair values of securities  available for sale
at December 31, 2005, by contractual maturity, are shown in the following chart.
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay  obligations with or without call or prepayment
penalties.


                                                         Amortized
                                                            Cost      Fair value
                                                            ----      ----------

Less than one year ...............................        $ 3,000        $ 2,967
One to five years ................................         13,547         13,307
Five to ten years ................................         10,175          9,907
After ten years ..................................          2,011          1,979
                                                          -------        -------

       Total investment securities ...............        $28,733        $28,160
                                                          =======        =======

           Investment  securities  with an  aggregate  amortized  cost of $1,499
(fair value of $1,465) at December 31, 2005 and $8,207 (fair value of $8,201) at
December 31, 2004 were pledged to collateralize public deposits and borrowings.


                                       30
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 3 - INVESTMENT SECURITIES, Continued

           The following table shows gross unrealized losses and fair value, and
length of time that individual  securities have been in a continuous  unrealized
loss position at December 31, 2005.

<TABLE>
<CAPTION>
                                                    Less than 12 Months           12 Months or More                Total
                                                    -------------------           -----------------                -----
                                                    Fair       Unrealized        Fair        Unrealized        Fair       Unrealized
                                                   Value         Losses         Value          Losses          Value        Losses
                                                   -----         ------         -----          ------          -----        ------

<S>                                               <C>            <C>            <C>            <C>            <C>            <C>
U.S. Government Agencies .................        $ 6,926        $    75        $ 7,363        $   134        $14,289        $   209
State and municipals .....................            461              2              -              -            461              2
Mortgage backed ..........................          8,808            143          4,602            219         13,410            362
                                                  -------        -------        -------        -------        -------        -------
  Total ..................................        $16,195        $   220        $11,965        $   353        $28,160        $   573
                                                  =======        =======        =======        =======        =======        =======
</TABLE>

         Thirteen  individual  securities were in a continuous loss position for
twelve  months or more.  The  Company  has the  ability and intent to hold these
securities until such time as the value recovers or the securities  mature.  The
Company believes, based on industry analyst reports and credit ratings, that the
deterioration  in value is  attributable to changes in market interest rates and
not in the credit  quality of the issuer  and  therefore,  these  losses are not
considered other-than-temporary.

         The Bank,  as a member  institution  of the  Federal  Home Loan Bank of
Atlanta  ("FHLB"),  is required to own capital stock in the FHLB based generally
upon the balance of  investment  securities  pledged and FHLB  borrowings.  FHLB
capital  stock,  with a cost of $798 and $955 at  December  31,  2005 and  2004,
respectively,  is  included in other  investments  in the  consolidated  balance
sheets. No ready market exists for the stock, and it has no quoted market value.
However, redemption of the stock has historically been at par value.

NOTE 4 - LOANS

         The composition of net loans by major loan category is presented below:

<TABLE>
<CAPTION>
                                                                                                   December 31,
                                                                                                   ------------
                                                                                            2005                      2004
                                                                                            ----                      ----
<S>                                                                                       <C>                       <C>
Commercial .....................................................................          $ 41,915                  $ 33,644
Real estate - construction .....................................................            39,895                    39,170
Real estate - mortgage .........................................................           110,694                    96,984
Consumer .......................................................................             7,858                     6,660
                                                                                          --------                  --------
Loans, gross ...................................................................           200,362                   176,458
Less allowance for possible loan losses ........................................             3,050                     2,293
                                                                                          --------                  --------
                                                                                          $197,312                  $174,165
                                                                                          ========                  ========
</TABLE>

           At December 31, 2005 and 2004,  non-accrual  loans totaled $2,551 and
$1,497,  respectively.  The gross interest  income that would have been recorded
under the original  terms of the loans  amounted to $96, $168, and $94, in 2005,
2004 and 2003, respectively. The Bank had no loans with payments past due ninety
days or more and accruing interest at December 31, 2005 and 2004.  Variable rate
and fixed rate loans totaled $141,172 and $59,190, respectively, at December 31,
2005.


                                       31
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 4 - LOANS, Continued

           The  following is a summary of the activity  within the allowance for
possible loan losses for the periods presented:

<TABLE>
<CAPTION>
                                                                                            For the years ended December 31,
                                                                                            --------------------------------
                                                                                        2005                2004             2003
                                                                                        ----                ----             ----
<S>                                                                                   <C>                <C>                <C>
Balance, beginning of year ................................................           $ 2,293            $ 2,345            $ 1,395
Provision for possible loan losses ........................................             1,125              1,000              1,339
Loans charged against the allowance, net of recoveries ....................              (368)            (1,052)              (389)
                                                                                      -------            -------            -------
Balance, end of year ......................................................           $ 3,050            $ 2,293            $ 2,345
                                                                                      =======            =======            =======
</TABLE>


         The following is a summary of impaired loans for the periods reported:

                                                               At December 31,
                                                               ---------------
                                                             2005          2004
                                                             ----          ----
Impaired loans:
     No valuation allowance required ...............        $  280        $2,196
     Valuation allowance required ..................         2,160         1,161
                                                            ------        ------
Total impaired loans ...............................        $2,440        $3,357
                                                            ======        ======
Valuation allowance ................................        $  630        $  305
                                                            ======        ======

<TABLE>
<CAPTION>
                                                                                        For the years ended December 31,
                                                                                        --------------------------------
                                                                                   2005                2004             2003
                                                                                   ----                ----             ----
<S>                                                                              <C>                <C>                <C>
Average recorded investment in impaired loans ...........................        $3,388             $3,4062            $     -
Interest income recognized on impaired loans ............................           172                 102                  -
</TABLE>


NOTE 5 - PROPERTY AND EQUIPMENT

         Components of property and equipment  included in the balance sheet are
as follows:

                                                               December 31,
                                                               ------------
                                                           2005           2004
                                                           ----           ----
Land and land improvements .......................       $ 1,104        $   567
Building and leasehold improvements ..............         2,752          2,891
Construction in process ..........................           335              -
Furniture and equipment ..........................         1,353          1,293
Vehicles .........................................           251            133
                                                         -------        -------
                                                           5,795          4,884
Accumulated depreciation .........................        (1,415)        (1,255)
                                                         -------        -------
        Total property and equipment .............       $ 4,380        $ 3,629
                                                         =======        =======


                                       32
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 5 - PROPERTY AND EQUIPMENT, Continued

           Construction in process consists of capitalized  costs related to the
construction of the Anderson branch office.  Depreciation  expense for the years
ended  December  31,  2005,  2004 and 2003  amounted  to $329,  $385,  and $334,
respectively.  Depreciation is charged to operations  over the estimated  useful
lives of the assets.  The estimated useful lives and methods of depreciation for
the principal items follow:

<TABLE>
<CAPTION>
                  Type of Asset                           Life in Years                   Depreciation Method
     ----------------------------------------       --------------------------      ---------------------------------

<S>                                                              <C>                         <C>
     Software                                                    3                           Straight-line
     Furniture and equipment                                     5 to 7                      Straight-line
     Buildings and improvements                                  5 to 40                     Straight-line
     Vehicles                                                    3                           Straight-line
</TABLE>


NOTE 6 - DEPOSITS

         The following is a detail of deposit accounts:

                                                              December 31,
                                                              ------------
                                                         2005              2004
                                                         ----              ----

Noninterest bearing ..........................         $ 12,321         $  8,818
Interest bearing:
   NOW accounts ..............................            2,941            2,914
   Money market accounts .....................           50,905           61,240
   Savings ...................................              751              742
                                                       --------         --------
                                                         66,918           73,714
                                                       --------         --------
   Time, less than $100,000 ..................           80,064           50,222
   Time, $100,000 and over ...................           74,679           52,210
                                                       --------         --------
                                                        154,743          102,432
                                                       --------         --------
     Total deposits ..........................         $221,661         $176,146
                                                       ========         ========

         Interest  expense on time  deposits  greater than  $100,000 was $2,226,
$905, and $519, in 2005, 2004 and 2003,  respectively.  Brokered  deposits as of
December 31, 2005 amounted to $30,774.

         At December  31,  2005 the  scheduled  maturities  of  certificates  of
deposit are as follows:

                   2006                                         $    136,418
                   2007                                               16,150
                   2008                                                1,934
                   2009                                                  129
                   2010 and thereafter                                   112
                                                                ------------
                                                                $    154,743
                                                                ============


                                       33
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES

           The Bank had advances  outstanding  from the FHLB totaling $8,500 and
$13,500 at December 31, 2005 and 2004, respectively.  The advances bear interest
at fixed rates ranging from 4.33 percent to 4.38  percent.  An advance of $6,500
matures in 2006, and an advance of $2,000 matures in 2011. The advance  maturing
in 2011 is callable, and may reprice prior to its final maturity date.

           Advances are  collateralized  by qualifying  residential 1 - 4 family
first mortgages and qualifying commercial loans. During 2005, the maximum amount
of advances  outstanding was $16,500 and the average amount  outstanding  during
2005 was $11,392.

NOTE 8 - OTHER BORROWINGS

           At December 31, 2005 and 2004, the Company had outstanding $3,900 and
$2,500, respectively, in other borrowings from an unrelated bank. The borrowings
bear interest at the federal prime rate (7.25 percent at December 31, 2005). The
borrowings mature in 2017 and may be repaid before maturity without penalty.


NOTE 9 - SUBORDINATED DEBENTURES

         In  2001,  the  Company  issued  ten-year   variable  rate  convertible
subordinated  debentures  (the  "Debentures").   The  Debentures  paid  interest
quarterly at prime minus 2 percent.  Under the original  terms of the  Debenture
agreement  (the  "Terms"),  the  holders of the  Debentures  could  convert  the
principal  amount of each  Debenture  into  common  stock of the  Company at the
conversion  rate of $5.12  (which  was based on the  approximate  fair  value at
issuance of $6.50, as adjusted for the 2003,  2004 and 2005 stock  dividends) of
Debenture  principal for one share of the Company's stock.  Under the Terms, the
Company had the option of redeeming the  Debentures  at any time after  December
31, 2005 as a whole or in part and from time to time at predetermined prices. At
the Company's request,  during the third and fourth quarters of 2005, holders of
$3,500 of the Company's  Debentures  converted  their principal to common stock.
This conversion was made in advance of the earliest contractual  redemption date
of January 1, 2006,  provided for by the Terms.  The Company paid the holders an
amount  equal  to the  interest  income  that  would  have  been  earned  on the
Debentures through January 1, 2006. This interest was paid based on the interest
rate in  effect  at the time of  conversion:  4.25%  and 4.75% for the third and
fourth quarters of 2005, respectively.

NOTE 10 - COMMITMENTS AND CONTINGENCIES

           The Company is party to litigation  and claims  arising in the normal
course of business.  Management, after consultation with legal counsel, believes
that the  liabilities,  if any, arising from such litigation and claims will not
be material to the Company's financial position or results of operations.

           The  Company  has  entered  into a  contract  with an  architect  and
contractor  to  construct  the  Anderson  branch  office in the  amount of $688.
Management  estimates  the total cost of  construction  of the  Anderson  branch
office to be approximately $750.

           The Company has a ground  lease on its main  office  location,  which
expires in 2021.  The monthly lease  payment is $1 for years one through  eleven
and increases to $2 per month in year sixteen.

           The Company  leased an office,  which it used as a branch  until July
2003, under a non-cancelable  operating lease, which terminated in October 2004.
Monthly  lease  payments  of $3 were due on the lease until  cancellation.  This
office was closed in July 2003, but the lease obligation continued until October
2004.

           The  Company  also  leases  land upon which it  constructed  a branch
office under a non-cancelable  operating lease,  which expires in March of 2018.
The lease  requires  monthly  lease  payments of $0.8.  The lease  contains four
renewal  options of five  years  each with  provisions  for  adjustments  to the
monthly  lease  payments.  The lease  agreement  requires the Company to pay all
property taxes.


                                       34
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 10 - COMMITMENTS AND CONTINGENCIES, Continued

         Future  minimum  lease  payments  under  these  operating   leases  are
summarized as follows:

    For the year ended
            ended
         December 31,
         ------------
            2006                                     $    23
            2007                                          23
            2008                                          23
            2009                                          23
            2010                                          23
         Thereafter                                      241
                                                     -------
                                                     $   356
                                                     =======


NOTE 11 - UNUSED LINES OF CREDIT

           At  December  31,  2005,  the Bank had two unused  lines of credit to
purchase  federal funds  totaling  $7,400 from unrelated  banks.  These lines of
credit  are  available  on a one to  fourteen  day basis for  general  corporate
purposes  of the Bank.  The lenders  reserve  the right to withdraw  the line at
their option.  The Bank had an additional line of credit with the FHLB to borrow
up to fifteen percent of the Bank's total assets. At December 31, 2005, the Bank
had unused  available credit of $29,286.  The line of credit agreement  requires
the Bank to pledge investment securities or qualifying loans as collateral. (See
Note 7.)


NOTE 12 - INCOME TAXES

           The following  summary of the provision for income taxes includes tax
deferrals,  which arise from temporary differences in the recognition of certain
items of revenue and expense for tax and  financial  reporting  purposes for the
years ended December 31:

                                                2005        2004           2003
                                                ----        ----           ----

Income taxes currently payable
   Federal ............................      $ 1,400       $   649      $   552
   State ..............................          116            65           24
                                             -------       -------      -------

                                               1,516           714          576
Deferred tax provision (benefit) ......         (361)           55         (194)
                                             -------       -------      -------

       Income tax provision ...........      $ 1,155       $   769      $   382
                                             =======       =======      =======


                                       35
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 12 - INCOME TAXES, Continued

The income tax effect of cumulative temporary differences at December 31, are as
follows:

<TABLE>
<CAPTION>
                                                                                                      Deferred tax asset (liability)
                                                                                                      ------------------------------
                                                                                                         2005                 2004
                                                                                                         ----                 ----
<S>                                                                                                     <C>                   <C>
Allowance for possible loan losses .....................................................                $ 699                 $ 456
Nonaccrual loan interest ...............................................................                   40                    14
Unrealized net losses on investment securities available for sale ......................                  212                    26
Depreciation ...........................................................................                 (234)                 (195)
Amortization ...........................................................................                  (10)                    -
Write down of assets acquired in settlement of loans ...................................                   86                     -
Deferred compensation ..................................................................                   88                     -
Other ..................................................................................                   10                    (7)
                                                                                                        -----                 -----
       Deferred tax asset ..............................................................                  891                   294
                                                                                                        -----                 -----
Less:  valuation allowance .............................................................                  (50)                    -
                                                                                                        -----                 -----
       Net deferred tax asset ..........................................................                $ 841                 $ 294
                                                                                                        =====                 =====
</TABLE>


           The net  deferred  tax  asset  is  included  in other  assets  in the
consolidated balance sheets. The valuation allowance is related to the Company's
stand-alone state net operating loss carryforwards.

           The  provision for income taxes is reconciled to the amount of income
tax computed at the federal statutory rate on income before income taxes for the
years ended December 31, as follows:

<TABLE>
<CAPTION>
                                                                      2005                      2004                     2003
                                                                      ----                      ----                     ----
                                                            Amount            %        Amount          %         Amount          %
                                                            ------       ------        ------       -----        ------       ------
<S>                                                       <C>            <C>          <C>           <C>         <C>           <C>
Tax expense at statutory rate ......................      $ 1,196            34       $   710           34      $   351           34
Increase in taxes resulting from:
   State bank tax (net of federal benefit) .........           77             2            43            2           24            2
   Officers life insurance .........................          (55)           (1)            -            -            -            -
   Other ...........................................          (63)           (2)           16            1            7            1
                                                          -------       -------       -------      -------      -------      -------

       Income tax provision ........................      $ 1,155            33       $   769           37      $   382           37
                                                          =======       =======       =======      =======      =======      =======
</TABLE>

NOTE 13 - RELATED PARTY TRANSACTIONS

         Certain directors, executive officers and companies with which they are
affiliated,  are customers of and have banking transactions with the Bank in the
ordinary  course of business.  These loans were made on  substantially  the same
terms, including interest rates and collateral,  as those prevailing at the time
for comparable  arms-length  transactions.  A summary of loan  transactions with
directors, including their affiliates and executive officers are as follows:

                                                           For the years ended
                                                               December 31,
                                                               ------------
                                                         2005              2004
                                                         ----              ----
Balance, beginning of year ...................         $ 2,071          $ 1,808
New loans ....................................             202            1,688
Less loan payments ...........................            (627)          (1,425)
                                                       -------          -------

Balance, end of year .........................         $ 1,646          $ 2,071
                                                       =======          =======


                                       36
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 13 - RELATED PARTY TRANSACTIONS, Continued

         Deposits by directors and their related  interests at December 31, 2005
and 2004 approximated $1,216 and $1,883, respectively.

         The Company leases land from a relative of a director,  shareholder and
executive  officer  of the  Company  (see Note 10).  Lease  expenses  charged to
operations under these agreements approximated $10 in 2005, $40 in 2004, and $46
in 2003.

         Of the $3,500 in  debentures  that were  converted  into common  stock,
$1,810  were  converted  into  353,511  shares of common  stock  held by related
parties.


NOTE 14 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

         In the ordinary course of business,  and to meet the financing needs of
its  customers,  the  Bank is a party  to  various  financial  instruments  with
off-balance sheet risk. These financial  instruments,  which include commitments
to extend credit and standby  letters of credit,  involve,  to varying  degrees,
elements of credit and interest rate risk in excess of the amounts recognized in
the balance sheet. The contract amount of those instruments  reflects the extent
of involvement the Bank has in particular classes of financial instruments.

         The Bank's  exposure to credit loss in the event of  nonperformance  by
the other party to the financial instrument for commitments to extend credit and
standby  letters of credit is  represented by the  contractual  amounts of those
instruments.  The Bank uses the same credit  policies in making  commitments and
conditional obligations as it does for on-balance sheet instruments. Commitments
to extend  credit are  agreements  to lend to a customer  as long as there is no
violation of any material  condition  established  in the contract.  Commitments
generally  have fixed  expiration  dates or other  termination  clauses  and may
require  the  payment  of a  fee.  At  December  31,  2005  and  2004,  unfunded
commitments  to extend credit were $45,968 and $27,848,  respectively.  Variable
rate and fixed rate  unfunded  commitments  to extend  credit  were  $29,853 and
$16,115,  respectively, at December 31, 2005. The Bank evaluates each customer's
credit worthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit,  is based on management's
credit  evaluation of the borrower.  Collateral  varies but may include accounts
receivable, inventory, property, plant and equipment, commercial and residential
real estate.  At December 31, 2005 and 2004, there were  outstanding  letters of
credit totaling $332 and $994, respectively.


NOTE 15 - EMPLOYEE BENEFIT PLAN

         The Bank sponsors the  GrandSouth  Bank Profit  Sharing  Section 401(k)
Plan  (the  "Plan")  for  the  benefit  of  all  eligible  employees.  The  Bank
contributes  seventy-five  percent of the first four  percent of the  employee's
compensation  contributed to the Plan.  Contributions  made to the Plan in 2005,
2004, and 2003 amounted to $56, $40, and $35, respectively.

         In 2001,  supplemental benefits were approved by the Board of Directors
for certain  executive  officers of the Bank.  These  benefits are not qualified
under  the  Internal  Revenue  Code and they are not  funded.  However,  certain
funding is provided  informally and indirectly by life insurance  policies owned
by the Bank. The Company  recorded net expense related to these benefits of $61,
$56, and $29 in 2005, 2004 and 2003, respectively.


                                       37
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 16 - STOCK OPTION PLAN

         During 1998,  the Board of  Directors  approved a stock option plan for
the benefit of the directors,  officers and employees. The Board may grant up to
778,330  options (after the  shareholders  approved an amendment to increase the
number of shares in the plan at the 2005 Annual  meeting) at an option price per
share not less than the fair  market  value on the date of  grant.  All  options
granted to officers and  employees  vest 20 percent each year for five years and
expire 10 years from the grant  date.  Information  on options  outstanding  and
exercisable at December 31, 2005 is disclosed in the table below.

<TABLE>
<CAPTION>
                                               Options outstanding                           Options exercisable
                                               -------------------                           -------------------
                                                     Weighted
                                                      Average           Weighted                            Weighted
      Range of                                       Remaining          Average                             Average
      Exercise                     Number           Contractual         Exercise           Number           Exercise
       Prices                    Outstanding            Life             Price           Exercisable         Price
       ------                    -----------            ----             -----           -----------         -----

<S>                                <C>                <C>             <C>                      <C>         <C>
  $    3.58                        181,682             2.87           $     3.58               181,682     $     3.58
       3.94                         47,842             5.12                 3.94                38,274           3.94
       5.51 - 5.71                  41,489             6.20                 5.68                23,623           5.69
       6.69                         33,000             8.13                 6.69                 6,600           6.69
       8.50 - 9.5                   17,500            10.00                 9.04                     -              -
      10.05                         93,358            10.00                10.05                     -              -
                                   -------                                                     -------

                                   414,871                                                     250,179
                                   =======                                                     =======
</TABLE>

         A summary  of the  status of the plan and  changes  during  the year is
presented below:

<TABLE>
<CAPTION>
                                                              For the years ended December 31,
                                                              --------------------------------
                                                  2005                        2004                      2003
                                                  ----                        ----                      ----
                                                        Weighted                   Weighted                  Weighted
                                                        Average                    Average                   Average
                                                        Exercise                   Exercise                  Exercise
                                          Shares         Price        Shares        Price        Shares       Price
                                          ------         -----        ------        -----        ------       -----
<S>                                       <C>             <C>        <C>             <C>        <C>            <C>
Outstanding at beginning of year ....     304,013         $4.26      271,013         $3.85      264,660        $3.82
Granted .............................     110,858          9.89       33,000          6.69        6,353         5.51
Exercised ...........................           -                          -                          -
Forfeited or expired ................           -                          -                          -
                                          -------                    -------                    -------
Outstanding at end of year ..........     414,871          5.76      304,013          4.26      271,013         3.85
                                          =======                    =======                    =======
Options exercisable at December 31, .     250,179          3.92      225,712          3.77      207,846         3.69
Shares available for grant ..........     363,459                     26,317                     59,317
</TABLE>

         Granted  shares and per share  exercise  prices  have been  restated to
reflect the 2003, 2004 and 2005 stock dividends.


                                       38
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 17 - COMMON STOCK AND NET INCOME PER COMMON SHARE

Following  is a  reconciliation  of basic net income  per share to  diluted  net
income per share for the years ended December 31, 2005, 2004 and 2003.

<TABLE>
<CAPTION>
                                                                                         Income             Shares         Per-share
                                                                                       (numerator)       (denominator)       amount
                                                                                       -----------       -------------       ------
For the year ended December 31, 2005
      Basic net income per common share
<S>                                                                                    <C>                 <C>              <C>
         Income available to common shareholders ...........................           $   2,361           2,582,298        $   0.91
         Effect of dilutive instruments:
            Stock options ..................................................                   -             152,728               -
         Effect of convertible instruments:
            Interest savings/weighted average
                incremental shares assumed
                conversion of subordinated debentures ......................                  73             483,960               -
                                                                                       ---------           ---------
      Diluted net income per common share
         Income available to common shareholders
            plus assumed exercises of stock options ........................           $   2,434           3,218,986        $   0.76
                                                                                       =========           =========

For the year ended December 31, 2004
      Basic net income per common share
         Income available to common shareholders ...........................           $   1,319           2,382,357        $   0.55
         Effect of dilutive instruments:
            Stock options ..................................................                   -             134,086               -
         Effect of convertible instruments:
            Interest savings/weighted average
                incremental shares assumed on
                conversion of subordinated debentures ......................                  50             684,115               -
                                                                                       ---------           ---------
      Diluted net income per common share
         Income available to common shareholders
            plus assumed exercises of stock options ........................           $   1,369           3,200,558        $   0.43
                                                                                       =========           =========

For the year ended December 31, 2003
      Basic net income per common share
         Income available to common shareholders ...........................           $     650           2,382,567        $   0.27
         Effect of dilutive instruments:
            Stock options ..................................................                   -              95,896               -
         Effect of convertible instruments:
            Interest savings/weighted average
                incremental shares assumed on
                conversion of subordinated debentures ......................                  47             683,837               -
                                                                                       ---------           ---------
      Diluted net income per common share
         Income available to common shareholders
            plus assumed exercises of stock options ........................           $     697           3,162,300        $   0.22
                                                                                       =========           =========
</TABLE>


                                       39
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 18 - RESTRICTIONS ON DIVIDENDS

           The ability of the Company to pay cash  dividends is  dependent  upon
its  receiving  cash in the form of  dividends  from the  Bank.  South  Carolina
banking  regulations  restrict the amount of cash  dividends the Bank can pay to
the Company.

NOTE 19 - REGULATORY MATTERS

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

         In connection with the Company's  acquisition of a specialty  lender in
2005, the Company committed to the Federal Reserve to increase the amount of its
Tier 1 capital to the well capitalized level by June 30, 2006. The conversion of
subordinated  debentures  to  common  stock in 2005 was in  furtherance  of this
commitment.  The Company plans to raise additional Tier 1 capital in 2006 and is
exploring several avenues to do so.

         Quantitative  measures  established  by  regulation  to ensure  capital
adequacy require the Company and the Bank to maintain minimum amounts and ratios
(set  forth in the table  below) of total  and Tier 1 capital  to  risk-weighted
assets,  and of Tier 1 capital to average  assets.  The  Company and Bank actual
capital  amounts  and  ratios  and  minimum  regulatory  amounts  and ratios are
presented as follows:

<TABLE>
<CAPTION>
                                                                                                           To be well capitalized
                                                                                          For capital      under prompt corrective
                                                                                       adequacy purposes       action provisions
                                                                                       -----------------       -----------------
                                                                    Actual                  Minimum                 Minimum
                                                                    ------                  -------                 -------
                                                            Amount         Ratio      Amount       Ratio        Amount      Ratio
                                                            ------         -----      ------       -----        ------      -----

Company (consolidated):
As of December 31, 2005
<S>                                                        <C>              <C>      <C>             <C>     <C>           <C>
Total capital (to risk weighted assets) ...............    $18,374          8.8%     $16,787         8.0%         N/A       N/A
Tier 1 capital (to risk weighted assets) ..............     15,747          7.5        8,393         4.0          N/A       N/A
Tier 1 capital (to average assets) ....................     15,747          6.7        9,416         4.0          N/A       N/A

Bank:
As of December 31, 2005
Total capital (to risk weighted assets) ...............    $21,145         10.1%     $16,778         8.0%     $20,972       10.0%
Tier 1 capital (to risk weighted assets) ..............     18,518          8.8        8,389         4.0       12,583        6.0
Tier 1 capital (to average assets) ....................     18,518          8.0        9,230         4.0       11,538        5.0

Company (consolidated):
As of December 31, 2004
Total capital (to risk weighted assets) ...............    $16,577          9.3%     $14,331         8.0%         N/A        N/A
Tier 1 capital (to risk weighted assets) ..............     10,840          6.1        7,166         4.0          N/A        N/A
Tier 1 capital (to average assets) ....................     10,840          5.6        8,196         4.0          N/A        N/A

Bank:
As of December 31, 2004
Total capital (to risk weighted assets) ...............    $18,715         10.5%     $14,312         8.0%     $17,891       10.0%
Tier1 capital (to risk weighted assets) ...............     16,478          9.2        7,156         4.0       10,734        6.0
Tier 1 capital (to average assets) ....................     16,478          8.5        8,196         4.0       10,246        5.0
</TABLE>


                                       40
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS

         SFAS No. 107,  "Disclosures about Fair Value of Financial  Instruments"
requires disclosure of fair value information,  whether or not recognized in the
balance  sheets,  when it is practical to estimate the fair value.  SFAS No. 107
defines a financial  instrument as cash, evidence of an ownership interest in an
entity or  contractual  obligations  that  require the exchange of cash or other
instruments.  Certain  items  are  specifically  excluded  from  the  disclosure
requirements,  including  the Bank's  common  stock,  property and equipment and
other assets and liabilities.

         Fair value approximates  carrying value for cash and due from banks and
federal funds sold due to the short-term nature of the instrument.

         Investment  securities  available for sale are valued using quoted fair
market  prices.  Other  investments  at cost are considered to be an appropriate
estimate of fair value due to historical redemption of the stock at cost.

         Fair value for loans maturing after one year is based on the discounted
present value of the estimated  future cash flows.  Discount rates used in these
computations  approximate  the rates  currently  offered  for  similar  loans of
comparable terms and credit quality.

         Fair value for demand deposit  accounts is equal to the carrying value.
Interest-bearing  accounts with no fixed maturity date are valued based on rates
offered  within  the  Bank's  market  using  current  interest  rates on similar
instruments. Certificate of deposit accounts maturing within one year are valued
at their  carrying  value.  The fair value of  certificate  of deposit  accounts
maturing  after one year are estimated by  discounting  cash flows from expected
maturities using current interest rates on similar instruments.

         The fair  values of other  borrowings  are  estimated  using  currently
offered market rates.

         The fair  values of fixed  rate  advances  from the FHLB are  estimated
using the discounted cash flow calculation that applies to the Company's current
borrowing rate  available  from the FHLB.  The carrying  amounts of the variable
rate subordinated debentures are reasonable estimates of fair value because they
could be repriced frequently.

         The Bank has used management's best estimate of fair value based on the
above  assumptions.  Thus, the fair values presented may not be the amounts that
could be realized in an  immediate  sale or  settlement  of the  instrument.  In
addition, any income taxes or other expenses that would be incurred in an actual
sale or settlement are not taken into consideration in the fair value presented.

         The estimated fair values of the Bank's  financial  instruments  are as
follows:

<TABLE>
<CAPTION>
                                                                                                December 31,
                                                                                                ------------
                                                                                 2005                                  2004
                                                                                 ----                                  ----
                                                                     Carrying             Fair             Carrying            Fair
                                                                      Amount             value              Amount             value
                                                                      ------             -----              ------             -----
Financial Assets:
<S>                                                                   <C>               <C>               <C>               <C>
   Cash and due from banks .................................          $  6,628          $  6,628          $  2,544          $  2,544
   Federal funds sold ......................................             6,312             6,312             3,424             3,424
   Investment securities available for sale ................            28,160            28,160            16,351            16,351
   Other investments, at cost ..............................               798               798               955               955
   Loans, gross ............................................           200,362           199,796           176,458           176,707

Financial Liabilities:
   Deposits ................................................           221,661           221,528           176,146           176,695
   Federal Home Loan Bank advances .........................             8,500             8,462            13,500            13,483
   Other borrowings ........................................             3,900             3,900             2,500             2,500
   Subordinated debentures .................................                 -                 -             3,500             3,500
</TABLE>


                                       41
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 21 - PARENT COMPANY FINANCIAL INFORMATION

         Following   is   condensed   financial    information   of   GrandSouth
Bancorporation (parent company only):

                            CONDENSED BALANCE SHEETS

                                                               December 31,
                                                               ------------
                                                           2005             2004
                                                           ----             ----
ASSETS
     Cash ........................................        $    64        $   226
     Investment in bank subsidiary ...............         18,914         16,435
     Due from subsidiary .........................            737              -
     Deferred tax asset ..........................            374            233
                                                          -------        -------

                                                          $20,089        $16,894
                                                          =======        =======

LIABILITIES AND SHAREHOLDERS' EQUITY
     Accrued expenses ............................        $    61        $    54
     Due to subsidiary ...........................              -             43
     Note payable ................................          3,900          2,500
     Subordinated debentures .....................              -          3,500
     Shareholders' equity ........................         16,128         10,797
                                                          -------        -------

                                                          $20,089        $16,894
                                                          =======        =======



                         CONDENSED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                                                  For the years ended
                                                                                                      December 31,
                                                                                                      ------------
                                                                                      2005                2004               2003
                                                                                      ----                ----               ----
<S>                                                                                 <C>                 <C>                 <C>
REVENUES ...............................................................            $     -             $     -             $     -

EXPENSES
      Interest .........................................................                320                 160                  75
      Sundry ...........................................................                 67                  40                  36
                                                                                    -------             -------             -------

            Loss before equity in undistributed net
                income of bank subsidiary ..............................               (387)               (200)               (111)

EQUITY IN UNDISTRIBUTED NET INCOME
      OF BANK SUBSIDIARY ...............................................              2,606               1,445                 720
                                                                                    -------             -------             -------

            Income before income taxes .................................              2,219               1,245                 609

      Income tax benefit ...............................................                142                  74                  41
                                                                                    -------             -------             -------

            Net income .................................................            $ 2,361             $ 1,319             $   650
                                                                                    =======             =======             =======
</TABLE>


                                       42
<PAGE>

                    GRANDSOUTH BANCORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  (Dollars in thousands except per share data)

NOTE 21 - PARENT COMPANY FINANCIAL INFORMATION, Continued

                       CONDENSED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                                     For the years ended
                                                                                                        December 31,
                                                                                                        ------------
                                                                                            2005             2004              2003
                                                                                            ----             ----              ----

OPERATING ACTIVITIES
<S>                                                                                       <C>              <C>              <C>
      Net income ................................................................         $ 2,361          $ 1,319          $   650
      Adjustments to reconcile net income to net cash
         used for operating activities
         Deferred income taxes ..................................................            (132)             (75)             (41)
         Accrued expenses and other .............................................               7               36               85
         Increase in due to (from) subsidiary ...................................            (780)              43                -
         Equity in undistributed net income of bank subsidiary ..................          (2,606)          (1,445)            (720)
                                                                                          -------          -------          -------

                Net cash used for operating activities ..........................          (1,150)            (122)             (26)
                                                                                          -------          -------          -------

INVESTING ACTIVITY
      Investment in bank subsidiary .............................................            (200)          (2,039)             (17)
                                                                                          -------          -------          -------

FINANCING ACTIVITIES
      Proceeds from note payable ................................................           1,400            2,500                -
      Payment of cash dividends .................................................            (210)            (173)             (79)
      Cash paid in lieu of fractional shares ....................................              (2)              (1)               -
                                                                                          -------          -------          -------

                Net cash provided by (used for)
                   financing activities .........................................           1,188            2,326              (79)
                                                                                          -------          -------          -------

                Net increase (decrease) in cash .................................            (162)             165             (122)

CASH, BEGINNING OF YEAR .........................................................             226               61              183
                                                                                          -------          -------          -------

CASH, END OF YEAR ...............................................................         $    64          $   226          $    61
                                                                                          =======          =======          =======
</TABLE>






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