EXHIBIT 13

                            GRANDSOUTH BANCORPORATON

                   Portions of Annual Report to Shareholders
                           Incorporated by Reference
                             into December 31, 2008
                                    Form 10-K


























<PAGE>
                             BUSINESS OF THE COMPANY

         GrandSouth   Bancorporation   (the   "Company")  is  a  South  Carolina
corporation  organized in 2000 under the laws of South  Carolina for the purpose
of being a bank 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 capital stock of the Bank were exchanged for shares of the
Company and the Company became the owner of all of the outstanding capital stock
of the Bank.  The Company  presently  engages in no business  other than that of
owning the Bank and has no employees.

         The Bank is a South Carolina  state bank,  which was  incorporated  and
commenced  operations as a commercial  bank in 1998.  The Bank operates from its
offices in  Greenville,  Fountain Inn and  Anderson,  South  Carolina.  The main
office is located at 381 Halton  Road in  Greenville,  SC. One branch  office is
located at 325 South Main Street in Fountain Inn,  South  Carolina and the other
is at 1601 North Fant Street, Anderson, South Carolina.

         The Bank  offers a full  array of  commercial  bank  services.  Deposit
services include business and personal checking accounts, NOW accounts,  savings
accounts,  money market  accounts,  various term  certificates  of deposit,  IRA
accounts, and other deposit services.  Most of the Bank's deposits are attracted
from  individuals  and  small  businesses.  The  Bank  does not  offer  trust or
brokerage services.

         The Bank  offers  secured  and  unsecured,  short-to-intermediate  term
loans,  with floating and fixed rates for  commercial,  consumer and residential
purposes.  Consumer  loans  include  car loans,  home equity  improvement  loans
(secured by first and second mortgages),  personal expenditure loans,  education
loans,  overdraft  lines of  credit,  and the  like.  Commercial  loans  include
short-term  unsecured loans,  short and  intermediate  term real estate mortgage
loans,  loans secured by listed stocks,  loans secured by equipment,  inventory,
accounts  receivable,  and the like.  Management  believes that the credit staff
possesses knowledge of the community and lending skills sufficient to enable the
Bank to maintain a sufficient volume of high quality loans.

                        CAUTIONARY NOTICE WITH RESPECT TO
                           FORWARD LOOKING STATEMENTS

         This report contains "forward-looking statements" within the meaning of
the  securities  laws.  The  Private  Securities  Litigation  Reform Act of 1995
provides a safe harbor for forward-looking  statements.  In order to comply with
the terms of the safe harbor,  the Company notes that a variety of factors could
cause the Company's actual results and experience to differ  materially from the
anticipated   results  or  other   expectations   expressed  in  the   Company's
forward-looking statements.

         All statements that are not historical  facts are statements that could
be  "forward-looking   statements."  You  can  identify  these   forward-looking
statements  through the use of words such as "may," "will,"  "should,"  "could,"
"would," "expect,"  "anticipate,"  "assume,  "indicate,"  "contemplate," "seek,"
"plan,"  "predict,"  "target,"  "potential,"  "believe,"  "intend,"  "estimate,"
"project,"  "continue,"  or  other  similar  words.  Forward-looking  statements
include,  but are not limited to,  statements  regarding  the  Company's  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 the banking 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  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.  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    future economic and business conditions;
          o    lack of sustained growth in the economies of the Company's market
               areas;
          o    government monetary and fiscal policies;
          o    the  effects  of  changes  in  interest   rates  on  the  levels,
               composition and costs of deposits, loan demand, and the values of
               loan collateral,  securities,  and interest  sensitive assets and
               liabilities;
          o    the  effects  of  competition  from  a  wide  variety  of  local,
               regional, national and other providers of financial,  investment,
               and insurance services, as well as competitors that offer banking
               products and  services by mail,  telephone,  computer  and/or the
               Internet;
          o    credit risks;
          o    higher than anticipated levels of defaults on loans;
          o    perceptions by depositors about the safety of their deposits;
          o    capital adequacy;


                                       1
<PAGE>

          o    the failure of assumptions  underlying the  establishment  of the
               allowance  for loan  losses and other  estimates,  including  the
               value of collateral securing loans;
          o    ability to weather the current economic downturn;
          o    loss of consumer or investor confidence;
          o    availability of liquidity sources;
          o    the risks of opening new offices, including,  without limitation,
               the related costs and time of building customer relationships and
               integrating operations as part of these endeavors and the failure
               to achieve expected gains,  revenue growth and/or expense savings
               from such endeavors;
          o    changes  in laws and  regulations,  including  tax,  banking  and
               securities laws and regulations;
          o    changes in accounting policies, rules and practices;
          o    changes  in  technology  or  products  may be more  difficult  or
               costly, or less effective, than anticipated;
          o    the effects of war or other conflicts, acts of terrorism or other
               catastrophic  events that may affect general economic  conditions
               and economic confidence; and
          o    other factors and information described in this report and in any
               of the  other  reports  that  we file  with  the  Securities  and
               Exchange Commission under the Securities Exchange Act of 1934.

         All  forward-looking   statements  are  expressly  qualified  in  their
entirety by this cautionary notice. The Company has no obligation,  and does not
undertake,  to update,  revise or correct any of the forward-looking  statements
after the date of this  report.  The Company  has  expressed  its  expectations,
beliefs and projections in good faith and believes they have a reasonable basis.
However,  there is no assurance that these expectations,  beliefs or projections
will result or be achieved or accomplished.


            MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

         The  Company's  common  stock  trades  over the  counter and trades are
reported  on the OTC  Bulletin  Board (the  "OTCBB")  under the  symbol  "GRRB."
Although  trading in the  Company's  stock is limited  (only 21,600  shares were
reported to have traded in 2008),  the  following  table shows the reported high
and low bid prices of the Company's  common stock  reported by the OTCBB and the
per share amounts of cash dividends paid for the periods shown. The sales prices
reflect inter-dealer prices, without retail mark-up, mark-down or commission and
may not represent actual transactions.

<TABLE>
<CAPTION>
                                                                          Years ended December 31,
                                                                          ------------------------
                                                                     2008                                      2007
                                                                     ----                                      ----
                                                   Sales Prices              Cash                Sales Prices                 Cash
                                                   ------------            Dividends             ------------              Dividends
                                                 Low           High           Paid            Low             High            Paid
                                                 ---           ----           ----            ---             ----            ----

<S>                                         <C>             <C>             <C>            <C>             <C>             <C>
First Quarter ........................      $   10.00       $   11.00       $   0.02       $   16.75       $   19.05       $   0.02
Second Quarter .......................      $    9.00       $   10.75           0.02       $   12.00       $   17.00           0.02
Third Quarter ........................      $    5.00       $    9.75           0.02       $   11.02       $   12.20           0.02
Fourth Quarter .......................      $    4.05       $    8.00           0.02       $    9.50       $   12.00           0.02
</TABLE>

         As of March 23, 2009, there were  approximately 560 shareholders of the
Company's common stock,  excluding individual  participants in security position
listings.

         In each of 2008 and 2007,  the Company paid cash  dividends of $.08 per
share.  The dividend policy of the Company as well as the Bank is subject to the
discretion of their respective  Boards of Directors and depends upon a number of
factors,  including  earnings,  financial  condition,  cash  needs  and  general
business  conditions,  as well as applicable  regulatory  considerations.  South
Carolina banking  regulations  restrict the amount of cash dividends that can be
paid to the Company by the Bank.  Any of the banking  subsidiary's  dividends to
the parent company which exceed in amount the amount of the subsidiary's current
year-to-date  earnings  ($1,659 at December  31,  2008) are subject to the prior
approval of the South Carolina  Commissioner of Banking. In addition,  dividends
paid by the banking  subsidiary to the parent company would be prohibited if the
effect  thereof would cause the Bank's  capital to be reduced  below  applicable
minimum capital requirements.  Furthermore,  in the event that interest payments
on the junior subordinated  debentures are deferred by the Company,  the Company
would be  restricted  in its ability to pay  dividends on its common  stock.  In
January,  2009 the Company issued  preferred  stock to the US Treasury under the
Capital Purchase Program.  The terms of that preferred stock provide for various
restrictions  on the ability of the Company to pay or increase its dividends and
to repurchase its common stock.



                                       2
<PAGE>

                   AVAILABILITY OF ANNUAL REPORT ON FORM 10-K

         GrandSouth  Bancorporation  will  furnish  free of charge a copy of its
Annual  Report on Form 10-K filed with the  Securities  and Exchange  Commission
upon written request to J. B. Garrett, Senior Vice President and Chief Financial
Officer, GrandSouth Bancorporation, 381 Halton Road, Greenville, SC 29607.


Management's Discussion and Analysis of Financial Condition
         and Results of Operations

         This discussion is intended to assist in understanding the consolidated
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. All dollar amounts are in thousands except for
per share amounts,  unless otherwise noted. Per share net income and net income,
assuming dilution, have been adjusted to reflect stock dividends.

         During the  second  half of 2008,  severe  economic  and credit  market
disruptions  caused by increasing  foreclosure rates and valuation  difficulties
related to sub-prime and other problem  mortgages led to  significant  losses in
stock  valuations and sharp and sudden  decreases in the  availability of credit
for  companies  of all sizes.  Interest  rates  associated  with  short-term  US
Treasury securities reached  historically low levels as some investors preferred
to entrust their funds to entities  presumed  riskless  regardless of rate.  The
Federal Reserve pushed its target rate for federal funds lower, as well.

         In their  efforts to  mitigate  the  factors  constraining  the flow of
credit  and to  restore  confidence  in the  banking  system,  Congress  enacted
legislation and governmental agencies implemented programs designed to alleviate
the fears of bank  depositors (by  temporarily  increasing the limits on insured
interest-bearing  deposits to $250 per account owner and temporarily eliminating
the cap on the amount of insured  noninterest  bearing  demand  deposits) and to
provide guarantees for constant dollar money market mutual funds investors.  The
legislation  and programs also made available  additional  capital for banks and
other financial  institutions in the form of direct preferred stock  investments
by the US Treasury,  and through  various other  measures  which  continue to be
added to and refined.  In addition,  the Federal  Reserve  expanded the types of
assets eligible to be used as collateral for discount window  borrowings and the
types of entities that could use those services.  Early in the fourth quarter of
2008,  the Federal  Reserve  Bank began  paying  interest on bank's  holdings of
required reserves with the Federal Reserve and various programs were implemented
to increase the  availability  of credit from the Federal Reserve by an expanded
range of companies.

         The demise of several of the large investment houses and the closing or
forced  mergers of a few large and  recognizable  commercial  banking  companies
caused  depositors to become concerned about the ongoing  viability of their own
banks and made them more acutely aware of the FDIC  insurance  coverage of their
deposits.  Accordingly,  in some cases, the Company's depositors, and those with
funds on deposit at other  financial  institutions,  took action to maximize the
amount of funds covered by FDIC  insurance.  This resulted in funds flowing from
one institution to another as customers decreased the amount of their funds held
by any one institution to the insurance limit.  Because there are several larger
financial  institutions  in the  Company's  market areas which likely could have
held significant amounts of such deposits, management believes that the Bank was
a net  recipient of such funds;  i.e.,  the amount of such funds  flowing to the
Bank exceeded the amount that the Bank's customers moved to other banks. Because
the  depositors'  primary  concern was about the safety of  principal,  the Bank
could compete for the funds without  having to increase the rates it offered for
deposits. However, management maintained the rates the Bank paid for deposits at
levels  competitive with other local institutions to enhance the likelihood that
it could retain  those  accounts in the future and also  increased  the level of
wholesale  funding  utilized.  By  participating  in the  Certificate of Deposit
Account Registry  Service  ("CDARS")  program,  the Bank is able to offer to its
depositors deposit insurance in excess of the $250 limit currently applicable to
time deposits.

         To  further  address  depositors'  concerns  about  the  safety of bank
deposits  and debt  instruments,  the  FDIC,  through  its  Temporary  Liquidity
Guarantee  Program,  provided  financial  institutions  with  options  to accept
unlimited  insurance  coverage  for  noninterest  bearing  transaction  accounts
(including  certain  low-interest  NOW and IOLTA  accounts,  but excluding money
market deposit accounts) through December 31, 2009 and,  separately,  the FDIC's
guarantee of a portion of an institution's  unsecured senior debt with a term of
at least 31 days.  The FDIC's  guarantee of such debt lasts until the earlier of
the maturity of the debt or June 30, 2012, provided the institution does not opt
out of the program.  If an institution  participates in these optional programs,
its  deposit   insurance   assessments  will  increase  more  than  if  did  not
participate.  The Company and the Bank opted out of the debt  guarantee  program
but the Bank continues to participate in the expanded deposit insurance program.

         The U.S. Treasury's Capital Purchase Program ("CPP") was implemented to
provide  additional  capital  to  healthy  financial  institutions.  Under  this


                                       3
<PAGE>

program,  the Treasury  purchases  preferred stock and, in some cases,  receives
warrants  to  purchase  common  stock.  Under the terms of the sale,  limits are
imposed  on the  amounts  of  dividends  that the  recipients  may pay to common
stockholders  and on certain other  activities  as well.  The Company sold 9,450
shares of  cumulative  non-voting  preferred  stock  under the CPP on January 9,
2009.

Critical Accounting Policies

         The Company has adopted various accounting  policies,  which govern the
application of accounting  principles generally accepted in the United States of
America in the preparation of the Company's financial statements.  The Company's
significant   accounting   policies  are  described  in  the  footnotes  to  the
consolidated financial statements.

         Certain   accounting   policies  involve   significant   judgments  and
assumptions by management,  which have a material effect on the carrying amounts
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  in 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  estimate that requires the most significant  judgments and estimates
used in the preparation of its consolidated  financial statements.  Refer to the
"Allowance  for Loan Losses"  section  below for a detailed  description  of the
Company's  estimation process and methodology  related to the allowance for loan
losses.


Financial Condition

         The major components of the Company's balance sheets are:

                                                        Years ended December 31,
                                                          2008           2007
                                                          ----           ----
                                                        (Dollars in thousands)
Total assets .......................................    $375,017      $345,124
Loans, net .........................................     297,523       259,786
Investments and federal funds sold .................      49,733        64,752
Cash and due from banks ............................      10,782         4,585
Total liabilities ..................................     350,661       322,657
Deposits ...........................................     310,885       305,639
Short-term borrowings ..............................           -         5,000
Long-term Federal Home Loan Bank advances ..........      29,000             -
Junior subordinated debt ...........................       8,247         8,247
Shareholders' equity ...............................      24,356        22,467

         As a result of recent events in the financial  markets and the response
of Congress and the regulators as discussed  above,  by the end of 2008 the Bank
reduced its federal funds sold position.

         Due to the economic  slowdown in the  Company's  market area,  the Bank
experienced a decrease in loan demand  across all sectors of its loan  portfolio
during  the third and fourth  quarters  of 2008.  The  decrease  was  especially
pronounced in the demand for new construction and land development  loans due to
credit market disruptions and increased  foreclosure rates.  Consequently,  loan
growth during the last six months was only slightly more than half of the growth
experienced in the first six months of the year. During the second half of 2008,
the Bank  experienced  a significant  increase in  nonaccrual  and other problem
loans.

         The Bank  experienced  only  modest  growth in  deposits  during  2008.
Brokered deposits totaled $40,346, or 13.0% of total deposits as of December 31,
2008 compared with $16,857, or 5.5% of total deposits,  as of December 31, 2007.
The FDIC is in the process of implementing changes to the calculation it uses in
assessing insured banks' deposit  insurance  premiums to include a larger factor
for  banks  that  fund  rapid  asset  growth  by the use of  brokered  deposits.
Consequently,  it is likely that the Bank's deposit insurance expenses in future
periods will be higher for funding sources such as brokered deposits relative to
other more  traditional  deposit  products.  The Bank borrowed  $29,000 from the
Federal  Home Loan Bank of Atlanta  in the  second  quarter of 2008 to match the
maturities and secure funding for loans originated.

                                       4
<PAGE>


Issuance of Junior Subordinated Debentures

         On May 3,  2006,  the  Company  sponsored  the  creation  of a Delaware
statutory trust, GrandSouth Capital Trust I (the "Trust"), and is the sole owner
of the $247 in common securities issued by the Trust. On May 10, 2006, the Trust
issued  $8,000  in  floating  rate  capital  securities.  The  proceeds  of this
issuance,  and the amount of the Company's  investment in the common securities,
were used to acquire  $8,247  principal  amount of the  Company's  floating rate
junior subordinated debt securities due 2036 ("Debentures").  The debentures are
prepayable  without  penalty  any time  after  their  fifth  anniversary.  These
securities,  and the accrued interest  thereon,  now constitute the Trust's sole
assets. Under current Federal Reserve regulations, these securities are eligible
to be treated as Tier 1 capital by the Company.  Upon repayment or redemption of
the Debentures,  the Trust will use the proceeds of the transaction to redeem an
equivalent  amount of capital  securities  and common  securities.  The  Trust's
obligations under the capital securities are  unconditionally  guaranteed by the
Company. For further discussion, please see Note 9 to the Company's consolidated
financial statements.

Earnings Performance

         Net income for 2008 was $1,348,  a decrease of $1,451,  or 51.8%,  from
net income of $2,799 for 2007.  Net interest  income for 2008 was $636 less than
for 2007. The 2008 provision for loan losses was $2,880,  an increase of $1,835,
or 175.6%,  over the amount for 2007.  Income tax expense  for 2008 was $732,  a
decrease of $848 from the 2007 amount.

         Net income for 2007 was $2,799, a decrease of $461, or 14.1%,  from net
income of $3,260 for 2006.  While net interest  income for 2007  increased  only
slightly over the 2006 amount,  noninterest  expenses  increased  significantly.
Salaries and benefits,  premises and  equipment,  data  processing and printing,
postage and supplies expenses were higher,  primarily because 2007 was the first
full-year  of  operation  of  the  new  Anderson  branch  office.  In  addition,
significantly  higher professional fees were incurred to ensure that the Company
continues to comply with increasingly stringent regulatory requirements.

Net Interest Income

         Net   interest   income   is  the   amount   of   interest   earned  on
interest-earning assets (loans, investment securities, interest-earning deposits
in other banks,  and federal funds sold) less the interest  expense  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,  the volume and mix of interest  earning-assets
and  interest-bearing  liabilities and the relative funding of  interest-earning
assets.

2008 Compared with 2007

         Net  interest  income for 2008  decreased by $636 from the 2007 amount.
Interest  income for 2008  decreased by $2,201 from the 2007 amount and interest
expense  decreased by $1,565.  Decreases in market interest rates were primarily
responsible for these decreases.

         The average  yield on loans was 7.65% for 2008, a decrease of 188 basis
points from the 2007 yield.  Loans are the largest  component  of the  Company's
earning assets and, accordingly, the largest determinant of its interest income.
Approximately 51% of the Company's loans are variable rate loans.  Consequently,
as interest  rates fell during 2008,  the rates  associated  with those variable
rate loans were lowered as well.  Fixed rate loans originated and renewed during
2008  were  also  subject  to yield  reductions.  The  significant  increase  in
nonaccrual loans during 2008, and the accompanying effects on interest income of
the reversal of previously  recorded but uncollected income and the cessation of
future  accruals,  also contributed to the decrease in interest income on loans.
Interest income from federal funds sold and interest bearing accounts with other
banks also were affected significantly by lower market rates.

         Interest  expense on deposit  accounts  decreased for all categories of
deposits except for NOW accounts.  The Bank offers a  high-yielding  tiered-rate
NOW deposit account which requires that the customer  maintain only a relatively
low  balance  in order to earn a higher  rate of  interest.  The Bank uses these
accounts  both to  attract  deposit  customers  from other  institutions  and to
increase sales of multiple products to its pre-existing customers.

         During 2008, the Company increased  significantly its use of fixed rate
long-term funds borrowed from the Federal Home Loan Bank of Atlanta.  During the
first six months of 2008,  the Company  received  proceeds of $29,000  from such
advances at an average  interest  rate of 3.62%.  Maturities  of the advances at


                                       5
<PAGE>

their  inception  ranged  from one to five  years.  The level of such  long-term
borrowings  currently  used is low  relative to the Bank's  history and to other
banks in its peer group.


2007 Compared with 2006

         Net  interest  income  for 2007  increased  by only  $154 over the 2006
amount.  Interest  income for 2007  increased  by $3,233  over the 2006  amount,
primarily as a result of higher  average  volumes of investment  securities  and
loans.  Yield on loans  decreased  slightly  during 2007 because of decreases in
interest rates that occurred late in the year.

         Higher  volumes of  interest-bearing  liabilities  combined with higher
rates paid for such funds to increase  interest  expense for 2007 by $3,079 over
the 2006  amount.  In  particular,  expenses  related to money  market  accounts
increased significantly.  The increased expense is almost entirely due to higher
average amounts of such deposits,  which were a result of the highly competitive
rates  paid  by the  Company.  The  success  realized  in the  deposit-gathering
function allowed the Company to reduce,  on average,  its reliance on short-term
borrowed funds and Federal Home Loan Bank advances during the year.

         The table,  "Average Balances,  Income and Expense,  Yields and Rates",
provides  an  analysis  of the  average  amounts  of the  Company's  assets  and
liabilities  and the  effective  yields and rates on the  categories  of average
interest  earning assets and interest  bearing  liabilities  for the years ended
December 31, 2008, 2007 and 2006.



                                       6
<PAGE>

             Average Balances, Income and Expense, Yields and Rates

<TABLE>
<CAPTION>
                                                                            Years ended December 31,
                                                                            ------------------------
                                                      2008                            2007                           2006
                                                      ----                            ----                           ----
                                          Average    Income/    Yields/  Average     Income/  Yields/    Average    Income/  Yields/
                                        Balances (1) Expense    Rates    Balances(1) Expense   Rates    Balances(1) Expense   Rates
                                        --------------------    -----    -------------------   -----    -------------------   -----
                                                                      (Dollars in thousands)
Assets
<S>                                      <C>        <C>       <C>        <C>        <C>        <C>       <C>        <C>        <C>
Federal funds sold and interest
    bearing accounts with other banks .  $ 11,665   $   217   1.86%      $ 10,672   $   583    5.46%     $ 13,144   $   651    4.95%
Investments and other securities (2) ..    55,165     2,799   5.07%        50,347     2,435    4.84%       36,451     1,622    4.45%
Loans(2)(3 (4) ........................   282,857    21,627   7.65%       250,024    23,826    9.53%      215,673    21,338    9.89%
                                         --------   -------              --------   -------              --------   -------
       Total interest earning assets ..   349,687    24,643   7.05%       311,043    26,844    8.63%      265,268    23,611    8.90%
Cash and due from banks ...............     4,233                           4,422                           4,087
Allowance for loan losses .............    (3,261)                         (2,765)                         (2,831)
Premises and equipment ................     4,863                           5,038                           4,938
Other assets ..........................     9,795                           8,629                           8,508
                                         --------                        --------                        -------
       Total assets ...................  $365,317                        $326,367                        $279,970
                                         ========                        ========                        =======

Liabilities and
 shareholders' equity
Interest bearing deposits
    NOW accounts ......................  $  7,236   $   168   2.32%      $  3,924   $    62    1.58%     $  2,934   $     8    0.27%
    Savings ...........................       581         1   0.17%           616         3    0.49%          656         3    0.46%
    Money market accounts .............   101,210     2,821   2.79%        92,373     3,940    4.27%       66,774     2,805    4.20%
    Time deposits .....................   182,663     8,137   4.45%       180,340     9,306    5.16%      160,594     7,229    4.50%
                                         --------   -------              --------   -------              --------   -------
       Total interest
         bearing deposits .............   291,690    11,127   3.81%       277,253    13,311    4.80%      230,958    10,045    4.35%
FHLB advances .........................    21,773       796   3.66%           169        10    5.92%        6,905       301    4.36%
Other borrowings ......................        17         -   0.00%             -         -    0.00%        1,401       106    7.57%
Junior subordinated debentures ........     8,247       432   5.24%         8,247       599    7.26%        5,267       389    7.39%
                                         --------   -------              --------   -------              --------   -------
       Total interest
         bearing liabilities ..........   321,727    12,355   3.84%       285,669    13,920    4.87%      244,531    10,841    4.43%
Noninterest bearing demand deposits ...    16,570                          15,970                          14,296
Other liabilities .....................     3,121                           3,746                           3,188
Shareholders' equity ..................    23,899                          20,982                          17,955
                                         --------                        --------                        -------
       Total liabilities and
       shareholders' equity ...........  $365,317                        $326,367                        $279,970
                                         ========                        ========                        =======
Interest rate spread (5) ..............                       3.21%                            3.76%                           4.47%
Net interest income and net yield
    on earning assets (6) .............             $12,288   3.51%                 $12,924    4.16%                $12,770    4.81%
Interest free funds supporting
    earning assets (7) ................  $ 27,960                        $ 25,374                        $ 20,737
</TABLE>

--------------------------
(1)  Average balances are computed on a daily basis.
(2)  Income and yields on tax-exempt securities and loans have not been adjusted
     on a tax equivalent basis.
(3)  Nonaccrual  loans are included in the average  loan  balances and income on
     such loans generally is recognized on a cash basis.
(4)  Includes immaterial amounts of loan fees.
(5)  Total  interest  earning  assets  yield  less the  total  interest  bearing
     liabilities rate.
(6)  Net interest income divided by total interest earning assets.
(7)  Total interest earning assets less total interest bearing liabilities.

                                       7
<PAGE>


         The table,  "Volume and Rate Variance Analysis",  provides a summary of
changes in net  interest  income  resulting  from changes in volumes of interest
earning  assets and  interest  bearing  liabilities  (change in volume times old
rate),  and the rates earned and paid on such assets and liabilities  (change in
rate times old volume).

             Volume and Rate Variance Analysis

<TABLE>
<CAPTION>
                                                                2008 Compared with 2007                 2007 Compared with 2006
                                                                -----------------------                 -----------------------
                                                          Volume (1)     Rate (1)      Total      Volume (1)   Rate (1)      Total
                                                          ----------     --------      -----      ----------   --------      -----
                                                                                      (Dollars in thousands)
<S>                                                         <C>         <C>          <C>          <C>          <C>          <C>
Federal funds sold and interest
      bearing accounts with other banks ...............     $    50     $  (416)     $  (366)     $  (130)     $    62      $   (68)
Investment securities .................................         240         124          364          662          151          813
Loans .................................................       2,882      (5,081)      (2,199)       3,296         (808)       2,488
                                                            -------     -------      -------      -------      -------      -------
                 Total interest income ................       3,172      (5,373)      (2,201)       3,828         (595)       3,233
                                                            -------     -------      -------      -------      -------      -------
Interest bearing deposits
      NOW accounts ....................................          68          38          106            4           50           54
      Savings accounts ................................           -          (2)          (2)           -            -            -
      Money market accounts ...........................         349      (1,468)      (1,119)       1,091           44        1,135
      Time deposits ...................................         119      (1,288)      (1,169)         948        1,129        2,077
FHLB advances .........................................         791          (5)         786         (389)          98         (291)
Other borrowings ......................................           -           -            -         (106)           -         (106)
Junior subordinated debentures ........................           -        (167)        (167)         216           (6)         210
                                                            -------     -------      -------      -------      -------      -------
                 Total interest expense ...............       1,327      (2,892)      (1,565)       1,764        1,315        3,079
                                                            -------     -------      -------      -------      -------      -------
                 Change in net interest income ........     $ 1,845     $(2,481)     $  (636)     $ 2,064      $(1,910)     $   154
                                                            =======     =======      =======      =======      =======      =======
</TABLE>
-------------------
(1)  The  rate/volume  variance  for  each  category  has  been  allocated  on a
     consistent  basis between rate and volume variances based on the percentage
     of rate or volume variance to the sum of the two absolute  variances except
     in categories having balances in only one period. In such cases, the entire
     variance is attributed to volume variances.

         Management  currently  expects  that  interest  rates will be likely to
remain mostly unchanged during the first half of 2009 due to the problems in the
housing and credit markets and actions that may be taken by the Federal Reserve.
During the  second  half of the year,  the trend in  interest  rates  could take
widely divergent paths depending on developments in unemployment levels, changes
in  expectations  about  inflation  and/or  recession,  oil prices,  etc.  While
management has not presently  identified  any specific  factors that it believes
might cause  market  interest  rates to increase or decrease  rapidly in a short
period of time,  changes in interest rates that could  significantly  affect the
Company, either positively or negatively, are possible. Management believes that
net interest  income should  increase  somewhat  during 2009 as  certificates of
deposit mature and are repriced at the current lower rates offered.


Interest Rate Sensitivity

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

         The  table,  "Interest  Sensitivity  Analysis",  indicates  that,  on a
cumulative basis through twelve months, rate sensitive liabilities exceeded rate
sensitive  assets at the end of 2008 by $79,749,  resulting in a cumulative  gap
ratio  of  .71.  When  interest   sensitive  assets  exceed  interest  sensitive
liabilities for a specific repricing  "horizon," a positive interest sensitivity
gap results.  The gap is negative when  interest  sensitive  liabilities  exceed
interest  sensitive  assets,  as was the case at the end of 2008 with respect to
the one-year time  horizon.  For a bank with a negative  gap,  falling  interest
rates would  ordinarily  be expected to have a positive  effect on net  interest
income and rising rates would ordinarily be expected to have a negative effect.

         The table,  "Interest Sensitivity  Analysis",  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


                                       8
<PAGE>

loans' final maturity dates. Variable rate loans are reflected at the earlier of
their  contractual  maturity date or the date at which the loans may be repriced
contractually.  Securities  are  reflected  at the earlier of each  instrument's
ultimate  maturity or contractual  repricing date.  Overnight federal funds sold
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.  These
liabilities  are subject to contractual  arrangements  that allow  management to
vary the rates paid on these  deposits  within a thirty-day  or shorter  period.
However,  the Company is not obligated to vary the rates paid on those  deposits
within any given period. Fixed rate time deposits,  principally  certificates of
deposit, are reflected at their contractual  maturity dates.  Variable rate time
deposits,  principally  individual  retirement  accounts,  are  reflected at the
earlier of their next repricing or maturity dates.

               Interest Sensitivity Analysis

<TABLE>
<CAPTION>
                                                                                        December 31, 2008
                                                                                        -----------------
                                                                 Within     Over 3 to 12      Over 12      Nonaccrual
                                                                3 Months       Months          Months        Loans           Total
                                                                --------       ------          ------        -----           -----
                                                                                  (Dollars in thousands)
Interest earning assets
<S>                                                           <C>            <C>             <C>            <C>            <C>
     Interest bearing deposits due from banks ..........      $   8,453      $       -       $   2,000      $       -      $  10,453
     Federal funds sold ................................            429              -               -              -            429
     Securities ........................................              -            563          46,815              -         47,378
     Federal Home Loan Bank stock ......................          1,926              -               -              -          1,926
     Loans .............................................        164,602         23,646         106,888          6,497        301,633
                                                              ---------      ---------       ---------      ---------      ---------
             Total interest earning assets .............        175,410         24,209         155,703          6,497      $ 361,819
                                                              ---------      ---------       ---------      ---------      =========

Interest bearing liabilities
     Interest bearing deposits
         NOW accounts ..................................      $   9,124      $       -       $       -      $       -      $   9,124
         Savings and money market accounts .............         92,714              -               -              -         92,714
         Time deposits $100M and over ..................         13,684         36,472          10,662              -         60,818
         Other time deposits ...........................         33,835         80,292          18,771              -        132,898
                                                              ---------      ---------       ---------      ---------      ---------
             Total interest bearing deposits ...........        149,357        116,764          29,433              -        295,554
     Federal Home Loan Bank advances ...................          5,000              -          24,000              -         29,000
     Junior subordinated debentures ....................          8,247              -               -              -          8,247
                                                              ---------      ---------       ---------      ---------      ---------
             Total interest bearing liabilities ........        162,604        116,764          53,433              -      $ 332,801
                                                              ---------      ---------       ---------      ---------      =========

Interest sensitivity gap ...............................      $  12,806      $ (92,555)
Cumulative interest sensitivity gap ....................      $  12,806      $ (79,749)
Gap ratio ..............................................           1.08           0.21
Cumulative gap ratio ...................................           1.08           0.71
</TABLE>


Provision for Loan Losses

         The allowance for loan losses is established through charges to expense
in the form of a provision for loan losses.  The level of the allowance for loan
losses is based on  management's  judgment  of the amount  sufficient  to absorb
losses inherent in the loan portfolio.  Loan losses or recoveries are charged or
credited  directly  to the  allowance.  The  provision  for  losses for 2008 was
$2,880,  an increase of $1,835 over the 2007 provision.  This increase  resulted
from significantly  higher amounts of net charge-offs and  non-performing  loans
during 2008.  The 2007  provision was $1,045,  a decrease of $65 from the amount
provided in 2006.  This  decrease  resulted  primarily  from a reduction  in the
amount of net charge-offs from $1,737 in 2006 to $525 in 2007.

         See "Allowance for Loan Losses" and "Critical  Accounting Policies" for
further  information  about  the  methodology  used and  factors  considered  by
management in determining the amount of the allowance for loan losses.


                                       9
<PAGE>

Noninterest  Income

         Noninterest  income for 2008 totaled  $754, an increase of $92 over the
2007  amount,  primarily  due to a $94  increase  in service  charges on deposit
accounts.  Also  contributing to the increase were a $40 turnaround in gains and
losses  from  sales  of  investment  securities  and a $40  gain on the  sale of
premises and equipment.

         Noninterest  income  for 2007  decreased  by $97  from the 2006  amount
because of  non-recurring  gains of $119 realized on sales of assets acquired in
settlement  of loans in 2006 and  losses  of $24  realized  on  dispositions  of
investment  securities in 2007. Service charges on deposit accounts increased by
$31 over the 2006  amount  due to  larger  account  volumes  resulting  from the
opening of the Anderson, SC branch office.


Noninterest Expenses

         Noninterest  expenses for 2008 totaled  $8,082,  a decrease of $80 from
the 2007 amount.  Premises and equipment expenses for 2008 were $671, a decrease
of $156  from  the  2007  amount.  Insurance  costs  fell by $87 as the  Company
increased  the  deductibles  for some of its  policies.  Expenses for  printing,
postage and supplies decreased due to lower volumes of, and price reductions in,
courier  services  for  the  Bank's  automobile  floor  plan  lending  division.
Professional fees for 2008 were $106 less than for 2007 due to the non-recurring
nature of some of the services obtained in 2007.

         Noninterest  expenses for 2007  increased by $764,  or 10.3%,  over the
2006 amount. Salaries and employee benefits increased by $328 due to an increase
of $107 in the amounts of incentive compensation and automobile  allowances,  an
increase of $51 in matching  contributions to the Company's 401(k) plan due to a
change  in the  Company's  matching  contribution  formula,  and  $142  from the
deferral of costs associated with loan  originations in accordance with SFAS 91.
Also, 2007 was the first full year of operation of the Bank's  Anderson  office.
Professional  fees increased by $226 due to the Company's  efforts to assess its
system of internal control over financial reporting pursuant to the requirements
of the Sarbanes-Oxley Act of 2002, and services in connection with assessment of
the impact of Internal Revenue Code Section 409A on various  executive  deferred
compensation   arrangements  and  amendments  to  the   arrangements   resulting
therefrom.  Insurance  expenses  increased by $81  primarily  due to higher FDIC
assessments for federal deposit  insurance  coverage.  Data processing  expenses
increased by $86 due to higher numbers of deposit accounts.


Income Taxes

         Income tax expense for 2008 was $732,  a decrease of $848 from the 2007
amount,  due to lower net income  before  income  taxes and a $220  increase  in
income  from  nontaxable  investment  securities.  Income tax  expense  for 2007
decreased by $181 from the 2006 amount due to lower  amounts of taxable  income.
Income from  nontaxable  investment  securities  increased by $285 over the 2006
amount.  The effective tax rates were 35.2%,  36.1%, and 35.1% in 2008, 2007 and
2006, respectively.  The effective tax rates decreased in 2008 primarily because
of the increase in nontaxable  investment income and increased in 2007 primarily
due to increased  nondeductible  expenses,  including  share-based  compensation
recorded for incentive stock options granted.


Investment Portfolio

         As of December 31, 2008,  the Bank's  investment  portfolio,  excluding
investments  required for  membership  in the Federal Home Loan Bank of Atlanta,
was  approximately  13% of total assets.  The  following  table  summarizes  the
carrying  value amounts of  investments  held as of December 31, 2008,  2007 and
2006. The Bank had no trading or held-to-maturity securities at any of the dates
shown.

         During 2008, the Company did not invest  significantly  in any class of
investment  securities,  as only $3,199 of investment securities were purchased.
Maturities, calls, paydowns and sales of such instruments totaled $15,544 during
the year. During 2007, the Bank significantly  increased the amounts invested in
state,  county and municipal bonds and in  mortgage-backed  securities issued by
government-sponsored   enterprises  as  management  sought  to  increase  income
production from these instruments.

                                       10
<PAGE>

                        Securities Portfolio Composition

                                                         December 31,
                                                         ------------
                                                 2008        2007          2006
                                                 ----        ----          ----
                                                    (Dollars in thousands)
Available-for-sale
Government-sponsored
     enterprises (GSEs) .................      $11,478      $19,544      $22,469
State, county and municipal .............       13,393       13,289        3,339
Mortgage-backed securities
    issued by GSEs ......................       22,507       26,734       15,838
                                               -------      -------      -------
        Total available-for-sale ........      $47,378      $59,567      $41,646
                                               =======      =======      =======

         The following table presents  maturities and weighted average yields of
securities  at  December  31,  2008.  Yields on  tax-exempt  state,  county  and
municipal obligations have not been computed on a taxable-equivalent basis.

                   Securities Portfolio Maturities and Yields

<TABLE>
<CAPTION>
                                                                         December 31, 2008
                                                                         -----------------
                                                            After             After
                                                          One Year          Five Years
                                      Within              Through            Through                After
                                    One Year (1)       Five Years (1)       Ten Years (1)        Ten Years (1)          Total
                                    ------------       --------------       -------------        -------------          -----
                                    Amount   Yield     Amount    Yield     Amount     Yield     Amount     Yield     Amount   Yield
                                    ------   -----     ------    -----     ------     -----     ------     -----     ------   -----
                                                                      (Dollars in thousands)
<S>                                <C>       <C>      <C>        <C>      <C>         <C>      <C>         <C>      <C>        <C>
Government-sponsored
     enterprises ................  $    -    0.00%    $ 7,144    5.66%    $ 4,334     5.53%    $     -     0.00%    $11,478    5.61%
State, county and municipal .....       -    0.00%          -    0.00%      1,174     3.93%     12,219     4.23%     13,393    4.20%
Mortgage-backed securities
     issued by GSEs .............     563    4.14%      3,609    4.00%      1,428     4.76%     16,907     5.74%     22,507    5.36%
          Total .................  $  563    4.14%    $10,753    5.10%    $ 6,936     5.10%    $29,126     5.11%    $47,378    5.09%

</TABLE>

----------------------------
(1)  Maturity  categories  based  upon  final  stated  maturity  dates.  Average
     maturity  is  substantially  shorter  because  of  the  monthly  return  of
     principal on certain securities.


         Government-sponsored enterprises ("GSEs") are agencies and corporations
established by the U.S.  Government,  including,  among others, the Federal Home
Loan Banks,  Federal National Mortgage  Association  ("FNMA") , and Federal Home
Loan Mortgage Corporation ("FHLMC"). Debt securities issued by these enterprises
are not obligations of the U.S.  Government and are not backed by the full faith
and  credit  of  the  U.S.  Government  or  otherwise  guaranteed  by  the  U.S.
Government.  Late in 2008, FNMA and FHLMC were placed into  conservatorship  and
their debt obligations were effectively  assumed by the U.S. Government when the
U.S.  Treasury  intervened  to  recapitalize  those  entities.   Evidencing  the
relatively  high-quality  of the GSE  issuers,  however,  their debt  securities
generally  are eligible to be used as security  for public  deposits of the U.S.
Treasury,  government  agencies and  corporations and states and other political
subdivisions.  The Company  believes that its investment in these  securities at
these levels is prudent, given the excellent credit ratings enjoyed by the GSEs.
The  mortgage-backed  securities  in the  Company's  portfolio are not backed by
sub-prime mortgages.

         On an ongoing basis,  management  assigns securities upon purchase into
one of three categories (trading,  available-for-sale or held-to-maturity) based
on intent,  taking into consideration  other factors including  expectations for
changes in market rates of interest, liquidity needs, asset/liability management
strategies, and capital requirements.  The Company has never held securities for
trading  purposes.  During  2008,  the  Company  realized  gains  of  $16 on the
disposition of available-for-sale  investment  securities.  In 2007, the Company
realized losses of $24 on such securities and no such activity occurred in 2006.
No transfers  of  available-for-sale  or  held-to-maturity  securities  to other
categories were made in any of the years 2006 through 2008.



                                       11
<PAGE>

         As  of  December  31,  2008,  the  Company  held  debt  obligations  of
individual GSEs as follows:  Federal Home Loan Banks - $7,156; Federal Home Loan
Mortgage  Corporation  - $8,996;  and Federal  National  Mortgage  Association -
$17,833.

         As of December 31, 2008, the Company did not have any concentrations in
debt  securities that are payable from and secured by the same source of revenue
or taxing  authority  of any state,  county and  municipal  issuers in an amount
equal to 10% or more of shareholders' equity.


Loan Portfolio

         Management believes the loan portfolio is adequately diversified. There
are no concentrations of loans in any particular individual,  industry or groups
of  related  individuals  or  industries,  and there are no foreign  loans.  The
Company's loan portfolio is, however,  dependent upon economic and other factors
that affect its local market areas.

         The amounts of loans outstanding as of the end of each of the last five
years,  and the  percentage  of each  category to total loans,  are shown in the
following tables according to type of loan:

                           Loan Portfolio Composition

<TABLE>
<CAPTION>
                                                                                           December 31,
                                                                                           ------------
                                                              2008            2007             2006           2005            2004
                                                              ----            ----             ----           ----            ----
                                                            (Dollars in thousands)

<S>                                                         <C>             <C>             <C>             <C>             <C>
Commercial, financial and agricultural .............        $ 42,734        $ 44,640        $ 35,783        $ 41,915        $ 33,644
Real estate - construction .........................          75,537          84,458          65,096          39,895          39,170
Real estate - mortgage .............................         178,387         128,633         120,673         110,694          96,984
Consumer installment ...............................           4,975           4,998           5,209           7,858           6,660
                                                            --------        --------        --------        --------        --------
       Total loans .................................        $301,633        $262,729        $226,761        $200,362        $176,458
                                                            ========        ========        ========        ========        ========
</TABLE>

                      Percentage Loan Portfolio Composition

<TABLE>
<CAPTION>
                                                                                       December 31,
                                                                                       ------------
                                                             2008           2007           2006           2005           2004
                                                             ----           ----           ----           ----           ----

<S>                                                         <C>            <C>            <C>            <C>            <C>
Commercial, financial and agricultural .............         14.2%          17.0%          15.8%          20.9%          19.1%
Real estate - construction .........................         25.0%          32.1%          28.7%          19.9%          22.2%
Real estate - mortgage .............................         59.1%          49.0%          53.2%          55.2%          55.0%
Consumer installment ...............................          1.7%           1.9%           2.3%           4.0%           3.7%
                                                            -----          -----          -----          -----          -----
       Total loans .................................        100.0%         100.0%         100.0%         100.0%         100.0%
                                                            =====          =====          =====          =====          =====
</TABLE>

         A certain degree of risk taking is inherent in the extension of credit.
Management has established  loan and credit  policies and practices  designed to
control  both the types and amounts of risks  assumed,  and to minimize  losses.
Such policies and practices 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,  financial and agricultural loans primarily represent loans
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 the  customer's  business,  and the debt service
capacity of a business  can  deteriorate  due to downturns in national and local
economic conditions. To control risk, management performs initial and continuing
analyses of customers' financial information.



                                       12
<PAGE>

         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 construction  loan proceeds.  Due to the short-term
nature of its funding  sources,  the Bank generally  does not provide  permanent
financing  for these  properties.  The Bank  experienced  significant  growth in
construction  loans in 2007 and 2006.  During 2008,  the  Company's  exposure to
construction  loans decreased by $8,921. In light of recent  developments in the
housing and credit markets,  management  currently expects that the Company will
maintain or decrease its amount of construction  loans due to the lack of demand
for housing in the local market.

         Loans secured by real estate mortgages comprised approximately 59%, 49%
and 53% of the  Company's  loan  portfolio  at the end of 2008,  2007 and  2006,
respectively.  Real  estate  mortgage  loans grew by $49,754 in 2008,  by $7,960
during 2007 and by $9,979  during 2006.  Residential  real estate loans  consist
mainly of first and second  mortgage  loans on single  family  homes,  with some
multifamily home loans. Loan-to-value ratios for these instruments are generally
limited to 80%.

         The Bank offers a variety of  fixed-rate  residential  real estate loan
products.  Loans retained  in-house  generally  have repayment  amounts based on
either  15 or 30 year  terms  and  include  5-year  balloon-payment  provisions.
Underwriting  for these loans is  performed  in-house  within the limits of loan
officers' lending  authorities and the loans typically are renegotiated near the
end of the balloon  period.  In addition,  conventional,  variable rate mortgage
loans may be  originated  and closed by the Bank in the name of other  financial
institutions  in exchange for an  origination  fee. Such loans are not funded by
the Bank.

         Nonfarm,  nonresidential  real estate loans are secured by business and
commercial  properties with loan-to-value ratios generally limited to 80%. These
loans made up $108,417  of the  $178,387  in real  estate  mortgage  loans as of
December 31, 2008 and $78,095 of the  $128,633 in real estate loans  reported at
December 31, 2007. At December 31, 2008 and 2007, the Bank had 10 loans totaling
$5,001 and 5 loans totaling $1,349, respectively,  in this category with initial
loan-to-value ratios exceeding 100%.

         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.  The Company
does not originate high-risk mortgage loans such as so-called option ARMs, loans
with high  debt-to-worth  ratios  (without  requiring  the  purchaser  to obtain
private mortgage  insurance),  loans with fixed monthly payment amounts that are
less than the interest  accrued on the loan,  or loans with low initial  monthly
payments that increase to much higher levels at some future time.

         Real  estate  values  in  the  Company's  market  areas,   particularly
residential real properties, have so far remained relatively steady and have not
suffered  the  precipitous  decreases  seen in some areas,  though  there can no
assurances  that this stability will continue.  However,  there has been a trend
toward a longer marketing period required to sell properties.  As a result, real
estate collateral has become a somewhat less reliable source of prompt repayment
when a borrower defaults, but it remains, nevertheless, a valuable source.


Maturity and Interest Sensitivity Distribution of Loans

         The  following  table  sets  forth  the  maturity  distribution  of the
Company's  commercial,  financial and  agricultural  loans and its real estate -
construction  loans,  as of December 31,  2008,  as well as the type of interest
requirement on such loans.



                                       13
<PAGE>

<TABLE>
<CAPTION>
                                                                                              December 31, 2008
                                                                                              -----------------
                                                                                 Due in       Due after
                                                                                One Year      One through    Due after
                                                                                or Less       Five Years      Five Years      Total
                                                                                -------       ----------      ----------      -----
                                                                                             (Dollars in thousands)

<S>                                                                             <C>            <C>            <C>            <C>
Commercial, financial and agricultural .................................        $26,616        $ 8,695        $ 7,423        $42,734
Real estate - construction .............................................         45,420         30,117              -         75,537

Above loans with fixed rate and due after one year .....................                                                     $19,434
                                                                                                                             =======
Above loans with variable rate and due after one year ..................                                                     $26,801
                                                                                                                             =======
</TABLE>

Nonperforming Loans; Assets Acquired in Settlement of Loans

         Generally,  when a loan is 90 days past due as to interest or principal
or when payment in full is not  anticipated,  the accrual of interest  income is
discontinued.  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.  When it is probable  the Bank will be
unable to collect all amounts due in  accordance  with the loan  agreement,  the
principal  balance is  reduced to the  estimated  fair  value of  collateral  by
charge-off to the allowance for loan losses of the difference between book value
and estimated fair value.  Any subsequent  collections are credited first to the
remaining  principal  balance  and then to the  allowance  for loan  losses as a
recovery.

         The amount of interest  income that would have been  included in income
in 2008, 2007 and 2006, if nonaccrual loans had performed in accordance with the
loans'  original terms was $405,  $164 and $318,  respectively.  Interest income
recorded on nonaccrual loans was $33, $34 and $68, respectively.  As of December
31, 2008,  loans that were 90 days or more past due and still accruing  interest
totaled  $714 and there were no  restructured  loans.  At December  31, 2007 and
2006,  there were no loans that were 90 days or more past due and still accruing
interest and there were no restructured loans.

         As of December 31, 2008, 2007 and 2006, the Bank had $6,497, $1,127 and
$834, respectively,  of nonaccrual loans. The increase for 2008 was attributable
primarily to the downturn in economic activity in the Company's market areas. In
general,  the economic slowdown in those areas was manifested  through prolonged
marketing  periods for  residential and commercial real estate and higher levels
of unemployment in the manufacturing sector.

         Nonaccrual  loans  increased by $5.4 million from  December 31, 2007 to
December 31, 2008.  The increase in  nonaccrual  loans  included  several  large
defaults  involving  customers within the Company's market area. Of the December
31, 2008 amount of nonaccrual loans,  $2,160 represents one customer.  The loans
are well-secured by commercial  property and the Bank expects to recover all, or
substantially  all, of the outstanding  balance.  Of the remaining  amount as of
December 31, 2008, $1,430 is secured by completed commercial  buildings,  $1,030
is  secured  by  commercial  land  development  projects,  $705  is  secured  by
residential land development properties, $547 is secured by completed 1-4 family
residences,  and $378 is secured by partially  completed 1-4 family  residential
properties.

         The  increase  in 2007 was  attributable  primarily  to one large  loan
secured by commercial real estate that was added to nonaccrual  loans during the
year.  The decrease in nonaccrual  loans from the end of 2005 to the end of 2006
was  attributable  primarily  to the  charge-off  in 2006 of more than $2,000 of
loans that were previously nonaccrual loans. Additionally,  the Bank acquired an
asset in settlement of a loan of $149.

         Included in nonaccrual  loans at December 31, 2005 were $1,660 in loans
to one customer for which the Company specifically reserved $500 in anticipation
of  charge-offs.  At the time of filing of the 2005 Annual  Report on Form 10-K,
the Company believed that the business remained a going concern with enough cash
flows to service the debt, or was saleable for an amount sufficient to repay its
debts.  However,  events occurred in 2006 that were not foreseeable and included
the loss of the debtor's largest customer which accounted for  approximately 65%
of  sales.   Realizing  that  full  collectibility  was  improbable,   the  Bank
charged-off $1,360 in 2006.



                                       14
<PAGE>

      Nonaccrual and Past Due Loans; Assets Acquired in Settlement of Loans

<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                             ------------
                                                                      2008          2007         2006           2005          2004
                                                                      ----          ----         ----           ----          ----
                                                                                         (Dollars in thousands)

Nonaccrual loans
<S>                                                                  <C>           <C>           <C>           <C>           <C>
      Commercial, financial and agricultural .................       $  248        $  266        $  435        $  329        $    -
      Real estate - construction .............................        3,824             -             -             -            10
      Real estate - mortgage .................................        2,413           833           378         2,210         1,394
      Installment loans to individuals .......................           12            28            21            12            93
                                                                     ------        ------        ------        ------        ------
          Total nonaccrual loans .............................        6,497         1,127           834         2,551         1,497
Accruing loans 90 days or more past due ......................          714             -             -             -             -
                                                                     ------        ------        ------        ------        ------
          Total nonperforming loans ..........................       $7,211        $1,127        $  834        $2,551        $1,497
                                                                     ======        ======        ======        ======        ======

Nonperforming loans as a percent of total loans ..............          2.4%          0.4%          0.4%          1.3%          0.8%

Assets acquired in settlement of loans .......................       $  674        $1,752        $  149        $  630        $  881
                                                                     ======        ======        ======        ======        ======
</TABLE>


         As of December 31, 2008, impaired loans totaled $9,799. Of this amount,
$6,497  was  classified  as  nonaccrual  loans.  The Bank  classifies  a loan as
impaired  when it is  probable  that the  Company  will be unable to collect all
amounts due according to the contractual terms of the loan agreement.

         As of December 31, 2008, there were no irrevocable  commitments to lend
additional funds to debtors owing amounts on nonaccrual loans.

         There were no restructured loans during any of the periods in the table
above.


Potential Problem Loans

         Management  has  identified  and maintains a list of potential  problem
loans that are not included in nonperforming loans (nonaccrual or loans past due
90 days or more and still accruing).  Management  monitors this list closely and
maintains  dialogue  with the  customers to determine if and when  circumstances
arise that warrant removal of the loan from this list or establishing a specific
loan loss  allowance for it. A loan is added to the potential  problem list when
management  becomes  aware of  information  about  possible  credit  problems of
borrowers  that causes doubts as to the ability of such borrowers to comply with
the current loan repayment  terms. At December 31, 2008,  loans in the amount of
$3,300,  or 1.0% of total loans,  were  determined by management to be potential
problem loans. This amount does not represent management's estimate of potential
losses  since a large  proportion  of such loans is secured by various  types of
collateral.  As of December 31, 2007,  potential  problem loans totaled $828, or
..3% of total loans.


Allowance for Loan Losses

         The  allowance  for  loan  losses  is  based  on  management's  ongoing
evaluation of the loan  portfolio  and reflects an amount which in  management's
opinion is sufficient to absorb  probable losses in the existing loan portfolio.
Loan losses are charged  against,  and recoveries are credited to the allowance.
Provisions for loan losses charged to expense are credited to the allowance. The
amounts  of loan  loss  provisions  are  based  on  various  factors  which,  in
management's  judgment,  merit current  recognition in estimating  losses.  Such
factors  include  the  market  value of any  underlying  collateral,  growth and
composition of credit risk within the loan portfolio, loss experience, review of
problem loans,  delinquency trends, and local and regional economic  conditions.
Management evaluates the carrying value of loans quarterly and the allowance for
loan losses is adjusted  accordingly.  While  management uses the best available
information in making its evaluations,  future  adjustments to the allowance may
be needed if conditions differ substantially from the assumptions used in making
the  current  evaluation.  The  allowance  for loan  losses is also  subject  to
evaluation by various regulatory authorities and may be subject to adjustment as
a result of those evaluations.

         The evaluation of the allowance is segregated into general  allocations
and specific allocations.  For general allocations,  the portfolio is segregated


                                       15
<PAGE>

into  risk-similar  segments for which historical loss ratios are calculated and
adjusted for identified trends or changes in current portfolio  characteristics.
Historical loss ratios are calculated by risk grade.  The resulting  percentages
are then applied to the dollar amounts of the loans in each segment to arrive at
each  segment's  probable loss amount.  The general  allocation  also includes a
component for probable losses  inherent in the portfolio,  based on management's
analysis, that is not fully captured otherwise in the allowance.  This component
serves to address  inherent  imprecision  in the estimation  methodology  and to
recognize  management's  evaluation of other factors or conditions not otherwise
directly  measured in the  evaluation  of the general and specific  allocations.
Such factors or conditions may include  evaluation of current  general  economic
and business conditions; geographic, collateral or other concentrations; system,
procedural,  policy or underwriting changes;  experience of lending staff; entry
into new  markets or new  product  offerings;  and  results  from  internal  and
external portfolio examinations.

         Assessing  the adequacy of the  allowance  is a process  that  requires
considerable  judgment.  No  assurance  can be given that loan  losses in future
periods will not exceed the current  allowance  or that future  increases in the
allowance will not be required. Nor can any assurance be given that management's
ongoing  evaluation  of the  loan  portfolio,  in  light  of  changing  economic
conditions  and  other  relevant  information,   will  not  require  significant
additions  to the  allowance  for loan  losses,  thus  adversely  affecting  the
Company's  operating  results.  Management  believes that the allowance for loan
losses currently is sufficient.

         Certain  nonperforming  and potential  problem  loans are  individually
assessed for impairment  under SFAS 114,  "Accounting for Impairment of a Loan,"
and assigned specific allocations.

         The table, "Summary of Loan Loss Experience,"  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.



                                       16
<PAGE>

                         Summary of Loan Loss Experience

<TABLE>
<CAPTION>
                                                                                         Years Ended December 31,
                                                                                         ------------------------
                                                                         2008         2007         2006         2005         2004
                                                                         ----          ---         ----         ----         ----
                                                                                          (Dollars in thousands)

<S>                                                                    <C>          <C>          <C>          <C>          <C>
Total loans outstanding at end of period ..........................    $301,633     $262,729     $226,761     $200,362     $176,458
Average amount of loans outstanding ...............................     282,857      250,024      215,673      183,576      162,044

Balance of allowance for loan losses - beginning ..................    $  2,943     $  2,423     $  3,050     $  2,293     $  2,345
                                                                       --------     --------     --------     --------     --------
Loans charged off
     Commercial, financial and agricultural .......................       1,944          532          787          123          135
     Real estate -construction ....................................           5           90            -            -            -
     Real estate - mortgage .......................................         381          689        1,375          347          466
     Installment loans to individuals .............................          52           18           17           13          475
                                                                       --------     --------     --------     --------     --------
           Total charge-offs ......................................       2,382        1,329        2,179          483        1,076
                                                                       --------     --------     --------     --------     --------
Recoveries of loans previously charged off
     Commercial, financial and agricultural .......................         657          382          342           25            -
     Real estate -construction ....................................           -            -            -            -            -
     Real estate - mortgage .......................................           6          419           54           76            1
     Installment loans to individuals .............................           6            3           46           14           23
                                                                       --------     --------     --------     --------     --------
           Total recoveries .......................................         669          804          442          115           24
                                                                       --------     --------     --------     --------     --------
Net charge-offs ...................................................       1,713          525        1,737          368        1,052
                                                                       --------     --------     --------     --------     --------
Additions to allowance charged to expense .........................       2,880        1,045        1,110        1,125        1,000
                                                                       --------     --------     --------     --------     --------
Balance of allowance for loan losses - ending .....................    $  4,110     $  2,943     $  2,423     $  3,050     $  2,293
                                                                       ========     ========     ========     ========     ========

Ratios
     Net charge-offs to average loans .............................        0.61%        0.21%        0.81%        0.20%        0.65%
     Net charge-offs to loans at end of period ....................        0.57%        0.20%        0.77%        0.18%        0.60%
     Allowance for loan losses to average loans ...................        1.45%        1.18%        1.12%        1.66%        1.42%
     Allowance for loan losses to loans at end of period ..........        1.36%        1.12%        1.07%        1.52%        1.30%
     Net charge-offs to allowance for loan losses .................       41.68%       17.84%       71.69%       12.07%       45.88%
     Net charge-offs to provision for loan losses .................       59.48%       50.24%      156.49%       32.71%      105.20%
</TABLE>

         The  following  tables show the  allocation  of the  allowance for loan
losses to various  types of loans and the  percentage  of loans in each category
for each of the last three years.  For years prior to 2005,  the Company did not
allocate the allowance for loan losses to the various loan categories.



                                       17
<PAGE>

                     Allocation of Allowance for Loan Losses

<TABLE>
<CAPTION>
                                                                                                  December 31,
                                                                                                  ------------
                                                                           2008              2007             2006             2005
                                                                           ----              ----             ----             ----
                                                                                           (Dollars in thousands)
Amount allocated to loan category
<S>                                                                        <C>              <C>              <C>              <C>
Commercial, financial and agricultural .........................           $  909           $1,255           $  884           $1,104
Real estate - construction .....................................            1,008              191              228              100
Real estate - mortgage .........................................            1,680              880              790              624
Installment loans to individuals ...............................                5               19               33               26
Unallocated ....................................................              508              598              488            1,196
                                                                           ------           ------           ------           ------
     Total .....................................................           $4,110           $2,943           $2,423           $3,050
                                                                           ======           ======           ======           ======
</TABLE>

<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                             ------------
                                                                        2008             2007             2006             2005
                                                                        ----             ----             ----             ----
Percentage of loans in category
<S>                                                                    <C>              <C>              <C>              <C>
Commercial, financial and agricultural .........................        14.2%            17.0%            15.8%            20.9%
Real estate - construction .....................................        25.0%            32.1%            28.7%            19.9%
Real estate - mortgage .........................................        59.1%            49.0%            53.2%            55.2%
Installment loans to individuals ...............................         1.7%             1.9%             2.3%             4.0%
                                                                       -----            -----            -----            -----
     Total .....................................................       100.0%           100.0%           100.0%           100.0%
                                                                       =====            =====            =====            =====
</TABLE>


         Although  the  allowance  has been  allocated  internally  as indicated
above,  all amounts  within the  allowance  are  available  for any and all loan
losses incurred.


Deposits

         The average amounts and percentage  composition of deposits held by the
Company for the years ended  December 31, 2008,  2007 and 2006,  are  summarized
below:

                                Average Deposits

<TABLE>
<CAPTION>
                                                                               Years Ended December 31,
                                                                               ------------------------
                                                          2008                         2007                          2006
                                                          ----                         ----                          ----
                                                   Average     Average        Average       Average        Average         Average
                                                   Balance      Cost          Balance        Cost          Balance          Cost
                                                   -------      ----          -------        ----          -------          ----
                                                                           (Dollars in thousands)

<S>                                             <C>              <C>          <C>            <C>           <C>             <C>
Noninterest-bearing demand                      $   16,570           -        $  15,970          -         $  14,296           -
NOW Accounts                                         7,236       2.32%            3,924      1.58%             2,934       0.27%
Savings                                                581       0.17%              616      0.49%               656       0.46%
Money market accounts                              101,210       2.79%           92,373      4.27%            66,774       4.20%
Time deposits                                      182,663       4.45%          180,340      5.16%           160,594       4.50%
                                                ----------                    ---------                    ---------
Total average deposits                          $  308,260                    $ 293,223                    $ 245,254
                                                ==========                    =========                    =========
</TABLE>


         As of December 31, 2008,  the Bank had $60,818 in time deposits of $100
or more.  Approximately  $13,684 mature within three months,  $9,021 mature over
three  through six months,  $27,451  mature over six through  twelve  months and
$10,662 mature after one year. This level of large time deposits, as well as the
growth in other  deposits,  is attributed to growth planned by  management.  The
majority of time deposits $100 and over are acquired within the Company's market


                                       18
<PAGE>

areas in the ordinary  course of business from customers  with standing  banking
relationships. It is a common industry practice not to consider time deposits of
$100 or more as core deposits since their retention can be influenced heavily by
rates offered. Therefore, such deposits have the characteristics of shorter-term
purchased funds.  Certificates of deposit $100 and over require that the Company
achieve and maintain an  appropriate  matching of maturity  distributions  and a
diversification of sources to achieve an appropriate level of liquidity.

         As of December 31, 2008, time deposits  included  $40,346 obtained from
deposit  brokers  compared  with  $16,857 at the end of 2007.  The  increase  in
brokered  deposits is  attributable  to the Bank's decision to access funding at
market  rates  that were  significantly  less than the local  market  during the
second half of 2008. This difference was driven primarily by large  institutions
in the market offering above market rates. These institutions have since lowered
rates or have been acquired.

Return on Equity and Assets

         The following  table shows the return on assets (net income  divided by
average total 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 each period indicated.

                                               Years Ended December 31,
                                               ------------------------
                                         2008              2007             2006
                                         ----              ----             ----

      Return on assets ...............    0.37%           0.86%            1.16%
      Return on equity ...............    5.64%          13.34%           18.16%
      Dividend payout ratio ..........   20.51%           9.64%            8.25%
      Equity to assets ratio .........    6.54%           6.43%            6.41%


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 loan  originations and deposit  withdrawals in the most timely and
economical  manner.  Some  liquidity is ensured by  maintaining  assets that are
convertible  immediately  into cash at minimal cost  (amounts due from banks and
federal funds sold).  Asset  liquidity is also provided from funds from maturing
or redeemed  securities  available-for-sale,  maturing loans and other scheduled
loan repayments.  However, the most manageable sources of liquidity are composed
of  liabilities,  with the primary  focus of liquidity  management  being on the
ability to obtain  deposits within the Bank's service area. Core deposits (total
deposits  less time deposits of $100 and over and brokered  deposits)  provide a
relatively stable funding base, and were equal to 56% and 64% of total assets as
of December 31, 2008 and December 31, 2007, respectively.

         Because of the potentially  volatile nature of its funding sources, the
Bank maintains  membership in the Federal Home Loan Bank of Atlanta (the "FHLB")
in order to gain access to its credit  programs.  During  2008,  the Bank repaid
$5,000 of short-term borrowings and obtained  approximately $29,000 of long-term
borrowings  from the FHLB.  As of  December  31,  2008,  the Bank is eligible to
borrow up to an additional $43,078 from the FHLB. Such borrowings are secured by
a lien on the Bank's  investment in FHLB stock and all qualifying first mortgage
residential loans and certain  commercial real estate loans.  Assets actually or
potentially  subject to this lien totaled  approximately  $96,512 as of December
31, 2008.  In addition,  the Bank has  available  an unused  short-term  line of
credit to purchase up to $4,400 of federal funds from an unrelated correspondent
institution.  The line  generally  limits  the  period of time that any  related
borrowings  may  be  outstanding  and is  cancelable  at any  time  in the  sole
discretion of the lender.

         The  Company's  ability  to meet  its  cash  obligations  or to pay any
possible  future cash dividends to  shareholders  is dependent  primarily on the
successful  operation  of the Bank and its ability to pay cash  dividends to the
Company.  Any of the Bank's cash dividends in excess of the amount of the Bank's
current year-to-date earnings of $1,659 are subject to the prior approval of the
South Carolina Commissioner of Banking. In addition,  dividends paid by the Bank
to the Company would be prohibited if the effect  thereof would cause the Bank's
capital to be reduced below applicable  minimum regulatory  requirements.  Under
Federal  Reserve  Board  regulations,  the amounts of loans or advances from the
Bank to the Company are also  restricted.  The terms of the Company's  preferred
stock  further  limit its ability to pay or increase its dividends or repurchase
its common stock.  Those terms also establish  limits on executive  compensation
and the Company's ability to engage in certain other transactions.

         Management  believes  that the  overall  liquidity  sources of both the
Company the Bank are adequate to meet their operating needs.



                                       19
<PAGE>

Short-Term Borrowings

         Short-term  borrowings  consist  primarily  of  Federal  Home Loan Bank
advances  with an original  maturity of one year or less.  The  following  table
presents  information about short-term  Federal Home Loan Bank advances for each
of the years indicated.

<TABLE>
<CAPTION>
                                                                               December 31,
                                                                               ------------
                                                                  2008             2007             2006
                                                                  ----             ----             ----
                                                                         (Dollars in thousands)
<S>                                                              <C>            <C>               <C>
Outstanding at end of period .................................   $   -          $ 5,000           $    -
Weighted average rate, end of period .........................    0.00%            4.40%            0.00%
Maximum amount outstanding at any month end ..................   $   -           $5,000           $8,500
Average amount outstanding during the period .................   $  17           $  169           $6,905
Weighted average rate during the period ......................    1.98%            5.92%            4.36%
</TABLE>


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 that is not
reflected in 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 enforceable agreements to lend
money to customers at  predetermined  interest  rates for a specified  period of
time. At December 31, 2008, the Bank had issued  commitments to extend credit of
$66,748  through  various  types of lending.  Commitments  at variable  rates of
interest  totaled  $32,650 and commitments at fixed rates totaled  $34,098.  The
commitments  generally  expire within one year. Past  experience  indicates that
many  of  these  commitments  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.  If these standby letters of credit are utilized,
they become loans on the Bank's books.  Standby letters of credit totaled $1,200
at December 31, 2008.  Past  experience  indicates that many of these letters of
credit will expire unused.  Management believes the Bank's liquidity sources are
sufficient to meet any funding requirements under these instruments.

         Neither  the Company  nor the Bank are  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  significantly   affect  earnings.   Obligations  under  noncancelable
operating lease agreements  totaled  approximately $287 as of December 31, 2008.
These  obligations  are payable  over  several  years as shown in Note 10 to the
Company's consolidated financial statements.

Capital Resources

         Shareholders'  equity  increased by $1,889 during 2008. The increase in
shareholders'  equity  is the  result of $1,348  in  earnings  generated  by the
Company, an increase in accumulated other  comprehensive  income of $79, $624 in
proceeds from the exercise of stock options and $116 in capital generated by the
recognition  of the expense of granting of stock  options,  offset by  dividends
declared of $278.

         The  Company  and the Bank  are  each  subject  to  regulatory  capital
adequacy standards.  Under these standards, bank holding companies and banks 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  Improvement Act of 1991,  federal bank  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
affected   institution  fell  below  certain  levels,   increasingly   stringent
regulatory corrective actions are mandated.  Unrealized holding gains and losses
on  available-for-sale   securities  are  generally  excluded  for  purposes  of
calculating  regulatory  capital ratios.  However,  the extent of any unrealized
appreciation  or  depreciation  on securities  will continue to be a factor that
regulatory examiners consider in their overall assessment of capital adequacy.



                                       20
<PAGE>

         It is  management's  intention 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 the regulation,  and as of
December 31, 2008,  the Company and the Bank exceed the minimum  capital  levels
that are  required  to be  maintained.  There are no  conditions  or events that
management believes would cause the Company's or the Bank's category to be other
than that resulting from meeting the minimum ratio requirements.

         Company and Bank capital  levels at December 31, 2008 are  presented in
the following  table,  compared with the "well  capitalized"  and minimum ratios
under the Federal Reserve and FDIC regulatory definitions and guidelines.

<TABLE>
<CAPTION>
                                                                                    Minimum for                    Minimum to be
                                                          Actual                  Capital Adequacy               Well Capitalized
                                                          ------                  ----------------               ----------------
                                                  Amount          Ratio         Amount          Ratio          Amount         Ratio
                                                  ------          -----         ------          -----          ------         -----
December 31, 2008                                                              (Dollars in thousands)
<S>                                               <C>              <C>         <C>              <C>         <C>             <C>
     Tier 1 Capital (to Average Assets)
         Company ..............................   $ 30,999          8.3%       $ 14,942         4.0%              NA            NA
         GrandSouth Bank ......................     30,112          8.1%         14,930         4.0%        $ 18,641          5.0%

     Tier 1 Capital (to Risk Weighted Assets)
         Company ..............................   $ 30,999         10.0%       $ 12,454         4.0%              NA            NA
         GrandSouth Bank ......................     30,112          9.7%         12,440         4.0%        $ 18,660          6.0%

     Total Capital (to Risk Weighted Assets)
         Company ..............................   $ 35,135         11.3%       $ 24,908         8.0%              NA            NA
         GrandSouth Bank ......................     34,002         10.9%         24,880         8.0%        $ 31,099         10.0%

December 31, 2007
     Tier 1 Capital (to Average Assets)
         Company ..............................   $ 28,850          8.4%       $ 13,750         4.0%              NA            NA
         GrandSouth Bank ......................     27,526          8.6%         12,869         4.0%        $ 16,087          5.0%

     Tier 1 Capital (to Risk Weighted Assets)
         Company ..............................   $ 28,850         10.1%       $ 11,414         4.0%              NA            NA
         GrandSouth Bank ......................     27,526          9.6%         11,432         4.0%        $ 17,148          6.0%

     Total Capital (to Risk Weighted Assets)
         Company ..............................   $ 32,489         11.4%       $ 22,828         8.0%              NA            NA
         GrandSouth Bank ......................     30,469         10.7%         22,864         8.0%        $ 28,580         10.0%
</TABLE>

         On January 9, 2009,  the Company sold 9,450  shares of preferred  stock
for $9,000 to the U. S. Treasury under the Treasury's  Capital Purchase Program.
This preferred stock  constitutes  Tier 1 capital for the purpose of calculating
the  Company's  regulatory  capital  ratios.  The terms of the  preferred  stock
include,  among other things,  restrictions on the Company's  ability to pay and
increase the amounts of cash dividends.

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  having 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.


                                       21
<PAGE>

Impact of Recent Accounting Changes

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

         In  December  2007,  the  FASB  issued  SFAS No.  160,  "Noncontrolling
Interests  in  Consolidated  Financial  Statements - an amendment of ARB No. 51"
("SFAS 160").  SFAS 160 establishes  new accounting and reporting  standards for
the  noncontrolling  interest in a subsidiary and for the  deconsolidation  of a
subsidiary.  Before this  statement,  limited  guidance  existed  for  reporting
noncontrolling interests (formerly known as "minority interests").  As a result,
diversity in practice exists. In some cases,  minority interests are reported as
a liability and in other cases it is reported in the mezzanine  section  between
liabilities  and equity.  Specifically,  SFAS 160 requires the  recognition of a
noncontrolling  interest as equity in the consolidated  financial statements and
separate from the parent company's equity. The amount of net income attributable
to the  noncontrolling  interest will be included in consolidated  net income in
the consolidated income statement. SFAS 160 clarifies that changes in a parent's
ownership  interest in a subsidiary  that do not result in  deconsolidation  are
equity transaction if the parent retains its controlling  financial interest. In
addition,  this  statement  requires that parent  recognize  gain or loss in net
income when a subsidiary is  deconsolidated.  Such gain or loss will be measured
using  the  fair  value  of  the   noncontrolling   equity   investment  on  the
deconsolidation  date. SFAS 160 also includes expanded  disclosure  requirements
regarding the interest of the parent and its noncontrolling  interests. SFAS 160
was  effective  for the  Company  on  January  1,  2009 and had no effect on the
Company's financial position, results of operations or cash flows.

         In  February  2008,  the FASB  issued FASB Staff  Position  No.  142-3,
"Determination  of the Useful Life of  Intangible  Assets" ("FSP  142-3").  This
Staff  Position  amends the factors  that  should be  considered  in  developing
renewal  or  extension  assumptions  used  to  determine  the  useful  life of a
recognized  intangible asset under SFAS No. 142,  "Goodwill and Other Intangible
Assets"  ("SFAS  142").  The intent of this  Staff  Position  is to improve  the
consistency between the useful life of a recognized  intangible asset under SFAS
142 and the period of expected  cash flows used to measure the fair value of the
asset under SFAS 141(R) and other U.S. generally accepted accounting principles.
This Staff  Position was effective for the Company on January 1, 2009 and had no
material impact on the Company's  financial  position,  results of operations or
cash flows.

         In  March  2008,  the FASB  issued  SFAS No.  161,  "Disclosures  about
Derivative  Instruments and Hedging  Activities" ("SFAS 161"). SFAS 161 requires
enhanced disclosure about an entity's derivative and hedging activities, thereby
improving  the  transparency  of  financial  reporting.  It  requires  that  the
objectives for using derivative  instruments be disclosed in terms of underlying
risk and accounting  designation thereby conveying the purpose of derivative use
in terms of the risks that the entity is intending to manage. SFAS was effective
for the Company on January 1, 2009 and will result in  additional  disclosure if
the Company enters into any material derivative or hedging activities.

         In May 2008,  the FASB issued SFAS No. 162, "The Hierarchy of Generally
Accepted Accounting Principles" ("SFAS 162"). SFAS 162 identifies the sources of
accounting principles and the framework for selecting the principles used in the
preparation  of  financial  statements  of  nongovernmental  entities  that  are
presented in conformity with generally accepted  accounting  principles ("GAAP")
is the United States (the GAAP hierarchy).  SFAS 162 was effective  November 15,
2008. The FASB has stated that it does not expect that SFAS 162 will result in a
change in current  practice.  The  application  of SFAS 162 had no effect on the
Company's financial position, results of operations or cash flows.

         In May  2008,  the FASB  issued  FASB  Staff  Position  No.  APB  14-1,
"Accounting for Convertible  Debt  Instruments  That May Be Settled in Cash upon
Conversion  (Including  Partial Cash Settlement)"  ("FSP APB 14-1").  This Staff
Position  specifies that issuers of  convertible  debt  instruments  that may be
settled in cash upon conversion should separately  account for the liability and
equity components in a manner that will reflect the entity's nonconvertible debt
borrowing  rate when interest cost is recognized in subsequent  period.  FSP APB
14-1  provides  guidance  for  initial  and  subsequent  measurement  as well as
derecognition provisions. The Staff Position was effective as of January 1, 2009
and had no  material  effect on the  Company's  financial  position,  results of
operations or cash flows.

         In June 2008,  the FASB issued  FASB Staff  Position  No. EITF  03-6-1,
"Determining Whether Instruments Granted in Share-Based Payment Transactions are

                                       22
<PAGE>

Participating Securities" ("FSP EITF 03-6-1"). This Staff Position provides that
unvested  share-based  payment  awards  that  contain  nonforfeitable  rights to
dividends  or dividend  equivalents  are  participating  securities  and must be
included in the earnings per share  computation.  FSP EITF 03-6-1 was  effective
January 1, 2009 and had no effect on the Company's financial  position,  results
of operations, earnings per share or cash flows.

         FASB Staff Position SFAS 133-1 and FIN 45-4  "Disclosures  about Credit
Derivatives and Certain  Guarantees:  An Amendment of FASB Statement No. 133 and
FASB  Interpretation  No. 45; and  Clarification  of the Effective  Date of FASB
Statement No. 161" ("FSP SFAS 133-1 and FIN 45-4") was issued in September  2008
effective for reporting  periods  (annual or interim)  ending after November 15,
2008.  FSP SFAS  133-1 and FIN 45-4  amends  SFAS 133 to  require  the seller of
credit derivatives to disclose the nature of the credit derivative,  the maximum
potential amount of future payments,  the fair value of the derivative,  and the
nature of any recourse  provisions.  Disclosures  must be made for entire hybrid
instruments that have embedded credit derivatives.

         FSP SFAS  133-1 and FIN 45-4 also  amends  FASB  Interpretation  No. 45
("FIN   45")   to   require   disclosure   of   the   current   status   of  the
payment/performance  risk  of the  credit  derivative  guarantee.  If an  entity
utilizes  internal  groupings as a basis for the risk,  disclosure  must also be
made of how the groupings are determined and how the risks are managed.

         The Staff  Position  encourages  that the  amendments  be  provided  in
periods  earlier than the effective  date to facilitate  comparisons  at initial
adoption. After initial adoption,  comparative disclosures are required only for
subsequent periods.

         FSP SFAS 133-1 and FIN 45-4  clarifies the  effective  date of SFAS 161
such that  required  disclosures  should be provided  for any  reporting  period
(annual or interim)  beginning  after  November 15,  2008.  The adoption of this
Staff  Position  had no material  effect on the  Company's  financial  position,
results of operations or cash flows.

         The Securities and Exchange Commission's Office of the Chief Accountant
and the staff of the FASB issued press  release  2008-234 on September  30, 2008
("Press  Release") to provide  clarification  about fair value  accounting.  The
Press Release includes guidance on the use of management's  internal assumptions
and the use of  "market"  quotes.  It also  reiterates  the factors in SEC Staff
Accounting  Bulletin  Topic 5M  which  should  be  considered  when  determining
other-than-temporary  impairment:  the  length  of time and  extent to which the
market  value  has been  less  than  cost;  financial  condition  and  near-term
prospects of the issuer;  and the intent and ability of the holder to retain its
investment for a period of time sufficient to allow for any anticipated recovery
in market value.

         On October 10, 2008,  the FASB issued FSP SFAS 157-3  "Determining  the
Fair Value of a  Financial  Asset When the Market for That Asset Is Not  Active"
("FSP SFAS 157-3").  This FSP clarifies  the  application  of SFAS No. 157 "Fair
Value  Measurements"  ) (see Note N) in a market that is not active and provides
an example to illustrate key  considerations  in determining the fair value of a
financial  asset  when the  market  for that  asset is not  active.  The FSP was
effective upon issuance,  including prior periods for which financial statements
had not yet been issued.

         The Company  considered  guidance in the Press  Release and in FSP SFAS
157-3 when  conducting  its review for  other-than  temporary  impairment  as of
December 31, 2008 as discussed in Note 3.

         FSP  SFAS  140-4  and  FIN  46(R)-8  "Disclosures  by  Public  Entities
(Enterprises)  about  Transfers  of  Financial  Assets and  Interest in Variable
Interest  Entities" was issued in December 2008 to require  public  companies to
disclose  additional  information  about  transfers of financial  assets and any
involvement  with variable  interest  entities.  The FSP also  requires  certain
disclosures  for public  entities  that are sponsors and servicers of qualifying
special purpose  entities.  The FSP is effective for the first reporting  period
ending after  December 15,  2008.  Application  of this FSP had no impact on the
financial position of the Company.


                                       23
<PAGE>

Management's Report on Internal Control Over Financial Reporting

Management  of the  Company is  responsible  for  establishing  and  maintaining
adequate internal control over financial  reporting as defined in Rule 13a-15(f)
of the  Securities  Exchange Act of 1934 as amended (the  "Exchange  Act").  The
Company's  internal  control over financial  reporting is a process  designed to
provide reasonable  assurance  regarding the reliability of financial  reporting
and the preparation of financial  statements for external purposes in accordance
with accounting  principles  generally accepted in the United States of America.
The Company's internal control over financial  reporting includes those policies
and  procedures  that  (1)  pertain  to the  maintenance  of  records,  that  in
reasonable   detail,   accurately  and  fairly  reflect  the   transactions  and
dispositions  of the Company's  assets;  (2) provide  reasonable  assurance that
transactions  are recorded as necessary to permit the  preparation  of financial
statements in accordance with generally accepted accounting  principles and that
receipts and  expenditures  of the Company are made only in accordance  with the
authorizations  of the  Company's  management  and  directors;  and (3)  provide
reasonable  assurance  regarding  prevention or timely detection of unauthorized
acquisition,  use or  disposition  of the  Company's  assets  that  could have a
material impact on the financial statements.

Under the supervision and with the  participation  of management,  including the
Chief Executive Officer and the Chief Financial  Officer,  the Company conducted
an evaluation of the effectiveness of internal control over financial  reporting
as of December 31, 2008 based on the criteria  established in a report  entitled
"Internal  Control -  Integrated  Framework"  promulgated  by the  Committee  of
Sponsoring  Organizations  of  the  Treadway  Commission  and  the  interpretive
guidance  issued by the  Securities  and  Exchange  Commission  in  Release  No.
34-55929.  Based on this  evaluation,  management  concluded  that the Company's
internal control over financial reporting was effective as of December 31, 2008.

This  annual  report  does not include an  attestation  report of the  Company's
independent  registered public  accounting firm regarding  internal control over
financial  reporting because  management's report was not subject to attestation
by the Company's  registered  public accounting firm pursuant to temporary rules
of the  Securities  and Exchange  Commission  that permit the Company to provide
only management's report in this annual report.



                                       24
<PAGE>

Report of Independent Registered Public Accounting Firm




The Shareholders and Board of Directors
    of GrandSouth Bancorporation

         We  have  audited  the  accompanying  consolidated  balance  sheets  of
GrandSouth  Bancorporation  and Subsidiary as of December 31, 2008 and 2007, and
the related consolidated  statements of income,  changes in shareholders' equity
and  comprehensive  income,  and cash  flows for each of the three  years in the
period  ended   December  31,  2008.   These   financial   statements   are  the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

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

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material  respects,  the financial position of GrandSouth
Bancorporation  and Subsidiary as of December 31, 2008 and 2007, and the results
of their  operations  and their  cash  flows for each of the three  years in the
period ended  December 31, 2008, in  conformity  with U. S.  generally  accepted
accounting principles.

         We were  not  engaged  to  examine  management's  assertion  about  the
effectiveness of GrandSouth  Bancorporation  and  Subsidiary's  internal control
over  financial  reporting as of December 31, 2008 included in the  accompanying
Management's   Report  on  Internal   Control  Over  Financial   Reporting  and,
accordingly, we do not express an opinion thereon.

/s/ Elliott Davis, LLC

Elliott Davis, LLC
Greenville, South Carolina
March 30, 2009





                                       25
<PAGE>


GRANDSOUTH BANCORPORATION
Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                                                               December 31,
                                                                                                               ------------
                                                                                                           2008               2007
                                                                                                           -----              ----
                                                                                                           (Dollars in thousands)
Assets
<S>                                                                                                      <C>                <C>
      Cash and due from banks ................................................................           $  2,329           $  4,287
      Interest bearing transaction accounts with other banks .................................              8,453                298
      Federal funds sold .....................................................................                429              4,420
                                                                                                         --------           --------
          Cash and cash equivalents ..........................................................             11,211              9,005
      Certificates of deposit with other banks ...............................................              2,000                  -
      Securities available-for-sale ..........................................................             47,378             59,567
      Other investments, at cost .............................................................              1,926                765
      Loans, net of allowance for loan losses of $4,110 for 2008 and
          $2,943 for 2007 ....................................................................            297,523            259,786
      Premises and equipment, net ............................................................              4,744              4,896
      Bank owned life insurance ..............................................................              4,944              4,753
      Assets acquired in settlement of loans .................................................                674              1,752
      Interest receivable ....................................................................              2,077              2,313
      Deferred income taxes ..................................................................              1,033                544
      Goodwill ...............................................................................                737                737
      Other assets ...........................................................................                770              1,006
                                                                                                         --------           --------
              Total assets ...................................................................           $375,017           $345,124
                                                                                                         ========           ========

Liabilities
      Deposits
          Noninterest bearing ................................................................           $ 15,331           $ 15,037
          Interest bearing ...................................................................            295,554            290,602
                                                                                                         --------           --------
              Total deposits .................................................................            310,885            305,639
      Short-term borrowings ..................................................................                  -              5,000
      Long-term Federal Home Loan Bank advances ..............................................             29,000                  -
      Junior subordinated debentures .........................................................              8,247              8,247
      Interest payable .......................................................................                639                754
      Other liabilities ......................................................................              1,890              3,017
                                                                                                         --------           --------
              Total liabilities ..............................................................            350,661            322,657
                                                                                                         --------           --------

Commitments and Contingencies - Notes 10 and 13

Shareholders' equity
      Preferred stock - no par value; 20,000,000 shares authorized;
          none issued and outstanding ........................................................                  -                  -
      Common stock - no par value; 20,000,000 shares authorized;
          issued and outstanding - 3,573,695 at December 31, 2008 and
          3,381,488 at December 31, 2007 .....................................................             19,940             19,200
      Retained earnings ......................................................................              4,153              3,083
      Accumulated other comprehensive income .................................................                263                184
                                                                                                         --------           --------
              Total shareholders' equity .....................................................             24,356             22,467
                                                                                                         --------           --------
              Total liabilities and shareholders' equity .....................................           $375,017           $345,124
                                                                                                         ========           ========
</TABLE>

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



                                       26
<PAGE>

GRANDSOUTH BANCORPORATION
Consolidated Statements of Income

<TABLE>
<CAPTION>
                                                                                                    Years ended December 31,
                                                                                                    ------------------------
                                                                                            2008             2007            2006
                                                                                            -----            -----           ----
                                                                                           (Dollars in thousands, except per share)

Interest income
<S>                                                                                       <C>              <C>              <C>
      Interest and fees on loans .................................................        $ 21,627         $ 23,826         $ 21,338
      Investment securities
        Taxable ..................................................................           2,177            2,052            1,510
        Nontaxable ...............................................................             571              351               66
      Dividends ..................................................................              51               32               46
      Other, principally federal funds sold ......................................             217              583              651
                                                                                          --------         --------         --------
          Total interest income ..................................................          24,643           26,844           23,611
                                                                                          --------         --------         --------

Interest expense
      Deposits ...................................................................          11,127           13,311           10,045
      Short-term borrowings ......................................................               -               10              106
      Federal Home Loan Bank  advances ...........................................             796                -                -
      Junior subordinated debt ...................................................             432              599              690
                                                                                          --------         --------         --------
          Total interest expense .................................................          12,355           13,920           10,841
                                                                                          --------         --------         --------

Net interest income ..............................................................          12,288           12,924           12,770
Provision for loan losses ........................................................           2,880            1,045            1,110
                                                                                          --------         --------         --------
Net interest income after provision for loan losses ..............................           9,408           11,879           11,660
                                                                                          --------         --------         --------

Noninterest income
      Service charges on deposit accounts ........................................             513              419              388
      Gain (loss) on sale of investment securities ...............................              16              (24)               -
      Gain (loss) on sale of assets acquired in settlement of loans ..............             (77)               6              119
      Net gain on sale of premises and equipment .................................              40                -               14
      Increase in value of life insurance assets .................................             191              177              168
      Other ......................................................................              71               84               70
                                                                                          --------         --------         --------
          Total noninterest income ...............................................             754              662              759
                                                                                          --------         --------         --------

Noninterest expenses
      Salaries and employee benefits .............................................           5,094            4,956            4,628
      Premises and equipment .....................................................             671              827              796
      Data processing ............................................................             507              494              408
      Insurance ..................................................................             405              492              411
      Printing, postage and supplies .............................................             192              229              222
      Professional fees ..........................................................             467              573              347
      Miscellaneous loan expense .................................................             154              193              153
      Other operating ............................................................             592              398              433
                                                                                          --------         --------         --------
          Total noninterest expenses .............................................           8,082            8,162            7,398
                                                                                          --------         --------         --------

Income before income taxes .......................................................           2,080            4,379            5,021
Income tax expense ...............................................................             732            1,580            1,761
                                                                                          --------         --------         --------
Net income .......................................................................        $  1,348         $  2,799         $  3,260
                                                                                          ========         ========         ========

Per share*
      Net income, basic ..........................................................        $   0.39         $   0.83         $   0.97
      Net income, assuming dilution ..............................................            0.39             0.77             0.89
</TABLE>

--------
* Per share  amounts  have been  retroactively  adjusted  to reflect a 10% stock
dividend declared July 19, 2006.

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


                                       27
<PAGE>

GRANDSOUTH BANCORPORATION

Consolidated  Statements of Changes in  Shareholders'  Equity and  Comprehensive
Income

<TABLE>
<CAPTION>
                                                                     Common Stock
                                                                     ------------                       Accumulated
                                                            Number of                    Retained   Other Comprehensive
                                                             Shares          Amount      Earnings       Income (Loss)       Total
                                                             ------          ------      --------       -------------       -----
                                                                             (Dollars in thousands, except per share)

<S>                                                         <C>            <C>            <C>             <C>             <C>
Balance, December 31, 2005 ...........................      3,065,726      $  14,340      $   2,149       $    (361)      $  16,128
                                                                                                                          ---------
Comprehensive income:
    Net income .......................................              -              -          3,260               -           3,260
                                                                                                                          ---------
    Unrealized holding gains and losses
    on available-for-sale securities
    arising during the period, net of
    income taxes of $141 .............................              -              -              -             223             223
                                                                                                                          ---------
    Total other comprehensive income .................              -              -              -               -             223
                                                                                                                          ---------
    Total comprehensive income .......................              -              -              -               -           3,483
                                                                                                                          ---------
Share-based compensation .............................              -            110              -               -             110
Exercise of stock options ............................          1,954             12              -               -              12
Issuance of 10% stock dividend, including
    cash payment for fractional shares ...............        306,166          4,592         (4,597)              -              (5)
Cash dividends declared, $.08 per share ..............              -              -           (258)              -            (258)
                                                            ---------      ---------      ---------       ---------       ---------
Balance, December 31, 2006 ...........................      3,373,846         19,054            554            (138)         19,470
Comprehensive income:
    Net income .......................................              -              -          2,799               -           2,799
                                                                                                                          ---------
    Unrealized holding gains and losses
    on available-for-sale securities
    arising during the period, net of
    income taxes of $157 .............................              -              -              -             306             306
    Add: Reclassification adjustment for
    securities losses included in net income,
    net of income taxes of $8 ........................              -              -              -              16              16
                                                                                                                          ---------
    Total other comprehensive income .................              -              -              -               -             322
                                                                                                                          ---------
    Total comprehensive income .......................              -              -              -               -           3,121
                                                                                                                          ---------
Share-based compensation .............................              -            121              -               -             121
Exercise of stock options ............................          7,642             25              -               -              25
Cash dividends declared, $.08 per share ..............              -              -           (270)              -            (270)
                                                            ---------      ---------      ---------       ---------       ---------
Balance, December 31, 2007 ...........................      3,381,488         19,200          3,083             184          22,467
Comprehensive income:
    Net income .......................................              -              -          1,348               -           1,348
                                                                                                                          ---------
    Unrealized holding gains and losses
    on available-for-sale securities
    arising during the period, net of
    income taxes of $46 ..............................              -              -              -              89              89
    Less: Reclassification adjustment for
    securities gains included in net income,
    net of income taxes of $6 ........................              -              -              -             (10)            (10)
                                                                                                                          ---------
    Total other comprehensive income .................              -              -              -               -              79
                                                                                                                          ---------
    Total comprehensive income .......................              -              -              -               -           1,427
                                                                                                                          ---------
Share-based compensation .............................              -            116              -               -             116
Exercise of stock options ............................        192,207            624              -               -             624
Cash dividends declared, $.08 per share ..............              -              -           (278)              -            (278)
                                                            ---------      ---------      ---------       ---------       ---------
Balance, December 31, 2008 ...........................      3,573,695      $  19,940      $   4,153       $     263       $  24,356
                                                            =========      =========      =========       =========       =========
</TABLE>

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


                                       28
<PAGE>

GRANDSOUTH BANCORPORATION
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
                                                                                                      Years Ended December 31,
                                                                                                      ------------------------
                                                                                                2008           2007            2006
                                                                                                ----           ----            ----
                                                                                                     (Dollars in thousands)
Operating activities
<S>                                                                                          <C>            <C>            <C>
      Net income ......................................................................      $  1,348       $  2,799       $  3,260
      Adjustments to reconcile net income to net
          cash provided by operating activities
              Provision for loan losses ...............................................         2,880          1,045          1,110
              Writedowns of assets acquired in settlement of loans ....................             -              -             15
              Depreciation ............................................................           327            380            388
              Deferred income tax expense (benefit) ...................................          (449)          (282)           273
              Net securities (accretion) and premium amortization .....................           (21)             2             (6)
              (Gain) loss on sale of available-for-sale securities ....................           (16)            24              -
              Gain on sale or other disposition of premises and equipment .............           (40)             -            (14)
              Loss (gain) on sale of assets acquired in settlement of loans ...........            77             (6)          (119)
              Increase in cash surrender value of bank owned life insurance ...........          (191)          (177)          (168)
              Decrease (increase) in interest receivable ..............................           236           (543)          (325)
              (Decrease) increase in interest payable .................................          (115)            69            170
              Decrease (increase) in prepaid expenses and other assets ................           158            231           (693)
              (Decrease) increase in accrued expenses and other liabilities ...........        (1,131)            32          1,733
              Share-based compensation expense ........................................           116            121            110
                                                                                             --------       --------       --------
                  Net cash provided by operating activities ...........................         3,179          3,695          5,734
                                                                                             --------       --------       --------
Investing activities
      Purchases of available-for-sale securities ......................................        (3,199)       (37,310)       (21,338)
      Maturities and calls of available-for-sale securities ...........................         9,000         14,015          5,000
      Paydowns of available-for-sale mortgage-backed securities .......................         5,530          3,386          3,222
      Proceeds from sale of available-for-sale securities .............................         1,014          2,449              -
      Purchases of other investments ..................................................        (1,161)          (261)             -
      Proceeds of redemptions of other investments ....................................             -              -            294
      Purchases of certificates of deposit with other banks ...........................        (2,000)             -              -
      Investment in capital trust .....................................................             -              -           (247)
      Net increase in loans made to customers .........................................       (42,252)       (38,580)       (28,300)
      Purchases of premises and equipment .............................................          (193)          (156)        (1,151)
      Proceeds from sale of premises and equipment ....................................            58              -             37
      Investments in assets acquired in settlement of loans ...........................            (4)             -              -
      Proceeds from sale of assets acquired in settlement of loans ....................         2,640            490            749
                                                                                             --------       --------       --------
                  Net cash used by investing activities ...............................       (30,567)       (55,967)       (41,734)
                                                                                             --------       --------       --------
Financing activities
      Net increase in deposits ........................................................         5,246         36,716         47,262
      Net (decrease) increase in short-term borrowings ................................        (5,000)         5,000              -
      Proceeds from Federal Home Loan Bank advances ...................................        29,000              -              -
      Repayment of Federal Home Loan Bank advances ....................................             -              -         (8,500)
      Proceeds from issuance of junior subordinated debentures ........................             -              -          8,247
      Proceeds from other borrowings ..................................................             -              -            100
      Repayment of other borrowings ...................................................             -              -         (4,000)
      Cash dividends paid .............................................................          (276)          (268)          (252)
      Payment of cash in lieu of fractional shares ....................................             -              -             (5)
      Exercise of stock options .......................................................           624             25             12
                                                                                             --------       --------       --------
                  Net cash provided by financing activities ...........................        29,594         41,473         42,864
                                                                                             --------       --------       --------
Increase (decrease) in cash and cash equivalents ......................................         2,206        (10,799)         6,864
Cash and cash equivalents, beginning ..................................................         9,005         19,804         12,940
                                                                                             --------       --------       --------
Cash and cash equivalents, ending .....................................................      $ 11,211       $  9,005       $ 19,804
                                                                                             ========       ========       ========
</TABLE>

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


                                       29
<PAGE>

GRANDSOUTH BANCORPORATION
Consolidated Statements of Cash Flows - continued
<TABLE>
<CAPTION>
                                                                                                        Years Ended December 31,
                                                                                                        ------------------------
                                                                                                     2008         2007         2006
                                                                                                     ----         ----         ----
                                                                                                        (Dollars in thousands)
Supplemental  Disclosure  of Cash Flow  Information
Cash paid during the period for:
<S>                                                                                                <C>          <C>          <C>
          Interest ..........................................................................      $12,470      $13,851      $10,671
          Income taxes ......................................................................        1,724        1,502        1,548
      Noncash investing and financing activities:
          Transfer of loans to assets acquired in settlement of loans .......................        1,635        2,087          164
          Dividends declared but unpaid .....................................................           71           69           67
          Other comprehensive income (loss), before income tax ..............................          119          487          364
          Stock dividend ....................................................................            -            -        4,592
</TABLE>

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

Notes to Consolidated Financial Statements
GrandSouth Bancorporation

(Dollars in thousands, except per share data)

NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

GrandSouth  Bancorporation (the "Company") is a South Carolina company 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  transactions
and accounts have been eliminated in consolidation. The GrandSouth Capital Trust
1 (see Note 9) is an unconsolidated subsidiary.

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  within the banking  industry.  The Company  uses the accrual
basis of  accounting.  In certain  instances,  amounts  reported in prior years'
consolidated  financial  statements  have been  reclassified  to  conform to the
current  presentation.  Such  reclassifications  had  no  effect  on  previously
reported shareholders' equity or net income.

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  amounts 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.


                                       30
<PAGE>

In  addition  to  monitoring  potential  concentrations  of loans to  particular
borrowers or groups of borrowers,  industries and geographic regions, management
monitors exposure to credit risks 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  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,  government-sponsored  entities 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."  This
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 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 the  amortization of premiums and the accretion
          of discounts.  Premiums and discounts are included in interest  income
          using 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 value,  and related  unrealized  gains and losses are
          recognized  in the  income  statement.  The  Company  has  no  trading
          securities.

Other investments - Other investments consist of Federal Home Loan Bank stock, a
restricted security, and are carried at cost. Management  periodically evaluates
this  stock  for  impairment  and  makes  any  appropriate   downward  valuation
adjustments when necessary.

Loans and interest  income on loans - Loans are stated at the principal  balance
outstanding,  increased  or reduced  by  deferred  net loan  costs or fees.  The
allowance  for loan  losses is  deducted  from total  loans in the  consolidated
balance  sheets.  Loan  origination  and commitment fees and certain direct loan
origination costs (principally  salaries and employee benefits) are deferred and
amortized as an adjustment of the related loan's yield. Generally, these amounts
are amortized  over the  contractual  life of the related loans or  commitments.
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  nonaccrual  status when  principal  or interest
becomes ninety days past due, or when payment in full is not anticipated. When a
loan is placed on  nonaccrual  status,  interest  accrued  but not  received  is
generally  reversed against interest income. If collectibility is in doubt, cash
receipts on nonaccrual 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.

Allowance for loan losses - The  provision for loan losses  charged to operating
expense  reflects the amount  deemed  appropriate  by management to establish an
adequate  allowance 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.  The provision  for loan losses and  recoveries on loans
previously charged off are added to the allowance.


                                       31
<PAGE>

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 in accordance with 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 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.

Premises  and  equipment  - Premises  and  equipment  are  stated at cost,  less
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 premises and equipment,  the cost and
accumulated  depreciation  are eliminated from the accounts and any gain or loss
is included in income from operations.

Bank owned life  insurance  - The Company has  entered  into  arrangements  that
provide  for  deferred  compensation  for  certain  officers.  Bank  owned  life
insurance  policies  provide an informal and indirect  method for funding  those
arrangements.  The  amounts  recorded  as  bank  owned  life  insurance  in  the
consolidated  balance sheets represent the cash surrender value of the policies.
The  deferred  compensation  liability is included in other  liabilities  at the
present value of the obligation.

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 fair value,
less  estimated  costs to sell, at the date of  foreclosure,  establishing a new
cost basis. Loan losses arising from the acquisition of such property as of that
date  are  charged  against  the  allowance  for  loan  losses.   Subsequent  to
foreclosure,  valuations are periodically performed by management and the assets
are  carried at the lower of the new cost basis or fair  value,  less  estimated
costs  to sell.  Revenues  and  expenses  from  operations  and  changes  in any
subsequent  valuation  allowance are included in other noninterest income in the
Consolidated Statements of Income.

Goodwill - Goodwill is evaluated  for  impairment on at least an annual basis by
comparing the fair value of the  operating  unit(s) from which it arose to their
carrying  value(s).  If the carrying value of an operating unit exceeds its fair
value,  the Company  considers  whether the implied fair value of the  goodwill,
determined 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 recorded any impairments of its goodwill.

Income taxes - The Company uses an asset and  liability  approach for  financial
accounting  and  reporting  of deferred  income  taxes.  Deferred tax assets and
liabilities  are  determined  based  on the  difference  between  the  financial
statement  and income tax bases of assets and  liabilities  as  measured  by the
currently  enacted  tax rates  which are  assumed  will be in effect  when these
differences reverse. If it is more likely than not that some portion or all of a
deferred tax asset will not be realized,  a valuation  allowance is  recognized.
Deferred  income tax expense or credit is the result of changes in deferred  tax
assets and liabilities.

The Company  adopted the  provisions  of Financial  Accounting  Standards  Board
("FASB")  Interpretation  48 ("FIN 48"),  "Accounting  for Uncertainty in Income
Taxes,  an  Interpretation  of FASB Statement 109," during 2007. The adoption of
FIN 48 had no effect on the Company's consolidated financial statements.

 The Company has analyzed its filing  positions in all open tax years in each of
the federal and South Carolina income tax jurisdictions  where it is required to
file income tax returns and believes that those  positions will more likely than
not be sustained upon audit by the taxing authorities.  The Company is no longer
subject to  examination by these taxing  authorities  for years before 2005. The
Company anticipates that no audit adjustments by such authorities will result in
a material  adverse  impact on the  Company's  financial  condition,  results of
operations  or cash flows.  Therefore,  no  reserves  for  uncertain  income tax
adjustments have been recorded pursuant to FIN 48.


                                       32
<PAGE>

Advertising  and  public  relations  expense - The  Company  generally  expenses
advertising and promotion costs as they are 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 share - Net  income  per 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  on the  weighted  average  number  of  common  shares
outstanding  for  diluted  earnings  per share.  On July 19,  2006,  the Company
declared a ten percent stock dividend.

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.

Retirement  plan - The  Company  has a  salary  reduction  profit  sharing  plan
pursuant to Section 401(k) of the Internal  Revenue Code as more fully described
in Note 14. The Company does not sponsor any  postretirement  or  postemployment
benefits,  except  with  respect  to  certain  supplemental  benefits  that were
provided to certain  executive  officers by the Board of Directors  in 2001,  as
more fully described in Note 14.

Fair values of financial  instruments  - SFAS No. 107,  "Disclosures  About Fair
Values of Financial Instruments," requires disclosures of fair value information
for financial instruments, whether or not recognized in the consolidated balance
sheets,  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  and  other
nonfinancial  instruments  such as property and  equipment  and other assets and
liabilities. See Note 17 for fair value disclosures.

Risks  and  uncertainties  - In  the  normal  course  of  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  reprice  or  mature  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.

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

Share-Based  Compensation - The Company has a share-based employee  compensation
plan, which is described more fully in Note 15.  Effective  January 1, 2006, the
Company  adopted  Statement of Financial  Accounting  Standards No. 123 (revised
2004) ("SFAS 123(R)")"  Share-Based  Payment." Prior to adoption of SFAS 123(R),
the  Company  accounted  for this plan  under the  recognition  and  measurement
principles of Accounting  Principles  Board ("APB") Opinion No. 25,  "Accounting
for Stock Issued to Employees," and related interpretations.  Accordingly, prior
to  adoption of SFAS  123(R),  no  share-based  employee  compensation  cost was
reflected in net income,  as all options  granted under the plan had an exercise
price equal to the market  value of the  underlying  common stock on the date of
grant.

Comprehensive  Income - Comprehensive  income consists of net income or loss for
the current period and other comprehensive income, defined as income,  expenses,
gains and  losses  that  bypass  the  consolidated  statement  of income and are
reported directly in a separate  component of shareholders'  equity. The Company
classifies and reports items of other  comprehensive  income  according to their
nature, reports total comprehensive income or loss in the consolidated statement
of changes in shareholders' equity and displays the accumulated balance of other
comprehensive  income or loss separately in the shareholders'  equity section of
the consolidated balance sheet. See Note 16 for further discussion.


NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS

The Bank is required by  regulation to maintain  average cash reserve  balances,
computed by applying  prescribed  percentages  to its various types of deposits,


                                       33
<PAGE>

either at the Bank or in an account  maintained  with the Federal  Reserve Bank.
The average amounts of the cash reserve  balances  required at December 31, 2008
and 2007 were approximately $384 and $287, respectively.


NOTE 3 - INVESTMENT SECURITIES

The aggregate amortized cost and estimated fair values of securities, as well as
gross unrealized gains and losses of securities were as follows:

<TABLE>
<CAPTION>
                                                                                    December 31,
                                                                                    ------------
                                                                  2008                                        2007
                                                                  ----                                        ----
                                                            Gross       Gross                           Gross     Gross
                                                          Unrealized  Unrealized Estimated           Unrealized Unrealized Estimated
                                               Amortized   Holding     Holding     Fair    Amortized    Holding   Holding     Fair
                                                  Cost      Gains       Losses     Value     Cost        Gains    Losses     Value
                                                  ----      -----       ------     -----     ----        -----    ------     -----
                                                                           (Dollars in thousands)
Available-for-sale
<S>                                             <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>
      Government-sponsored
          enterprises (GSEs) ...............    $11,251    $   227    $     -    $11,478    $19,250    $   296    $     2    $19,544
      State, county and
          municipal ........................     13,645         84        336     13,393     13,406         32        149     13,289
      Mortgage-backed
          securities
          issued by GSEs ...................     22,085        705        283     22,507     26,633        266        165     26,734
                                                -------    -------    -------    -------    -------    -------    -------    -------
             Total .........................    $46,981    $ 1,016    $   619    $47,378    $59,289    $   594    $   316    $59,567
                                                =======    =======    =======    =======    =======    =======    =======    =======
</TABLE>


Securities issued by  government-sponsored  enterprises include debt instruments
issued by the Federal Home Loan Banks,  Federal Home Loan Mortgage Company,  and
the Federal National Mortgage Association. The amortized cost and estimated fair
value of securities by contractual maturity are shown below. 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.


                                                        December 31, 2008
                                                        -----------------
                                                        Available-for-sale
                                                        ------------------
                                                      Amortized      Estimated
                                                         Cost        Fair Value
                                                         ----        ----------
                                                        (Dollars in thousands)

Due within one year ............................      $   562         $   563
Due after one through five years ...............       10,576          10,753
Due after five through ten years ...............        6,796           6,936
Due after ten years ............................       29,047          29,126
                                                      -------         -------
                                                      $46,981         $47,378
                                                      =======         =======

The estimated  fair values and gross  unrealized  losses of all of the Company's
investment  securities whose estimated fair values were less than amortized cost
as  of  December  31,  2008  and  2007  which  had  not  been  determined  to be
other-than-temporarily  impaired,  are presented below. The securities have been
aggregated  by  investment  category  and the  length  of time  that  individual
securities have been in a continuous unrealized loss position.

                                       34
<PAGE>
<TABLE>
<CAPTION>
                                                                              December 31, 2008
                                                                              -----------------
                                                       Continuously in Unrealized Loss Position for a Period of
                                                       --------------------------------------------------------
                                                 Less than 12 Months             12 Months or more               Total
                                                 -------------------             -----------------               -----
                                                Estimated      Unrealized       Estimated     Unrealized    Estimated     Unrealized
                                                Fair Value        Loss          Fair Value      Loss        Fair Value       Loss
                                                ----------        ----          ----------      ----        ----------       ----
                                                                                (Dollars in thousands)
Available-for-sale
<S>                                               <C>            <C>                <C>         <C>           <C>            <C>
Government-sponsored
  enterprises (GSEs) .....................        $    -         $    -             $ -         $ -           $    -         $    -
State, county and
  municipal securities ...................         8,757            336               -           -            8,757            336
Mortgage-backed securities
  issued by GSEs .........................           578            283               -           -              578            283
                                                  ------         ------             ---         ---           ------         ------
                     Total ...............        $9,335         $  619             $ -         $ -           $9,335         $  619
                                                  ======         ======             ===         ===           ======         ======
</TABLE>

<TABLE>
<CAPTION>
                                                                              December 31, 2007
                                                                              -----------------
                                                       Continuously in Unrealized Loss Position for a Period of
                                                       --------------------------------------------------------
                                                 Less than 12 Months             12 Months or more               Total
                                                 -------------------             -----------------               -----
                                                Estimated      Unrealized       Estimated     Unrealized    Estimated     Unrealized
                                                Fair Value        Loss          Fair Value      Loss        Fair Value       Loss
                                                ----------        ----          ----------      ----        ----------       ----
                                                                                (Dollars in thousands)
Available-for-sale
<S>                                               <C>            <C>            <C>            <C>            <C>            <C>
Government-sponsored
  enterprises (GSEs) .....................        $     -        $     -        $   998        $     2        $   998        $     2
State, county and
  municipal securities ...................          6,955            117          1,634             32          8,589            149
Mortgage-backed securities
  issued by GSEs .........................          3,021             29          8,579            136         11,600            165
                                                  -------        -------        -------        -------        -------        -------
                     Total ...............        $ 9,976        $   146        $11,211        $   170        $21,187        $   316
                                                  =======        =======        =======        =======        =======        =======
</TABLE>

At December 31, 2008, 22 securities had been  continuously in an unrealized loss
position for less than 12 months and no securities had been  continuously  in an
unrealized  loss  position for 12 months or more.  The Company does not consider
these investments to be  other-than-temporarily  impaired because the unrealized
losses  resulted  primarily  from  higher  interest  rates,  there  have been no
downgrades below  "investment  grade" of the credit ratings of the issuers,  and
there have been no delinquencies of scheduled  principal or interest payments by
any  of  the  issuers.   The   contractual   terms  of   securities   issued  by
government-sponsored  enterprises  do  not  permit  the  issuer  to  settle  the
securities at a price less than the face amount of the securities.  Although the
Company classifies its investment securities as  available-for-sale,  management
has not  determined  that any specific  securities  will be disposed of prior to
maturity  and  believes  that the Company has both the ability and the intent to
hold those investments until a recovery of fair value, including until maturity.
Also,  there  have  been  no  significant  adverse  changes  to a  rating  below
investment grade of the credit ratings of any of the security issuers that would
indicate  that the Company will be unable to collect all  principal and interest
amounts  according to  contractual  terms.  Substantially  all of the issuers of
state,  county and  municipal  securities  held were rated at least  "investment
grade" as of December 31, 2008 and 2007.

The Bank is a member of the  Federal  Home Loan Bank of  Atlanta  ("FHLB")  and,
accordingly,  is required to own restricted stock in that institution in amounts
that may vary from time to time. Because of the restrictions  imposed, the stock
may not be sold to  other  parties,  but is  redeemable  by the FHLB at the same
price as that at which it was acquired by the Bank.  The Company  evaluates this
security for impairment based on the probability of ultimate  recoverability  of
the recorded amount of the investment.  No impairment has been recognized  based
on this evaluation.

During 2008, the Company sold available-for-sale  securities with amortized cost
of $998 for proceeds of $1,014,  resulting in gross  realized  gains of $16. The
income tax  provision  charged to  expense  related to this gain was $6.  During
2007,  the Company  sold  available-for-sale  securities  with  amortized  costs
totaling  $2,473 for proceeds of $2,449,  resulting in gross realized  losses of
$24. The income tax provision credited to expense applicable to the net realized
losses was $8.  During  2006,  the Company  did not sell any  available-for-sale
securities.  There were no transfers of  available-for-sale  securities to other
categories in 2008, 2007 or 2006.

                                       35
<PAGE>

At December 31, 2008 and 2007,  securities  with a carrying value of $22,724 and
$2,199,  respectively,  were pledged as collateral  to secure  Federal Home Loan
Bank advances, public deposits and other purposes.


NOTE 4 - LOANS

Loans consisted of the following:

                                                              December 31,
                                                              ------------
                                                          2008           2007
                                                          ----           ----
                                                        (Dollars in thousands)

Commercial, financial and agricultural .........      $  42,734       $  44,640
Real estate- construction ......................         75,537          84,458
Real estate - mortgage .........................        178,387         128,633
Installment loans to individuals ...............          4,975           4,998
                                                      ---------       ---------
      Loans, gross .............................        301,633         262,729
Allowance for possible loan losses .............         (4,110)         (2,943)
                                                      ---------       ---------
      Loans - net ..............................      $ 297,523       $ 259,786
                                                      =========       =========


At December 31, 2008,  approximately $60,726 of loans were pledged as collateral
to secure amounts borrowed from the Federal Home Loan Bank of Atlanta.

At  December  31, 2008 and 2007,  nonaccrual  loans  totaled  $6,497 and $1,127,
respectively.  The gross interest income that would have been recorded under the
original terms of the nonaccrual loans was $405, $164 and $318 in 2008, 2007 and
2006,  respectively.  The average amounts of impaired loans were $6,920,  $1,255
and $2,171 for 2008, 2007 and 2006, respectively.  Interest income recognized on
impaired loans was $33, $34 and $68 in 2008,  2007 and 2006,  respectively.  The
Bank had loans with payments past due ninety days or more and accruing  interest
totaling $714 as of December 31, 2008 and no such loans as of December 31, 2007.
Variable rate and fixed rate loans totaled $154,628 and $147,006,  respectively,
at December 31, 2008.

Following is a summary of the Company's impaired loans:

                                                                December 31,
                                                                ------------
                                                              2008         2007
                                                              ----         ----
                                                          (Dollars in thousands)
Impaired loans
     No valuation allowance required .....................    $3,912    $  184
     Valuation allowance required ........................     5,887       990
                                                              ------    ------
         Total impaired loans ............................    $9,799    $1,174
                                                              ======    ======

Allowance for loan losses on impaired loans at year end ..    $1,655    $  391
                                                              ======    ======

There were no irrevocable  commitments to lend additional funds to debtors owing
amounts on impaired loans at December 31, 2008.

Transactions in the allowance for loan losses are summarized below:



                                       36
<PAGE>

<TABLE>
<CAPTION>
                                                                                              Years Ended December 31,
                                                                                              ------------------------
                                                                                2008                   2007                  2006
                                                                               -----                   -----                 ----
                                                                                               (Dollars in thousands)

<S>                                                                           <C>                    <C>                    <C>
Balance at January 1 ..........................................               $ 2,943                $ 2,423                $ 3,050
Provision charged to expense ..................................                 2,880                  1,045                  1,110
Recoveries ....................................................                   669                    804                    442
Charge-offs ...................................................                (2,382)                (1,329)                (2,179)
                                                                              -------                -------                -------
Balance at December 31 ........................................               $ 4,110                $ 2,943                $ 2,423
                                                                              =======                =======                =======
</TABLE>

NOTE 5 - PREMISES AND EQUIPMENT

Premises and equipment consisted of the following:

                                                               December 31,
                                                               ------------
                                                            2008            2007
                                                            ----            ----
                                                          (Dollars in thousands)

Land and land improvements .......................       $ 1,214        $ 1,214
Building and leasehold improvements ..............         3,774          3,743
Furniture and equipment ..........................         1,788          1,765
Vehicles .........................................           305            298
                                                         -------        -------
     Total .......................................         7,081          7,020
Accumulated depreciation .........................        (2,337)        (2,124)
                                                         -------        -------
     Premises and equipment, net .................       $ 4,744        $ 4,896
                                                         =======        =======

Depreciation  expense for the years ended  December 31, 2008,  2007 and 2006 was
$327,  $380,  and $388,  respectively.  Estimated  useful  lives and  methods of
depreciation for the principal items follow:

Type of Asset                          Life in Years     Depreciation Method
-------------                          -------------     -------------------
Software                               3                 Straight-line
Furniture and equipment                5 to 7            Straight-line
Buildings and improvements             5 to 40           Straight-line
Vehicles                               3                 Straight-line


                                       37
<PAGE>


NOTE 6 - DEPOSITS

A summary of deposits follows:

                                                               December 31,
                                                               ------------
                                                             2008         2007
                                                             ----         ----
                                                          (Dollars in thousands)

Noninterest bearing demand ...........................     $ 15,331     $ 15,037
Interest bearing:
    Demand accounts ..................................        9,124        5,312
    Money market accounts ............................       92,106       99,496
    Savings ..........................................          608          607
                                                           --------     --------
                                                            117,169      120,452
Time certificates of deposit, less than $100 .........      132,898      101,671
Time certificates of deposit, $100 and over ..........       60,818       83,516
                                                           --------     --------
                                                            193,716      185,187
       Total deposits ................................     $310,885     $305,639
                                                           ========     ========

Interest  expense on time  deposits  greater than $100 was $3,706,  $4,182,  and
$3,294 in 2008, 2007 and 2006, respectively.  Brokered deposits were $40,346 and
$16,857 as of December 31, 2008 and 2007, respectively.  As of December 31, 2008
and 2007, $41 and $17,  respectively,  of overdrawn demand deposit balances were
reclassified as loans.

At December 31, 2008, the scheduled maturities of time deposits are as follows:

                              Year                     Amount
                              ----                     ------
                                   (Dollars in thousands)

                               2009                   $ 164,031
                               2010                      19,082
                               2011                       6,733
                               2012                       2,417
                               2013                       1,452
                         Thereafter                           1
                                                              -
                   Total time deposits                $ 193,716
                                                      =========

NOTE 7 - SHORT-TERM BORROWINGS

The following table presents information about short-term FHLB advances for each
of the years indicated.

<TABLE>
<CAPTION>
                                                            Years Ended December 31,
                                                            ------------------------
                                                        2008           2007          2006
                                                        ----           ----          ----
                                                       (Dollars in thousands)
<S>                                                    <C>           <C>           <C>
Outstanding at end of period .......................   $   -         $5,000        $    -
Weighted average rate, end of period ...............    0.00%          4.40%         0.00%
Maximum amount outstanding at any month end ........   $   -         $5,000        $8,500
Average amount outstanding during the period .......   $  17         $  169        $6,905
Weighted average rate during the period ............    1.98%          5.92%         4.36%
</TABLE>

As of December 31, 2008, the banking  subsidiary had an unused short-term credit
accommodation  available  from  an  unrelated  bank  which  allows  the  banking
subsidiary  to  purchase up to $4,400 of federal  funds.  This line of credit is
available  generally  on a one to  fourteen  day  basis  for  general  corporate
purposes of the Bank and imposes various other  conditions.  The lender reserves
the right to withdraw the line at its option.

                                       38
<PAGE>


NOTE 8 - LONG-TERM DEBT

The  Company's  long-term  debt as of December 31, 2008  consisted of fixed rate
notes issued to the Federal Home Loan Bank of Atlanta as follows:

<TABLE>
<CAPTION>
                                                                                               December 31,
                                                                                               ------------
                                                                                          2008                 2007
                                                                                          ----                 ----
                                                                                          (Dollars in thousands)
<S>                                                                                   <C>                      <C>
Interest rate 3.31%, maturing 1/16/09 ...........................................     $  5,000                 $ -
Interest rate 3.342%, maturing 4/18/11 ..........................................        2,000                   -
Interest rate 3.555%, maturing 5/2/11 ...........................................        2,000                   -
Interest rate 4.09%, maturing 6/20/011 ..........................................        3,000                   -
Interest rate 3.64%, maturing 4/17/12 ...........................................        2,000                   -
Interest rate 3.79%, maturing 5/2/12 ............................................        3,000                   -
Interst rate 3.695%, maturing 5/16/12 ...........................................        3,000                   -
Interest rate 3.42% maturing 3/26/13 ............................................        5,000                   -
Interest rate 3.845%, maturing 4/17/13 ..........................................        2,000                   -
Interest rate 3.852%, maturing 5/16/13 ..........................................        2,000                   -
                                                                                      --------                 ---
               Total ............................................................     $ 29,000                 $ -
                                                                                      ========                 ===
</TABLE>


At December 31, 2008, the Bank had unused credit  availability  of up to $43,078
under  the  FHLB's  various  credit  programs,  subject  to  pledging  and other
requirements.  The amount of eligible  collateral  instruments  available  as of
December 31, 2008 to secure any additional FHLB borrowings totaled approximately
$67,512.


NOTE 9 - CAPITAL TRUST AND JUNIOR SUBORDINATED DEBENTURES

On May 3, 2006,  the Company  sponsored  the  creation  of a Delaware  statutory
trust,  GrandSouth  Capital  Trust I, (the "Trust") and is the sole owner of the
$247 of common securities issued by the Trust. On May 10, 2006, the Trust issued
$8,000 in floating rate capital securities.  The proceeds of this issuance,  and
the amount of the Company's  investment in the common  securities,  were used to
acquire  $8,247  principal   amount  of  the  Company's   floating  rate  junior
subordinated debt securities due in 2036 ("Debentures").  These securities,  and
the accrued  interest  thereon,  now  constitute  the Trust's sole  assets.  The
interest rate associated with the debt securities,  and the distribution rate on
the common  securities of the Trust,  is  adjustable  quarterly at 3 month LIBOR
plus 185 basis points (aggregating 3.275% at December 31, 2008). The Company may
defer interest payments on the Debentures for up to 20 consecutive quarters, but
not  beyond  the  stated  maturity  of the  Debentures.  In the event  that such
interest payments are deferred by the Company, the Trust may defer distributions
on the capital and common  securities.  In such an event,  the Company  would be
restricted in its ability to pay dividends on its common stock and perform under
obligations that are not senior to the Debentures.

The Debentures  are redeemable at par at the option of the Company,  in whole or
in part, on any interest  payment date on or after June 23, 2011.  Prior to that
date,  the Debentures are redeemable at par plus a premium of up to 4.40% of par
upon the  occurrence of certain  events that would have a negative tax effect on
the  Trust  or  that  would  cause  it to be  required  to be  registered  as an
investment  company under the Investment Company Act of 1940 or that would cause
trust preferred securities not to be eligible to be treated as Tier 1 capital by
the Federal Reserve.  Upon repayment or redemption of the Debentures,  the Trust
will use the  proceeds  of the  transaction  to redeem an  equivalent  amount of
capital  securities and common  securities.  The Trust's  obligations  under the
capital securities are unconditionally  guaranteed by the Company. In accordance
with  FASB  Interpretation  No.  46(R),  the  Trust is not  consolidated  in the
Company's financial statements.


                                       39
<PAGE>

Junior subordinated debentures consisted of:

<TABLE>
<CAPTION>
                                                                                                                 December 31,
                                                                                                                 ------------
                                                                                                           2008                2007
                                                                                                           ----                ----
                                                                                                           (Dollars in thousands)
<S>                                                                                                      <C>                  <C>
Junior Subordinated Debt due to Unconsolidated Trust (1),
  dated May 10, 2006 maturing May 10, 2036,
  with variable interest rate based on 3-month LIBOR .....................................               $8,247               $8,247
                                                                                                         ------               ------
               Total .....................................................................               $8,247               $8,247
                                                                                                         ======               ======
</TABLE>
---------------------------------------------
(1) Securities qualify as Tier 1 capital under the regulatory risk-based capital
guidelines, subject to certain limitations.

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 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
incrementally to $2 per month by year sixteen. The Company also leases land upon
which it  constructed a branch  office under a  non-cancelable  operating  lease
which expires in March,  2018. The lease requires monthly lease payments of $0.8
and contains four renewal  options of five years each which  contain  provisions
for adjustments to the monthly lease payments.  The lease agreement requires the
Company to pay all property taxes.

The future minimum lease payments due under the current  operating leases are as
follows:

                                     Year                           Amount
                                     ----                           ------
                                             (Dollars in thousands)

                                     2009                            $  23
                                     2010                               23
                                     2011                               23
                                     2012                               23
                                     2013                               23
                                 Thereafter                            172
                                                                     -----
                                          Total                      $ 287
                                                                     =====

NOTE 11 - 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
revenues and expense for tax and financial reporting purposes:



                                       40
<PAGE>

                                                    Years Ended December 31,
                                                    ------------------------
                                                 2008         2007         2006
                                                 ----         ----         ----
                                                       (Dollars in thousands)
Current
    Federal ..............................     $ 1,106      $ 1,717      $ 1,323
    State ................................          75          145          165
                                               -------      -------      -------
           Total current .................       1,181        1,862        1,488

Deferred
    Federal provision (benefit) ..........        (449)        (282)         273
                                               -------      -------      -------
           Total income tax expense ......     $   732      $ 1,580      $ 1,761
                                               =======      =======      =======

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

                                                               December 31,
                                                               ------------
                                                            2008          2007
                                                            ----          ----
                                                          (Dollars in thousands)
Deferred tax assets
    Allowance for loan losses ......................      $   957       $   628
    Nonaccrual loan interest .......................          138            32
    State net operating loss carryforward ..........          137           113
    Deferred compensation ..........................          127           109
    Other ..........................................          194           147
                                                          -------       -------
           Gross deferred tax assets ...............        1,553         1,029
    Valuation allowance ............................         (137)         (113)
                                                          -------       -------
           Total ...................................        1,416           916
                                                          -------       -------

Deferred tax liabilities
    Unrealized net holding gains on
      available-for-sale securities ................          134            94
    Accelerated depreciation .......................          190           171
    Other ..........................................          139           107
                                                          -------       -------
           Gross deferred tax liabilities ..........          463           372
                                                          -------       -------
Net deferred income tax assets .....................      $   953       $   544
                                                          =======       =======

The  valuation  allowance  is related  to the  Company's  stand-alone  state net
operating  loss  carryforwards.  The portion of the change in net  deferred  tax
assets or liabilities which is related to unrealized holding gains and losses on
available-for-sale   securities  is  charged  or  credited   directly  to  other
comprehensive  income or loss.  The  balance of the change in net  deferred  tax
assets is charged or credited to income tax expense. In 2008, 2007 and 2006, $40
was  charged,  $165 was charged  and $141 was  charged,  respectively,  to other
comprehensive  income or loss. In 2008, 2007 and 2006,  $449 was credited,  $282
was credited and $273 was charged, respectively, to income tax expense.

The  provision  for  income  taxes is  reconciled  to the  amount of income  tax
computed at the federal  statutory  rate of 34% on income before income taxes as
follows:

                                       41
<PAGE>

                                                    Years Ended December 31,
                                                    ------------------------
                                                 2008         2007          2006
                                                 ----         ----          ----
                                                     (Dollars in thousands)

Tax expense at statutory rate ...........     $   707      $ 1,489      $ 1,707
State income tax, net of federal
    income tax benefit ..................          49           96          107
Tax-exempt interest income ..............        (194)        (119)         (22)
Bank-owned life insurance increase ......         (65)         (60)         (57)
Other, net ..............................         235          174           26
                                              -------      -------      -------
           Total ........................     $   732      $ 1,580      $ 1,761
                                              =======      =======      =======

NOTE 12 - RELATED PARTY TRANSACTIONS

Certain  directors,  executive  officers  and  companies  with  which  they  are
affiliated are customers of and have banking  transactions,  including loans and
commitments  to lend,  with the Bank in the ordinary  course of  business.  Such
transactions are 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 and commitment  transactions with directors and
executive officers, including their affiliates, follows:

                                                            Years ended
                                                            December 31,
                                                            ------------
                                                         2008             2007
                                                         ----             ----
                                                         (Dollars in thousands)

Balance, beginning of year ...................         $ 2,427          $ 2,946
New loans ....................................           1,937              611
Less - loan payments .........................            (638)            (904)
Other ........................................               7             (226)
                                                       -------          -------
Balance, end of year .........................         $ 3,733          $ 2,427
                                                       =======          =======

Deposits of directors and their related  interests at December 31, 2008 and 2007
approximated $2,352 and $2,140, respectively.

During the third quarter of 2007,  the  Company's  Chief  Executive  Officer and
Chairman  of the  Board  purchased  from  the Bank a 100%  participation  in two
nonaccrual loans of an unaffiliated  borrower totaling $811. Interest of $33 was
collected in connection with the sale of the  participation  interest.  The Bank
made no  commitments  nor entered into any other  agreements  that would make it
contingently liable to repurchase the participated interest.

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 arrangements totaled $23, $9 and $9 in 2008, 2007 and 2006, respectively.


NOTE 13 - 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 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
sheets.  The  contract  amounts  of those  instruments  reflect  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 statndby
letters  of  credit  is  represented  by  the   contractual   amounts  of  those


                                       42
<PAGE>

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,  2008  and  2007,  unfunded
commitments  to extend credit were $66,748 and $76,874,  respectively.  The Bank
evaluates each customer's  creditworthiness  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,  and commercial and residential real estate. At December 31, 2008 and
2007,  there  were  outstanding  letters  of credit  totaling  $1,200  and $897,
respectively.


NOTE 14 - 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 2008, 2007 and 2006
were $125, $118 and $67, 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 (income)  expense related to these benefits of $52, $4
and $61 in 2008, 2007 and 2006, respectively.


NOTE 15 - STOCK OPTION PLAN

During 1998, the Board of Directors approved a stock option plan for the benefit
of the directors, officers and employees. The plan provided that the Board could
grant  options to  purchase  up to  856,028  shares of common  stock  (after the
shareholders  approved an amendment to increase the number of shares in the plan
at the 2005 Annual  Meeting)  at an  exercise  price per share not less than the
fair  market  value on the date of grant.  All  options  granted  to  directors,
officers  and  employees  vest 20 percent each year for five years and expire 10
years from the grant date.  The related  compensation  expense of the options is
recognized over the vesting period.  The Company measures the fair value of each
option award on the date of grant using the Black-Scholes  option-pricing  model
with the following  assumptions  used for awards granted in 2008, 2007 and 2006,
as indicated in the following table:

                                                        Years Ended December 31,
                                                        ------------------------
                                                       2008      2007       2006
                                                       ----      ----       ----
Assumptions:

Dividend yield ................................        0.74%     0.72%     0.64%
Weighted average risk-free interest rate ......        3.11%     4.55%     5.04%
Weighted average expected volatility ..........       26.61%    60.30%    31.14%
Weighted average expected life in years .......        6.50      6.00      8.00

Weighted average grant date fair value ........       $3.32     $6.35     $5.42

The Company determines the assumptions used in the Black-Scholes  option-pricing
model as follows:  the dividend yield is based on the historical  dividend yield
of the Company's stock, adjusted to reflect the expected dividend yield over the
expected life of the option,  the  risk-free  interest rate is based on the U.S.
Treasury yield curve in effect at the time of the grant;  volatility is based on
historical  volatility adjusted to reflect the ways in which current information
indicates  that the future is reasonably  expected to differ from the past;  and
the  average  life is based on  historical  behaviors  of  employees  related to
exercises, forfeitures and cancellations.

The following table summarizes the activity during 2008 related to stock options
awarded by the Company:

                                       43
<PAGE>

<TABLE>
<CAPTION>
                                                                                      Year Ended December 31, 2008
                                                                                      ----------------------------
                                                                                                       Weighted Average
                                                                                         Weighted         Remaining
                                                                                      Average Exercise  Contractual Life  Intrinsic
                                                                      Shares          Price Per Share        (Years)       Value
                                                                      ------          ---------------        -------       -----
                                                                             (Dollars in thousands, except per share)
<S>                                                                   <C>                 <C>                  <C>          <C>
Outstanding at beginning of year ........................             489,396             $    6.04
Granted .................................................               5,500                 10.75
Exercised ...............................................            (192,207)                 3.25
Forfeited or expired ....................................                   -                                                      -
                                                                     --------
Outstanding at end of year ..............................             302,689             $    7.90            5.40         $    116
                                                                     ========                                               ========

Options outstanding .....................................             302,689             $    7.90            5.40         $    116
  and expected to vest

Options exercisable at year-end .........................             211,374             $    6.73            4.66         $    116
</TABLE>

The total  intrinsic  value of options  exercised  in 2008 and 2007 was $896 and
$57, respectively.

As of December 31, 2008, total  compensation costs of unvested options that have
not yet been recognized were $240. Those  compensation  costs will be recognized
over the remaining weighted average vesting period of 1.3 years.

Intrinsic value is calculated for shares granted, outstanding and exercisable by
taking the closing price of the Company's  common stock as of December 31, 2008,
as reported by the OTCBB,  and  subtracting the exercise price of the each stock
option grant. When the result is a positive number, the difference is multiplied
by the number of options  outstanding for each such grant and the total of those
values is shown in the table.

Intrinsic value for shares  exercised  represents the closing price of the stock
on the date of exercise as reported by the OTCBB less the actual  exercise price
of the options exercised  multiplied by the number of options  exercised.  These
intrinsic  values  are  calculated  for each  exercise  during  the year and the
resulting total is presented.

All share and per share  values have been  retroactively  restated for all stock
dividends since the date the options were granted. The Company issues authorized
but unissued shares to satisfy option  exercises.  The stock option plan expired
in  2008.  Consequently,   unexpired  options  granted  under  the  Plan  remain
outstanding subject to their terms, but no more options may be granted under the
Plan.


NOTE 16 - SHAREHOLDERS' EQUITY

Preferred  Stock - On December 22, 2008,  the  Company's  shareholders  approved
amendments of its Articles of  Incorporation  authorizing  the issuance of up to
20,000,000  shares of preferred stock in one or more series. On January 9, 2009,
the Company entered into and consummated a Letter Agreement  ("Agreement")  with
the United  States  Department  of the  Treasury  ("Treasury").  Pursuant to the
Agreement,  the  Company  issued  9,000  shares  of its  Fixed  Rate  Cumulative
Perpetual  Preferred Stock,  Series T, having a liquidation  amount per share of
$1,000 to the Treasury for proceeds of $9,000.  Cumulative dividends are payable
at a rate of 5% per year for each of the first  five years and  thereafter  at a
rate of 9% per year.  The Company may not pay cash dividends on its common stock
if the preferred dividends are in arrears.  Until January 9, 2012, the Agreement
generally  restricts the Company's  ability to redeem these preferred shares, to
increase its common stock dividends,  or to repurchase its common stock or other
equity or capital  securities.  Furthermore,  the terms of the  Agreement  could
limit the amount,  nature,  and tax  deductibility  of compensation  paid by the
Company to its  executive  management.  These  shares  generally  have no voting
rights.

Without the payment of any additional consideration,  the Treasury also received
and  immediately  exercised  a warrant to purchase  450 shares of the  Company's
Fixed Rate Cumulative  Perpetual  Preferred  Stock,  Series W. The terms of this
series of  preferred  stock are  nearly  identical  to the terms of the Series T
Preferred  Stock,  except  that the Series W  Preferred  Stock  pays  cumulative
dividends  at a rate of 9% per year and may not be  redeemed  while share of the
Series T Preferred Stock are outstanding.


                                       44
<PAGE>

Both Series T and Series W Preferred  Stock are treated as  components of Tier 1
capital for purposes of computing the Company's regulatory capital ratios.

Restrictions  on  Subsidiary  Dividends,  Loans or Advances - In addition to the
restrictions  specified  under the heading  "Preferred  Stock,"  South  Carolina
banking  regulations  restrict  the  amount of  dividends  that banks can pay to
shareholders.  Any of the banking  subsidiary's  dividends to the parent company
which exceed in amount the subsidiary's current year-to-date earnings ($1,659 at
December  31,  2008) are  subject to the prior  approval  of the South  Carolina
Commissioner of Banking.  Therefore,  $28,820 of the Company's equity in the net
assets  of the Bank  was  restricted  as of  December  31,  2008.  In  addition,
dividends  paid  by the  banking  subsidiary  to the  parent  company  would  be
prohibited if the effect  thereof  would cause the Bank's  capital to be reduced
below  applicable  minimum  capital  requirements.  Under Federal  Reserve Board
regulations, the amounts of loans or advances from the banking subsidiary to the
parent  company are  generally  limited to 10% of the Bank's  capital  stock and
surplus on a secured basis. Furthermore,  in the event that interest payments on
the junior subordinated debentures (see Note 9) are deferred by the Company, the
Company would be restricted in its ability to pay dividends on its common stock.
The terms of the Company's  preferred stock also impose limits on its ability to
pay dividends.

Stock Dividends - The Company's Board of Directors declared a 10% stock dividend
on July 19, 2006. All per share information has been  retroactively  adjusted to
give effect to the stock dividend.

Accumulated  Other  Comprehensive  Income  (Loss) - As of December  31, 2008 and
2007,  accumulated other comprehensive  income (loss) included as a component of
shareholders' equity in the consolidated balance sheets consisted of accumulated
changes in the  unrealized  holding  gains and  (losses)  on  available-for-sale
securities, net of income tax effects, amounting to $263 and $184, respectively.

Earnings  per Share - Net  income  per  share,  basic and net  income per share,
assuming dilution, were computed as follows:

<TABLE>
<CAPTION>
                                                                                             Years Ended December 31,
                                                                                             ------------------------
                                                                                 2008                  2007                 2006
                                                                                 -----                 -----                ----
                                                                                 (Dollars in thousands, except per share amounts)
Net income per share, basic
<S>                                                                            <C>                  <C>                   <C>
  Numerator - net income ..........................................            $   1,348            $    2,799            $    3,260
                                                                               =========            ==========            ==========
  Denominator
    Weighted average common shares
      issued and outstanding ......................................            3,454,515             3,373,909             3,372,065
                                                                               =========            ==========            ==========

      Net income per share, basic .................................            $     .39            $      .83            $      .97
                                                                               =========            ==========            ==========


Net income per share, assuming dilution
  Numerator
    Net income ....................................................            $   1,348            $    2,799            $    3,260
                                                                               =========            ==========            ==========
  Denominator
    Weighted average common shares
      issued and outstanding ......................................            3,454,515             3,373,909             3,372,065
    Effect of dilutive stock options ..............................                    -               251,042               281,784
                                                                               ---------            ----------            ----------
               Total shares .......................................            3,454,515             3,624,951             3,653,849
                                                                               =========            ==========            ==========

      Net income per share, assuming dilution .....................            $     .39            $      .77            $      .89
                                                                               =========            ==========            ==========
</TABLE>

Weighted average common shares outstanding have been  retroactively  restated to
reflect a 10% stock dividend declared on July 19, 2006.

Regulatory Capital - All bank holding companies and banks are subject to various
regulatory  capital  requirements  administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory, and


                                       45
<PAGE>

possibly  additional  discretionary,  actions by regulators that, if undertaken,
could have a direct  material  effect on the  Company's  consolidated  financial
statements.  Under capital adequacy guidelines and the regulatory  framework for
prompt  corrective  action,  bank holding companies and banks must meet specific
capital  guidelines  that  involve   quantitative   measures  of  their  assets,
liabilities,  and certain off-balance-sheet items as calculated under regulatory
accounting  practices.  Capital amounts and  classification  are also subject to
qualitative judgments by the regulators about components,  risk weightings,  and
other factors.

Quantitative  measures  established  by  regulation to ensure  capital  adequacy
require the Company and its banking  subsidiary to maintain  minimum amounts and
ratios set forth in the table  below of Total and Tier 1 Capital,  as defined in
the regulations,  to risk weighted assets, as defined, and of Tier 1 Capital, as
defined, to average assets, as defined.  Management believes, as of December 31,
2008 and 2007,  that the Company and its  subsidiary  bank  exceeded all capital
adequacy minimum requirements.

As of December 31, 2008, the most recent  notification from the FDIC categorized
the  Bank  as  well  capitalized  under  the  regulatory  framework  for  prompt
corrective  action.  To be  categorized  as well  capitalized  as defined in the
Federal Deposit  Insurance Act, the Bank must maintain minimum total risk-based,
Tier 1 risk-based,  and Tier 1 leverage ratios as set forth in the table.  There
are no conditions or events since that  notification  that  management  believes
have changed the Bank's category.  Bank holding  companies with higher levels of
risk, or that are experiencing or anticipating  significant growth, are expected
by the  Federal  Reserve  to  maintain  capital  well  above the  minimums.  The
Company's and Bank's actual capital amounts and ratios are also presented in the
table.

<TABLE>
<CAPTION>
                                                                                          Minimum for               Minimum to be
                                                                  Actual                Capital Adequacy          Well Capitalized
                                                                  ------                ----------------          ----------------
                                                            Amount         Ratio       Amount        Ratio       Amount       Ratio
                                                            ------         -----       ------        -----       ------       -----
December 31, 2008                                                                    (Dollars in thousands)
     Tier 1 Capital (to Average Assets)
<S>                                                         <C>             <C>      <C>              <C>      <C>           <C>
        Company .......................................     $ 30,999        8.3%     $ 14,942         4.0%           NA          NA
        GrandSouth Bank ...............................       30,112        8.1%       14,930         4.0%     $ 18,641        5.0%

     Tier 1 Capital (to Risk Weighted Assets)
        Company .......................................     $ 30,999       10.0%     $ 12,454         4.0%           NA          NA
        GrandSouth Bank ...............................       30,112        9.7%       12,440         4.0%     $ 18,660        6.0%

     Total Capital (to Risk Weighted Assets)
        Company .......................................    $ 35,135        11.3%     $ 24,908         8.0%           NA          NA
        GrandSouth Bank ...............................       34,002       10.9%       24,880         8.0%     $ 31,099       10.0%

December 31, 2007
     Tier 1 Capital (to Average Assets)
        Company .......................................     $ 28,850        8.4%     $ 13,750         4.0%           NA          NA
        GrandSouth Bank ...............................       27,526        8.6%       12,869         4.0%     $ 16,087        5.0%

     Tier 1 Capital (to Risk Weighted Assets)
        Company .......................................     $ 28,850       10.1%     $ 11,414         4.0%           NA          NA
        GrandSouth Bank ...............................       27,526        9.6%       11,432         4.0%     $ 17,148        6.0%

     Total Capital (to Risk Weighted Assets)
        Company .......................................     $ 32,489       11.4%     $ 22,828         8.0%           NA          NA
        GrandSouth Bank ...............................       30,469       10.7%       22,864         8.0%     $ 28,580       10.0%
</TABLE>

NOTE 17 - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS

SFAS No. 157, "Fair Value  Measurements," which became effective for the Company
on January 1, 2008 provides a consistent definition of fair value, establishes a
framework for measuring fair value and expands the disclosures about fair value.
In February 2008, the Financial  Accounting Standards Board Staff issued FSP FAS
157-2 which deferred for one year the effective date of the  application of SFAS
No.  157 to  nonfinancial  assets  and  liabilities,  except  for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually).  Accordingly,  the Company has only partially applied
SFAS No. 157.  There are currently no major  categories of assets or liabilities
disclosed at fair value in the  financial  statements  for which the Company has
not applied  the  provisions  of SFAS No.  157. It is expected  that the initial
application of the deferred  provisions of SFAS No. 157 will not have a material
effect on the  Company's  financial  position,  its result of operations or cash
flows.


                                       46
<PAGE>

No cumulative effect adjustments were required upon initial  application of SFAS
No.  157.  Available-for-sale  securities  continue to be measured at fair value
with  unrealized  gains and  losses,  net of  income  taxes,  recorded  in other
comprehensive income or (loss).

SFAS No.  159,  "The Fair  Value  Option  for  Financial  Assets  and  Financial
Liabilities,  Including an amendment of FASB  Statement  No. 115," was effective
for the Company on January 1, 2008. This Statement permits entities to choose to
measure many  financial  instruments  and certain other items at fair value with
changes in the unrealized  gains and losses on those items included in earnings.
The Company's  decision  about whether to elect the fair value option  generally
may be applied on an  instrument-by-instrument  basis, is irrevocable  (unless a
new election date  occurs),  and is applied to an entire  instrument  and not to
only specific  risks,  specific cash flows or portions of that  instrument.  The
objective  of the  Statement  is to improve  financial  reporting  by  providing
entities with the  opportunity to mitigate the  volatility of reported  earnings
caused by  measuring  related  assets and  liabilities  without  having to apply
complex hedge  accounting  provisions.  The Statement also provided for enhanced
presentation  and  disclosure  requirements  to facilitate  comparisons  between
entities  that choose  different  measurement  attributes  for similar  types of
assets and liabilities.  Generally, the option to value an asset or liability at
fair value must be exercised at the date that the Company first  recognizes  the
asset or  liability.  The  Company  has not  elected  to  value  any  assets  or
liabilities at fair value pursuant to SFAS No. 159.

Under SFAS No.  157,  fair value is the price that would be  received to sell an
asset  or  transfer  a  liability  in  an  orderly  transaction  between  market
participants at the measurement date. Fair value under this Standard may reflect
actual transaction prices or may reflect the application of valuation techniques
if the transaction was between related parties,  the transaction  occurred under
duress, or other circumstances where the transaction price may not be indicative
of  the  fair  value  of the  particular  asset  or  liability.  When  valuation
techniques are used, the inputs may be either  observable or unobservable.  SFAS
157 establishes a three level hierarchy for fair value  measurements  based upon
the transparency of inputs to the valuation technique. Assets or liabilities may
be measured at fair value on either a recurring basis or a non-recurring  basis.
SFAS No. 157 proscribes different  disclosures  requirements for those different
measurement attributes.

When available,  fair value is based upon quoted market prices in active markets
for identical  assets or liabilities  (Level 1 inputs) or for similar assets and
liabilities  or upon  inputs  that are  observable  for the asset or  liability,
either directly or indirectly (Level 2 inputs). When neither Level 1 nor Level 2
inputs are  available,  the Company  may use  unobservable  inputs  which may be
significant to the fair value  measurement  (Level 3). The lowest level of input
that  is  significant  to  the  fair  value  measurement  determines  an  item's
categorization within the fair value hierarchy.

The  following  is  a  description  of  the  valuation  methodologies  used  for
instruments  measured  at fair value on a  recurring  basis in the  Consolidated
Balance  Sheets,  including  the  general  classification  of  such  instruments
pursuant to the valuation hierarchy.

<TABLE>
<CAPTION>
                                                     Fair Value Measurement at Reporting Date Using
                                                     ----------------------------------------------
                                                   Quoted Prices
                                                     in Active         Significant
                                                    Markets for           Other           Significant
                                                     Identical         Observable        Unobservable
                                                       Assets            Inputs             Inputs
Description                    December 31, 2008     (Level 1)         (Level 2)          (Level 3)
-----------                    -----------------     ----------        ----------         ---------
                                                        (Dollars in thousands)

<S>                                                   <C>                <C>                <C>
Securities available-for-sale                         $      -           $ 47,378           $     -
</TABLE>

Pricing for the  Company's  securities  available-for-sale  is obtained  from an
independent third-party that uses a process that may incorporate current prices,
benchmark  yields,  broker/dealer  quotes,  issuer spreads,  two-sided  markets,
benchmark  securities,  bids,  offers,  other  reference  items and industry and
economic events that a market  participant would be expected to use as inputs in
valuing the  securities.  Not all of the inputs listed apply to each  individual
security at each measurement  date. The independent third party assigns specific
securities  into an "asset  class" for the purpose of assigning  the  applicable
level of the fair value hierarchy used to value the securities. The methods used
after adoption of SFAS No. 157 are consistent with the methods used previously.



                                       47
<PAGE>

The following is a description of the valuation methodologies used for financial
instruments  measured at fair value on a non-recurring basis in the Consolidated
Balance Sheets including the general classification of such instruments pursuant
to the valuation hierarchy.

<TABLE>
<CAPTION>
                                                     Fair Value Measurement at Reporting Date Using
                                                     ----------------------------------------------
                                                   Quoted Prices
                                                     in Active         Significant
                                                    Markets for           Other           Significant
                                                     Identical         Observable        Unobservable
                                                       Assets            Inputs             Inputs
Description                    December 31, 2008     (Level 1)         (Level 2)          (Level 3)
-----------                    -----------------     ----------        ----------         ---------
                                                        (Dollars in thousands)
<S>                                                   <C>                <C>               <C>
Collateral-dependent impaired loans                   $      -           $ 9,799           $      -
</TABLE>

Fair values of collateral dependent impaired loans are estimated based on recent
appraisals of the underlying properties or other information derived from market
sources.

SFAS No. 107,  "Disclosures  about Fair  Values of  Financial  Instruments,"  as
amended, requires disclosure of the estimated fair value of on-balance sheet and
off-balance sheet financial  instruments.  A financial  instrument is defined by
SFAS No.  107 as cash,  evidence  of an  ownership  interest  in an  entity or a
contract  that creates a  contractual  obligation or right to deliver or receive
cash or  another  financial  instrument  from a  second  entity  on  potentially
favorable or unfavorable terms.

Fair  value  estimates  are made at a specific  point in time based on  relevant
market  information  about the  financial  instrument.  These  estimates  do not
reflect any premium or discount  that could result from offering for sale at one
time the Company's  entire  holdings of a particular  financial  instrument.  No
active  trading  market  exists  for a  significant  portion  of  the  Company's
financial  instruments.  Fair value estimates for these instruments are based on
management's  judgments  regarding  future  expected  loss  experience,  current
economic conditions, risk characteristics of various financial instruments,  and
other   factors.   These   estimates  are   subjective  in  nature  and  involve
uncertainties  and  matters of  significant  judgment  and  therefore  cannot be
determined with precision. Changes in assumptions could significantly affect the
estimates.

Fair value  estimates are based on existing  on-and-off  balance sheet financial
instruments  without  attempting  to estimate  the value of  anticipated  future
business  and the  value of  assets  and  liabilities  that  are not  considered
financial instruments.  Significant assets and liabilities that are specifically
excluded  from the  disclosure  requirements  include net  deferred  tax assets,
interest  receivable and payable,  assets acquired in settlement of loans,  bank
owned life insurance,  goodwill, other assets and liabilities,  and premises and
equipment.  In addition, the income tax ramifications related to the realization
of the unrealized  gains and losses can have a significant  effect on fair value
estimates and have not been considered in the estimates.

The following methods and assumptions were used by the Company in estimating the
fair values of its financial instruments:

For cash and due  from  banks  and  federal  funds  sold,  the  carrying  amount
approximates fair value because these instruments generally mature in 90 days or
less.  The  carrying  amounts  of  interest   receivable  and  interest  payable
approximate their fair values.

The fair value of  certificates  of deposit with other banks are estimated using
discounted  cash flow  analyses,  using  interest  rates  currently  offered for
instruments with the same remaining maturity.

The fair value of debt securities issued by government-sponsored  enterprises is
estimated based on published closing quotations. The fair value of state, county
and municipal  securities is generally not available from published  quotations;
consequently,  their fair values estimates are based on matrix pricing or quoted
market prices of similar  instruments  adjusted for credit  quality  differences
between the quoted  instruments and the securities being valued.  Fair value for
mortgage-backed securities is estimated primarily using dealers' quotes.

The fair value of other investments approximates the carrying amount.

                                       48
<PAGE>

Fair values are estimated for loans using  discounted cash flow analyses,  using
interest  rates  currently  offered  for loans  with  similar  terms and  credit
quality.  The Company  does not engage in  originating,  holding,  guaranteeing,
servicing or investing in loans where the terms of the loan product give rise to
a concentration of credit risk.

The fair value of deposits with no stated maturity  (noninterest bearing demand,
interest  bearing demand and money market  accounts and savings) is estimated as
the  amount  payable  on  demand,  or  carrying  amount.  The fair value of time
deposits is estimated  using a  discounted  cash flow  calculation  that applies
rates currently offered to aggregate expected maturities.

The fair  values  of the  Company's  short-term  borrowings,  approximate  their
carrying amounts.

The fair values of variable rate long-term debt instruments are estimated at the
carrying amount.

The estimated fair values of  off-balance-sheet  financial  instruments  such as
loan  commitments  and standby  letters of credit are generally  based upon fees
charged to enter into  similar  agreements,  taking into  account the  remaining
terms  of the  agreements  and the  counterparties'  creditworthiness.  The vast
majority  of the  banking  subsidiary's  loan  commitments  do not  involve  the
charging of a fee,  and fees  associated  with  outstanding  standby  letters of
credit are not material. For loan commitments and standby letters of credit, the
committed  interest rates are either  variable or approximate  current  interest
rates offered for similar commitments.  Therefore,  the estimated fair values of
these off-balance-sheet financial instruments are nominal.

The following is a summary of the carrying  amounts and estimated fair values of
the Company's financial assets and liabilities:

<TABLE>
<CAPTION>
                                                                                                 December 31,
                                                                                                 ------------
                                                                                       2008                        2007
                                                                                       ----                        ----
                                                                               Carrying     Estimated      Carrying     Estimated
                                                                                Amount      Fair Value      Amount      Fair Value
                                                                               of Assets     of Assets     of Assets     of Assets
                                                                             (Liabilities) (Liabilities) (Liabilities) (Liabilities)
                                                                             ------------- ------------- ------------- -------------
                                                                                            (Dollars in thousands)
Financial Assets:
<S>                                                                            <C>            <C>            <C>            <C>
  Cash and due from banks ..............................................       $  2,329       $  2,329       $  4,287       $  4,287
  Interest bearing transaction accounts with other banks ...............          8,453          8,453            298            298
  Federal funds sold ...................................................            429            429          4,420          4,420
  Certificates of deposit with other banks .............................          2,000          2,104              -              -
  Securities available-for-sale ........................................         47,378         47,378         59,567         59,567
  Other investments ....................................................          1,926          1,926            765            765
  Loans, net ...........................................................        297,523        297,872        259,786        259,911
  Interest receivable ..................................................          2,077          2,077          2,313          2,313

Financial Liabilities:
  Deposits .............................................................        310,885        313,445        305,639        306,514
  Short-term borrowings ................................................              -              -          5,000          5,000
  Long-term debt .......................................................         37,247         38,661          8,247          8,247
  Interest payable .....................................................            639            639            754            754
</TABLE>

<TABLE>
<CAPTION>
                                                                       Notional        Estimated           Notional        Estimated
                                                                        Amount         Fair Value           Amount        Fair Value
                                                                        ------         ----------           ------        ----------
Off-balance-sheet commitments
<S>                                                                   <C>                  <C>              <C>                  <C>
  Loan commitments .....................................              $66,748              $ -              $76,874              $ -
  Standby letters of credit ............................                1,200                -                  897                -
</TABLE>


                                       49
<PAGE>

NOTE 18 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Impact of Recent Accounting Changes

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

In December  2007,  the FASB issued SFAS No. 160,  "Noncontrolling  Interests in
Consolidated  Financial  Statements - an amendment of ARB No. 51" ("SFAS  160").
SFAS  160   establishes   new  accounting   and  reporting   standards  for  the
noncontrolling  interest  in a  subsidiary  and  for  the  deconsolidation  of a
subsidiary.  Before this  statement,  limited  guidance  existed  for  reporting
noncontrolling interests (formerly known as "minority interests").  As a result,
diversity in practice exists. In some cases,  minority interests are reported as
a liability and in other cases it is reported in the mezzanine  section  between
liabilities  and equity.  Specifically,  SFAS 160 requires the  recognition of a
noncontrolling  interest as equity in the consolidated  financial statements and
separate from the parent company's equity. The amount of net income attributable
to the  noncontrolling  interest will be included in consolidated  net income in
the consolidated income statement. SFAS 160 clarifies that changes in a parent's
ownership  interest in a subsidiary  that do not result in  deconsolidation  are
equity transaction if the parent retains its controlling  financial interest. In
addition,  this  statement  requires that parent  recognize  gain or loss in net
income when a subsidiary is  deconsolidated.  Such gain or loss will be measured
using  the  fair  value  of  the   noncontrolling   equity   investment  on  the
deconsolidation  date. SFAS 160 also includes expanded  disclosure  requirements
regarding the interest of the parent and its noncontrolling  interests. SFAS 160
was  effective  for the  Company  on  January  1,  2009 and had no effect on the
Company's financial position, results of operations or cash flows.

In February 2008, the FASB issued FASB Staff Position No. 142-3,  "Determination
of the Useful Life of Intangible  Assets"  ("FSP  142-3").  This Staff  Position
amends the factors that should be considered in developing  renewal or extension
assumptions  used to determine the useful life of a recognized  intangible asset
under SFAS No. 142,  "Goodwill and Other  Intangible  Assets" ("SFAS 142").  The
intent of this Staff Position is to improve the  consistency  between the useful
life of a recognized  intangible asset under SFAS 142 and the period of expected
cash  flows used to measure  the fair value of the asset  under SFAS  141(R) and
other U.S. generally  accepted  accounting  principles.  This Staff Position was
effective  for the Company on January 1, 2009 and had no material  impact on the
Company's financial position, results of operations or cash flows.

In March  2008,  the FASB issued SFAS No.  161,  "Disclosures  about  Derivative
Instruments and Hedging  Activities"  ("SFAS 161").  SFAS 161 requires  enhanced
disclosure  about  an  entity's  derivative  and  hedging  activities,   thereby
improving  the  transparency  of  financial  reporting.  It  requires  that  the
objectives for using derivative  instruments be disclosed in terms of underlying
risk and accounting  designation thereby conveying the purpose of derivative use
in terms of the risks that the entity is intending to manage. SFAS was effective
for the Company on January 1, 2009 and will result in  additional  disclosure if
the Company enters into any material derivative or hedging activities.

In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally  Accepted
Accounting  Principles"  ("SFAS  162").  SFAS  162  identifies  the  sources  of
accounting principles and the framework for selecting the principles used in the
preparation  of  financial  statements  of  nongovernmental  entities  that  are
presented in conformity with generally accepted  accounting  principles ("GAAP")
is the United States (the GAAP hierarchy).  SFAS 162 was effective  November 15,
2008. The FASB has stated that it does not expect that SFAS 162 will result in a
change in current  practice.  The  application  of SFAS 162 had no effect on the
Company's financial position, results of operations or cash flows.


                                       50
<PAGE>

In May 2008, the FASB issued FASB Staff Position No. APB 14-1,  "Accounting  for
Convertible  Debt  Instruments  That  May Be  Settled  in Cash  upon  Conversion
(Including  Partial  Cash  Settlement)"  ("FSP APB 14-1").  This Staff  Position
specifies that issuers of convertible  debt  instruments  that may be settled in
cash upon  conversion  should  separately  account for the  liability and equity
components  in a manner  that will  reflect  the  entity's  nonconvertible  debt
borrowing  rate when interest cost is recognized in subsequent  period.  FSP APB
14-1  provides  guidance  for  initial  and  subsequent  measurement  as well as
derecognition provisions. The Staff Position was effective as of January 1, 2009
and had no  material  effect on the  Company's  financial  position,  results of
operations or cash flows.

In June 2008, the FASB issued FASB Staff Position No. EITF 03-6-1,  "Determining
Whether   Instruments   Granted  in   Share-Based   Payment   Transactions   are
Participating Securities" ("FSP EITF 03-6-1"). This Staff Position provides that
unvested  share-based  payment  awards  that  contain  nonforfeitable  rights to
dividends  or dividend  equivalents  are  participating  securities  and must be
included in the earnings per share  computation.  FSP EITF 03-6-1 was  effective
January 1, 2009 and had no effect on the Company's financial  position,  results
of operations, earnings per share or cash flows.

FASB  Staff  Position  SFAS  133-1  and  FIN  45-4  "Disclosures   about  Credit
Derivatives and Certain  Guarantees:  An Amendment of FASB Statement No. 133 and
FASB  Interpretation  No. 45; and  Clarification  of the Effective  Date of FASB
Statement No. 161" ("FSP SFAS 133-1 and FIN 45-4") was issued in September  2008
effective for reporting  periods  (annual or interim)  ending after November 15,
2008.  FSP SFAS  133-1 and FIN 45-4  amends  SFAS 133 to  require  the seller of
credit derivatives to disclose the nature of the credit derivative,  the maximum
potential amount of future payments,  the fair value of the derivative,  and the
nature of any recourse  provisions.  Disclosures  must be made for entire hybrid
instruments that have embedded credit derivatives.

FSP SFAS 133-1 and FIN 45-4 also amends FASB Interpretation No. 45 ("FIN 45") to
require disclosure of the current status of the payment/performance  risk of the
credit derivative guarantee. If an entity utilizes internal groupings as a basis
for the risk,  disclosure  must also be made of how the groupings are determined
and how the risks are managed.

The Staff Position encourages that the amendments be provided in periods earlier
than the effective  date to facilitate  comparisons at initial  adoption.  After
initial  adoption,  comparative  disclosures  are required  only for  subsequent
periods.

FSP SFAS 133-1 and FIN 45-4  clarifies the effective  date of SFAS 161 such that
required  disclosures  should be provided for any  reporting  period  (annual or
interim)  beginning after November 15, 2008. The adoption of this Staff Position
had  no  material  effect  on  the  Company's  financial  position,  results  of
operations or cash flows.

The Securities and Exchange  Commission's Office of the Chief Accountant and the
staff of the FASB issued press  release  2008-234 on September  30, 2008 ("Press
Release")  to  provide  clarification  about fair  value  accounting.  The Press
Release includes  guidance on the use of management's  internal  assumptions and
the use of  "market"  quotes.  It  also  reiterates  the  factors  in SEC  Staff
Accounting  Bulletin  Topic 5M  which  should  be  considered  when  determining
other-than-temporary  impairment:  the  length  of time and  extent to which the
market  value  has been  less  than  cost;  financial  condition  and  near-term
prospects of the issuer;  and the intent and ability of the holder to retain its
investment for a period of time sufficient to allow for any anticipated recovery
in market value.

On October 10, 2008, the FASB issued FSP SFAS 157-3  "Determining the Fair Value
of a Financial  Asset When the Market for That Asset Is Not  Active"  ("FSP SFAS
157-3").  This FSP  clarifies  the  application  of SFAS  No.  157  "Fair  Value
Measurements"  ) (see Note N) in a market  that is not  active and  provides  an
example to illustrate  key  considerations  in  determining  the fair value of a
financial  asset  when the  market  for that  asset is not  active.  The FSP was
effective upon issuance,  including prior periods for which financial statements
had not yet been issued.

The Company considered  guidance in the Press Release and in FSP SFAS 157-3 when
conducting  its review for  other-than  temporary  impairment as of December 31,
2008 as discussed in Note 3.

FSP SFAS 140-4 and FIN 46(R)-8  "Disclosures  by Public  Entities  (Enterprises)
about Transfers of Financial Assets and Interest in Variable Interest  Entities"
was issued in December 2008 to require public  companies to disclose  additional
information  about  transfers  of  financial  assets  and any  involvement  with
variable interest entities. The FSP also requires certain disclosures for public
entities that are sponsors and servicers of qualifying special purpose entities.
The FSP is effective for the first  reporting  period ending after  December 15,
2008.  Application  of this FSP had no impact on the  financial  position of the
Company.


                                       51
<PAGE>

NOTE 19 - GRANDSOUTH BANCORPORATION (PARENT COMPANY ONLY)

                                                                December 31,
                                                                ------------
                                                              2008        2007
                                                              ----        ----
                                                          (Dollars in thousands)
Condensed Balance Sheets
     Assets
        Cash .............................................    $   319    $   343
        Investment in banking subsidiary .................     31,112     28,447
        Due from subsidiary ..............................         41        968
        Investment in capital trust ......................        247        247
        Deferred tax asset ...............................        962        787
                                                              -------    -------
           Total assets ..................................    $32,681    $30,792
                                                              =======    =======
     Liabilities
        Other liabilities ................................    $    78    $    78
        Junior subordinated debt .........................      8,247      8,247
     Shareholders' equity ................................     24,356     22,467
                                                              -------    -------
           Total liabilities and shareholders' equity ....    $32,681    $30,792
                                                              =======    =======

<TABLE>
<CAPTION>
                                                                                                 Years Ended December 31,
                                                                                                 ------------------------
                                                                                           2008              2007            2006
                                                                                           ----              ----            ----
                                                                                                   (Dollars in thousands)
Condensed Statements of Income
<S>                                                                                       <C>              <C>              <C>
       Income
            Dividends received from banking subsidiary ..........................         $   516          $   900          $     -
            Other income ........................................................              13               18               12
                                                                                          -------          -------          -------
                 Total income ...................................................             529              918               12
                                                                                          -------          -------          -------
       Expenses
            Interest expense ....................................................             432              599              495
            Other expenses ......................................................              67               84               76
                                                                                          -------          -------          -------
                 Total expenses .................................................             499              683              571
                                                                                          -------          -------          -------
       Income before income taxes and equity in
            undistributed earnings of banking subsidiary ........................              30              235             (559)
       Income tax benefit .......................................................            (175)            (238)            (188)
       Equity in undistributed earnings of banking subsidiary ...................           1,143            2,326            3,631
                                                                                          -------          -------          -------
       Net income ...............................................................         $ 1,348          $ 2,799          $ 3,260
                                                                                          =======          =======          =======
</TABLE>


                                       52
<PAGE>


<TABLE>
<CAPTION>
                                                                                                    Years Ended December 31,
                                                                                                    ------------------------
                                                                                             2008            2007             2006
                                                                                             ----            ----             ----
                                                                                                  (Dollars in thousands)
Condensed Statements of Cash Flows
     Operating activities
<S>                                                                                         <C>             <C>             <C>
        Net income .................................................................        $ 1,348         $ 2,799         $ 3,260
           Adjustments to reconcile net income to net
              cash provided (used) by operating activities
                 Deferred income taxes .............................................           (175)           (238)           (175)
                 Other liabilities .................................................             (2)              -              28
                 Share-based compensation ..........................................              -             121             110
                 Decrease (increase) in due from subsidiary ........................              -            (120)           (111)
                 Equity in undistributed net income of
                 banking subsidiary ................................................         (1,143)         (2,326)         (3,631)
                                                                                            -------         -------         -------
                   Net cash provided provided by (used for)
                      operating activities .........................................             28             236            (519)
                                                                                            -------         -------         -------
     Investing activities
        Investment in banking subsidiary ...........................................           (400)              -          (3,050)
        Investment in capital trust ................................................              -               -            (247)
                                                                                            -------         -------         -------
                   Net cash used for investing activities ..........................           (400)              -          (3,297)
                                                                                            -------         -------         -------
     Financing activities
        Proceeds of issuance of junior subordinated debentures .....................              -               -           8,247
        Proceeds from other borrowings .............................................              -               -             100
        Repayments of other borrowings .............................................              -               -          (4,000)
        Exercise of stock options ..................................................            624              25              12
        Cash dividends paid ........................................................           (276)           (268)           (252)
        Cash paid in lieu of fractional shares .....................................              -               -              (5)
                                                                                            -------         -------         -------
                   Net cash (used for) provided by financing activities ............            348            (243)          4,102
                                                                                            -------         -------         -------
     (Decrease) increase in cash and cash equivalents ..............................            (24)             (7)            286
     Cash and cash equivalents, beginning ..........................................            343             350              64
                                                                                            -------         -------         -------
     Cash and cash equivalents, ending .............................................        $   319         $   343         $   350
                                                                                            =======         =======         =======


Supplemental Schedule of Non-Cash Investing and Financing Activities
Dividends declared but unpaid ......................................................        $    71         $    69         $    67
                                                                                            =======         =======         =======
Stock dividend .....................................................................        $     -         $     -         $ 4,592
                                                                                            =======         =======         =======
Noncash transfers from due from subsidiary to
     investment in subsidiary bank .................................................        $ 1,043         $     -         $     -
                                                                                            =======         =======         =======
Other comprehensive income of subsidiary bank,
     after income taxes ............................................................        $    79         $   332         $   223
                                                                                            =======         =======         =======
</TABLE>

                                       53