**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**





**FORM
      10-Q**





(Mark
      One)


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


**For
      the quarterly period ended** **March
      31, 2008**





**OR**





o
            **Transitional
                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 of incorporation or organization
            
            (I.R.S.
                Employer Identification Number)





**519
                South New Hope Road, Gastonia, NC**
            
            **28054**(Address
                of principal executive offices)
            
            (Zip
                Code)





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











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





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.





(Check
      one):





Large
                accelerated filer o
            **Accelerated
                filer**x
            Non-accelerated
                filer o
            Smaller
                Reporting Company o





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





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





**Common
      stock, $0.01 par value**


**7,537,644
      shares outstanding as of May 9, 2008**








**Citizens
      South Banking Corporation**


**Index**


Page**PART
                I. -- Financial Information**Item
                1.   Condensed Consolidated Financial
                Statements:Condensed
                Consolidated Statements of Financial Condition March 31, 2008 and
                December
                31, 2007
            1Condensed
                Consolidated Statements of Operations for the Three Months Ended
                March 31,
                2008 and 2007
            2Condensed
                Consolidated Statements of Comprehensive Income for the Three Months
                Ended
                March 31, 2008 and 2007
            3Condensed
                Consolidated Statements of Changes in Stockholders’ Equity for the Three
                Months Ended March 31, 2008 and 2007
            4Condensed
                Consolidated Statements of Cash Flows for the Three Months Ended
                March 31,
                2008 and 2007
            5Notes
                to Condensed Consolidated Financial Statements
            6Item
                2.  Management's Discussion and Analysis of Financial Condition
                and Results of Operations
            9Item
                3. Quantitative and Qualitative Disclosures About Market
                Risk
            18Item
                4. Controls and Procedures
            18**PART
                II -- Other Information**
            18Item
                1. Legal Proceedings
            18Item
                1A. Risk Factors
            18Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            19Item
                3. Defaults Upon Senior Securities
            19Item
                4. Submission of Matters to a Vote of Security Holders
            19Item
                5. Other Information
            19Item
                6. Exhibits
            20Signatures
            20







**PART
      I.**  **FINANCIAL
      INFORMATION**





**ITEM
      1.  Condensed Consolidated Financial Statements**





**Citizens
      South Banking Corporation**


**Condensed
      Consolidated Statements of Financial Condition**


(dollars
      in thousands, except per share data)


**March
                  31,**
              
              **December
                  31,****2008**
              
              **2007****(unaudited)****Assets:**Cash
                  and cash equivalents:Cash
                  and due from banks
              
              $
              13,454
              
              $
              14,285Interest-earning
                  bank balances
              
              
              3,050
              
              
              11,201Fed
                  funds sold
              
              
              11,570
              
              
              4,253Total
                  cash and cash equivalents
              
              
              28,074
              
              
              29,739Investment
                  securities available-for-sale, at fair value
              
              
              31,725
              
              
              46,519Mortgage-backed
                  and related securities available-for-sale, at fair value
              
              
              70,171
              
              
              69,893Loans:Loans
                  receivable, net of unearned income
              
              
              571,938
              
              
              559,956Allowance
                  for loan losses
              
              
              (6,427
              )
              
              (6,144
              )Net
                  loans
              
              
              565,511
              
              
              553,812Other
                  real estate owned
              
              
              529
              
              
              529Premises
                  and equipment, net
              
              
              17,781
              
              
              17,965Accrued
                  interest receivable
              
              
              2,708
              
              
              3,254Federal
                  Home Loan Bank stock
              
              
              4,280
              
              
              4,236Intangible
                  assets
              
              
              30,896
              
              
              31,037Cash
                  value of bank-owned life insurance policies
              
              
              16,270
              
              
              16,099Other
                  assets
              
              
              8,638
              
              
              6,057Total
                  assets
              
              $
              776,583
              
              $
              779,140**Liabilities
                  and Stockholders’ Equity:**Deposits:Demand
                  deposit accounts
              
              $
              104,527
              
              $
              101,981Money
                  market deposit accounts
              
              
              123,733
              
              
              129,688Savings
                  accounts
              
              
              12,193
              
              
              12,037Time
                  deposits
              
              
              342,114
              
              
              347,059Total
                  deposits
              
              
              582,567
              
              
              590,765Borrowed
                  money
              
              
              101,324
              
              
              96,284Deferred
                  compensation
              
              
              4,992
              
              
              5,389Other
                  liabilities
              
              
              2,999
              
              
              2,669Total
                  liabilities
              
              
              691,882
              
              
              695,107Stockholders’
                  Equity:Preferred
                  stock, 10,000,000 shares authorized, none issued
              
              
              -
              
              
              -Common
                  stock, $0.01 par value, 20,000,000 shares authorized;Issued:
                  9,062,727 shares;Outstanding:
                  7,552,644 shares at March 31, 2008 and 7,610,017 sharesat
                  December 31, 2007
              
              
              91
              
              
              91Additional
                  paid-in-capital
              
              
              67,803
              
              
              67,718Unallocated
                  common stock held by Employee Stock Ownership Plan
              
              
              (1,202
              )
              
              (1,247
              )Retained
                  earnings
              
              
              36,268
              
              
              36,028Accumulated
                  other comprehensive income (loss), net of deferred income taxes
                  .
              
              
              450
              
              
              (343
              )Treasury
                  stock of 1,510,083 shares at March 31, 2008, and 1,452,710
                  sharesat
                  December 31, 2007, at cost
              
              
              (18,709
              )
              
              (18,214
              )Total
                  stockholders’ equity
              
              
              84,701
              
              
              84,033Total
                  liabilities and stockholders’ equity
              
              $
              776,583
              
              $
              779,140




***See
      notes to condensed consolidated financial
      statements.***


1


**Citizens
      South Banking Corporation**


**Condensed
      Consolidated**  **Statements
      of Operations** **(unaudited)**


**(in
      thousands, except per share data)**


**Three
                  Months****Ended
                  March 31,****2008**
              
              **2007****Interest
                  Income:**Loans
              
              $
              9,601
              
              $
              9,893Investment
                  securities
              
              
              413
              
              
              669Interest-bearing
                  deposits
              
              
              94
              
              
              132Mortgage-backed
                  and related securities
              
              
              864
              
              
              671Total
                  interest income
              
              
              10,972
              
              
              11,365**Interest
                  Expense:**Deposits
              
              
              5,066
              
              
              5,341Borrowed
                  funds
              
              
              1,119
              
              
              978Total
                  interest expense
              
              
              6,185
              
              
              6,319Net
                  interest income
              
              
              4,787
              
              
              5,046Provision
                  for loan losses
              
              
              345
              
              
              330Net
                  interest income after provision for loan losses
              
              
              4,442
              
              
              4,716**Noninterest
                  Income:**Fee
                  income on deposit accounts
              
              
              678
              
              
              653Mortgage
                  banking income
              
              
              203
              
              
              232Income
                  on lending activities
              
              
              111
              
              
              110Dividends
                  on FHLB stock
              
              
              62
              
              
              51Increase
                  in cash value of bank-owned life insurance
              
              
              188
              
              
              209Fair
                  value adjustment on deferred compensation assets
              
              
              (14
              )
              
              37Net
                  gain on sale of assets
              
              
              242
              
              
              5Other
                  noninterest income
              
              
              210
              
              
              233Total
                  noninterest income
              
              
              1,680
              
              
              1,530**Noninterest
                  Expense:**Compensation
                  and benefits
              
              
              2,555
              
              
              2,342Fair
                  value adjustment on deferred comp. obligations
              
              
              (14
              )
              
              37Occupancy
                  and equipment expense
              
              
              674
              
              
              668Professional
                  services
              
              
              201
              
              
              124Amortization
                  of intangible assets
              
              
              141
              
              
              165Reorganization
                  expenses
              
              
              220
              
              
              -Other
                  noninterest expense
              
              
              1,105
              
              
              949Total
                  noninterest expense
              
              
              4,882
              
              
              4,285Income
                  before income taxes
              
              
              1,240
              
              
              1,961Provision
                  for income taxes
              
              
              270
              
              
              561**Net
                  income**
              
              $
              970
              
              $
              1,400**Net
                  income per common share:****Basic**
              
              $
              0.13
              
              $
              0.18**Diluted**
              
              $
              0.13
              
              $
              0.18**Weighted
                  average common shares outstanding:****Basic**
              
              
              **7,406,656**
              
              
              **7,862,519****Diluted**
              
              
              **7,447,544**
              
              
              **7,938,506**
  ***See
        notes to condensed consolidated financial statements.***
  2
  **Citizens
        South Banking Corporation**


**Condensed
        Consolidated**  **Statements
        of Comprehensive Income** **(unaudited)**
 **(dollars
        in thousands)**
  **Three
                    Months**
                  Ended
                    March 31,**2008**
              
              **2007**Net
                  income
              
              $
              970
              
              $
              1,400**Items
                  of other comprehensive income:**Items
                  of other comprehensive income, before taxUnrealized
                  holding losses arising during period
              
              
              1,533
              
              
              335Reclassification
                  adjustment for securities gains included in net income
              
              
              (242
              )
              
              -Other
                  comprehensive income, before tax
              
              
              1,291
              
              
              335Change
                  in deferred income taxes related to changes in unrealized gains
                  or
                  losseson
                  securities available for sale
              
              
              (497
              )
              
              (129
              )Items
                  of other comprehensive income, net of tax
              
              
              793
              
              
              206Comprehensive
                  income
              
              $
              1,763
              
              $
              1,606




*See
      notes to condensed consolidated
      financial statements.*





3


**Citizens
      South Banking Corporation**


**Condensed
      Consolidated**  **Statements
      of Changes in Stockholders’ Equity** **(unaudited)**


**(dollars
      in thousands)**


**Three
                  Months****Ended
                  March 31,****2008**
              
              **2007****Common
                  stock, $0.01 par value:**At
                  beginning of period
              
              $
              91
              
              $
              91Issuance
                  of common stock
              
              
              -
              
              
              -At
                  end of period
              
              
              91
              
              
              91**Additional
                  paid-in-capital:**At
                  beginning of period
              
              
              67,718
              
              
              67,439Vesting
                  of shares for RRP
              
              
              77
              
              
              70Stock-based
                  compensation expense
              
              
              8
              
              
              7At
                  end of period
              
              
              67,803
              
              
              67,516**Unallocated
                  common stock held by ESOP:**At
                  beginning of period
              
              
              (1,247
              )
              
              (1,430
              )Allocation
                  from shares purchased with loan from ESOP
              
              
              45
              
              
              45At
                  end of period
              
              
              (1,202
              )
              
              (1,385
              )**Retained
                  earnings, substantially restricted:**At
                  beginning of period
              
              
              36,028
              
              
              30,031Net
                  income
              
              
              970
              
              
              1,400Exercise
                  of options
              
              
              (127
              )
              
              -Dividends
                  paid
              
              
              (603
              )
              
              (601
              )At
                  end of period
              
              
              36,268
              
              
              33,830**Accumulated
                  unrealized loss on securities available for sale, net of
                  tax:**At
                  beginning of period
              
              
              (343
              )
              
              (991
              )Other
                  comprehensive income, net of tax
              
              
              793
              
              
              206At
                  end of period
              
              
              450
              
              
              (785
              )**Treasury
                  stock:**At
                  beginning of period
              
              
              (18,214
              )
              
              (12,179
              )Exercise
                  of options
              
              
              181
              
              
              -Purchase
                  of common stock for treasury
              
              
              (676
              )
              
              (1,477
              )At
                  end of period
              
              
              (18,709
              )
              
              (13,656
              )




***See
      notes to condensed consolidated financial
      statements.***


4


**Citizens
      South Banking Corporation**


**Condensed
      Consolidated**  **Statements
      of Cash Flows** **(unaudited)**


**(dollars
      in thousands)** **Three
                  Months****Ended
                  March 31,****2008**
              
              **2007****Cash
                  flows from operating activities:**Net
                  income
              
              $
              970
              
              $
              1,400Adjustments
                  to reconcile net income to net cash provided by operating
                  activities:Provision
                  for loan losses
              
              
              345
              
              
              330Depreciation
              
              
              276
              
              
              306Net
                  gain on sale of investment securities
              
              
              (83
              )
              
              -Net
                  gain on sale of mortgage-backed securities
              
              
              (159
              )
              
              -Net
                  gain on sale of loans
              
              
              -
              
              
              (5
              )Deferred
                  loan origination fees (costs)
              
              
              11
              
              
              (20
              )Allocation
                  of shares to the ESOP
              
              
              45
              
              
              45Stock-based
                  compensation expense
              
              
              8
              
              
              7Vesting
                  of shares for the Recognition and Retention Plan
              
              
              77
              
              
              70Increase
                  (decrease) in accrued interest receivable
              
              
              546
              
              
              (77
              )Amortization
                  of intangible assets
              
              
              141
              
              
              165(Increase)
                  decrease in other assets
              
              
              (3,249
              )
              
              2,217Decrease
                  in other liabilities
              
              
              (218
              )
              
              (484
              )Net
                  cash provided by (used in) operating activities
              
              
              (1,290
              )
              
              3,954**Cash
                  flows from investing activities:**Net
                  increase in loans
              
              
              (12,055
              )
              
              (3,954
              )Proceeds
                  from the sale of investment securities
              
              
              13,402
              
              
              -Proceeds
                  from the sale of mortgage-backed securities
              
              
              12,535
              
              
              -Proceeds
                  from the sale of loans
              
              
              -
              
              
              202Maturities
                  and prepayments of investment securities
              
              
              1,541
              
              
              5,650Maturities
                  and prepayments of mortgage-backed securities
              
              
              3,612
              
              
              3,200Purchases
                  of investments
              
              
              -
              
              
              (1,515
              )Purchases
                  of mortgage-backed securities
              
              
              (15,042
              )
              
              (3,120
              )(Purchases)
                  sale of FHLB stock
              
              
              (44
              )
              
              268Capital
                  expenditures for premises and equipment
              
              
              (91
              )
              
              (75
              )Net
                  cash provided by investment activities
              
              
              3,858
              
              
              656**Cash
                  flows from financing activities:**Net
                  increase (decrease) in deposits
              
              
              (8,198
              )
              
              5,371Exercise
                  of options
              
              
              54
              
              
              -Dividends
                  paid
              
              
              (603
              )
              
              (601
              )Purchase
                  of common stock for treasury
              
              
              (676
              )
              
              (1,477
              )Net
                  increase (decrease) in borrowed money
              
              
              5,040
              
              
              (10,441
              )Increase
                  in advances from borrowers for insurance and taxes
              
              
              150
              
              
              172Net
                  cash used in financing activities
              
              
              (4,233
              )
              
              (6,976
              )Net
                  decrease in cash and cash equivalents
              
              
              (1,665
              )
              
              (2,366
              )Cash
                  and cash equivalents at beginning of period
              
              
              29,739
              
              
              26,221Cash
                  and cash equivalents at end of period
              
              $
              28,074
              
              $
              23,855




***See
      notes to condensed consolidated financial
      statements.***


5


**CITIZENS
      SOUTH BANKING CORPORATION**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1 - Basis of Presentation**





The
      condensed consolidated financial statements of Citizens South Banking
      Corporation (the “Company”) are unaudited and reflect all adjustments of a
      normal recurring nature which are, in the opinion of management, necessary
      for a
      fair presentation of the interim period financial statements as of and for
      the
      three-month periods ended March 31, 2008 and 2007. Amounts as of December 31,
      2007, included in the condensed consolidated financial statements and related
      notes were derived from the audited consolidated financial statements. Results
      for the three-month period ended March 31, 2008, are not necessarily indicative
      of the results that may be expected for future periods, including the year
      ending December 31, 2008.





The
      unaudited condensed consolidated financial statements of the Company have been
      prepared pursuant to the rules and regulations of the Securities and Exchange
      Commission, including Rule
      10-01 of Regulation S-X .
      Accordingly, certain information normally included in financial statements
      prepared in conformity with accounting principles generally accepted in the
      United States of America have been condensed or omitted. These condensed
      consolidated financial statements should be read in
      conjunction with the consolidated financial statements and notes thereto in
      the
      Company’s Annual Report on Form 10-K for the year ended December 31,
      2007.





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





**Note
      2 - Earnings per Share**





Basic
      earnings per share is calculated by dividing net income by the weighted average
      number of common shares outstanding. Diluted earnings per share is calculated
      by
      dividing net income by the sum of the weighted average number of common shares
      outstanding 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. This 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. The following is a
      summary of the diluted earnings per share calculation for the three months
      ended
      March 31, 2008 and 2007:


**Three
                  Months****Ended
                  March 31,****2008**
              
              **2007****(dollars
                  in thousands, except per share amounts)**Net
                  income
              
              $
              970
              
              $
              1,400Weighted
                  average shares outstanding
              
              
              7,406,656
              
              
              7,862,519Dilutive
                  effect of stock options
              
              
              40,888
              
              
              75,987Weighted
                  average diluted shares outstanding
              
              
              7,447,544
              
              
              7,938,506Diluted
                  earnings per share
              
              $
              0.13
              
              $
              0.18





For
      the
      periods ended March 31, 2008 and 2007, there were 602,290 and 557,751 shares,
      respectively, attributed to stock options that were excluded from the
      calculation of diluted earnings per share because their inclusion would have
      been anti-dilutive because the average market price of the stock was below
      the
      strike price on these options.




6


**Note
      3 - 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. Commitments to extend credit that include both fixed and
      variable rates are as follows:





March
                31, 2008
            
            December
                31, 2007Loan
                commitments:Residential
                mortgage loans
            
            $
            14,087,350
            
            $
            7,160,455Non-residential
                mortgage loans
            
            
            17,940,769
            
            
            20,987,431Commercial
                loans
            
            
            1,045,275
            
            
            6,559,700Consumer
                loans
            
            
            4,775,600
            
            
            6,840,137Total
                loan commitments
            
            $
            37,848,994
            
            $
            41,547,723Unused
                lines of credit:Commercial
            
            $
            39,119,766
            
            $
            38,120,483Consumer
            
            
            74,610,813
            
            
            71,831,349Total
                unused lines of credit
            
            $
            113,730,579
            
            $
            109,951,832





**Note
      4 - Dividend Declaration**





On
      April
      21, 2008, the Board of Directors of the Company approved and declared a regular
      cash dividend of eight and one half cents ($0.085) per share of common stock
      to
      stockholders of record as of May 1, 2008, payable on May 15, 2008.





**Note
      5 - Stock Repurchase Program**





On
      October 22, 2007, the Board of Directors of the Company authorized the
      repurchase of up to 200,000 shares, or approximately 2.5% of the Company’s then
      outstanding shares of common stock. 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. Under this plan the Company had repurchased
      a total of 173,648 shares at an average price of $11.02 per share and had 26,352
      shares remaining to be repurchased at March 31, 2008. The Company will consider
      repurchasing additional shares of common stock of the Company at prices
      management considers to be attractive and in the best interests of both the
      Company and its stockholders. Any repurchased shares will be held as treasury
      stock and will be available for general corporate purposes **.**




**Note
      6 - 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”), which enhances existing guidance for measuring assets and
      liabilities using fair value and requires additional disclosure about the use
      of
      fair value for measurement. This Statement does not require any new fair value
      measurements. SFAS
      No.
      157 is effective for the Company January 1, 2008. Management
      determined that t he
      adoption of SFAS No.157 did not have a material effect on the Company’s
      consolidated financial statements.




7




In
      accordance with SFAS No. 157, the Corporation determines the fair market value
      of its financial instruments based on the fair value hierarchy which requires
      an
      entity to maximize the use of observable inputs when measuring fair value.
      The
      standard describes three levels of inputs that may be used to measure fair
      value. These three levels are described as follows:





Level
      1:   Quoted
      prices in active markets for identical assets or liabilities. Such financial
      instruments generally include equity market securities that are traded in an
      active market.





Level
      2:  Observable
      inputs other than Level 1 prices, such as quoted prices for similar assets
      or
      liabilities; quoted prices in markets that are not active; or other inputs
      that
      are observable or can be corroborated by observable market data for
      substantially the full term of the assets or liabilities. Level 2 assets
      generally include U.S. Government agency securities, mortgage-backed securities,
      and municipal and corporate debt securities.





Level
      3:  Unobservable
      inputs that are supported by little or no market activity and that are
      significant to the fair value of the assets or liabilities. Level 3 assets
      and
      liabilities include financial instruments whose value is determined using
      pricing models, discounted cash flow methodologies, or similar techniques,
      as
      well as instruments for which the determination of fair value requires
      significant management judgment or estimation. This category generally includes
      loans receivable, deposits, and borrowed money.





In September 2006,
      the Emerging Issues Task Force issued EITF Issue 06-4, “ *Accounting
      for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
      Split-Dollar Life Insurance Arrangements* ”
(“EITF
      Issue 06-4”). EITF Issue 06-4 requires that for endorsement split-dollar
      insurance arrangements that provide a benefit to an employee that extends to
      postretirement periods, an employer should recognize a liability for future
      benefits in accordance with SFAS No. 106 or APB No. 12 based on
      the substantive agreement of the employee. If the employee has effectively
      agreed to maintain a life insurance policy during postretirement periods, the
      costs of the life insurance policy during the postretirement periods should
      be
      accrued in accordance with either SFAS No. 106 or APB No. 12. If the
      employer has agreed to provide a death benefit, the employer should recognize
      a
      liability for the future death benefit in accordance with either SFAS
      No. 106 or APB No. 12. EITF Issue 06-4 is effective for fiscal years
      beginning after December 15, 2007. The
      adoption of SFAS No 106 did not have a material effect on the Company’s
      consolidated financial statements.





In
      June
      2007, the FASB ratified the consensus reached by the EITF on Issue No. 06-11,
      “ *Accounting
      for Income Tax Benefits of Dividends on Share-Based Payment
      Awards* ”
to
      provide guidance on how an entity should recognize the income tax benefit
      received on dividends that are paid to employees holding certain types of shares
      or options and are charged to retained earnings under Statement 123(R). This
      issue will be applied for the Company beginning January 1, 2008.  The
      adoption of EITF Issue No. 06-11 did not have a material effect on the Company’s
      consolidated financial statements.




8


**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.





9




**Overview**





Management’s
      Discussion and Analysis is provided to assist in understanding and evaluating
      the Company’s results of operations and financial condition. The following
      discussion is designed to provide a general overview of the Company’s
      performance for the three-month periods ended March 31, 2008 and 2007. Readers
      seeking a more in-depth analysis should read the detailed discussions below,
      as
      well as the condensed consolidated financial statements and related notes.
      Financial highlights are presented in the table below.




Three
                  months ended
                March
                  31, 2008
            
            Three
                  months ended
                March
                  31, 2007
            
            %
                  Change**Earnings:**Net
                interest income
            
            $
            4,787
            
            $
            5,046
            
            
            (5.13
            )%Provision
                for loan losses
            
            
            (345
            )
            
            (330
            )
            
            4.55Noninterest
                income
            
            
            1,680
            
            
            1,530
            
            
            9.80Noninterest
                expense
            
            
            (4,882
            )
            
            (4,285
            )
            
            13.93Income
                tax expense
            
            
            (270
            )
            
            (561
            )
            
            (51.87
            )**Net
                Income**
            
            **$**
            **970**
            
            **$**
            **1,400**
            
            
            **(30.71**
            **)%****Per
                Share Data:**Avg.
                common shares outstanding, basic
            
            
            7,406,656
            
            
            7,862,519
            
            
            (5.80)
            %Basic
                net income
            
            $
            0.13
            
            $
            0.18
            
            
            (27.78
            )Avg.
                common shares outstanding, diluted
            
            
            7,447,544
            
            
            7,938,506
            
            
            (6.13)
            %Diluted
                net income
            
            $
            0.13
            
            $
            0.18
            
            
            (27.78
            )Cash
                dividends paid
            
            $
            0.08
            
            $
            0.075
            
            
            6.67
            %Period-end
                book value
            
            
            11.21
            
            
            10.71
            
            
            4.67**Financial
                Ratios**(annualized)**:**Return
                on average stockholders’ equity
            
            
            4.61
            %
            
            6.62
            %
            
            (30.36)
            %Return
                on average assets
            
            
            0.50
            
            
            0.77
            
            
            (35.06
            )Efficiency
                ratio
            
            
            75.49
            
            
            65.15
            
            
            15.87Net
                interest margin
            
            
            2.89
            
            
            3.18
            
            
            (9.12
            )Average
                equity to average assets
            
            
            10.93
            
            
            11.61
            
            
            (5.86
            )**Asset
                Quality Data:**Allowance
                for loan losses
            
            $
            6,427
            
            $
            6,023
            
            
            6.71
            %Nonperforming
                loans
            
            
            2,477
            
            
            1,686
            
            
            46.92Nonperforming
                assets
            
            
            3,006
            
            
            1,879
            
            
            59.98Net
                charge-offs
            
            
            62
            
            
            71
            
            
            (12.68
            )Allowance
                for loan losses to total loans
            
            
            1.12
            %
            
            1.16
            %
            
            (3.45
            )Nonperforming
                loans to total loans
            
            
            0.43
            
            
            0.32
            
            
            34.38Nonperforming
                assets to total assets
            
            
            0.39
            
            
            0.25
            
            
            56.00**Average
                Balances:**Total
                assets
            
            $
            774,030
            
            $
            738,674
            
            
            4.79
            %Loans,
                net of unearned income
            
            
            567,039
            
            
            520,342
            
            
            8.97Interest-earning
                assets
            
            
            680,566
            
            
            644,455
            
            
            5.60Deposits
            
            
            579,802
            
            
            565,070
            
            
            2.61Interest-bearing
                liabilities
            
            
            636,875
            
            
            603,396
            
            
            5.55Stockholders’
                equity
            
            
            84,568
            
            
            85,784
            
            
            (1.42
            )**At
                Period End:**Total
                assets
            
            $
            776,583
            
            $
            737,639
            
            
            5.28
            %Loans,
                net of unearned income
            
            
            571,938
            
            
            519,108
            
            
            10.18Interest-earning
                assets
            
            
            685,977
            
            
            648,109
            
            
            5.84Deposits
            
            
            582,567
            
            
            568,173
            
            
            2.53Interest-bearing
                liabilities
            
            
            642,115
            
            
            602,433
            
            
            6.59Stockholders’
                equity
            
            
            84,701
            
            
            85,611
            
            
            (1.06
            )




10




**Critical
      Accounting Policies**





The
      accounting and reporting policies of the Company and its subsidiaries are based
      on accounting principles generally accepted in the United States and conform
      to
      general practices in the banking industry. We consider a critical accounting
      policy to be one that is both very important to the portrayal of the Company’s
      financial condition and results of operations and requires a difficult,
      subjective or complex judgment by management. What makes these judgments
      difficult, subjective and/or complex is the need to make estimates about the
      effects of matters that are inherently uncertain. 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, our critical accounting and reporting policies
      include our accounting for the allowance for loan losses and evaluation of
      other-than-temporary impairment of investments.





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





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





**Other-Than-Temporary
      Impairment of Securities.** Management
      periodically reviews all investment securities with significant declines in
      fair
      value for potential other-than-temporary impairment pursuant to the guidance
      provided by SFAS No. 115, “ *Accounting
      for Certain Investments in Debt and Equity Securities”.* In
      November 2006, FASB issued Staff Position (“FSP”) FAS 115-1 and FAS 124-1,
“ *The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments.* ”
The
      FSP
      addressed the determination as to when an investment is considered impaired,
      whether the impairment is other than temporary, and the measurement of an
      impairment loss. It also included accounting considerations subsequent to the
      recognition of an other-than-temporary impairment and requires certain
      disclosures about unrealized losses that have not been recognized as
      other-than-temporary impairments. The guidance in this FSP amended SFAS No.
      115 *“Accounting
      for Certain Investments in Debt and Equity Securities”,* No.
      124,
“ *Accounting
      for Certain Investments Held by Not-for-Profit Organizations”,* and
      APB
      Opinion 18, “ *The
      Equity Method of Accounting for Investments in Common Stock”.*





Effective
      March 31, 2008, management evaluated the Company’s investment portfolio and
      determined that all unrealized losses were the direct result of temporary
      changes in interest rates and that such losses may be recovered in the
      foreseeable future. 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, 2008.




11




**Comparison
      of Financial Condition**





*Assets.* Total
      assets of the Company decreased by $2.5 million, or 0.3%, from $779.1 million
      at
      December 31, 2007, to $776.6 million at March 31, 2008. This decrease was
      primarily due to a $14.8 million decrease in investment securities, which was
      partly offset by a $12.0 million increase in loans.





During
      the quarter ended March 31, 2008, loans receivable increased by $12.0 million,
      or 2.1%, to $571.9 million. The growth in loans was primarily comprised of
      a
      $7.6 million, or 8.5%, increase in residential and commercial construction
      loans
      to $96.9 million, a $5.7 million, or 6.9%, increase in consumer loans to $87.7
      million, and a $3.3 million, or 10.0%, increase in commercial business loans
      to
      $36.5 million. In addition, commercial real estate loans increased by $100,000
      to $273.8 million at March 31, 2008. These increases in loans were partly offset
      by a $3.1 million, or 4.0%, decrease in residential mortgage loans to $74.9
      million. Loan production remained strong during the first quarter of 2008,
      totaling $68.5 million, compared to $66.9 million during the first quarter
      of
      2007. The economy in the Charlotte region remains vibrant compared to most
      of
      the country; however, housing starts and demand for commercial real estate
      have
      slowed during the past 12 months. A more significant 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
      slows.





As
      of
      March 31, 2008, $250.4 million, or 44.1%, of the Company’s loan portfolio, was
      scheduled to reprice in one month. This sensitivity to falling short-term
      interest rates was a factor in the Company’s margin compression during the first
      quarter of 2008 as the prime rate decreased by 200 basis points during the
      quarter. Decreasing short-term interest rates will cause margin compression,
      as
      these adjustable-rate loans reprice at lower interest rates at a faster pace
      than the Company’s funding costs. However, as time deposits reprice over time,
      the Company’s cost of funds is expected to decrease and the Company’s net
      interest margin should begin to expand.





Cash
      and
      cash equivalents decreased by $1.6 million, or 5.6%, from $29.7 million at
      December 31, 2007, to $28.1 million at March 31, 2008. This decrease was
      primarily attributable to loan growth of $12.0 million and deposit decreases
      of
      $8.2 million. These outlays of cash were partly offset by a $14.8 million
      decrease in investment securities and a $5.0 million increase in borrowed money.
      Management expects that the level of cash and cash equivalents will remain
      stable through 2008. Proceeds needed to fund future loan growth and repurchase
      Company stock will be generated from expected growth in deposits, maturing
      investment and mortgage-backed securities (“MBS”) and / or additional
      borrowings.





During
      the three-month period ended March 31, 2008, investment securities decreased
      by
      $14.8 million, or 31.8%, to $31.7 million. The decrease in investment securities
      was primarily due to normal maturities of $1.5 million and the sale of $13.4
      million of investment securities during the period. MBS increased $278,000,
      or
      0.4%, to $70.2 million. The increase in MBS was due to the purchase of $15.0
      million of MBS during the period, the effects of which were partly offset by
      the
      sale of $12.5 million in MBS and by $3.6 million of normal principal
      amortization. The investment securities and MBS were primarily sold to fund
      loan
      growth. Management expects the investment and MBS portfolios to decrease as
      a
      percentage of total assets as the cash flows generated from these investments
      and MBS are used to fund loan growth, repay borrowings and repurchase common
      stock. This rebalancing of the balance sheet from lower-yielding cash and cash
      equivalents, investments, and MBS to higher-yielding loans is expected to be
      a
      positive factor in improving the Company’s net interest margin.





Other
      real estate owned, which consisted of 12 one-to-four family residential
      dwellings acquired by the Bank through foreclosure, totaled $529,000 at March
      31, 2008, which was unchanged from December 31, 2007. All foreclosed properties
      are written down to their estimated fair value at acquisition and are located
      in
      the Bank’s primary lending area. Management will continue to aggressively market
      foreclosed properties for a timely disposition.




12




*Allowance
      for loan losses and nonperforming assets.* The
      Company has established a systematic methodology for determining the adequacy
      of
      the allowance for loan losses. This methodology is set forth in a formal policy
      and considers all loans in the portfolio. Specific allowances are established
      for certain individual loans that management considers impaired. The remainder
      of the portfolio is segmented into groups of loans with similar risk
      characteristics for evaluation and analysis. Management’s periodic evaluation of
      the allowance is consistently applied and based on inherent losses in the
      portfolio, past loan loss experience, risks inherent in the different types
      of
      loans, the estimated value of any underlying collateral, current economic
      conditions, the borrower’s financial position, and other relevant internal and
      external factors that may affect loan collectibility. The allowance for loan
      losses is increased by charging provisions for loan losses against income.
      As of
      March 31, 2008, the allowance for loan losses was $6.4 million, or 1.12% 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.


**At
                  and For the Three****Months
                  Ended March 31,****2008**
              
              **2007**(dollars
                  in thousands)**Allowance
                  for loan losses:**Beginning
                  of period
              
              $
              6,144
              
              $
              5,764Add:Provision
                  for loan losses
              
              
              345
              
              
              330Recoveries
              
              
              14
              
              
              12Less:Charge-offs
              
              
              76
              
              
              83End
                  of period
              
              $
              6,427
              
              $
              6.023Nonaccrual
                  loans
              
              $
              2,477
              
              $
              1,686Real
                  estate owned
              
              
              529
              
              
              193Nonperforming
                  assets
              
              $
              3,006
              
              $
              1,879Allowance
                  for loan losses as apercentage
                  of total loans
              
              
              1.12
              %
              
              1.16
              %Nonperforming
                  loans tototal
                  loans
              
              
              0.43
              %
              
              0.32
              %Nonperforming
                  assets tototal
                  assets
              
              
              0.39
              %
              
              0.25
              %





Premises
      and equipment decreased by $184,000, or 1.0%, to $17.8 million at March 31,
      2008. During the first quarter of 2008, the Company opened a full-service office
      located in a leased facility in Rock Hill, South Carolina. Also during the
      quarter, the Company closed its mortgage loan production office in Waxhaw,
      North
      Carolina and consolidated the operations of its two commercial loan production
      offices into existing branch facilities. As a result, there were no loan
      production offices operating as of March 31, 2008. This consolidation of loan
      production offices was a cost cutting measure that was done as a part of the
      Company’s reorganization efforts during the first quarter of 2008. No
      significant changes to the Company’s premises and equipment are anticipated for
      the remainder of 2008.




13




*Liabilities* .
      Total
      liabilities decreased by $3.2 million, or 0.5%, from $695.1 million at December
      31, 2007, to $691.9 million at March 31, 2008. This decrease was primarily
      due
      to a $8.2 million decrease in total deposits which was partly offset by a $5.0
      million increase in borrowed money.





While
      total deposits decreased by $8.2 million, or 1.4%, to $582.6 million at March
      31, 2008, demand deposits (checking accounts) increased by $2.5 million, or
      2.5%, to $104.5 million at March 31, 2008. The increase in demand deposits
      was
      primarily due to a continued emphasis on increasing the Company’s number of
      retail and business customers through employee incentive plans and enhanced
      treasury service products. Savings accounts also increased slightly during
      the
      three-month period, with growth of $156,000, or 1.3%, to $12.2 million at March
      31, 2008. These increases were offset by a $6.0 million, or 4.6%, decrease
      in
      money market demand accounts to $123.7 million at March 31, 2008, and a $5.0
      million, or 1.4%, decrease in time deposits to $342.1 million at the end of
      the
      period. The decrease in these interest-sensitive deposit accounts was largely
      due to the Company’s action to aggressively lower its deposit rates more quickly
      than some of its competitors in response to the Federal Reserve Board’s actions
      to lower the federal funds rate by 200 basis points during the quarter. 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. However,
      if
      loan growth significantly outpaces deposit growth in the future, management
      may
      be more aggressive in attracting retail deposits, which may increase the
      Company’s cost of funds. In addition, management may use brokered deposits to
      fund future loan growth if additional liquidity is needed. Brokered deposits
      totaled only $3.6 million, or 0.6% of total deposits, at March 31, 2008.





The
      Company opened its 15 th full-service office in Rock Hill, South Carolina during the first quarter of
      2008. This additional office, the Company’s first in South Carolina, will be an
      integral part of the Company’s efforts to continue growing core deposits and
      market share in the Charlotte region.





Borrowed
      money increased by $5.0 million, or 5.2%, to $101.3 million at March 31, 2008.
      This increase was primarily due to additional Federal Home Loan Bank (“FHLB”)
      advances that were obtained primarily for the purpose of funding loan growth.
      Additional borrowed money may be used in the future to fund additional loan
      growth, repurchase stock, or purchase investment or mortgage-backed securities.
      However, maturing advances will generally be repaid if there is a sufficient
      level of cash and cash equivalents.





*Stockholders’
      Equity* .
      Total
      stockholders’ equity increased by $668,000, or 0.8%, from $84.0 million at
      December 31, 2007, to $84.7 million at March 31, 2008. The increase in
      stockholders’ equity was primarily due to $970,000 in net income during the
      quarter coupled with a $793,000 increase in unrealized gains on
      available-for-sale securities during the quarter. The increase in unrealized
      gains on available-for-sale securities was primarily due to a decrease in market
      interest rates during the period resulting in part from a 200 basis point
      decrease in short-term interest rates by the Federal Reserve Board. These
      increases in stockholders’ equity were partly offset by the repurchase of 67,000
      shares of common stock for $676,000, at an average cost of $10.06 per share.
      On
      October 22, 2007, the Board of Directors authorized the repurchase of up to
      200,000 shares, or approximately 2.5%, of the then outstanding shares of common
      stock. As of March 31, 2008, the Company had repurchased a total of 173,648
      shares under the current program at an average price of $11.02 per share and
      had
      26,352 shares remaining to be repurchased. The Company will consider
      repurchasing additional shares of common stock at prices that management
      considers to be attractive and in the best interests of both the Company and
      its
      stockholders. Any repurchased shares will be held as treasury stock and will
      be
      available for general corporate purposes. In addition, the Company paid cash
      dividends totaling $603,000 during the period, representing $0.08 per
      outstanding share.




14




**Comparison
      of Results of Operations for the Three Months Ended March 31, 2008 and
      2007**





*General* .
      Net
      income for the three months ended March 31, 2008, amounted to $970,000, or
      $0.13
      per diluted share, as compared to $1.4 million, or $0.18 per diluted share,
      for
      the three months ended March 31, 2007. This represented a 30.7% decrease in
      net
      income and a 27.8% decrease in diluted earnings per share for the comparable
      periods. This decrease was largely due to net interest margin compression caused
      primarily by the Federal Reserve Board’s actions to decrease short-term interest
      rates by 200 basis points during the first quarter of 2008. This resulted in
      lower yields on assets tied to the prime lending rate and other short-term
      indices.





*Net
      interest income.* Interest
      income decreased by $393,000, or 3.5%, to $11.0 million for the first quarter
      of
      2008, primarily as a result of a 200 basis point decrease in short-term interest
      rates. As of March 31, 2008, approximately 44% of the Company’s loan portfolio
      was scheduled to reprice on a monthly basis. Average interest-earning assets
      increased by $36.1 million, or 5.6%, to $680.6 million for the three months
      ended March 31, 2008. The increase in average interest-earning assets was
      primarily the result of a $46.7 million, or 9.0%, increase in average
      outstanding loans to $567.0 million. The Company’s average yield on earning
      assets decreased by 99 basis points to 6.90% for the quarter ended March 31,
      2008. Interest expense decreased by $134,000, or 2.1%, for the comparable
      quarters to $6.2 million for the first quarter of 2008. This decrease in
      interest expense was largely due to lower market interest rates. The Company
      experienced a $33.5 million, or 5.6%, increase in the average balance of
      interest-bearing liabilities to $639.9 million for the three months ended March
      31, 2008. Average interest-bearing liabilities increased primarily as a result
      of a $13.9 million, or 2.6%, increase in average interest-bearing deposits
      coupled with a $19.6 million, or 25.2%, increase in average borrowed money.
      In
      addition, the average cost of funds decreased by 35 basis points to 3.89% for
      the quarter ended March 31, 2008.





As
      a
      result of the decrease in interest rates during the comparable periods, the
      tax-equivalent net interest margin decreased by 29 basis points to 2.89% for
      the
      quarter ended March 31, 2008, compared to 3.18% for the quarter ended March
      31,
      2007. 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
      twelve basis points from 3.01% for the fourth quarter of 2007 to 2.89% for
      the
      first quarter of 2008. 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 first
      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.* The
      provision for loan losses amounted to $345,000 for the first quarter of 2008
      compared to $330,000 for the first quarter of 2007, representing a 4.6%
      increase. The allowance for loan losses was $6.4 million, or 1.12% of total
      loans as of March 31, 2008, compared to $6.1 million, or 1.16% of total loans
      as
      of March 31, 2007. Credit quality continues to compare favorably with industry
      peers with a ratio of nonperforming loans to total loans of 0.43% on March
      31,
      2008, compared to 0.32% on March 31, 2007. A substantial portion of the
      Company’s nonperforming loans at March 31, 2008, was secured by real estate
      located in the Company’s normal lending market. In addition, the Company’s ratio
      of nonperforming assets to total assets was 0.39% at March 31, 2008, compared
      to
      0.25% at March 31, 2007. Net chargeoffs totaled $62,000, or 0.01% of average
      loans, during the first quarter of 2008 compared to $71,000, or 0.01% of average
      loans, during the first quarter of 2007.




*Noninterest
      income.* Noninterest
      income increased by $150,000, or 9.8%, to $1.7 million for the three months
      ended March 31, 2008, as compared to $1.5 million for the three months ended
      March 31, 2007. This decrease was largely attributable to $237,000 increase
      in
      the net gain on sale of assets. In addition, the Company realized increases
      of
      $25,000, or 3.8%, in fee income on deposit accounts and $11,000 in dividends
      on
      FHLB stock. An increase in the number of demand deposit customers contributed
      to
      the improvement in deposit fee income, while an increased number of shares
      of
      FHLB stock resulting from higher borrowing balances contributed to the increase
      in dividends on FHLB stock. These increases in noninterest income were partly
      offset by a $29,000, or 12.8%, decrease in mortgage banking income, a $21,000,
      or 10.3%, reduction of cash value accumulation on bank owned life insurance,
      a
      $51,000 reduction in the fair value adjustment on deferred compensation assets
      and a $23,000, or 9.8%, reduction in other noninterest income. The income
      generated from mortgage banking activities decreased due to a reduction in
      mortgage lending activity in the Charlotte region. However, the residential
      real
      estate market in the Charlotte region remains active and is expected to provide
      the Company with opportunities for continued growth during 2008. The reduction
      in cash value accumulation on bank owned life insurance policies was due in
      part
      to the death of one insured employee during the year and a decrease in market
      interest rates. 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 as a result of fewer penalties received from early withdrawal
      on time deposits and other miscellaneous items.




15




The
      Company recognized $242,000 in net gains from the sale of assets during the
      quarter ended March 31, 2008, compared to $5,000 during the quarter ended March
      31, 2007. During the first quarter of 2008 the Company sold $13.4 million in
      investment securities at a net gain of $83,000 and $12.5 million in
      mortgage-backed securities at a net gain of $159,000. The investment securities
      and MBS were primarily sold to generate gains which were used to offset $220,000
      in reorganization costs recognized during the first quarter of 2008. During
      the
      quarter ended March 31, 2007, the Company sold $202,000 of loans at a gain
      of
      $5,000.





*Noninterest
      expense.* Noninterest
      expense increased by $597,000, or 13.9%, to $4.9 million for the quarter ended
      March 31, 2008, compared to $4.3 million for the quarter ended March 31, 2007.
      The primary reason was a $213,000, or 9.1%, increase in compensation and
      benefits, a $6,000, or 0.9%, increase in occupancy and equipment expense, a
      $77,000, or 62.6%, increase in professional services, a $156,000, or a 16.4%,
      increase in other noninterest expenses and $220,000 in restructuring costs.
      Management hired several experienced lenders and an experienced credit officer
      during 2007 which contributed to the increase in compensation and benefits.
      However, we expect that the additional loan growth associated with these new
      positions will cover the additional compensation expense in 2008. The Company
      opened its 15th full-service office in Rock Hill, South Carolina, during the
      first quarter 2008. As a result, office occupancy and equipment expense is
      expected to continue to increase in 2008. However, this increase will be
      tempered by the consolidation of the Company’s three loan production offices
      into existing branch facilities. The increase in professional services was
      primarily associated with higher audit-related costs, consulting fees and legal
      services. Management expects that these expenses will decrease for the remainder
      of 2008. Other noninterest expenses increased as a result of higher expenses
      related to marketing efforts, loan administration and office supplies. A portion
      of the increase was related to the opening of a new office during the first
      quarter of 2008. The $220,000 of 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.





These
      increases in noninterest expense were partly offset by a $51,000 decrease in
      the
      fair value adjustment on deferred compensation and a $24,000 decrease in the
      amortization expense of intangible assets. 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. The amortization of intangible assets is expected to
      continue to decrease as the amount of the core deposit intangible decreases.




*Income
      taxes.* Income
      taxes amounted to $270,000, or 21.8% of taxable income, for the quarter ended
      March 31, 2008, as compared to $561,000, or 28.6% of taxable income, for the
      quarter ended March 31, 2007. The decrease in the effective tax rate during
      the
      comparable periods was primarily due to a $21,000 increase in nontaxable income
      from the first quarter 2007 to the first quarter 2008, coupled with a $721,000
      decrease in income before taxes. This nontaxable income was primarily generated
      from interest earned on bank-qualified municipal securities and loans. 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.




16


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





The
      objectives of the Company’s liquidity management policy include providing
      adequate funds to meet the cash needs of both borrowers and depositors, to
      provide for the on-going operations of the Company, and to capitalize on
      opportunities for expansion. Liquidity management addresses the Company’s
      ability to meet deposit withdrawals on demand or at contractual maturity, to
      repay borrowings as they mature, and to fund new loans and investments as
      opportunities arise. The primary sources of internally generated funds are
      principal and interest payments on loans receivable, increases in local
      deposits, cash flows generated from operations, and cash flows generated by
      investments. If the Company requires funds beyond its internal funding
      capabilities, it may rely upon external sources of funds such as brokered
      deposits, repurchase agreements, and advances. The Company has $91.0 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 has $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. The Company may also solicit brokered deposits for providing funds
      for asset growth. As of March 31, 2008, the Company had outstanding brokered
      deposits of $3.6 million, or 0.6% of total deposits. The Company believes that
      it has sufficient sources of liquidity to fund the cash needs of both borrowers
      and depositors, to provide for the ongoing operations of the Company, and to
      capitalize on opportunities for expansion.





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,
      2008, the Company had loan commitments of $37.8 million, unused lines of credit
      of $113.7 million, and undisbursed construction loan proceeds of $5.1 million.
      The Company believes that it has adequate resources to fund loan commitments
      and
      lines of credit as they arise. The Company does not have any special purpose
      entities or other similar forms of off-balance-sheet financing.





The
      Company’s most significant form of market risk is interest rate risk, as the
      Company’s assets and liabilities are sensitive to changes in interest rates. The
      Company’s Asset / Liability Committee is responsible for monitoring its level of
      interest rate risk and ensuring compliance with Board-adopted limits. There
      were
      no changes in the Company’s asset or liability composition that could result in
      a material change in the Company’s analysis of interest rate sensitivity as
      discussed in the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2007





The
      Bank
      is subject to various regulatory capital requirements administered by the
      banking regulatory agencies. As of March 31, 2008, the Bank’s capital exceeded
      all applicable regulatory requirements and was in the “well capitalized”
category for all regulatory capital measurements. The Bank's Tier I capital
      was
      $64.7 million, or 8.7% of adjusted total assets. The minimum Tier I capital
      ratio is 4.00%. 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.





17





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





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




**ITEM
      4. Controls and Procedures**





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





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




**PART
      II. OTHER INFORMATION**





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





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




**Item
      1A. Risk Factors**





There
      were no material changes in the risk factors that were identified in the Form
      10-K for the year ended December 31, 2007.




18




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





**a.**
            Not
                applicable.





**b.**
            Not
                applicable.





**c.**
            During
                the three-month period ended March 31, 2008, the Company repurchased
                67,000 shares of common stock for $676,000, at an average cost of
                $10.06
                per share, as detailed in the following
                table:





**Period**
            **Total
                Number of Shares Purchased**
            **Average
                Price Paid per Share**
            **Total
                Number of Shares Purchased as Part of Publicly Announced
                Plan**
            **Maximum
                Number of Shares that May Yet be Purchased Under the Publicly Announced
                Plan**January
            17,000
            $
                9.89
            123,648
            76,352February
            14,000
            $10.38
            137,648
            62,352March
            36,000
            $10.01
            173,648
            26,352**Total**
            **67,000**
            **$10.06**
            **173,648**
            **26,352**





As
      of
      March 31, 2008, the Company had repurchased a total of 3,178,083 shares, or
      35.1% of the outstanding shares of common stock, at an average price of $13.11.
      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 on October
      22, 2007, for the repurchase of up to 200,000 shares, or approximately 2.5%
      of
      the Company’s then outstanding shares of common stock. These repurchases may be
      carried out through open market purchases, block trades, and negotiated private
      transactions. The stock may be repurchased on an ongoing basis and will be
      subject to the availability of stock, general market conditions, the trading
      price of the stock, alternative uses for capital, and the Company’s financial
      performance. As of March 31, 2008, the Company had repurchased a total of
      173,648 shares at an average price of $11.02 per share and had 26,352 shares
      remaining to be repurchased under this plan. The Company will consider
      repurchasing additional shares of common stock of the Company at prices
      management considers to be attractive and in the best interests of both the
      Company and its stockholders. Any repurchased shares will be held as treasury
      stock and will be available for general corporate purposes **.**




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





Not
      applicable.





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





There
      were no meetings of stockholders during the quarter ended March 31,
      2008.




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





Not
      applicable.





19




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





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







**SIGNATURES**





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





**Citizens
              South Banking Corporation**Date: May
              12,
              2008
            By:
            /s/ Kim
              S.
              PriceKim
                S. Price
              President
                and Chief Executive Officer 
 Date: May
                12,
                2008
              By:
              /s/ Gary
                F.
                HoskinsGary
                    F. Hoskins
                  Executive
                    Vice President, Chief Financial Officer and
                    Treasurer
  20