**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**










**FORM
      10-Q**








**Quarterly
      report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934**





**For
      the quarterly period ended March 31, 2007**





**Commission
      File Number 0-23971**








**Citizens
      South Banking Corporation**


(Exact
      name of registrant as specified in its charter)




**Delaware**
            
            **54-2069979**(State
                or other jurisdiction of
            
            (I.R.S.
                Employerincorporation
                or organization)
            
            Identification
                Number)


****  ****   **** ****




**519
      South New Hope Road, Gastonia, North Carolina
      28054-4040**


(Address
      of principal executive offices)





Registrant's
      telephone number, including area code: **(704)
      868-5200**








Indicate
      by check mark whether the Registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the Registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes  ü  No





Indicate
      by check mark whether the Registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one): Large accelerated filer     Accelerated
      filer   ü  N on-accelerated
      filer





Indicate
      by check mark whether the Registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act. Yes ___ No  ü





Indicate
      the number of shares outstanding of each of the issuer's classes of common
      stock, as of the latest practicable date:




**Common
      stock, $0.01 par value**


**7,955,947
      shares outstanding as of May 2, 2007**










**Citizens
                South Banking Corporation**INDEXPage**PART
                I. FINANCIAL INFORMATION**Item
                1.
            Condensed
                Consolidated Financial Statements
            1Condensed
                Consolidated Statements of Financial ConditionMarch
                31, 2007 and December 31, 2006
            1Condensed
              Consolidated Statements of Operationsthree
                months ended March 31, 2007 and 2006
            2Condensed
                Consolidated Statements of Comprehensive Incomethree
                months ended March 31, 2007 and 2006
            3Condensed
                Consolidated Statements of Changes in Stockholders’ Equitythree
                months ended March 31, 2007 and 2006
            4Condensed
              Consolidated Statements of Cash Flowsthree
                months ended March 31, 2007 and 2006
            56Notes to
              Condensed
              Consolidated Financial StatementsItem
                2.
            Management's
                Discussion and Analysis of Financial Conditionand
                Results of Operations
            1017Item
                3.
            Quantitative
                and Qualitative Disclosures About Market RiskItem
                4.
            Controls
                and Procedures
            17**PART
                II. OTHER INFORMATION**
            18**SIGNATURES**
            
            20Exhibit
                31.1
            Certification
                of Chief Executive Officer Pursuantto
                Section 302 of the Sarbanes-Oxley Act of 2002
            21Exhibit
                31.2
            Certification
                of Chief Financial Officer Pursuantto
                Section 302 of the Sarbanes-Oxley Act of 2002
            22Exhibit
                32.1
            Statement
                of Chief Executive Officer Furnished Pursuantto
                Section 906 of the Sarbanes-Oxley Act of 2002
            23Exhibit
                32.2
            Statement
                of Chief Financial Officer Furnished Pursuantto
                Section 906 of the Sarbanes-Oxley Act of 2002
            24






i


**PART
                I.**
            **FINANCIAL
                INFORMATION****ITEM
                1.**
            **Condensed
                Consolidated Financial Statements**




**Citizens
                South Banking Corporation****Condensed
                Consolidated Statements of Financial Condition****(dollars
                in thousands, except per share data)****March
                31,**
            
            **December
                31,****2007**
            
            **2006****(unaudited)****Assets:**Cash
                and due from banks
            
            $
            10,740
            
            $
            17,581Interest-earning
                bank balances
            
            
            13,115
            
            
            8,640Cash
                and cash equivalents
            
            
            23,855
            
            
            26,221Investment
                securities available-for-sale, at fair value
            
            
            61,204
            
            
            65,326Mortgage-backed
                and related securities available-for-sale, at fair value
            
            
            60,934
            
            
            60,691Loans
                receivable, net of unearned income
            
            
            519,108
            
            
            515,402Allowance
                for loan losses
            
            
            (6,023
            )
            
            (5,764
            )Loans,
                net
            
            
            513,085
            
            
            509,638Real
                estate owned
            
            
            193
            
            
            139Premises
                and equipment, net
            
            
            18,056
            
            
            18,287Accrued
                interest receivable
            
            
            3,313
            
            
            3,236Federal
                Home Loan Bank stock
            
            
            3,313
            
            
            3,581Intangible
                assets
            
            
            31,501
            
            
            31,666Cash
                value of bank-owned life insurance policies
            
            
            15,716
            
            
            15,527Other
                assets
            
            
            6,469
            
            
            9,058Total
                assets
            
            $
            737,639
            
            $
            743,370**Liabilities
                and Stockholders’ Equity:**Demand
                deposit accounts
            
            $
            93,368
            
            $
            90,540Money
                market deposit accounts
            
            
            125,558
            
            
            117,632Savings
                accounts
            
            
            14,966
            
            
            16,027Time
                deposits
            
            
            334,281
            
            
            338,603Total
                deposits
            
            
            568,173
            
            
            562,802Borrowed
                money
            
            
            75,524
            
            
            85,964Deferred
                compensation
            
            
            5,074
            
            
            5,723Other
                liabilities
            
            
            3,257
            
            
            2,920Total
                liabilities
            
            
            652,028
            
            
            657,409Commitments
                and contingenciesStockholders’
                EquityPreferred
                stock, 10,000,000 shares authorized, none issued
            
            
            -
            
            
            -Common
                stock, $0.01 par value, 20,000,000 shares authorized;9,062,727
                shares issued at March 31, 2007 and December 31, 2006;7,996,947
                shares outstanding at March 31, 2007 and 8,111,659 sharesoutstanding
                at December 31, 2006
            
            
            91
            
            
            91Additional
                paid-in-capital
            
            
            68,585
            
            
            68,578Unallocated
                common stock held by Employee Stock Ownership Plan
            
            
            (1,385
            )
            
            (1,430
            )Unearned
                compensation related to Recognition and Retention Plan
            
            
            (1,069
            )
            
            (1,139
            )Retained
                earnings, substantially restricted
            
            
            33,830
            
            
            33,031Accumulated
                unrealized loss on securities available-for-sale, net of
                tax
            
            
            (785
            )
            
            (991
            )Treasury
                stock of 1,065,780 shares at March 31, 2007, and 951,068shares
                at December 31, 2006, at cost
            
            
            (13,656
            )
            
            (12,179
            )Total
                stockholders’ equity
            
            
            85,611
            
            
            85,961Total
                liabilities and stockholders’ equity
            
            $
            737,639
            
            $
            743,370**See
                accompanying notes to consolidated financial
                statements.**





1




**Citizens
                South Banking Corporation****Condensed
                Consolidated Statements of Operations (unaudited)****(in
                thousands, except per share data)**




**Three
                    Months****Ended
                  March 31****2007**
              
              **2006****Interest
                  Income:**Loans
              
              $
              9,893
              
              $
              8,505Investment
                  securities
              
              
              669
              
              
              492Interest-bearing
                  deposits
              
              
              132
              
              
              152Mortgage-backed
                  and related securities
              
              
              671
              
              
              716Total
                  interest income
              
              
              11,365**Interest
                  Expense:**Deposits
              
              
              5,341
              
              
              3,729Borrowed
                  funds
              
              
              978
              
              
              1,037Total
                  interest expense
              
              
              6,319
              
              
              4,766Net
                  interest income
              
              
              5,046
              
              
              5,099Provision
                  for loan losses
              
              
              330
              
              
              285Net
                  interest income after provision for loan losses
              
              
              4,716
              
              
              4,814**Noninterest
                  Income:**Fee
                  income on deposit accounts
              
              
              653
              
              
              678Income
                  on mortgage banking activities
              
              
              232
              
              
              78Income
                  on lending activities
              
              
              110
              
              
              171Dividends
                  on FHLB stock
              
              
              51
              
              
              54Increase
                  in cash value of bank-owned life insurance
              
              
              209
              
              
              247Fair
                  value adjustment on deferred compensation assets
              
              
              37
              
              
              63Net
                  gain (loss) on sale of assets
              
              
              5
              
              
              (56
              )Other
                  noninterest income
              
              
              233
              
              
              179Total
                  noninterest income
              
              
              1,530
              
              
              1,414**Noninterest
                  Expense:**Compensation
                  and benefits
              
              
              2,342
              
              
              2,379Fair
                  value adjustment on deferred compensation obligations
              
              
              37
              
              
              63Occupancy
                  and equipment expense
              
              
              668
              
              
              713Professional
                  services
              
              
              124
              
              
              170Amortization
                  of intangible assets
              
              
              165
              
              
              186Merger
                  and integration expenses
              
              
              -
              
              
              57Other
                  noninterest expense
              
              
              949
              
              
              977Total
                  noninterest expense
              
              
              4,285
              
              
              4,545Income
                  before income taxes
              
              
              1,961
              
              
              1,683Provision
                  for income taxes
              
              
              561
              
              
              495**Net
                income**
              ****
              **$**
              **1,400**
              ****
              ****
              **1,188**
              ******Basic
                  earnings per share**
              ****
              **$**
              **0.18**
              ****
              **$**
              **0.15**
              ******Diluted
                  earnings per share**
              ****
              **$**
              **0.18**
              ****
              **$**
              **0.15**
              ******Basic
                  average common shares outstanding**
              ****
              ****
              **7,862,519**
              ****
              ****
              **8,056,574**
              ******Diluted
                  average common shares outstanding**
              ****
              ****
              **7,938,506**
              ****
              ****
              **8,138,277**
 
 **See
        accompanying notes to consolidated financial statements.**
 2


**Citizens
                South Banking Corporation****Condensed
                Consolidated Statements of Comprehensive Income
                (unaudited)****(dollars
                in thousands)****Three
                Months Ended****March
                31,****2007**
            
            **2006**Net
                income
            
            $
            1,400
            
            $
            1,188Other
                comprehensive income, net of tax:Unrealized
                gains (losses) on securities available for sale:Unrealized
                holding gains (losses) arising during period
            
            
            206
            
            
            (126
            )Other
                comprehensive income (loss)
            
            
            206
            
            
            (126
            )Comprehensive
                income
            
            $
            1,606
            
            $
            1,062**See
                accompanying notes to consolidated financial
                statements.**








3


**Citizens
                South Banking Corporation****Condensed
                Consolidated Statements of Changes in Stockholders’ Equity
                (unaudited)****(dollars
                in thousands)****Three
                Months Ended****March
                31,****2007**
            
            **2006****Common
                stock:**At
                beginning of period
            
            $
            91
            
            $
            91Issuance
                of common stock
            
            
            -
            
            
            -At
                end of period
            
            
            91
            
            
            91**Additional
                paid-in-capital:**At
                beginning of period
            
            
            68,578
            
            
            68,468Stock
                option expense
            
            
            7
            
            
            6At
                end of period
            
            
            68,585
            
            
            68,474**Unallocated
                common stock held by ESOP:**At
                beginning of period
            
            
            (1,430
            )
            
            (1,613
            )Allocation
                from shares purchased with loan from ESOP
            
            
            45
            
            
            46At
                end of period
            
            
            (1,385
            )
            
            (1,567
            )**Unearned
                compensation related to Recognition and Retention
                Plan:**At
                beginning of period
            
            
            (1,139
            )
            
            (1,419
            )Vesting
                of shares for plan
            
            
            70
            
            
            70At
                end of period
            
            
            (1,069
            )
            
            (1,349
            )**Retained
                earnings, substantially restricted:**At
                beginning of period
            
            
            33,031
            
            
            30,311Net
                income
            
            
            1,400
            
            
            1,188Exercise
                of options
            
            
            -
            
            
            (35
            )Cash
                dividends declared on common stock
            
            
            (601
            )
            
            (574
            )At
                end of period
            
            
            33,830
            
            
            30,890**Accumulated
                unrealized loss on securities available for sale, net of
                tax:**At
                beginning of period
            
            
            (991
            )
            
            (1,567
            )Other
                comprehensive results, net of tax
            
            
            206
            
            
            (126
            )At
                end of period
            
            
            (785
            )
            
            (1,693
            )**Treasury
                stock:**At
                beginning of period
            
            
            (12,179
            )
            
            (10,013
            )Exercise
                of options
            
            
            -
            
            
            64Repurchase
                of common stock
            
            
            (1,477
            )
            
            (222
            )At
                end of period
            
            
            (13,656
            )
            
            (10,171
            )**See
                accompanying notes to consolidated financial
                statements.**





4






**Citizens
                South Banking Corporation****Condensed
                Consolidated Statements of Cash Flows (unaudited)****(dollars
                in thousands)****Three
                Months Ended****March
                31,****2007**
            
            **2006****Cash
                flows from operating activities:**Net
                income
            
            $
            1,400
            
            $
            1,188Adjustments
                to reconcile net income to net cash provided by operating
                activities:Provision
                for loan losses
            
            
            330
            
            
            285Depreciation
            
            
            306
            
            
            347Net
                (gain) loss on sale of other assets
            
            
            (5
            )
            
            56Deferred
                loan origination fees
            
            
            (20
            )
            
            772Allocation
                of shares to the ESOP
            
            
            45
            
            
            46Stock
                option expense
            
            
            7
            
            
            6Vesting
                of shares for the Recognition and Retention Plan
            
            
            70
            
            
            70Increase
                in accrued interest receivable
            
            
            (77
            )
            
            (52
            )Amortization
                of intangible assets
            
            
            165
            
            
            186(Increase)
                decrease in other assets
            
            
            2,217
            
            
            (767
            )Decrease
                in other liabilities
            
            
            (484
            )
            
            (1,298
            )Net
                cash provided by operating activities
            
            
            3,954
            
            
            839**Cash
                flows from investing activities:**Net
                increase in loans receivable
            
            
            (3,954
            )
            
            (19,323
            )Proceeds
                from the sale of other assets
            
            
            202
            
            
            571Maturities
                and prepayments of investment securities
            
            
            5,650
            
            
            402Maturities
                and prepayments of mortgage-backed securities
            
            
            3,200
            
            
            3,590Purchases
                of investments
            
            
            (1,515
            )
            
            -Purchases
                of mortgage-backed securities
            
            
            (3,120
            )
            
            -(Purchase)
                sale of FHLB stock
            
            
            268
            
            
            (15
            )Capital
                expenditures for premises and equipment
            
            
            (75
            )
            
            (95
            )Net
                cash provided by (used in) investment activities
            
            
            656
            
            
            (14,870
            )**Cash
                flows from financing activities:**Net
                increase in deposits
            
            
            5,371
            
            
            5,106Exercise
                of options
            
            
            -
            
            
            29Dividends
                paid to stockholders
            
            
            (601
            )
            
            (574
            )Repurchase
                of common stock
            
            
            (1,477
            )
            
            (222
            )Net
                decrease in borrowed money
            
            
            (10,441
            )
            
            (3,285
            )Increase
                in advances from borrowers for insurance and taxes
            
            
            172
            
            
            242Net
                cash provided by (used in) financing activities
            
            
            (6,976
            )
            
            1,296Net
                decrease in cash and cash equivalents
            
            
            (2,366
            )
            
            (12,735
            )Cash
                and cash equivalents at beginning of period
            
            
            26,221
            
            
            26,653Cash
                and cash equivalents at end of period
            
            $
            23,855
            
            $
            13,918**See
                accompanying notes to consolidated financial
                statements.**






5


**CITIZENS
      SOUTH BANKING CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1 - Basis of Presentation and Significant Accounting
      Policies**





In
      management’s opinion, the accompanying condensed consolidated financial
      statements, which are unaudited, reflect all adjustments, consisting solely
      of
      normal recurring accruals, necessary for a fair presentation of the financial
      information as of and for the three-month periods ended March 31, 2007 and
      2006,
      in conformity with accounting principles generally accepted in the United States
      of America. Results for the three months ended March 31, 2007, are not
      necessarily indicative of the results that may be expected for future periods,
      including the year ending December 31, 2007.





The
      condensed consolidated financial statements include the accounts of Citizens
      South Banking Corporation (the “Company”) and the Company’s wholly owned
      subsidiary, Citizens South Bank (the “Bank”).





The
      organization and business of the Company, accounting policies followed, and
      other related information are contained in the notes to the consolidated
      financial statements of the Company as of December 31, 2006 and 2005, and for
      the years ended December 31, 2006, 2005, and 2004, filed as part of the
      Company’s annual report on Form 10-K for the year ended December 31, 2006. These
      condensed consolidated financial statements should be read in conjunction with
      the annual consolidated financial statements.





**Critical
      Accounting Policies**





The
      accounting and financial policies of the Company and its subsidiaries are
      prepared in accordance with accounting principles generally accepted in the
      United States and conform to general practices in the banking industry. We
      consider accounting policies that require significant judgment and assumptions
      by management that have, or could have, a material impact on the carrying value
      of certain assets or on income to be critical accounting policies. Changes
      in
      underlying factors, assumptions or estimates could have a material impact on
      our
      future financial condition and results of operations. Based on the size of
      the
      item or significance of the estimate, the following accounting policies are
      considered critical to our financial results. The critical accounting policies
      described below, along with the application of these critical accounting
      policies, are periodically reviewed by the Audit Committee.





**Allowance
      for Loan Losses.** The
      allowance for loan losses is calculated with the objective of maintaining an
      allowance sufficient to absorb estimated probable loan losses. Management’s
      determination of the adequacy of the allowance is based on quarterly evaluations
      of the loan portfolio and other relevant factors. However, this evaluation
      is
      inherently subjective, as it requires an estimate of the loss for each type
      of
      loan and for each impaired loan, an estimate of the amounts and timing of
      expected future cash flows, and an estimate of the value of the
      collateral.





Management
      has established a systematic method for periodically evaluating the credit
      quality of the loan portfolio in order to establish an allowance for loan
      losses. The methodology is set forth in a formal policy and includes a review
      of
      all loans in the portfolio on which full collectibility may or may not be
      reasonably assured. The loan review considers among other matters, the estimated
      fair value of the collateral, economic conditions, historical loan loss
      experience, our knowledge of inherent losses in the portfolio that are probable
      and reasonably estimable and other factors that warrant recognition in providing
      an appropriate loan loss allowance. Specific allowances are established for
      certain individual loans that management considers impaired under Statement
      of
      Financial Accounting Standards (“SFAS”) No. 114, *Accounting
      by Creditors for Impairment of a Loan.* The
      remainder of the portfolio is segmented into groups of loans with similar risk
      characteristics for evaluation and analysis. In originating loans, we recognize
      that losses will be experienced and that the risk of loss will vary with, among
      other things, the type of loan being made, the creditworthiness of the borrower,
      the term of the loan, general economic conditions, and in the case of a secured
      loan, the quality of the collateral. We increase our allowance for loan losses
      by charging provisions for loan losses against our current period income.
      Management’s periodic evaluation of the adequacy of the allowance is
      consistently applied and is based on our past loan loss experience, particular
      risks inherent in the different kinds of lending that we engage in, adverse
      situations that may affect the borrower’s ability to repay, the estimated value
      of any underlying collateral, current economic conditions, and other relevant
      internal and external factors that affect loan collectibility. Management
      believes this is a critical accounting policy because this evaluation involves
      a
      high degree of complexity and requires us to make subjective judgments that
      often require assumptions or estimates about various matters.





6


**Other-Than-Temporary
      Impairment of Securities.** Management
      periodically reviews all investment securities with significant declines in
      fair
      value for potential other-than-temporary impairment pursuant to the guidance
      provided by SFAS No. 115, *Accounting
      for Certain Investments in Debt and Equity Securities.* In
      November 2006, the Financial Accounting Standards Board (“FASB”) issued Staff
      Position (“FSP”) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary
      Impairment and Its Application to Certain Investments”. The FSP addressed the
      determination as to when an investment is considered impaired, whether the
      impairment is other-than-temporary, and the measurement of an impairment loss.
      It also included accounting considerations subsequent to the recognition of
      an
      other-than-temporary impairment and requires certain disclosures about
      unrealized losses that have not been recognized as other-than-temporary
      impairments. The guidance in this FSP amended SFAS No. 115 *Accounting for Certain Investments in Debt and Equity Securities,* No.
      124, *Accounting
      for Certain Investments Held by Not-for-Profit Organizations,* and
      APB
      Opinion 18, *The
      Equity Method of Accounting for Investments in Common Stock.* Effective
      March 31, 2007 and 2006, management evaluated the Company’s investment portfolio
      and determined that all unrealized losses were the direct result of temporary
      changes in interest rates and that such losses may be recovered in the
      foreseeable future. As a result, management did not consider any unrealized
      losses as “other-than-temporary” at March 31, 2007 and 2006.





**Note
      2 - Use of Estimates**





The
      financial statements are prepared in accordance with accounting principles
      generally accepted in the United States of America, which require management
      to
      make estimates and assumptions that affect the amounts reported in the financial
      statements and accompanying notes. Actual results could differ from those
      estimates.




**Note
      3 - Earnings per Share**





Earnings
      per share has been determined under the provisions of SFAS No. 128, *Earnings
      Per Share* .
      The
      only potential stock of the Company, as defined in SFAS No. 128, *Earnings
      Per Share* ,
      is
      stock options that have been granted to various directors and officers of the
      Bank. The following is a summary of the diluted earnings per share calculation
      for the three months ended March 31, 2007 and 2006:




**Three
                  Months Ended****March
                  31,****2007**
              
              **2006****(dollars
                  in thousands, except per share amounts)**Net
                  income
              
              $
              1,400
              
              $
              1,188Weighted
                  average outstanding shares
              
              
              7,862,519
              
              
              8,056,574Dilutive
                  effect of stock options
              
              
              75,987
              
              
              81,703Weighted
                  average diluted shares
              
              
              7,938,506
              
              
              8,138,277Diluted
                  earnings per share
              
              $
              0.18
              
              $
              0.15




**Note
      4 - Dividend Declaration**





On
      April
      16, 2007, the Board of Directors of the Company approved and declared a regular
      cash dividend of eight cents per share of common stock to stockholders of record
      as of May 1, 2007, payable on May 15, 2007.




7


**Note
      5 - Stock Repurchase Programs**





On
      January 22, 2007, the Board of Directors of the Company authorized the
      repurchase of up to 400,000 shares, or approximately 5% of the Company’s then
      outstanding shares of common stock. These
      repurchases may be carried out through open market purchases, block trades,
      and
      negotiated private transactions. The stock may be repurchased on an ongoing
      basis and will be subject to the availability of stock, general market
      conditions, the trading price of the stock, alternative uses for capital, and
      the Company’s financial performance. As of March 31, 2007, the Company had
      repurchased a total of 106,723 shares at an average price of $13.11 per share
      and had 293,277 shares remaining to be repurchased under this plan. The Company
      will consider repurchasing additional shares of common stock of the Company
      at
      prices management considers to be attractive and in the best interests of both
      the Company and its stockholders. Any repurchased shares will be held as
      treasury stock and will be available for general corporate purposes **.**





On
      January 23, 2006, the Board of Directors of the Company authorized the
      repurchase of up to 200,000 shares, or approximately 2.5% of the Company’s then
      outstanding shares of common stock. The Company completed this stock repurchase
      plan in January 2007 at an average price of $12.78 per share.





**Note
      6 - Impact of Recently Issued Accounting Standards**





SFAS
      No. 156, “Accounting for Servicing of Financial Assets” (“SFAS
      No. 156”) was issued by the FASB during the first quarter of 2006. This new
      Statement amends SFAS No. 140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities,* with
      respect to the accounting for separately recognized servicing assets and
      servicing liabilities *.* SFAS
      No. 156 requires an entity to separately recognize a servicing asset or a
      servicing liability when a company undertakes an obligation to service a
      financial asset under a servicing contract in certain situations. Such servicing
      assets or servicing liabilities are required to be initially measured at fair
      value, if practicable. SFAS No. 156 also allows an entity to choose one of
      two methods when subsequently measuring its servicing assets and servicing
      liabilities: (1) the amortization method or (2) the fair value measurement
      method. The amortization method existed under Statement 140 and remains
      unchanged in (1) allowing entities to amortize their servicing assets or
      servicing liabilities in proportion to and over the period of estimated net
      servicing income or net servicing loss and (2) requiring the assessment of
      those
      servicing assets or servicing liabilities for impairment or increased obligation
      based on fair value at each reporting date. The fair value measurement method
      allows entities to measure their servicing assets or servicing liabilities
      at
      fair value each reporting date and report changes in fair value in earnings
      in
      the period the change occurs. SFAS No. 156 permits a one-time
      reclassification of available-for- sale securities to trading securities by
      entities with recognized servicing rights upon initial adoption, provided
      certain criteria are met. The Company adopted SFAS No. 156 effective
      January 1, 2007. The impact of the adoption of SFAS No. 156 did not have a
      material impact on the Company’s financial position and results of operations.





In
      July 2006, FASB issued Interpretation No. 48, “Accounting for
      Uncertainty in Income Taxes—an interpretation of SFAS No. 109” (“FIN 48”),
      which clarifies the accounting for uncertainty in tax positions. This
      Interpretation requires that the Company recognize in its financial statements,
      the impact of a tax position, if that position is more likely than not of being
      sustained on audit, based on the technical merits of the position. The
      provisions of FIN 48 are effective as of the beginning of the Company’s 2007
      fiscal year, with the cumulative effect of the change in accounting principle
      recorded as an adjustment to opening retained earnings. The Company adopted
      FIN
      48 effective January 1, 2007. The impact of the adoption of FIN 48 did not
      have
      a material impact on the Company’s financial position and results of operations.




In
      September 2006, FASB issued SFAS No. 157, “Fair Value Measurements”
(“SFAS No. 157”), which enhances existing guidance for measuring assets and
      liabilities using fair value and requires additional disclosure about the use
      of
      fair value for measurement. The Statement is effective for financial statements
      issued for fiscal years beginning after November 15, 2007, and interim
      periods within those fiscal years. The
      Company will be required to adopt SFAS No. 157 in the first quarter of 2008,
      and
      is currently evaluating the impact of the adoption of SFAS No. 157 on its
      financial position and results of operations, including the valuation methods
      and support for the assumptions that underlie the valuation.





8


In
      September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting
      for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”),
      which requires a calendar year-end company with publicly traded equity
      securities that sponsors a post-retirement benefit plan to fully recognize,
      as
      an asset or liability, the overfunded or underfunded status of its benefit
      plan(s) in its 2006 year-end balance sheet. Prospective application of SFAS
      No. 158 is required for fiscal years ending after December 15, 2006,
      for entities with publicly traded equity securities. The Company adopted SFAS
      No. 158 effective January 1, 2007. The impact of the adoption of SFAS No.
      158 did not have a material impact on the Company’s financial position and
      results of operations.





During
      the first quarter of 2007, FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities” (“SFAS 159”), which permits entities
      to choose and measure many financial instruments and certain other items at
      fair
      value. The Company will be required to adopt SFAS No. 159 in the first quarter
      of 2008, and is currently evaluating the impact of the adoption of SFAS
      No. 159 on its financial position and results of operations.




In
      September 2006, the Emerging Issues Task Force issued EITF Issue 06-4,
“ Accounting
      for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
      Split-Dollar Life Insurance Arrangements” (“EITF Issue 06-4”). EITF Issue 06-4
      requires that for endorsement split-dollar insurance arrangements that provide
      a
      benefit to an employee that extends to postretirement periods, an employer
      should recognize a liability for future benefits in accordance with SFAS
      No. 106 or APB No. 12 based on the substantive agreement of the
      employee. If the employee has effectively agreed to maintain a life insurance
      policy during postretirement periods, the costs of the life insurance policy
      during the postretirement periods should be accrued in accordance with either
      FASB Statement No. 106 or APB No. 12. If the employer has agreed to
      provide a death benefit, the employer should recognize a liability for the
      future death benefit in accordance with either SFAS No. 106 or APB
      No. 12. EITF Issue 06-4 is effective for fiscal years beginning after
      December 15, 2007. The Company is currently evaluating the impact of EITF
      Issue 06-4 on its financial statements.





**Note
      7 - Commitment to Extend Credit**





Commitments
      to extend credit are agreements to lend as long as there is no violation of
      any
      condition established in the contract. Commitments generally have fixed
      expiration dates or other termination clauses and may require payment of a
      fee.
      Since commitments may expire without being drawn upon, the total commitment
      amounts do not necessarily represent future cash requirements. These commitments
      represent no more than normal lending risk that the Bank commits to its
      borrowers and management believes that these commitments can be funded through
      normal operations. Commitments to extend credit that include both fixed and
      variable rates as of March 31 are as follows:





2007
            
            2006Loan
                commitments:Residential
                mortgage loans
            
            $
            5,260,000
            
            $
            5,970,000Non-residential
                mortgage loans
            
            
            23,836,000
            
            
            25,662,,000Commercial
                loans
            
            
            356,000
            
            
            2,389,000Consumer
                loans
            
            
            4,248,000
            
            
            541,000Total
                loan commitments
            
            $
            33,700,000
            
            $
            34,562,000Unused
                lines of credit:Commercial
            
            $
            51,104,000
            
            $
            27,087000Consumer
            
            
            61,135,000
            
            
            56,388,000Total
                unused lines of credit
            
            $
            112,239,000
            
            $
            83,475,000Undisbursed
                construction loan proceeds
            
            $
            9,574,000
            
            $
            4,304,000





9





**ITEM
      2. Management’s Discussion and Analysis of Financial Condition and Results of**  **Operations**





**Forward
      Looking Statements**





This
      report contains certain forward-looking statements that represent the Company's
      expectations or beliefs concerning future events. Such forward-looking
      statements are based on our current beliefs and expectations and are inherently
      subject to significant business, economic, and competitive uncertainties and
      contingencies, many of which are beyond our control. These forward-looking
      statements are based on assumptions with respect to future business strategies
      and decisions that are subject to change based on changes in the economic and
      competitive environment in which we operate. Forward-looking statements speak
      only as of the date they are made and the Company is under no duty to update
      these forward-looking statements or to reflect the occurrence of unanticipated
      events. A number of factors could cause actual conditions, events, or results
      to
      differ significantly from those described in the forward-looking statements.
      Factors that could cause such a difference include, but are not limited to,
      the
      timing and amount of revenues that may be recognized by the Company, changes
      in
      local or national economic trends, increased competition among depository and
      financial institutions, continuation of current revenue and expense trends
      (including trends affecting chargeoffs and provisions for loan losses), changes
      in interest rates, changes in the shape of the yield curve, and adverse legal,
      regulatory or accounting changes. Because of the risks and uncertainties
      inherent in forward-looking statements, readers are cautioned not to place
      undue
      reliance on these statements. Readers should carefully review the risk factors
      described in other documents the Company files from time to time with the SEC,
      including annual reports on Form 10-K, quarterly reports on Form 10-Q, and
      current reports on Form 8-K.





10


**Overview**





Management’s
      Discussion and Analysis is provided to assist in understanding and evaluating
      the Company’s results of operations and financial condition. The following
      discussion is designed to provide a general overview of the Company’s
      performance for the three month period ended March 31, 2007. Readers seeking
      a
      more in-depth analysis should read the detailed discussions below, as well
      as
      the condensed consolidated financial statements and related notes. Financial
      highlights are presented in the table below.





**Three
                months
                ended**
            
            **Three
                months
                ended****March
                31, 2007**
            
            **March
                31, 2006**
            
            **%
                Change****Earnings:**Net
                interest income
            
            $
            5,046
            
            $
            5,099
            
            
            -
                1.04
            %Provision
                for loan losses
            
            
            (330
            )
            
            (285
            )
            
            15.79Noninterest
                income
            
            
            1,530
            
            
            1,414
            
            
            8.20Noninterest
                expense
            
            
            (4,285
            )
            
            (4,545
            )
            
            -
                5.72Income
                tax expense
            
            
            (561
            )
            
            (495
            )
            
            13.33**Net
                Income**
            
            **$**
            **1,400**
            
            **$**
            **1,188**
            
            
            **17.85**
            **%****Per
                Share Data****:**Average
                common shares outstanding, basic
            
            
            7,862,519
            
            
            8,056,574
            
            
            -
                2.41
            %Basic
                net income
            
            $
            0.18
            
            $
            0.15
            
            
            20.00Average
                common shares outstanding, diluted
            
            
            7,938,506
            
            
            8,138,277
            
            
            -
                2.45
            %Diluted
                net income
            
            $
            0.18
            
            $
            0.15
            
            
            20.00Cash
                dividends paid
            
            $
            0.075
            
            $
            0.07
            
            
            6.67
            %Period-end
                book value
            
            
            10.71
            
            
            10.21
            
            
            4.90**Financial
                Ratios**(annualized)**:**Return
                on average stockholders’ equity
            
            
            6.62
            %
            
            5.70
            %
            
            16.14
            %Return
                on average assets
            
            
            0.77
            
            
            0.69
            
            
            11.59Efficiency
                ratio
            
            
            65.15
            
            
            69.78
            
            
            -
                6.64Net
                interest margin
            
            
            3.18
            
            
            3.39
            
            
            -
                6.19Average
                equity to average assets
            
            
            11.61
            
            
            12.05
            
            
            -
                3.65**Asset
                Quality Data:**Allowance
                for loan losses
            
            $
            6,023
            
            $
            5,263
            
            
            14.46
            %Nonperforming
                loans
            
            
            1,686
            
            
            1,539
            
            
            9.55Nonperforming
                assets
            
            
            1,879
            
            
            2,844
            
            
            -
                33.93Net
                charge-offs
            
            
            71
            
            
            126
            
            
            -
                43.65Allowance
                for loan losses to total loans
            
            
            1.16
            %
            
            1.07
            %
            
            8.41Nonperforming
                loans to total loans
            
            
            0.32
            
            
            0.31
            
            
            3.23Nonperforming
                assets to total assets
            
            
            0.25
            
            
            0.41
            
            
            -39.02**Average
                Balances:**Total
                assets
            
            $
            738,674
            
            $
            701,429
            
            
            5.31
            %Loans
                receivable, net of unearned income
            
            
            511,747
            
            
            483,136
            
            
            5.92Interest-earning
                assets
            
            
            644,455
            
            
            607,101
            
            
            6.15Deposits
            
            
            565,070
            
            
            518,712
            
            
            8.94Interest-bearing
                liabilities
            
            
            603,396
            
            
            575,349
            
            
            4.87Stockholders’
                equity
            
            
            85,784
            
            
            84,506
            
            
            1.51**At
                Period End:**Total
                assets
            
            $
            737,639
            
            $
            702,275
            
            
            5.06
            %Loans
                receivable, net of unearned income
            
            
            519,108
            
            
            491,761
            
            
            5.56Interest-earning
                assets
            
            
            648,109
            
            
            618,812
            
            
            4.73Intangible
                assets
            
            
            31,501
            
            
            32,214
            
            
            -
                2.21Deposits
            
            
            568,173
            
            
            522,650
            
            
            8.71Interest-bearing
                liabilities
            
            
            602,433
            
            
            579,505
            
            
            3.96Stockholders’
                equity
            
            
            85,611
            
            
            84,675
            
            
            1.28





11


**Comparison
      of Financial Condition**





*Assets.* Total
      assets of the Company decreased by $5.7 million, or 0.8%, from $743.4 million
      at
      December 31, 2006, to $737.6 million at March 31, 2007. This decrease was partly
      due to a moderate deleveraging of the balance sheet as maturing investments
      were
      used to repay maturing borrowings. Future leverage strategies may be executed
      by
      the Company if the interest rate spread between investment securities and
      borrowings becomes more attractive.





Loans
      receivable increased by $3.7 million, or 0.7%, to $519.1 million at March 31,
      2007. The growth in loans was primarily comprised of an $8.4 million, or 3.3%,
      increase in commercial real estate loans to $262.7 million. Also during the
      first quarter, commercial business loans increased by $704,000, or 2.2%, to
      $32.7 million. These increases in loans were partly offset by an $8.1 million,
      or 10.6%, decrease in construction loans to $68.2 million, a $1.5 million,
      or
      1.8%, decrease in residential mortgage loans to $81.6 million, and a $680,000,
      or 1.0% decrease in consumer loans to $69.4 million. While loan production
      was
      on target during the quarter with $66.9 million in loan closings, loan growth
      during the quarter was somewhat slower than projected due to an increased amount
      of loan payoffs during the quarter. Part of the reason for the increased payoffs
      was attributable to builders and developers curbing their starts and a
      continuing effort by management to move potential problem credits out of the
      Bank. In order to increase loan growth for the remainder of 2007, management
      added two experienced commercial lenders in the Union County and York County
      markets (two of the Company’s fastest growing markets) and one additional credit
      officer during the second quarter of 2007. However, a slowdown in the local
      economy could have a negative impact on the Company’s ability to increase the
      current level of loan growth.





Management
      will seek to continue to grow the loan portfolio in a safe and sound manner
      with
      an emphasis on adjustable-rate loans and shorter-term fixed rate loans. As
      of
      March 31, 2007, $268.8 million, or 52.4%, of the Company’s loan portfolio, was
      scheduled to reprice each month. This sensitivity to rising interest rates
      was a
      driving factor in the Company’s margin expansion during the first half of 2006
      as the prime interest rate steadily increased. However, decreasing interest
      rates could cause margin compression, as these adjustable-rate loans will
      reprice at lower interest rates at a faster pace than the Company’s funding
      costs.





Cash
      and
      cash equivalents decreased by $2.4 million, or 9.0%, from $26.2 million at
      December 31, 2006, to $23.9 million at March 31, 2007. This decrease was
      primarily attributable to a $10.4 million reduction of borrowed money coupled
      with a $3.7 million increase in loans receivable. These decreases were partly
      offset by a $5.4 million increase in deposits and a $4.1 million decrease in
      investment securities. Management expects that cash and cash equivalents will
      continue to decrease in 2007 as these funds are used to fund future loan growth,
      repay borrowings, and repurchase Company stock. Also during the three-month
      period, mortgage-backed securities increased $243,000, or 0.4%, to $60.9 million
      and investment securities decreased by $4.1 million, or 6.3%, to $61.2 million.
      The decreases in investment securities were due to normal maturities. The slight
      increase in mortgage-backed securities was due to the purchase of $3.2 million
      during the period, the effects of which were partly offset by the normal
      amortization of the mortgage-backed securities. The cash flows generated from
      the investment securities were primarily used to repay borrowings during the
      period. Management expects the investment and mortgage-backed securities
      portfolios to decrease as a percentage of total assets as the cash flows
      generated from these investments continue to be used to fund loan growth and
      repay borrowings. This restructuring of the balance sheet from lower-yielding
      cash and cash equivalents, investments, and mortgage-backed securities to
      higher-yielding loans is expected to be a positive factor in improving the
      Company’s net interest margin.





Other
      real estate owned, which consists of two residential dwellings and one
      residential lot acquired by the Bank through foreclosure, increased by $54,000,
      or 38.8%, to $193,000 at March 31, 2007. This increase was due to the
      acquisition of one residential dwelling during the first quarter of 2007.
      Management will continue to aggressively market foreclosed properties for a
      timely disposition. All foreclosed properties were located in the Bank’s primary
      lending area.





12


*Allowance
      for loan losses and nonperforming assets.* The
      Company has established a systematic methodology for determining the adequacy
      of
      the allowance for loan losses. This methodology is set forth in a formal policy
      and considers all loans in the portfolio. Specific allowances are established
      for certain individual loans that management considers impaired. The remainder
      of the portfolio is segmented into groups of loans with similar risk
      characteristics for evaluation and analysis. Management’s periodic evaluation of
      the allowance is consistently applied and based on inherent losses in the
      portfolio, past loan loss experience, risks inherent in the different types
      of
      loans, the estimated value of any underlying collateral, current economic
      conditions, the borrower’s financial position, and other relevant internal and
      external factors that may affect loan collectibility. The allowance for loan
      losses is increased by charging provisions for loan losses against income.
      As of
      March 31, 2007, the allowance for loan losses was $6.0 million. Management
      believes that this amount meets the requirement for losses on loans that
      management considers to be impaired, for known losses, and for incurred losses
      inherent in the remaining loan portfolio. Although management believes that
      it
      uses the best information available to make such determinations, future
      adjustments to the allowance for loan losses may be necessary and results of
      operations could be significantly adversely affected if circumstances differ
      substantially from the assumptions used in making the determinations. The
      following table presents an analysis of changes in the allowance for loan losses
      for the periods and information with respect to nonperforming assets at the
      dates indicated.




**At
                  and For the Three****Months
                  Ended March 31,****2007**
              
              **2006**(dollars
                  in thousands)**Allowance
                  for loan losses:**Beginning
                  of period
              
              $
              5,764
              
              $
              5,104Add:Provision
                  for loan losses
              
              
              330
              
              
              285Recoveries
              
              
              12
              
              
              1Less:Charge-offs
              
              
              83
              
              
              127End
                  of period
              
              $
              6,023
              
              $
              5,263Nonaccrual
                  loans
              
              $
              1,686
              
              $
              1,539Real
                  estate owned
              
              
              193
              
              
              1,305Nonperforming
                  assets
              
              $
              1,879
              
              $
              2,844Allowance
                  for loan losses as apercentage
                  of total loans
              
              
              1.16
              %
              
              1.07
              %Nonperforming
                  loans tototal
                  loans
              
              
              0.32
              %
              
              0.31
              %Nonperforming
                  assets tototal
                  assets
              
              
              0.25
              %
              
              0.41
              %


Premises
      and equipment decreased by $231,000, or 1.3%, to $18.1 million at March 31,
      2007. This decrease was primarily due to normal depreciation which is expensed
      on a monthly basis based on the expected lives of each asset. In addition,
      during the first quarter of 2007, the Company opened a loan production office
      in
      Waxhaw, North Carolina. The loan production office is located in leased office
      space and is staffed by a local mortgage originator. This represents the
      Company’s third loan production office. Management also plans to open a full
      service office in Rock Hill, South Carolina by the end of 2007 in a leased
      facility. This will replace the current loan production office in Rock Hill
      that
      was opened in February 2006. The Company has also purchased a lot in Indian
      Trail, North Carolina for future expansion in 2008.





*Liabilities* .
      Total
      liabilities decreased by $5.4 million, or 0.8%, from $657.4 million at December
      31, 2006, to $652.0 million at March 31, 2007. This decrease was primarily
      due
      to a $10.4 million, or 12.1%, reduction in borrowed money to $75.5 million
      at
      March 31, 2007. This decrease was due to normal maturities of Federal Home
      Loan
      Bank advances. Additional borrowed money may be used in the future to fund
      continued loan growth, repurchase stock, or purchase investment or
      mortgage-backed securities. However, maturing advances will generally be repaid
      if there is a sufficient level of cash and cash equivalents.





13


While
      total deposits increased by $5.4 million, or 1.0%, to $568.2 million at March
      31, 2007, core deposits (which exclude time deposits) increased by $9.7 million,
      or 4.3%, to $233.9 million at March 31, 2007. During the three-month period,
      demand deposit accounts (checking accounts) increased by $2.8 million, or 3.1%,
      to $93.4 million and money market deposit accounts increased by $7.9 million,
      or
      6.7%, to $125.6 million. The increase in these core deposits was primarily
      due
      to a continued emphasis on increasing the Company’s number of retail and
      business checking account customers. This increase was partially offset by
      a
      $1.0 million, or 6.6%, decrease in savings accounts to $15.0 million. The
      decrease in savings accounts was largely due to customers moving these
      lower-yielding deposit accounts to higher-yielding accounts such as time
      deposits or money market deposit accounts. Management has always focused on
      increasing deposits by building customer relationships and typically avoids
      growing deposits by offering the highest rates in the market. However, if loan
      growth significantly outpaces deposit growth in the future, management may
      be
      more aggressive in attracting more retail deposits, which may increase the
      Company’s cost of funds. In addition, management may use brokered deposits to
      fund future loan growth if additional liquidity is needed. During the
      three-month period ended March 31, 2007, time deposits decreased by $4.3
      million, or 1.3% to $334.3 million. Brokered deposits totaled $6.1 million,
      or
      1.1% of total deposits at March 31, 2007.




*Stockholders’
      Equity* .
      Total
      stockholders’ equity decreased by $350,000, or 0.4%, from $86.0 million at
      December 31, 2006, to $85.6 million at March 31, 2007. The decrease in
      stockholders’ equity was primarily due to the repurchase of 114,712 shares of
      common stock for $1.5 million, at an average cost of $13.09 per share. On
      January 22, 2007, the Board of Directors authorized the repurchase of up to
      400,000 shares, or approximately 5%, of the outstanding shares of common stock.
      As of March 31, 2007, the Company had repurchased a total of 106,723 shares
      under the current program at an average price of $13.11 per share and had
      293,277 shares remaining to be repurchased. The Company will consider
      repurchasing additional shares of common stock at prices that management
      considers to be attractive and in the best interests of both the Company and
      its
      stockholders. Any repurchased shares will be held as treasury stock and will
      be
      available for general corporate purposes **.** In
      addition, the Company paid cash dividends totaling $602,000 during the period,
      representing $0.075 per share. These decreases in stockholders’ equity were
      partly offset by $1.4 million in net income and a $206,000 decrease in
      unrealized losses on available for sale securities due to a decrease in market
      interest rates during the quarter. The Company did not consider the unrealized
      losses to be other-than-temporary.





**Comparison
      of Results of Operations for the Three Months Ended March 31, 2007 and
      2006**





*General* .
      Net
      income for the three months ended March 31, 2007, amounted to $1.4 million,
      or
      $0.18 per diluted share, as compared to $1.2 million, or $0.15 per diluted
      share, for the three months ended March 31, 2006. This represented a 17.8%
      increase in net income and a 20.0% increase in diluted earnings per share for
      the comparable periods.





*Net
      interest income.* Interest
      income increased by $1.5 million, or 15.2%, to $11.4 million, primarily as
      a
      result of organic loan growth and higher interest rates. Average
      interest-earning assets increased by $37.4 million, or 6.2%, to $644.5 million
      for the three months ended March 31, 2007. The increase in average
      interest-earning assets was primarily the result of a $38.9 million, or 8.2%,
      increase in average outstanding loans to $511.7 million. The Company’s average
      yield on earning assets increased by 62 basis points to 7.20% for the quarter
      ended March 31, 2007. Interest expense increased by $1.5 million, or 31.3%,
      for
      the comparable quarters. This increase in interest expense was largely due
      to
      increased deposits and higher interest rates. The average cost of funds
      increased by 88 basis points to 4.24% for the quarter ended March 31, 2007.
      In
      addition, the Company experienced a $28.0 million, or 4.9%, increase in the
      average balance of interest-bearing liabilities to $603.4 million for the three
      months ended March 31, 2007. Average interest-bearing liabilities increased
      primarily as a result of a $40.1 million, or 8.3%, increase in average
      interest-bearing deposits, the effects of which were partly offset by a $10.4
      million, or 12.2%, decrease in borrowed money.





14


Net
      interest income decreased by $53,000, or 1.0%, to $5.0 million for the three
      months ended March 31, 2007. In addition, the net interest margin decreased
      by
      21 basis point to 3.18% for the quarter ended March 31, 2007, compared to 3.39%
      for the quarter ended March 31, 2006. This decrease in the net interest margin
      was primarily the result of rising funding costs resulting from the continued
      flat / inverted yield curve. On a linked-quarter basis, the Company’s net
      interest margin improved by one basis point from 3.17% for the fourth quarter
      of
      2006 to 3.18% for the first quarter of 2007. This reverses the trend of margin
      compression during the last two quarters of 2006 in the amount of 14 basis
      points and 10 basis points, respectively.





*Provision
      for loan losses.* The
      provision for loan losses amounted to $330,000 for the three months ended March
      31, 2007, compared to $285,000 for the three months ended March 31, 2006. The
      increase in the provision for loan losses was primarily attributable to the
      continued growth in the commercial real estate portfolio. The allowance for
      loan
      losses was $6.0 million, or 1.16% of total loans, as of March 31, 2007, compared
      to $5.3 million, or 1.07% of total loans, as of March 31, 2006. While the
      Company continues to emphasize commercial loans and consumer loans that are
      generally secured by real estate, the Company’s ratio of nonperforming loans to
      total loans remained stable, at 0.32% of total loans on March 31, 2007, compared
      to 0.31% of total loans on March 31, 2006. A substantial portion of the
      Company’s nonperforming loans at March 31, 2007 were secured by real estate.




*Noninterest
      income.* Noninterest
      income increased by $116,000, or 8.20%, to $1.5 million for the three months
      ended March 31, 2007, as compared to $1.4 million for the three months ended
      March 31, 2006. This increase was largely attributable to the $154,000, or
      197.7%, increase in mortgage banking income and a $54,000, or 30.3%, increase
      in
      other noninterest income. During the past 12 months the Company almost doubled
      its number of commission-based mortgage loan originators located throughout
      the
      Company’s normal lending area, resulting in a significant increase in
      mortgage-banking revenues. Continued expansion of the mortgage banking area
      is
      expected in 2007. Other noninterest income increased, in part, due to increased
      commissions on the sale of financial products, higher merchant fee income,
      and
      increased early withdrawal fees on time deposits.





These
      increases in noninterest income were partly offset by a $25,000, or 3.7%,
      reduction in fee income on deposit accounts to $653,000, a $61,000, or 35.8%,
      decrease in fee income on lending activities, a $38,000, or 15.4%, reduction
      in
      the cash value of bank-owned life insurance, and a $26,000, or 41.7%, decrease
      in the fair value adjustment on deferred compensation assets. The decrease
      in
      fee income on deposit accounts follows a continuing trend of lower fees
      generated from checks returned for non-sufficient funds (“NSFs”). Management
      expects that this declining trend will continue for the remainder of 2007.
      Fees
      generated by lending activities decreased during the first quarter of 2007,
      as
      compared to the first quarter of 2006, due in part to a reduction of commercial
      construction loan originations which generally generate larger loan fees.
      Management expects that fee income from lending activities will increase during
      2007, due in part to the two additional commercial lenders that were hired
      during the second quarter of 2007. The decrease in cash value of bank-owned
      life
      insurance was primarily due to a one-time adjustment to increase the cash value
      during the first quarter of 2006. Since that time, a number of the life
      insurance contracts have been exchanged for contracts that offer a higher
      crediting rate. As such, management expects that the income generated from
      these
      policies will be higher in 2007, as compared to 2006. The fair value adjustment
      on deferred compensation assets also decreased during 2007. However, this item
      is directly offset by a corresponding credit to noninterest
      expense.





During
      the quarter ended March 31, 2007, the Company sold three loan participations
      totaling $202,000 at a gain of $5,000. These participations were part of a
      low-to-moderate income housing program that provides funding for qualified
      housing projects located in North Carolina. These participations were purchased
      by the Federal Home Loan Bank, in an effort to provide additional liquidity
      for
      financial institutions to fund similar low-to-moderate housing projects. During
      the quarter ended March 31, 2006, the Company recognized a loss of $56,000
      on
      the sale of four foreclosed residential properties for $571,000.





15


*Noninterest
      expense.* Noninterest
      expense decreased by $260,000, or 5.7%, to $4.3 million for the quarter ended
      March 31, 2007, compared to $4.5 million for the quarter ended March 31, 2006.
      Part of this decrease was attributable to the completion of the consolidation
      of
      the back-office functions of Trinity Bank, including the core processing and
      items processing systems, in February 2006. Partly as a result of this
      consolidation, compensation and benefits decreased by $36,000, or 1.5%, to
      $2.3
      million and office occupancy and equipment expense decreased by $44,000, or
      6.3%, to $668,000. Management has hired two additional commercial lenders and
      one additional credit officer during the second quarter of 2007. As such,
      compensation expense is expected to increase during the remainder of 2007.
      However, we expect that the additional loan growth associated with these new
      positions will cover the additional compensation expense beginning in 2008.
      The
      Company also has plans to add a full-service office in Rock Hill, South
      Carolina, and possibly a new loan production office by the end of 2007,
      resulting in increasing office occupancy and equipment expense by the end of
      2007.





The
      Company experienced a $46,000, or 27.1%, decrease in professional services
      expense during the comparable first quarters. This reduction was primarily
      due
      to higher than normal professional services needed during the first quarter
      of
      2006 due to the integration of the Trinity Bank acquisition. Management believes
      that the current level of expense associated with professional services should
      be sustainable through the end of 2007. Also, as a result of the Trinity Bank
      acquisition in October 2005, the Company experienced merger-related expenses
      of
      $57,000 during the first quarter of 2006. These were one-time expenses and
      as
      such, no such expenses were incurred during the first quarter of 2007. The
      fair
      value adjustment on deferred compensation decreased by $26,000, or 41.7%, during
      the comparable quarters. This expense was directly offset by a corresponding
      decrease to noninterest income, resulting in no net impact to the Company.
      The
      amortization of intangible assets also decreased during the comparable quarters.
      For the first quarter of 2007, the amortization of intangible assets amounted
      to
      $165,000, a reduction of $21,000, or 11.3%, over the previous year. Management
      expects a continuing decrease in the amortization of intangible assets as the
      amount of the core deposit intangible decreases.




*Income
      taxes.* Income
      taxes amounted to $561,000, or 28.6% of taxable income, for the quarter ended
      March 31, 2007, as compared to $495,000, or 29.4% of taxable income, for the
      quarter ended March 31, 2006. The increase in income tax expense during the
      first quarter of 2007 was primarily due to a $278,000 increase in net income
      before taxes. The effective tax rate decreased from the first quarter 2006
      to
      the first quarter 2007 due to an increased portion of income generated from
      tax-advantaged sources in 2007 as a percentage of total pretax income. The
      Company invests in tax-advantaged sources of income to reduce its overall tax
      burden. These tax-advantaged sources include s bank-qualified municipal
      securities and bank-owned life insurance contracts. As the Company continues
      to
      increase the amount of income derived from interest income on loans and fee
      income on loans and deposits, the effective tax rate is expected to increase.





**Liquidity,
      Market Risk, and Capital Resources**





The
      objectives of the Company’s liquidity management policy include providing
      adequate funds to meet the cash needs of both borrowers and depositors, to
      provide for the on-going operations of the Company, and to capitalize on
      opportunities for expansion. Liquidity management addresses the Company’s
      ability to meet deposit withdrawals on demand or at contractual maturity, to
      repay borrowings as they mature, and to fund new loans and investments as
      opportunities arise. The primary sources of internally generated funds are
      principal and interest payments on loans receivable, increases in local
      deposits, cash flows generated from operations, and cash flows generated by
      investments. If the Company requires funds beyond its internal funding
      capabilities, it may rely upon external sources of funds such as brokered
      deposits, repurchase agreements, and advances. The Company has $103.0 million
      available to draw from its line of credit with the Federal Home Loan Bank of
      Atlanta (“FHLB”). The FHLB functions as a central reserve bank providing credit
      for member financial institutions. As a member of the FHLB, we are required
      to
      own capital stock in the FHLB and we are authorized to apply for advances on
      the
      security of such stock and certain of our mortgage loans and other assets
      (principally securities that are obligations of, or guaranteed by, U.S.
      Government Agencies) provided certain creditworthiness standards have been
      met.
      Advances are made pursuant to several different credit programs. Each credit
      program has its own interest rate and range of maturities. Depending on the
      program, limitations on the amount of advances are based on the financial
      condition of the member institution and the adequacy of collateral pledged
      to
      secure the credit. The Company also has $20.0 million available from an
      unsecured federal funds accommodation with The Bankers Bank (“TBB”). TBB is the
      Company’s primary correspondent bank. The federal funds accommodation is for a
      term of 12 months and is used for the purpose of providing daily liquidity
      as
      needed by the Company. Outstanding advances made under this accommodation are
      generally repaid on a daily basis at a rate determined by TBB based on their
      marginal cost of funds. Advances are limited to not more than 14 days in any
      calendar month. Interest on any advances made over the established line or
      beyond the 14-day limit will be at a higher rate. The Company may also solicit
      brokered deposits for providing funds for asset growth. As of March 31, 2007,
      the Company had outstanding brokered deposits of $6.1 million, or 1.1% of total
      deposits. The Company believes that it has sufficient sources of liquidity
      to
      fund the cash needs of both borrowers and depositors, to provide for the ongoing
      operations of the Company, and to capitalize on opportunities for
      expansion.





16


In
      the
      normal course of business, various commitments are outstanding that are not
      reflected in the consolidated financial statements. Commitments to extend credit
      and undisbursed advances on customer lines of credit are agreements to lend
      to a
      customer as long as there is no violation of any condition established in the
      contract. The funding of these commitments and previously approved undisbursed
      lines of credit could affect the Company's liquidity position. At March 31,
      2007, the Company had loan commitments of $33.7 million, unused lines of credit
      of $112.2 million, and undisbursed construction loan proceeds of $9.6 million.
      The Company believes that it has adequate resources to fund loan commitments
      and
      lines of credit as they arise. The Company does not have any special purpose
      entities or other similar forms of off-balance-sheet financing.





The
      Company’s most significant form of market risk is interest rate risk, as the
      Company’s assets and liabilities are sensitive to changes in interest rates. The
      Company’s Asset / Liability Committee is responsible for monitoring its level of
      interest rate risk and ensuring compliance with Board-adopted limits. There
      were
      no changes in the Company’s asset or liability composition that could result in
      a material change in the Company’s analysis of interest rate sensitivity as
      discussed in the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2006.





The
      Bank
      is subject to various regulatory capital requirements administered by the
      banking regulatory agencies. As of March 31, 2007, the Bank’s capital exceeded
      all applicable regulatory requirements. The Bank's Tier I capital was $64.7
      million, or 9.2% of adjusted total assets. The minimum Tier I capital ratio
      is
      4.00%. Failure to meet minimum capital requirements can initiate certain
      mandatory and possibly discretionary actions by the regulators that, if
      undertaken, could have a direct material effect on the Bank’s financial
      statements. Under capital adequacy guidelines and the regulatory framework
      for
      prompt corrective action, the Bank must meet specific capital guidelines that
      involve quantitative measures of the Bank’s assets, liabilities, and certain
      off-balance-sheet items as calculated under regulatory accounting practices.
      The
      Bank’s capital amounts and classifications are subject to qualitative judgments
      by the regulators about components, risk-weightings, and other factors.




**ITEM
      3. Quantitative and Qualitative Disclosures About Market
      Risk**





The
      information required by this item is included above in Item 2, Management’s
      Discussion and Analysis of Financial Condition and Results of Operations, under
      the caption “Liquidity, Market Risk, and Capital Resources.”




**ITEM
      4. Controls and Procedures**





Under
      the
      supervision and with the participation of the Company’s management, including
      the Company’s Principal Executive Officer and Principal Financial Officer, the
      Company has evaluated the effectiveness of the design and operation of its
      disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
      under the Exchange Act) as of the end of the period covered by this report.
      Based upon that evaluation, the Principal Executive Officer and Principal
      Financial Officer concluded that, as of the end of the period covered by this
      report, the Company’s disclosure controls and procedures were effective to
      ensure that information required to be disclosed in the reports that the Company
      files or submits under the Exchange Act is recorded, processed, summarized
      and
      reported, within the time periods specified in the SEC’s rules and forms and in
      timely alerting them to material information relating to the Company (or its
      consolidated subsidiaries) required to be filed in its periodic SEC
      filings.





17


There
      has
      been no change in the Company’s internal control over financial reporting
      identified in connection with the quarterly evaluation that occurred during
      the
      Company’s last fiscal quarter that has materially affected, or is reasonably
      likely to materially affect, the Company’s internal control over financial
      reporting.




**PART
      II. OTHER INFORMATION**





**Item
      1.**   **Legal
      Proceedings**





There
      are
      various claims and lawsuits in which the Bank is periodically involved
      incidental to the Company's business. In the opinion of management, no material
      loss is expected from any of such pending claims or lawsuits.





**Item
      1A.**  **Risk
      Factors**





There
      were no material changes in the risk factors that were identified in the Form
      10-K for the period ended December 31, 2006.





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





During
      the three-month period ended March 31, 2007, the Company repurchased 114,712
      shares of common stock for $1.5 million, at an average cost of $13.09 per share,
      as detailed in the following table:





**Period**
            **Total
                Number of**
              **Shares
                Purchased**
            **Average
                Price**
              **Paid
                per Share**
            **Total
                Number of Shares Purchased**
              **as
                Part of Publicly**
              **Announced
                Plan**
            **Maximum
                Number of Shares**
              **that
                May Yet be Purchased**
              **Under
                the Publicly Announced Plan**January
            24,300
            $13.07
            24,300
            383,689February
            50,795
            $13.28
            50,795
            332,894March
            39,617
            $12.86
            39,617
            293,277**Total**
            **114,712**
            **$13.09**
            **114,712**
            **293,277**





On
      January 22, 2007, the Board of Directors of the Company authorized the
      repurchase of up to 400,000 shares, or approximately 5%, of the Company’s
      then-outstanding shares of common stock. These repurchases may be carried out
      through open market purchases, block trades, and negotiated private
      transactions. The stock may be repurchased on an ongoing basis and will be
      subject to the availability of stock, general market conditions, the trading
      price of the stock, alternative uses for capital, and the Company’s financial
      performance. As of March 31, 2007, the Company had repurchased a total of
      106,723 shares at an average price of $13.11 per share and had 293,277 shares
      remaining to be repurchased under this plan. Management will consider
      repurchasing additional shares of common stock of the Company at prices
      management considers to be attractive and in the best interests of both the
      Company and its stockholders. Any repurchased shares will be held as treasury
      stock and will be available for general corporate purposes **.**


18


**Item
      3.**   **Defaults
      Upon Senior Securities**





Not
      applicable.





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





There
      were no meetings of stockholders during the quarter ended March 31,
      2007.





**Item
      5.**   **Other
      Information**





Not
      applicable.





**Exhibits**




31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002.





31.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002.





32.1
            Written
                statement of Chief Executive Officer furnished pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002.





32.2
            Written
                statement of Chief Financial Officer furnished pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002.




19


**SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the Registrant
      has
      duly caused this report to be signed by the undersigned thereunto duly
      authorized.





**Citizens
              South Banking Corporation**Date: May
              9,
              2007
            By:
            /s/ Kim
              S.
              PriceKim
                S. PricePresident
              and
              Chief Executive Officer


Date:
              May 9, 2007
            By:
            /s/ Gary
              F.
              HoskinsGary
              F. HoskinsExecutive
              Vice
              President, Chief Financial Officer and
              Treasurer


20