UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549


FORM
10-Q





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the quarterly period ended March 31, 2009





or





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




For
the transition period from ______ to _____





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 ofincorporation or organization)
            (I.R.S.
      Employer Identification Number)





519
South New Hope Road, Gastonia, NC  28054


(Address
of principal executive offices)





(704)
868-5200


(Registrant's
telephone number, including area code)




Indicate
by check mark whether the Registrant has submitted electronically and posted on
its corporate website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the Registrant was required to file
such reports).  Yes ̈No ̈





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.  YesxNo ̈





Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definitions of “accelerated filer”, “large accelerated
filer” and “small reporting company” in Rule 12b-2 of the Exchange
Act.




Large
      accelerated filer o
              Accelerated
      filer oNon-accelerated
      filer o
              Smaller
      Reporting Company x




Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.)  Yes ̈Nox





As of May
14, 2009, there were 7,517,504 shares outstanding shares of the Registrant’s
common stock, $0.01 par value.












Citizens
South Banking Corporation


Form
10-Q for the Quarterly Period Ended March 31, 2009





Table
of Contents





Index


PagePART
      I.  FINANCIAL INFORMATIONItem
      1. Financial Statements:Condensed
      Consolidated Statements of Financial Condition as of March 31, 2009 and
      December 31, 2008
              1Condensed
      Consolidated Statements of Operations for the Three Months Ended March 31,
      2009 and 2008
              2Condensed
      Consolidated Statements of Changes in Stockholders’ Equity for
      the Three Months Ended March 31, 2009 and 2008
              3Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended March 31,
      2009 and 2008
              4Notes
      to Condensed Consolidated Financial Statements
              5Item
      2.  Management's Discussion and Analysis of Financial Condition
      and Results of Operations
              11Item
      3. Quantitative and Qualitative Disclosures About Market
      Risk
              21Item
      4.  Controls and Procedures
              21PART
      II.  OTHER INFORMATIONItem
      1.  Legal Proceedings
              21Item
      1A.  Risk Factors
              22Item
      2.  Unregistered Sales of Equity Securities and Use of
      Proceeds
              22Item
      3.  Defaults Upon Senior Securities
              22Item
      4.  Submission of Matters to a Vote of Security
      Holders
              22Item
      5. Other Information
              22Item
      6.  Exhibits
              23Signatures
              23Certifications
              24









PART
I. FINANCIAL INFORMATION





ITEM
1.  Financial Statements





Citizens
South Banking Corporation


Condensed
Consolidated Statements of Financial Condition


(Dollars
in thousands, except per share data)




March
      31,
              
              
              December
      31,2009
              
              
              2008(unaudited)Assets:Cash
      and cash equivalents:Cash
      and due from banks
              
              $
              10,877
              
              
              $
              9,444Interest-earning
      bank balances
              
              
              22,073
              
              
              
              613Total
      cash and cash equivalents
              
              
              32,950
              
              
              
              10,057Investment
      securities available-for-sale, at fair value
              
              
              32,562
              
              
              
              28,905Mortgage-backed
      and related securities available-for-sale, at fair value
              
              
              82,371
              
              
              
              80,275Loans:Loans
      receivable, net of unearned income and deferred fees
              
              
              635,008
              
              
              
              626,688Allowance
      for loan losses
              
              
              (8,730
              )
              
              
              (8,026
              )Net
      loans
              
              
              626,278
              
              
              
              618,662Other
      real estate owned
              
              
              1,672
              
              
              
              2,601Premises
      and equipment, net
              
              
              16,631
              
              
              
              16,834Accrued
      interest receivable
              
              
              2,637
              
              
              
              2,609Federal
      Home Loan Bank common stock, at cost
              
              
              4,149
              
              
              
              4,793Bank-owned
      life insurance
              
              
              16,981
              
              
              
              16,813Intangible
      assets
              
              
              30,444
              
              
              
              30,525Other
      assets
              
              
              4,715
              
              
              
              5,139Total
      assets
              
              $
              851,390
              
              
              $
              817,213Liabilities
      and Stockholders’ Equity:Deposits:Demand
      deposit accounts
              
              $
              136,833
              
              
              $
              122,731Money
      market deposit accounts
              
              
              114,061
              
              
              
              103,271Savings
      accounts
              
              
              11,144
              
              
              
              10,708Time
      deposits
              
              
              366,533
              
              
              
              344,778Total
      deposits
              
              
              628,571
              
              
              
              581,488Borrowed
      money
              
              
              112,651
              
              
              
              124,365Deferred
      compensation
              
              
              4,800
              
              
              
              5,413Other
      liabilities
              
              
              705
              
              
              
              1,227Total
      liabilities
              
              
              746,727
              
              
              
              712,493Stockholders’
      Equity:Preferred
      stock, $0.01 par value, 10,000,000 shares authorized;20,500
      shares issued and outstanding at March 31, 2009 andDecember
      31, 2008
              
              
              20,527
              
              
              
              20,507Common
      stock, $0.01 par value, 20,000,000 shares authorized;9,062,727
      shares issued and 7,515,957 shares outstanding atMarch
      31, 2009 and December 31, 2008
              
              
              91
              
              
              
              91Additional
      paid-in-capital
              
              
              67,483
              
              
              
              67,367Unallocated
      common stock held by Employee Stock Ownership Plan
              
              
              (1,018
              )
              
              
              (1,064
              )Retained
      earnings
              
              
              35,635
              
              
              
              36,088Accumulated
      other comprehensive income
              
              
              239
              
              
              
              25Treasury
      stock of 1,546,770 shares at March 31, 2009 and December 31,
      2008
              
              
              (18,294
              )
              
              
              (18,294
              )Total stockholders’ equity
              
              
              104,663
              
              
              
              104,720Total
      liabilities and stockholders’ equity
              
              $
              851,390
              
              
              $
              817,213




See
accompanying notes to condensed consolidated financial statements.




1




Citizens
South Banking Corporation


Condensed Consolidated Statements of Operations(unaudited)


(Dollars
in thousands, except share and per share data)




Three
      MonthsEnded
      March 31,2009
              
              
              2008Interest
      Income:Loans
              
              $
              8,358
              
              
              $
              9,601Investment
      securities
              
              
              366
              
              
              
              413Interest-bearing
      deposits
              
              
              12
              
              
              
              94Mortgage-backed
      and related securities
              
              
              949
              
              
              
              864Total
      interest income
              
              
              9,685
              
              
              
              10,972Interest
      Expense:Deposits
              
              
              3,528
              
              
              
              5,066Borrowed
      funds
              
              
              1,174
              
              
              
              1,119Total
      interest expense
              
              
              4,702
              
              
              
              6,185Net
      interest income
              
              
              4,983
              
              
              
              4,787Provision
      for loan losses
              
              
              900
              
              
              
              345Net
      interest income after provision for loan losses
              
              
              4,083
              
              
              
              4,442Noninterest
      Income:Service
      charges on deposit accounts
              
              
              747
              
              
              
              678Mortgage
      banking income
              
              
              298
              
              
              
              203Other
      loan fees
              
              
              58
              
              
              
              111Dividends
      on FHLB stock
              
              
              -
              
              
              
              62Income
      from bank-owned life insurance
              
              
              186
              
              
              
              188Fair
      value adjustment on deferred compensation assets
              
              
              (49
              )
              
              
              (14
              )Net
      gain (loss) on sale of assets
              
              
              (171
              )
              
              
              242Other
      noninterest income
              
              
              180
              
              
              
              210Total
      noninterest income
              
              
              1,249
              
              
              
              1,680Noninterest
      Expense:Compensation
      and benefits
              
              
              2,541
              
              
              
              2,555Fair
      value adjustment on deferred comp. obligations
              
              
              (49
              )
              
              
              (14
              )Occupancy
      and equipment expense
              
              
              674
              
              
              
              674Professional
      fees
              
              
              236
              
              
              
              201Amortization
      of intangible assets
              
              
              81
              
              
              
              141FDIC
      deposit insurance
              
              
              103
              
              
              
              17Valuation
      adjustment on other real estate owned
              
              
              125
              
              
              
              -Restructuring
      expenses
              
              
              -
              
              
              
              220Impairment
      of securities
              
              
              123
              
              
              
              -Other
      noninterest expense
              
              
              1,103
              
              
              
              1,088Total
      noninterest expense
              
              
              4,937
              
              
              
              4,882Net
      income before income taxes
              
              
              395
              
              
              
              1,240Income
      tax expense (benefit)
              
              
              (61
              )
              
              
              270Net
      income
              
              
              456
              
              
              
              970Dividends
      on preferred stock
              
              
              253
              
              
              
              -Net
      income available for common stockholders
              
              $
              203
              
              
              $
              970Net
      income per common share:Basic
              
              $
              0.03
              
              
              $
              0.13Diluted
              
              $
              0.03
              
              
              $
              0.13Weighted
      average common shares outstanding:Basic
              
              
              7,392,742
              
              
              
              7,406,656Diluted
              
              
              7,392,742
              
              
              
              7,447,544





See
accompanying notes to condensed consolidated financial statements.




2




Citizens
South Banking Corporation


Condensed
ConsolidatedStatements of
Changes in Stockholders’ Equity(unaudited)


(Dollars
in thousands)




Three
      Months Ended March 31,2009
              
              
              2008Preferred
      stock, $0.01 par value:At
      beginning of period
              
              $
              20,507
              
              
              $
              -Accumulated
      discount on preferred stock
              
              
              20
              
              
              
              -At
      end of period
              
              
              20,527
              
              
              
              -Common
      stock, $0.01 par value:At
      beginning of period
              
              $
              91
              
              
              $
              91Issuance
      of common stock
              
              
              -
              
              
              
              -At
      end of period
              
              
              91
              
              
              
              91Additional
      paid-in-capital:At
      beginning of period
              
              
              67,367
              
              
              
              67,718Vesting
      of shares for Recognition and Retention Plan
              
              
              90
              
              
              
              77Stock-based
      compensation expense
              
              
              26
              
              
              
              8At
      end of period
              
              
              67,483
              
              
              
              67,803Unallocated
      common stock held by ESOP:At
      beginning of period
              
              
              (1,064
              )
              
              
              (1,247
              )Allocation
      from shares purchased with loan from ESOP
              
              
              46
              
              
              
              45At
      end of period
              
              
              (1,018
              )
              
              
              (1,202
              )Retained
      earnings, substantially restricted:At
      beginning of period
              
              
              36,088
              
              
              
              36,028Net
      income
              
              
              203
              
              
              
              970Accumulated
      discount on preferred stock
              
              
              (20
              )
              
              
              -Stock
      options exercised
              
              
              -
              
              
              
              (127
              )Dividends
      paid
              
              
              (636
              )
              
              
              (603
              )At
      end of period
              
              
              35,635
              
              
              
              36,268Accumulated
      unrealized loss on securities available for sale, net of
    tax:At
      beginning of period
              
              
              25
              
              
              
              (343
              )Other
      comprehensive income
              
              
              214
              
              
              
              793At
      end of period
              
              
              239
              
              
              
              450Treasury
      stock:At
      beginning of period
              
              
              (18,294
              )
              
              
              (18,214
              )Stock
      options exercised
              
              
              -
              
              
              
              181Repurchase of common stock
              
              
              -
              
              
              
              (676
              )At
      end of period
              
              
              (18,294
              )
              
              
              (18,709
              )




See
accompanying notes to condensed consolidated financial statements.




3





Citizens
South Banking Corporation


Condensed
ConsolidatedStatements of Cash
Flows(unaudited)


(Dollars
in thousands)




Three
      Months Ended March 31,2009
              
              
              2008Cash
      flows from operating activities:Net
      income
              
              $
              203
              
              
              $
              970Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:Provision
      for loan losses
              
              
              900
              
              
              
              345Depreciation
              
              
              280
              
              
              
              276Impairment
      on equity investment
              
              
              123
              
              
              
              -Net
      gain on sale of investment securities
              
              
              -
              
              
              
              (83
              )Net
      gain on sale of mortgage-backed securities
              
              
              -
              
              
              
              (159
              )Net
      loss on sale of other real estate owned
              
              
              172
              
              
              
              -Writedown
      on other real estate owned
              
              
              125
              
              
              
              -Deferred
      loan origination fees
              
              
              10
              
              
              
              11Allocation
      of shares to the ESOP
              
              
              46
              
              
              
              45Stock
      based compensation
              
              
              26
              
              
              
              8Vesting
      of shares for the Recognition and Retention Plan
              
              
              90
              
              
              
              77Increase
      (decrease) in accrued interest receivable
              
              
              (28
              )
              
              
              546Amortization
      of intangible assets
              
              
              81
              
              
              
              141Increase
      in other assets
              
              
              (28
              )
              
              
              (3,249
              )Decrease
      in other liabilities
              
              
              (1,270
              )
              
              
              (218
              )Net
      cash provided by (used in) operating activities
              
              
              730
              
              
              
              (1,290
              )Cash
      flows from investing activities:Net
      increase in loans
              
              
              (8,527
              )
              
              
              (12,055
              )Proceeds
      from the sale of investment securities
              
              
              -
              
              
              
              13,402Proceeds
      from the sale of mortgage-backed securities
              
              
              -
              
              
              
              12,535Proceeds
      from the sale of premises and equipment
              
              
              6
              
              
              
              -Proceeds
      from the sale of other real estate owned
              
              
              782
              
              
              
              -Maturities
      and prepayments of investment securities
              
              
              1,051
              
              
              
              1,541Maturities
      and prepayments of mortgage-backed securities
              
              
              3,731
              
              
              
              3,612Purchases
      of investments
              
              
              (5,210
              )
              
              
              -Purchases
      of mortgage-backed securities
              
              
              (5,100
              )
              
              
              (15,042
              )(Purchases)
      sale of FHLB stock
              
              
              644
              
              
              
              (44
              )Capital
      expenditures for premises and equipment
              
              
              (83
              )
              
              
              (91
              )Net
      cash provided by (used in) investment activities
              
              
              (12,706
              )
              
              
              3,858Cash
      flows from financing activities:Net
      increase (decrease) in deposits
              
              
              47,084
              
              
              
              (8,198
              )Net
      increase (decrease) in borrowed money
              
              
              (11,714
              )
              
              
              5,040Dividends
      paid
              
              
              (636
              )
              
              
              (603
              )Issuance
      of common stock for options
              
              
              -
              
              
              
              54Repurchase
      of common stock
              
              
              -
              
              
              
              (676
              )Increase
      in advances from borrowers for insurance and taxes
              
              
              135
              
              
              
              150Net
      cash provided by (used in) financing activities
              
              
              34,869
              
              
              
              (4,233
              )Net
      increase (decrease) in cash and cash equivalents
              
              
              22,893
              
              
              
              (1,665
              )Cash
      and cash equivalents at beginning of period
              
              
              10,057
              
              
              
              29,739Cash
      and cash equivalents at end of period
              
              $
              32,950
              
              
              $
              28,074





See
accompanying notes to condensed consolidated financial statements.




4




CITIZENS
SOUTH BANKING CORPORATION


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





Note
1 – Basis of Presentation





The
accompanying unaudited condensed consolidated financial statements include the
accounts of Citizens South Banking Corporation (the “Company”) and its
wholly-owned subsidiary, Citizens South Bank (the “Bank”).  The
interim financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America
(“GAAP”).  These statements do not include all of the information and
footnote disclosures required by GAAP for complete financial statements and
should therefore be read in conjunction with the Company’s Annual Report on Form
10-K for December 31, 2008.





The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect reported amounts of assets and
liabilities and the reported amounts of revenues and expenses during the
reporting period.  The more significant estimates that are
particularly susceptible to significant change relate to the determination of
the allowance for loan losses.  Actual results could differ from those
estimates.





In the
opinion of management, all adjustments necessary for a fair presentation of the
interim financial statements as of and for the three-month periods ended March
31, 2009 and 2008 have been included.  All significant intercompany
transactions have been eliminated in consolidation.  Certain amounts
reported in prior periods have been reclassified to conform to the current
presentation.  Such reclassifications had no effect on total assets,
net income, or stockholders equity as previously reported.  Results
for the three-month period ended March 31, 2009, are not necessarily indicative
of the results that may be expected for future periods, including the year
ending December 31, 2009.





The
condensed consolidated balance sheet at December 31, 2008, was derived from the
audited consolidated financial statements presented in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008.





Note
2 - Recent Accounting Pronouncements





The
following is a summary of recent authoritative pronouncements that could impact
the accounting, reporting, and/or disclosure of financial information by the
Company.




In
September 2006, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)
No. 157, “Fair Value
Measurements.” SFAS No. 157 establishes a framework for measuring
fair value and expands disclosures about fair value measurements.  The
changes to current practice resulting from the application of this statement
relate to the definition of fair value, the methods used to measure fair value,
and the expanded disclosures about fair value measurements.  SFAS
No. 157 became effective beginning January 1, 2008, and did not have a
material effect on the Company’s financial condition, results of operations or
cash flows. In February 2008, Financial Accounting Standards Board Staff
Position (“FSP”) No. 157-2, “Effective Date of FASB Statement
No. 157,” was issued that delayed the application of SFAS
No. 157 for non-financial assets and non-financial liabilities, until
January 1, 2009.  The adoption of SFAS No. 157 did not have a
material effect on the Company’s financial condition, results of operations, or
cash flows.  See Note 3. – Fair Value Measurements for additional
information.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB
No. 51.”  SFAS No. 160 establishes new accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. SFAS No. 160 was effective for the Company on
January 1, 2009.  The adoption of SFAS No. 160 did not have a
material effect on the Company’s consolidated financial statements.




5





Also in
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations — a
replacement of FASB No. 141.” SFAS No. 141R replaces SFAS No. 141,
“Business
Combinations,” and applies to all transaction and other events in which
one entity obtains control over one or more other businesses.  SFAS
No. 141R requires an acquirer to recognize the assets acquired, liabilities
assumed and any non-controlling interest in the acquiree at their respective
fair values as of the acquisition date.  Contingent consideration is
required to be recognized and measured at fair value on the date of acquisition
rather than at a later date when the amount of that consideration may be
determinable beyond a reasonable doubt.  This fair value approach
replaces the cost-allocation process required under SFAS No. 141 whereby the
cost of an acquisition was allocated to the individual assets acquired and
liabilities assumed based on their estimated fair value. SFAS No. 141R retains
the guidance in SFAS No. 141 for identifying and recognizing intangible
assets apart from goodwill.  The revised standard applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008.  The Company will apply the provisions of SFAS
No. 141R to any business acquisition which occurs on or after the date the
standard becomes effective.





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities – an Amendment of FASB Statement
No. 133.”  SFAS No. 161 is intended to improve
financial reporting about derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better understand their
effects on an entity’s financial condition, financial performance, and cash
flows.  SFAS No. 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008. SFAS
No. 161 did not have a material impact on the Company’s consolidated
financial statements.





In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.”  SFAS No. 162 identifies the
sources of accounting principles and the framework for selecting the principles
used in the preparation of financial statements of nongovernmental entities that
are presented in conformity with GAAP. SFAS No. 162 will be effective 60
days following the SEC’s approval of the Public Company Accounting Oversight
Board’s amendments to AU Section 411, “The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles.”  The
FASB has stated that it does not expect SFAS No. 162 will result in a
change in current practice.  The application of SFAS No. 162 is
not expected to have an effect on the Company’s consolidated financial
statements.





Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies are not expected to have a material impact on the
Company’s financial statements.





Note
3 – Fair Value Measurements





On
January 1, 2008, the Company adopted SFAS No. 157 which provides a framework for
measuring fair value under GAAP and enhances disclosures about fair value
measurements.  This Statement defines fair value as the exchange price
that would be received for an asset or paid to transfer a liability in the most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date.  An orderly transaction
is a transaction that assumes exposure to the market for a sufficient period
prior to the measurement date to allow for marketing activities that are usual
and customary for such transactions.  Market participants are buyers
and sellers in the principal market that are independent, knowledgeable, and
willing and able to transact.  SFAS No. 157 clarifies that fair value
should be based on the assumptions market participants would use when pricing an
asset or liability and establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions. The fair value hierarchy gives
the highest priority to quoted prices in active markets (observable inputs) and
the lowest priority to the Company’s assumptions (unobservable
inputs).  SFAS No. 157 requires fair value measurements to be
separately disclosed by level within the fair value hierarchy. For assets and
liabilities recorded at fair value, it is the Company’s policy to maximize the
use of observable inputs and minimize the use of unobservable inputs when
developing fair value measurements, in accordance with the fair value hierarchy
in SFAS No. 157.





Fair
value measurements for assets and liabilities where there exists limited or no
observable market data and, therefore, are based primarily upon estimates, are
often calculated based on the economic and competitive environment, the
characteristics of the asset or liability and other
factors.  Therefore, the results cannot be determined with precision
and may not be realized in an actual sale or immediate settlement of the asset
or liability.  Additionally, there may be inherent weaknesses in any
calculation technique, and changes in the underlying assumptions used, including
discount rates and estimates of future cash flows, could significantly affect
the results of current or future values.




6





The
Company utilizes fair value measurements to record fair value adjustments to
certain assets and to determine fair value disclosures.  The Company
has not elected the fair value option for liabilities.  Investment
securities, available-for-sale, are recorded at fair value on a recurring
basis.  Additionally, the Company may be required to record at fair
value other assets on a nonrecurring basis, such as impaired loans and other
real estate owned.  These nonrecurring fair value adjustments
typically involve the application of lower of cost or market accounting for
these other assets.  The application of SFAS No. 157 in situations
where the market for a financial asset is not active was clarified by the
issuance of SFAS No. 157-3,“Determining the Fair Value of a Financial Asset When the Market for That Asset
Is Not Active,” in October 2008.  SFAS No. 157-3 became
effective immediately and did not significantly impact the methods by which the
Corporation determines the fair values of its financial assets.





In
accordance with SFAS No. 157, when measuring fair value, the Company uses
valuation techniques that are appropriate and consistently applied.  A
fair value hierarchy is used based on the markets in which the assets are traded
and the reliability of the assumptions used to determine the fair
value.  These levels are as follows:





Level
1: Valuations are based on quoted prices in active markets for
identical instruments.





Level
2: Valuations that are derived from readily available pricing
sources for market transactions involving similar types of instruments in
markets that are not active and model-based valuation techniques for which all
significant assumptions are observable in the market.





Level
3: Valuations are derived from other valuation methodologies,
including option pricing models, discounted cash flow models, and similar
techniques and not based on market exchange or broker traded
transactions.





The
following is a description of valuation methodologies used for assets and
liabilities recorded at fair value. The determination of where an instrument
falls in the hierarchy requires significant judgment.  The Company
evaluates its hierarchy disclosures each quarter and based on various factors,
it is possible that an instrument may be classified differently from quarter to
quarter.  However, the Company expects that changes in classifications
between levels will be limited.





Investment
Securities, Available-for-Sale–Investment securities
available-for-sale are recorded at fair value on at least a monthly
basis.  Fair value measurement is based upon quoted prices, if
available.  If quoted prices are not available, fair values are
measured using independent pricing models or other model-based valuation
techniques such as the present value of future cash flows, adjusted for the
security’s credit rating, prepayment assumptions and other factors such as
credit loss assumptions.  Level 1 fair value is used for those
securities traded on an active exchange, U.S. Treasury securities that are
traded by brokers or dealers in an active over-the-counter market, and money
market funds.  Level 2 securities include mortgage-backed securities
issued by government-sponsored enterprises, municipal bonds, and corporate debt
securities.  Securities valued using Level 3 include equity securities
that are not actively traded on an active exchange, investments in closely held
subsidiaries, and asset-backed securities traded in less liquid
markets.




Loans -The Company does not record loans at fair value on a recurring
basis.  However, from time to time, a loan is considered impaired and
an allowance for loan losses is established. Loans for which it is probable that
payment of interest and principal will not be made in accordance with the
contractual terms of the loan agreement are considered impaired. Once a loan is
identified as being impaired, management measures the impairment in accordance
with SFAS No. 114, “Accounting
by Creditors for Impairment of a Loan.”The fair value of impaired loans
is estimated using one of several methods, including collateral value, market
price and discounted cash flows. Those impaired loans not requiring an allowance
represent loans for which the fair value of the expected repayments or
collateral exceed the recorded investments in such loans. At March 31, 2009,
substantially all of the total impaired loans were evaluated based on the fair
value of the collateral. In accordance with SFAS No. 157, impaired loans where
an allowance is established based on the fair value of collateral require
classification in the fair value hierarchy. When the fair value of the
collateral is based on an observable market price or a current appraised value,
the Company records the impaired loan as nonrecurring Level 2. When an appraised
value is not available or management determines the fair value of the collateral
is further impaired below the appraised value and there is no observable market
price, the Company records the impaired loan as nonrecurring Level
3.




7




Other Real Estate
Owned -Foreclosed assets are adjusted to fair value upon transfer of the
loans to foreclosed assets. Subsequently, foreclosed assets are carried at the
lower of carrying value or fair value. Fair value is based upon independent
market prices, appraised values of the collateral or management’s estimation of
the value of the collateral. When the fair value of the collateral is based on
an observable market price or a current certified appraised value, the Company
records the foreclosed asset as nonrecurring Level 2. When an appraised value is
not available or management determines the fair value of the collateral is
further impaired below the appraised value and there is no observable market
price, the Company records the foreclosed asset as nonrecurring Level
3.





Assets
and Liabilities Recorded at Fair Value on a Recurring Basis




Level
      1
              
              
              Level
      2
              
              
              Level
      3
              
              
              Total(Dollars
      in thousands)March
      31, 2009Investment
      securities, available-for-sale
              
              $
              -
              
              
              $
              112,688
              
              
              $
              2,245
              
              
              $
              114,933
  Assets
and Liabilities Recorded at Fair Value on a Nonrecurring Basis


Level
      1
              
              
              Level
      2
              
              
              Level
      3
              
              
              Total(Dollars
      in thousands)March
      31, 2009Impaired
      loans
              
              $
              -
              
              
              $
              10,465
              
              
              $
              2,238
              
              
              $
              12,703Other
      real estate owned
              
              $
              -
              
              
              $
              1,672
              
              
              $
              -
              
              
              $
              1,672




Note
4 – Computation of Earnings per Share





The
Company is required to report both basic and diluted earnings per share
(“EPS”).  Basic EPS is calculated by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
for the period.  Diluted EPS is calculated by dividing net income
available to common stockholders by the sum of the weighted average number of
common shares outstanding for the period and potential common stock. Potential
common stock consists of additional common stock that would have been
outstanding as a result of the exercise of dilutive stock options.  In
determining the number of shares of potential common stock, the treasury stock
method was applied.  The treasury method assumes that the number of
shares issuable upon exercise of the stock options is reduced by the number of
common shares assumed purchased at market prices with the proceeds from the
assumed exercise of the common stock options plus any tax benefits received as a
result of the assumed exercise.





For the
three month periods ended March 31, 2009 and 2008, options to purchase 958,118
shares and 602,290 shares, respectively, were excluded from the calculation of
diluted earnings per share because the option price exceeded the average closing
price of the associated shares of common stock during the respective
periods.




8




The
following table provides a computation and reconciliation of basic and diluted
EPS for the three months ended March 31, 2009 and 2008:




Three
      Months Ended
      March 31,2009
              
              
              2008(Dollars
      in thousands, except per share amounts)Income
      available to common stockholders – basic and diluted
              
              $
              203
              
              
              $
              970Shares
      used in the computation of EPS:Weighted
      average number of shares outstanding
              
              
              7,392,742
              
              
              
              7,406,656Incremental
      shares from assumed exercise of stock options
              
              
              -
              
              
              
              40,888Weighted
      average number of shares outstanding - diluted
              
              
              7,392,742
              
              
              
              7,447,544Diluted
      EPS
              
              $
              0.03
              
              
              $
              0.13





Note
5 – Comprehensive Income





A summary
of comprehensive income is as follows:




Three Months Ended
      March 31,2009
              
              
              2008(Dollars
      in thousands)Net
      income
              
              $
              203
              
              
              $
              970Other
      comprehensive income:Items
      of other comprehensive income, before taxUnrealized
      gains arising during period
              
              
              348
              
              
              
              1,533Reclassification
      for realized losses included in net income
              
              
              -
              
              
              
              (242
              )Other
      comprehensive income, before tax
              
              
              348
              
              
              
              1,291Tax
      benefit
              
              
              (134
              )
              
              
              (498
              )Other comprehensive income
              
              
              214
              
              
              
              793Total
      comprehensive income
              
              $
              417
              
              
              $
              1,763




Note
6 – Commitments 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.




9





Commitments
to extend credit that include both fixed and variable rates are as
follows:





March 31, 2009
            
            
            December 31, 2008Loan
      commitments:
            
            (Dollars
      in thousands)Residential
      mortgage loans
            
            $
            7,126
            
            
            $
            5,904Non-residential
      mortgage loans
            
            
            15,271
            
            
            
            5,934Commercial
      loans
            
            
            290
            
            
            
            457Consumer
      loans
            
            
            3,227
            
            
            
            3,242Total
      loan commitments
            
            $
            25,914
            
            
            $
            15,537Unused
      lines of credit:Commercial
            
            $
            20,237
            
            
            $
            26,424Consumer
            
            
            76,587
            
            
            
            78,872Total
      unused lines of credit
            
            $
            96,824
            
            
            $
            105,296





Note
7 – Dividend Declaration





On April
20, 2009, the Board of Directors of the Company approved and declared a regular
cash dividend of four cents ($0.04) per share of common stock to stockholders of
record as of May 1, 2009, payable on May 15, 2009. The Company has paid cash
dividends in each of the 44 quarters since the Company’s conversion to public
ownership.  This dividend represents a decrease from the eight and one
half cent ($0.085) dividend paid in the previous quarter.  After
careful consideration, the Board of Directors of the Company determined that
reducing the dividend was in the long-term best interest of the Company and its
stockholders for the following reasons:





1)
            This
      action represents a non-dilutive method to retain capital at a time when
      the capital markets are essentially closed to community
      banks.  We anticipate that this action will preserve
      approximately $1.4 million for the Company on an annualized
      basis.





2)
            This
      action positions the Company to take advantage of organic and strategic
      growth opportunities that are becoming increasingly abundant in this
      market.





3)
            This
      action enhances the Company’s flexibility for repayment of the U.S.
      Treasury Department’s preferred stock investment in the Company through
      the Capital Purchase Program.





Note
8 – Stock Repurchase Program





In June
2008, the Board of Directors of the Company authorized the repurchase of up to
200,000 shares, or approximately 2.7% 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, 2009,
the Company had repurchased a total of 9,476 shares at an average price of $7.91
per share and had 190,524 shares remaining to be repurchased under the
plan.  On December 12, 2008, the Company entered into a Letter
Agreement with the United States Department of the Treasury ("U.S. Treasury")
pursuant to which the Company has issued and sold to the U.S. Treasury: (i)
20,500 shares of the Company's Fixed Rate Cumulative Perpetual Preferred Stock,
Series A, par value $0.01 per share, having a liquidation amount per share equal
to $1,000, for a total price of $20,500,000 and (ii) a warrant to purchase
428,870 shares of the Company's common stock, par value $0.01 per share, at an
exercise price per share of $7.17.  As a condition for issuing the
preferred stock, the U.S. Treasury limited the Company’s ability to repurchase
common stock of the Company and increase its dividend payments to stockholders
without receiving prior approval from the U.S. Treasury.   As a
result, future repurchases of Company common stock are not anticipated for
2009.




10





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.





Executive
Summary





Citizens
South Banking Corporation is a Delaware corporation that owns all of the
outstanding shares of common stock of Citizens South Bank (the
"Bank").  The Company’s principal business activities are overseeing
and directing the business of the Bank. The Company’s assets consist primarily
of the outstanding capital stock of the Bank, deposits held at the Bank, and
investment securities. The shares of common stock of the Company trade on the
Nasdaq Global Market under the ticker symbol “CSBC.”  Citizens South
Bank, which was chartered in 1904, is a federally chartered savings bank
headquartered in Gastonia, North Carolina.  The Bank’s principal
business activity is offering FDIC-insured deposits to local customers through
its 15 branch offices and investing those deposits, together with funds
generated from operations and borrowings, in residential and nonresidential real
estate loans, construction loans, commercial business loans, consumer loans,
investment securities, and mortgage-backed securities.  The Bank also
acts as a broker in both the origination of loans secured by one-to-four family
dwellings and in the sale of uninsured financial products. The Bank’s results of
operations are heavily dependent on net interest income, which is the difference
between the interest earned on loans and securities and the interest paid on
deposits and borrowings.  Results of operations are also materially
affected by the Bank’s provision for loan losses, noninterest income, and
noninterest expense.  Noninterest income includes fee income generated
from deposit and loan accounts, mortgage banking fees, commissions earned from
the sale of uninsured investment products, increases in the cash value of
bank-owned life insurance policies, net gains (losses) from the sale of assets
and other noninterest income items.  The Bank’s noninterest expense
primarily consists of compensation and employee benefits, occupancy expense,
professional services, advertising, amortization of intangible assets and other
noninterest expenses.  Results of operations are also significantly
affected by local economic and competitive conditions, changes in interest
rates, and actions of regulatory and governmental authorities.





The
following discussion is provided to assist in understanding and evaluating the
Company’s results of operations and financial condition and is designed to
provide a general overview of the Company’s performance for the three-month
periods ended March 31, 2009 and 2008.  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 for the comparable periods are presented
in the following table.




11
 Financial Highlights:(unaudited)
                
                Three
      months ended
                
                
                Three
      months ended(Dollars
      in thousands, except per share data)
                
                March
      31, 2009
                
                
                March
      31, 2008
                
                
                %
      ChangeSummary
      Income Statement:Interest
      income – taxable equivalent
                
                $
                9,829
                
                
                $
                11,096
                
                
                
                (11.4
                )
      %Interest
      expense
                
                
                4,702
                
                
                
                6,185
                
                
                
                (24.0
                )Net
      interest income – taxable equivalent
                
                
                5,127
                
                
                
                4,911
                
                
                
                4.4Less:
      Taxable-equivalent adjustment
                
                
                144
                
                
                
                124
                
                
                
                16.1Net
      interest income
                
                
                4,983
                
                
                
                4,787
                
                
                
                4.1Provision
      for loan losses
                
                
                900
                
                
                
                345
                
                
                
                160.9Noninterest
      income
                
                
                1,249
                
                
                
                1,680
                
                
                
                (25.7
                )Noninterest
      expense
                
                
                4,937
                
                
                
                4,882
                
                
                
                1.1Income
      tax expense (benefit)
                
                
                (61
                )
                
                
                270
                
                
                
                (122.6
                )Net
      income
                
                
                456
                
                
                
                970
                
                
                
                53.0Dividends
      on preferred stock
                
                
                253
                
                
                
                -
                
                
                NMNet
      Income available to common stockholders
                
                
                203
                
                
                
                970
                
                
                
                79.1Per
      Common Share Data:Earnings:Basic
                
                $
                0.03
                
                
                $
                0.13
                
                
                
                (76.9
                )
      %Diluted
                
                
                0.03
                
                
                
                0.13
                
                
                
                (76.9
                )Cash
      dividends paid
                
                
                0.085
                
                
                
                0.08
                
                
                
                6.3Book
      value
                
                
                11.19
                
                
                
                11.21
                
                
                
                (0.2
                )Tangible
      book value
                
                
                7.14
                
                
                
                7.12
                
                
                
                0.3Weighted
      average shares:Basic
                
                
                7,392,742
                
                
                
                7,406,656
                
                
                
                (0.2
                )Diluted
                
                
                7,392,742
                
                
                
                7,447,544
                
                
                
                (0.8
                )End
      of period shares outstanding
                
                
                7,515,957
                
                
                
                7,552,644
                
                
                
                (0.5
                )Performance
      Ratios:Return
      on average assets
                
                
                0.10
                %
                
                
                0.50
                %
                
                
                (80.0
                )
      %Return
      on average common stockholders’ equity
                
                
                0.98
                
                
                
                4.61
                
                
                
                (78.7
                )Net
      interest margin – taxable equivalent
                
                
                2.81
                
                
                
                2.89
                
                
                
                (2.8
                )Efficiency
      ratio
                
                
                79.22
                
                
                
                75.49
                
                
                
                4.9Noninterest
      expense to average assets
                
                
                2.38
                
                
                
                2.52
                
                
                
                (5.6
                )Credit
      Quality Data:Nonperforming
      loans
                
                $
                6,267
                
                
                $
                2,477
                
                
                
                153.1
                %Nonperforming
      assets
                
                
                7,939
                
                
                
                3,006
                
                
                
                164.1Nonperforming
      loans to total loans
                
                
                0.98
                %
                
                
                0.43
                %
                
                
                127.9Nonperforming
      assets to total assets
                
                
                0.93
                
                
                
                0.39
                
                
                
                138.5Nonperforming
      assets to total loans and OREO
                
                
                1.25
                
                
                
                0.53
                
                
                
                135.9Net
      charge-offs
                
                
                196
                
                
                
                62
                
                
                
                216.1Net
      charge-offs to average loans
                
                
                0.03
                
                
                
                0.01
                
                
                
                200.0Allowance
      for loan losses
                
                
                8,730
                
                
                
                6,427
                
                
                
                35.8Allowance
      for loan losses to total loans
                
                
                1.37
                
                
                
                1.12
                
                
                
                22.3Allowance
      for loan losses to nonperforming loans...
                
                
                1.39
                x
                
                
                2.54
                x
                
                
                (46.3
                )Average
      Balances:Total
      assets
                
                $
                829,319
                
                
                $
                774,030
                
                
                
                7.14
                %Loans,
      net of unearned income
                
                
                626,722
                
                
                
                567,039
                
                
                
                10.53Interest-earning
      assets
                
                
                740,404
                
                
                
                680,566
                
                
                
                8.79Deposits
                
                
                593,166
                
                
                
                579,802
                
                
                
                2.30Interest-bearing
      liabilities
                
                
                692,789
                
                
                
                636,875
                
                
                
                8.78Stockholders’
      equity
                
                
                104,884
                
                
                
                84,568
                
                
                
                24.02At
      Period End:Total
      assets
                
                $
                851,390
                
                
                $
                776,583
                
                
                
                9.63
                %Loans,
      net of unearned income
                
                
                635,008
                
                
                
                571,938
                
                
                
                11.03Interest-earning
      assets
                
                
                765,747
                
                
                
                685,977
                
                
                
                11.63Deposits
                
                
                628,571
                
                
                
                582,567
                
                
                
                7.90Interest-bearing
      liabilities
                
                
                696,085
                
                
                
                642,115
                
                
                
                8.41Stockholders’
      equity
                
                
                104,663
                
                
                
                84,701
                
                
                
                23.57




NM = Not
Meaningful




12




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.





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 inherent in the Bank’s portfolio at the measurement date.
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 collectability 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 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
collectability.  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.





Other-Than-Temporary Impairment of
Securities.On at least a quarterly basis management 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 2007,
the FASB issued Staff Position (“FSP”) FAS No. 115-1 and FAS No. 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,”FASNo. 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.”




13





Based on
management’s ongoing evaluation of its investment portfolio effective March 31,
2009, management determined that a $123,000 impairment on two equity investments
was other-than-temporary.  The first equity investment was determined
to have a $71,000 impairment on the Company’s $161,000 of common stock in its
correspondent bank.   Management determined that the impairment
was other-than-temporary because the correspondent bank is under a regulatory
directive to raise additional capital due to credit losses in its loan
portfolio. Its ability to raise additional capital and comply with the
regulatory directive was uncertain as of March 31, 2009.  The
Company’s remaining equity investment in the correspondent bank was $92,000
after the recognition of the impairment.  Subsequent to March 31,
2009, the correspondent bank was placed into receivership by the federal
regulators.  This will likely result in an other-than-temporary
impairment of the remaining $92,000 investment during the second quarter of
2009.   The other equity investment was determined to have a
$52,000 impairment on the Company’s $144,000 of common stock in a closely held
trust company.  Management determined that the impairment was
other-than-temporary due to declining asset balances under management and lack
of growth in new customers.  The Company’s remaining investment in the
trust company was $92,000 as of March 31, 2009, after the recognition of the
impairment.  In accordance with SFAS No. 157, “Fair Value Measurements,” the Company uses
valuation techniques that are appropriate and consistently applied.  A
fair value hierarchy is used to prioritize valuation inputs into the following
three levels to determine fair value:





Level 1: Quoted
prices in active markets for identical assets or liabilities.




Level
2: Observable inputs other than the quoted prices included in Level
1.




Level
3: Unobservable inputs.





Due to
the lack of liquidity for both of these equity investments, the security was
valued using Level 3.  The fair values were prepared based on the
Company’s most recent capital position and total common shares outstanding based
on information prepared by the individual companies.





Effective
March 31, 2009, management evaluated the Company’s investment portfolio and
determined that all other unrealized losses were the direct result of temporary
changes in interest rates and that such losses may be recovered in the
foreseeable future.  The Company has the ability to hold these
investments to maturity if necessary in order to recover any temporary losses
that may presently exist.  As a result, management did not consider
any additional unrealized losses as “other-than-temporary” as of March 31,
2009.





Comparison
of Financial Condition





Assets.  Total assets of
the Company increased by $34.2 million, or 4.2%, from $817.2 million at December
31, 2008, to $851.4 million at March 31, 2009.  This increase was
primarily due to a $21.5 million increase in interest-earning bank balances, an
$8.3 million increase in loans, a $3.6 million increase in investment securities
and a $2.1 million increase in mortgage-backed securities
(“MBS”).  These increases were partly offset by a $929,000 decrease in
other real estate owned and a $644,000 decrease in Federal Home Loan Bank
stock.





Interest-earning
bank balances increased by $21.5 million from $613,000 at December 31, 2008, to
$22.1 million at March 31, 2009.  This increase was primarily
attributable to strong deposit growth of $47.1 million during the first quarter
of 2009.  Management expects that the level of interest-bearing bank
balances will be substantially reduced in the second quarter of 2009 as the
excess liquidity from this rapid deposit growth are invested in higher yielding
loans and investment securities.





During
the quarter ended March 31, 2009, loans receivable increased by $8.3 million, or
1.3%, to $635.0 million.  The growth in loans was primarily comprised
of a $19.7 million, or 6.1%, increase in commercial real estate loans, a $4.4
million, or 12.9%, increase in commercial business loans, and a $1.4 million, or
1.2%, increase in consumer loans.  These increases were partly offset
by a $3.7 million, or 4.4%, decrease in permanent one-to-four family residential
loans and a $24.2 million, or 33.8%, decrease in construction loans. The large
decrease in construction loans was primarily due to the reclassification of
several larger commercial projects which converted from construction status to
permanent status during the quarter.  Loan production amounted to
$26.1 million during the first quarter of 2009 as compared to $68.5 million
during the first quarter of 2008.  The economy in the Charlotte region
continued to slow during the first quarter of 2009, but remains stronger than
most other large metropolitan areas of the country.  However, the
slowdown in housing starts and demand for commercial real estate has resulted in
decreased loan demand.  A continued slowdown in the local economy
would 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 prudent manner with an emphasis on borrowers that have a
demonstrated capacity to meet their debt obligations, even if the local economy
continues to slow.




14





During
the three-month period ended March 31, 2009, investment securities increased by
$3.7 million, or 12.7%, to $32.6 million.  The increase in investment
securities was primarily due to the purchases of $5.2 million in securities with
funds generated from excess liquidity generated from deposit growth during the
quarter.  These purchases were partly offset by normal maturities of
$1.1 million, a $379,000 increase in unrealized losses on investments
available-for-sale, and a $123,000 other-than-temporary
impairment.  MBS increased $2.1 million, or 2.6%, to $82.4 million.
The increase in MBS was due to the purchase of $5.1 million of MBS during the
quarter and a $727,000 increase in unrealized gains on the sale of MBS
available-for-sale.  The effects of these increases were partly offset
by $3.7 million of normal principal amortization.  Management expects
the investment and MBS portfolios to increase as a percentage of total assets
over the next quarter as the excess liquidity generated from rapid deposit
growth in the first quarter of 2009 is invested in higher-yielding
assets.





Other
real estate owned, which includes all properties acquired by the Company through
foreclosure, totaled $1.7 million at March 31, 2009, compared to $2.6 million at
December 31, 2008.   At March 31, 2009, other real estate owned
consisted of eight one-to-four family residential dwellings, two residential
lots, and one commercial property. During the first quarter of 2009, the Company
foreclosed on one residential lot and sold four foreclosed residential
properties for a loss of $171,000. Also, the Company decreased the book value of
one residential property by $125,000 during the quarter, due to a drop in
housing prices for comparably priced residences in the property’s
neighborhood.  All foreclosed properties are written down to their
estimated fair value (market value less estimated disposition costs) at
acquisition and are located in the Bank’s primary lending
area.  Management will continue to aggressively market foreclosed
properties for a timely disposition.





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, 2009, the
allowance for loan losses was $8.7 million, or 1.37% of total
loans.  Management believes that this amount meets the requirement for
losses on loans that management considers to be impaired, for known losses, and
for 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 comparable periods and information with
respect to nonperforming assets at the dates indicated.




15





At
      and For the Three Months Ended March 31,2009
                
                
                2008(Dollars
      in thousands)Allowance
      for loan losses:Beginning
      of period
                
                $
                8,026
                
                
                $
                6,144Add:
      Provision for loan losses
                
                
                900
                
                
                
                345Recoveries
                
                
                141
                
                
                
                14Less:
      Charge-offs
                
                
                337
                
                
                
                76End
      of period
                
                $
                8,730
                
                
                $
                6,427Nonperforming
      assets:Nonaccrual
      loans
                
                $
                6,267
                
                
                $
                2,477Other
      real estate owned
                
                
                1,672
                
                
                
                529Nonperforming
      assets
                
                $
                7,939
                
                
                $
                3,066Credit
      Quality Ratios:Nonperforming
      loans to total loans
                
                
                0.98
                %
                
                
                0.43
                %Nonperforming
      assets to total assets
                
                
                0.93
                %
                
                
                0.39
                %Nonperforming assets to total loans and
    OREO
                
                
                1.25
                %
                
                
                0.53
                %Allowance
      for loan losses as a percentage of total loans
                
                
                1.37
                %
                
                
                1.12
                %Ratio
      of allowance for loan losses to nonperforming loans
                
                1.39
                x
                
                
                2.59
                x




Premises
and equipment decreased by $202,000, or 1.2%, to $16.6 million at March 31,
2009.  This decrease was primarily due to normal
depreciation.  During the first quarter of 2009, the Company opened a
loan production office located in a leased facility in Charlotte, North
Carolina. No significant changes to the Company’s premises and equipment are
anticipated for the remainder of 2009.





Liabilities.Total liabilities increased
by $34.2 million, or 4.8%, from $712.5 million at December 31, 2008, to $746.7
million at March 31, 2009.  This increase was primarily due to a $47.1
million increase in total deposits which was partly offset by an $11.7 million
decrease in borrowed money.





During
the first quarter of 2009 total deposits increased by $47.1 million, or 8.1%, to
$628.6 million at March 31, 2009. This increase in deposits was fueled in part
by positive publicity that the Company received relating to our nationally
recognized program for utilization of TARP funds for low interest mortgage
loans.  The Company’s low interest rate mortgage program was featured
in an article in The
Washington Post and was subsequently covered by several other nationally
recognized print and electronic media organizations. Our deposit growth was also
partly due to increased numbers of customers moving funds out of brokerage
accounts and a continued emphasis on increasing the Company’s number of retail
and business customers through employee incentive plans and enhanced treasury
service products.  The deposit growth occurred in all categories of
deposits.  During the first quarter of 2009 demand deposits (checking
accounts) increased by $14.1 million, or 11.5%, to $136.8 million, money market
deposit accounts increased by $10.8 million, or 10.5%, to $114.1 million,
savings accounts increased by $437,000, or 4.1%, to $11.1 million and time
deposits increased by $21.8 million, or 6.3%, to $366.5 million. The Company
will continue to actively market the Company’s deposit products at pricing
points that management believes to be profitable. Management has always focused
on increasing deposits by building customer relationships and typically avoids
growing deposits by offering the highest rates in the
market.   From time to time management may use brokered deposits
as an alternative funding source for additional loan growth or liquidity
needs.  At March 31, 2009, brokered deposits totaled only
$99,000.





Borrowed
money decreased by $11.7 million, or 9.4%, to $112.7 million at March 31,
2009.  This decrease was primarily due to the repayment of short-term
Federal Home Loan Bank (“FHLB”) advances that were obtained primarily for the
purpose of funding loan growth.  Funds generated from growth in
deposits were used to repay these short-term FHLB
advances.  Additional borrowed money may be used in the future to fund
additional loan growth, 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.




16





Stockholders’
Equity.Total
stockholders’ equity remained at $104.7 million at March 31,
2009.  During the first quarter of 2009, the Company paid $636,000 in
dividends on common stock.  This decrease in capital was offset by
$203,000 of net income, a $214,000 increase in the unrealized gain on available
for sale securities, and $162,000 of vesting expenses relating to various
benefit plans.  The increase in unrealized gains on available-for-sale
securities was primarily due to a decrease in long-term interest rates during
the period resulting in part from the program by the Federal Reserve Board to
purchase longer-term government agency mortgage-backed securities.





Comparison
of Results of Operations for the Three Months Ended March 31, 2009 and
2008





General.  Net income for
the three months ended March 31, 2009, amounted to $203,000, or $0.03 per
diluted share, as compared to $970,000, or $0.13 per diluted share, for the
three months ended March 31, 2008.  This represented a 79.1% decrease
in net income and a 76.9% decrease in diluted earnings per share for the
comparable periods.  This decrease was largely due to increased credit
losses arising as a result of a slowing economy and increased nonperforming
assets.





Net interest
income.
Interest income decreased by $1.3 million, or 11.7%, to $9.7 million for the
first quarter of 2009, primarily as a result of a 400 basis point decrease in
short-term interest rates during 2008.  As of March 31, 2009,
approximately 42% of the Company’s loan portfolio was scheduled to reprice on a
monthly basis. Average interest-earning assets increased by $59.8 million, or
8.8%, to $740.4 million for the three months ended March 31, 2009. The increase
in average interest-earning assets was primarily the result of a $59.7 million,
or 10.5%, increase in average outstanding loans to $626.7
million.  The Company’s average yield on earning assets decreased by
116 basis points to 5.38% for the quarter ended March 31,
2009.   Interest expense decreased by $1.5 million, or 24.0%, for
the comparable quarters to $4.7 million for the first quarter of
2009.  This decrease in interest expense was largely due to lower
market interest rates.  The Company experienced a $55.9 million, or
8.8%, increase in the average balance of interest-bearing liabilities to $692.8
million for the three months ended March 31, 2009. Average interest-bearing
liabilities increased primarily as a result of an $11.2 million, or 2.1%,
increase in average interest-bearing deposits coupled with a $44.7 million, or
46.0%, increase in average borrowed money.   In addition, the
average cost of funds decreased by 99 basis points to 2.90% for the quarter
ended March 31, 2009.





As a
result of the decrease in interest rates during the comparable periods, the
tax-equivalent net interest margin decreased by eight basis points to 2.81% for
the quarter ended March 31, 2009, compared to 2.89% for the quarter ended March
31, 2008. This decrease in the net interest margin was primarily the result of
yields on earning assets falling at a faster rate than the cost of funds. On a
linked-quarter basis, the Company’s tax-equivalent net interest margin decreased
six basis points from 2.87% for the fourth quarter of 2008 to 2.81% for the
first quarter of 2009.  While the Company maintains a relatively
neutral interest rate risk position on a cumulative one-year basis, the Federal
Reserve Board’s action to lower short-term interest rates by 200 basis points in
the fourth quarter of 2008 will have a more pronounced negative impact in the
first three months following the decrease in short-term interest
rates.  The short-term negative effects of a decrease in interest
rates are expected to be mostly offset by time deposits that mature over the
next 12 months and reprice at a lower cost to the Company.





Provision for
loan losses.Due to the general weakness in the local economy and an
increase in nonperforming assets, the Company increased its provision for loan
losses to $900,000 for the first quarter of 2009 compared to $345,000 for the
first quarter of 2008.  As a result, the allowance for loan losses was
$8.7 million, or 1.37% of total loans, as of March 31, 2009, compared to $8.0
million, or 1.12% of total loans, as of March 31, 2008.  While the
Company’s credit quality continues to compare favorable with industry peers, the
continued decline in local economic conditions has resulted in an upward trend
in the Company’s loan delinquency ratios.   The Company’s ratio
of non-performing assets to total assets increased from 0.39% at March 31, 2008,
to 0.93% at March 31, 2009. A substantial portion of the Company’s nonperforming
loans at March 31, 2009, was secured by real estate located in the Company’s
normal lending market.  Net chargeoffs totaled $196,000, or 0.03% of
average loans, during the first quarter of 2009 compared to $62,000, or 0.01% of
average loans, during the first quarter of 2008.




17




Noninterest
income.Noninterest
income decreased by $431,000, or 25.7%, to $1.2 million for the three months
ended March 31, 2009, as compared to $1.7 million for the three months ended
March 31, 2008. This decrease was largely attributable to a $413,000 increase in
the net loss on sale of assets for the comparable periods.  During the
first quarter of 2009 the Company sold four residential properties that were
acquired through foreclosure at a net loss of $171,000.  During the
first quarter of 2008 the Company recognized $242,000 in net gains from the sale
of $13.4 million in investment securities and $12.5 million in mortgage-backed
securities.





Excluding
the impact of the net gains and losses from the sales of assets during the
comparable quarters, noninterest income would have decreased by $18,000, or
1.3%, from the first quarter of 2008 to the first quarter of
2009.  This decrease was primarily attributable to a $62,000 decrease
in dividends on FHLB stock, a $53,000 decrease in fees on lending activities, a
$35,000 increase in the fair value adjustment on deferred compensation assets
and a $30,000 reduction in other noninterest income.   The FHLB
suspended its dividend paid to stockholders in 2008, resulting in no dividend
payment during the first quarter of 2009.  It is unclear when, or if,
the FHLB will reinstate the dividend.  The reduction in fee income
from lending activities was largely due to reduced construction loan activity
resulting from the economic slowdown that is expected to last through 2009. The
reduction in the fair value adjustment on deferred compensation assets is
directly offset by a corresponding decrease in noninterest expense, resulting in
no net impact on earnings.  Other noninterest income decreased, in
part, as a result of fewer commissions earned from the sale of uninsured
financial products.





These
decreases in noninterest income were partly offset by a $69,000 increase in fees
on deposits and a $95,000 increase in mortgage banking fee
income.   An increase in the number of demand deposit customers
over the past year contributed to the improvement in deposit fee
income.  The increase in mortgage banking fee income was primarily due
to increased refinancing activity in the housing market as a result of lower
long-term mortgage rates for consumers.





Noninterest
expense.Noninterest expense
increased by $55,000, or 1.13%, to $4.9 million for the quarter ended March 31,
2009.  The primary reasons for this increase were a $125,000 writedown
on a foreclosed residential property, a $123,000 other-than-temporary impairment
on two equity securities, an $86,000 increase in FDIC deposit insurance
premiums, a $35,000 increase in professional fees, and a $15,000 increase in
other noninterest expenses.  The writedown on the foreclosed property
was the result of a softening in residential sales prices for similarly priced
properties located near the Company’s foreclosed property.  Additional
valuation adjustments on foreclosed properties may be recognized if sales prices
for local properties continue to soften. The other-than-temporary impairment was
on two equity investments.  The first equity investment was common
stock in its correspondent bank that management determined was
other-than-temporary because the correspondent bank was under a regulatory
directive to raise additional capital due to credit losses in its loan
portfolio.  Their ability to raise additional capital and comply with
the regulatory directive was uncertain as of March 31, 2009.  The
other equity investment was common stock in a closely held trust company that
was determined to be other-than-temporary due to declining balances of assets
under management and a declining customer base.  The increase in FDIC
insurance premiums was due to the fact that the FDIC revised the formula for
calculating deposit insurance premiums in an effort to replenish the deposit
insurance fund, resulting in higher deposit insurance premiums for the
Bank.  These deposit premium increases are expected to continue
throughout the foreseeable future.  In addition, there is a proposed
one-time FDIC insurance assessment of up to 20 basis points of outstanding
deposits on the measurement date of June 30, 2009, which could result in an
additional premium expense of up to $1.2 million in the third quarter of
2009.  The actual amount of the one-time FDIC insurance assessment has
not been finalized. The increase in professional fees was primarily due to
increased legal fees paid during the first quarter of 2009 for services related
to ensuring compliance with the TARP restrictions. Other noninterest expense
increased partly to the increased costs of servicing a higher number of checking
accounts and increased expenses for foreclosed properties.




18





These
increases in noninterest expense were partly offset by a $220,000 reduction in
restructuring expenses, a $14,000 reduction in compensation and benefits, a
$60,000 decrease in the amortization of intangible assets, and a $35,000
reduction in the fair value adjustment on deferred compensation. The
restructuring expense was attributable to severance payments made to various
employees whose positions were eliminated during the first quarter of
2008.  As a part of the restructuring, four positions were eliminated
and three leased loan production offices were consolidated into existing
facilities.  No additional expenses are expected in conjunction with
the reorganization. As a result of this reorganization in 2008, the Company’s
compensation and benefits decreased during the first quarter of 2009, as
compared to the first quarter 2008.  The amortization of intangible
assets is expected to continue to decrease as the amount of the core deposit
intangible decreases.  The decrease in the fair value adjustment on
deferred compensation during the comparable quarters was directly offset by a
corresponding decrease to noninterest income, resulting in no net impact to the
Company.





Income
taxes.Income taxes amounted
to a benefit of $61,000 for the quarter ended March 31, 2009.  This
benefit was largely due to the fact that nontaxable income generated from
interest earned on bank-qualified municipal securities and loans exceeded the
Company’s income tax provision.  This nontaxable income was primarily
generated from interest earned on bank-qualified municipal securities and
increases in cash value on bank-owned life insurance policies.  The
Company invests in tax-advantaged sources of income to reduce its overall tax
burden.  However, 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. The Company expects to
generate sufficient taxable income in 2009 to fully recognize the taxable
benefits of these investments.  During the first quarter of 2008 the
Company’s income tax expense totaled $270,000, or 21.8% of taxable
income.





Liquidity





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 $110.6 million available to draw from its line of credit with the
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 had $20.0 million available from
an unsecured federal funds accommodation with Silverton Bank
(“Silverton”).  Silverton 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 Silverton 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.  During the second quarter of 2009 the Company moved its
correspondent banking relationship to another bank which included a $15.0
million unsecured federal funds accommodation.  As a result, the
Company cancelled its $20.0 million federal funds accommodation with Silverton
during the second quarter of 2009.  The Company may also solicit
brokered deposits for providing funds for asset growth.  As of March
31, 2009, the Company had outstanding brokered deposits of $99,000. 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.





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, 2009, the Company had loan
commitments of $25.9 million, unused lines of credit of $96.8 million, and
undisbursed construction loan proceeds of $4.9 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.




19





Capital
Resources





On
December 12, 2008, Citizens South Banking Corporation entered into a Letter
Agreement (the "Purchase Agreement") with the U.S. Treasury pursuant to which
the Company has issued and sold to the U.S. Treasury: (i) 20,500 shares of the
Company's Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value
$0.01 per share, having a liquidation amount per share equal to $1,000, for a
total price of $20,500,000 and (ii) a warrant to purchase 428,870 shares of the
Company's common stock, par value $0.01 per share, at an exercise price per
share of $7.17. The warrant has a ten-year term and is immediately exercisable.
The warrant provides for the adjustment of the exercise price and the number of
shares of the Company's common stock issuable upon exercise pursuant to
customary anti-dilution provisions, such as upon stock splits or distributions
of securities or other assets to holders of the Company's common stock, and upon
certain issuances of the Company's common stock at or below a specified price
relative to the then current market price of the Company's common stock. If, on
or prior to December 31, 2009, the Company receives aggregate gross cash
proceeds of not less than the purchase price of the Series A Preferred Stock
from one or more "qualified equity offerings," the number of shares of common
stock issuable pursuant to the Warrant will be reduced by one-half of the
original number of shares, taking into account all adjustments. Pursuant to the
Purchase Agreement, the U.S. Treasury has agreed not to exercise voting power
with respect to any shares of common stock issued upon exercise of the
warrant.  Both the Series A Preferred Stock and warrant are accounted
for as components of Tier 1 capital.





The
Series A Preferred Stock pays cumulative dividends at a rate of 5% per annum for
the first five years and thereafter at a rate of 9% per annum.  The
Series A Preferred Stock can be repaid at any time from non-equity sources with
the approval of the OTS.  The Series A Preferred Stock is generally
non-voting. Prior to December 12, 2011, and unless the Company has redeemed all
of the Series A Preferred Stock or the U.S. Treasury has transferred all of the
Series A Preferred Stock to a third party, the approval of the U.S. Treasury
will be required for the Company to increase its common stock dividend or
repurchase its common stock or other equity or capital securities, other than in
certain circumstances specified in the Purchase Agreement.   In
addition the U.S. Treasury placed certain restrictions on the amount and type of
compensation that can be paid to certain senior level executives of the
Company.





The Bank
is subject to various regulatory capital requirements administered by the
banking regulatory agencies. Failure to meet minimum capital requirements can
result in 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.




20





The
Bank’s actual capital levels and regulatory capital ratios as of March 31, 2009,
are presented in the following table.





Regulatory
      Capital Ratios:
            
            Actual
            
            
            Minimum
      Requirements to be Well Capitalized(Dollars
      in Thousands)
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioCitizens
      South Bank:Total
      Capital (to risk-weighted assets)
            
            $
            89,606
            
            
            
            13.07
            %
            
            $
            68,567
            
            
            
            10.00
            %Tier
      1 Capital (to risk-weighted assets)
            
            
            82,603
            
            
            
            12.05
            %
            
            
            41,140
            
            
            
            6.00
            %Tier
      1 Capital (to adjusted total assets)
            
            
            82,603
            
            
            
            10.09
            %
            
            
            40,937
            
            
            
            5.00
            %Tangible
      Capital (to adjusted total assets)
            
            
            82,603
            
            
            
            10.09
            %
            
            
            24,562
            
            
            
            3.00
            %




ITEM
3.  Quantitative and Qualitative Disclosures About Market
Risk





As
described in more detail in our Annual Report on Form 10-K for the year ended
December 31, 2008, asset/liability management involves the evaluation,
monitoring and management of interest rate risk, liquidity and funding. While
the Board of Directors has overall responsibility for the Company’s
asset/liability management policies, the Bank’s Asset and Liability Committee
monitors loan, investment, and liability portfolios to ensure comprehensive
management of interest rate risk and adherence to the Bank’s policies.
Management does not believe there has been any significant change in the overall
sensitivity of its interest-earning assets and interest-bearing liabilities from
the results presented in the Annual Report on Form 10-K for the year ended
December 31, 2008.





ITEM
4.  Controls and Procedures





Our
management, with the participation of our Chief Executive Officer and our Chief
Financial Officer, has evaluated the effectiveness of the design and operation
of our disclosure controls and procedures in accordance with Rule 13a-15 of the
Securities Exchange Act of 1934 (the “Exchange Act”).  Based upon
their evaluation, our Chief Executive Officer and our Chief 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 provide
reasonable assurance 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.





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.




21




Item
1A.  Risk Factors





There
were no material changes in the risk factors that were identified in the Form
10-K for the year ended December 31, 2008.





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





During
the three-month period ended March 31, 2009, the Company did not repurchase any
shares of common stock 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
      PlanJanuary
            
            
            0
            
            
            $
            0.00
            
            
            
            9,476
            
            
            
            190,524February
            
            
            0
            
            
            $
            0.00
            
            
            
            9,476
            
            
            
            190,524March
            
            
            0
            
            
            $
            0.00
            
            
            
            9,476
            
            
            
            190,524Total
            
            
            0
            
            
            $
            0.00
            
            
            
            9,476
            
            
            
            190,524





As of
March 31, 2009, the Company had repurchased a total of 3,213,911 shares, or
35.5% of the outstanding shares of common stock, at an average price of
$13.06.  This stock was repurchased under a series of repurchase
programs that have been authorized by the Board of Directors over the past
several years.  The most recent repurchase authorization was granted
by the Board of Directors in June 2008, for the repurchase of up to 200,000
shares, or approximately 2.7% of the Company’s then outstanding shares of common
stock.  As of March 31, 2009, the Company had repurchased a total of
9,476 shares at an average price of $7.91 per share and had 190,524 shares
remaining to be repurchased under this plan.  On December 12, 2008,
the Company entered into a Letter Agreement with the U.S. Treasury pursuant to
which the Company has issued and sold to the U.S. Treasury: (i) 20,500 shares of
the Company's Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par
value $0.01 per share, having a liquidation amount per share equal to $1,000,
for a total price of $20,500,000 and (ii) a warrant to purchase 428,870 shares
of the Company's common stock, par value $0.01 per share, at an exercise price
per share of $7.17.  As a condition for issuing the preferred stock,
the U.S. Treasury limited the Company’s ability to repurchase common stock of
the Company and increase its dividend payments to stockholders without receiving
prior approval from the U.S. Treasury.   As a result, future
repurchases of Company common stock are not anticipated for 2009.




Item
3. Defaults Upon Senior Securities




None.




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


None.




Item
5. Other Information





None.




22





Item
6. 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
            Writtenstatement
      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.




SIGNATURES





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




Citizens
      South Banking CorporationDate:
      May 14, 2009
            By:
            /s/
      Kim S. PriceKim
      S. PricePresident
      and Chief Executive OfficerDate:
      May 14, 2009
            By:
            /s/
      Gary F. HoskinsGary
      F. HoskinsExecutive
      Vice President, Chief Financial Officer and Treasurer




23