**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**








**FORM
      10-Q**





(Mark
      One)




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




**For
      the quarterly period ended** **September
      30, 2007**





**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
              (I.R.S.
                  Employer Identification Number)incorporation
                  or organization)**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** þ No
      o





Indicate
      by check mark whether the Registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer.


See
      definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of
      the Exchange Act. (Check one):





Large
      accelerated filer o  **Accelerated
      filer** þ N on-accelerated
      filer 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** þ





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**


**7,724,432
      shares outstanding as of November 6, 2007**







**Citizens
      South Banking Corporation**


**Index**


Page**PART
                  I. —
                  Financial
                  Information**Item
                  1.
              
              Condensed
                  Consolidated Financial Statements:Condensed
                  Consolidated Statements of Financial Condition September 30, 2007
                  and
                  December 31, 2006
              
              1Condensed
                  Consolidated Statements of Operations for the Three and Nine Months
                  Ended
                  September 30, 2007 and 2006
              
              2Condensed
                  Consolidated Statements of Comprehensive Income for the Nine Months
                  Ended
                  September 30, 2007 and 2006...
              
              3Condensed
                  Consolidated Statements of Changes in Stockholders’ Equity for
                  the Nine Months Ended September 30, 2007 and 2006
              
              4Condensed
                  Consolidated Statements of Cash Flows for the Nine Months Ended
                  September
                  30, 2007 and 2006
              
              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
              
              19Item
                  4.
              
              Controls
                  and Procedures
              
              19**PART
                  II —
                  Other Information**
              
              20Item
                  1.
              
              Legal
                  Proceedings
              
              20Item
                1A.
              
              Risk Factors
              
              20Item
                  2.
              
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              
              20Item
                  3.
              
              Defaults
                  Upon Senior Securities
              
              20Item
                  4.
              
              Submission
                  of Matters to a Vote of Security Holders
              
              20Item 5.
              
              Other
                  Information
              
              21Item
                  6.
              
              Exhibits
              
              21Signatures
              
              21


**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) ****  ******


**September
                  30,**
              
              **December
                  31,****2007**
              
              **2006****(unaudited)****Assets:**Cash
                  and cash equivalents:Cash
                  and due from banks
              
              $
              10,633
              
              $
              17,581Interest-earning
                  bank balances
              
              
              960
              
              
              8,433Fed
                  funds sold
              
              
              67
              
              
              207Total
                  cash and cash equivalents
              
              
              11,660
              
              
              26,221Investment
                  securities available-for-sale, at fair value
              
              
              61,537
              
              
              65,326Mortgage-backed
                  and related securities available-for-sale, at fair value
              
              
              66,284
              
              
              60,691Loans:Loans
                  receivable, net of unearned income
              
              
              548,026
              
              
              515,402Allowance
                  for loan losses
              
              
              (6,292
              )
              
              (5,764
              )Net
                  loans
              
              
              541,734
              
              
              509,638Other
                  real estate owned
              
              
              636
              
              
              139Premises
                  and equipment, net
              
              
              18,122
              
              
              18,287Accrued
                  interest receivable
              
              
              3,712
              
              
              3,236Federal
                  Home Loan Bank stock
              
              
              3,786
              
              
              3,581Intangible
                  assets
              
              
              31,183
              
              
              31,666Cash
                  value of bank-owned life insurance policies
              
              
              15,926
              
              
              15,527Other
                  assets
              
              
              6,407
              
              
              9,058Total
                  assets
              
              $
              760,987
              
              $
              743,370**Liabilities
                  and Stockholders’ Equity:**Deposits:Demand
                  deposit accounts
              
              $
              93,159
              
              $
              90,540Money
                  market deposit accounts
              
              
              124,304
              
              
              117,632Savings
                  accounts
              
              
              12,901
              
              
              16,027Time
                  deposits
              
              
              341,750
              
              
              338,603Total
                  deposits
              
              
              572,114
              
              
              562,802Borrowed
                  money
              
              
              95,983
              
              
              85,964Deferred
                  compensation
              
              
              5,300
              
              
              5,723Other
                  liabilities
              
              
              3,212
              
              
              2,920Total
                  liabilities
              
              
              676,609
              
              
              657,409Stockholders’
                  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:
                  7,769,732 shares in 2007 and 8,111,659 shares in 2006
              
              
              91
              
              
              91Additional
                  paid-in-capital
              
              
              67,560
              
              
              67439Unallocated
                  common stock held by Employee Stock Ownership Plan
              
              
              (1,293
              )
              
              (1,430
              )Retained
                  earnings
              
              
              35,315
              
              
              33,031Accumulated
                  other comprehensive loss, net of deferred income taxes
              
              
              (996
              )
              
              (991
              )Treasury
                  stock of 1,292,995 shares at September 30, 2007, and951,068
                  shares at December 31, 2006, at cost
              
              
              (16,299
              )
              
              (12,179
              )Total
                  stockholders’ equity
              
              
              84,378
              
              
              85,961Total
                  liabilities and stockholders’ equity
              
              $
              760,987
              
              $
              743,370


***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**
                
                **Nine
                    Months****Ended
                    September 30,**
                
                **Ended
                    September 30,****2007**
                
                **2006**
                
                **2007**
                
                **2006****Interest
                    Income:**Loans
                
                $
                10,377
                
                $
                9,804
                
                $
                30,331
                
                $
                27,501Investment
                    securities
                
                
                710
                
                
                467
                
                
                2,070
                
                
                1,458Interest-bearing
                    deposits
                
                
                73
                
                
                210
                
                
                342
                
                
                487Mortgage-backed
                    and related securities
                
                
                783
                
                
                644
                
                
                2,150
                
                
                2,027Total
                    interest income
                
                
                11,943
                
                
                11,125
                
                
                34,893
                
                
                31,473**Interest
                    Expense:**Deposits
                
                
                5,741
                
                
                4,858
                
                
                16,672
                
                
                12,802Borrowed
                    funds
                
                
                1,099
                
                
                1,065
                
                
                2,999
                
                
                3,156Total
                    interest expense
                
                
                6,840
                
                
                5,923
                
                
                19,671
                
                
                15,958Net
                    interest income
                
                
                5,103
                
                
                5,202
                
                
                15,222
                
                
                15,515Provision
                    for loan losses
                
                
                300
                
                
                300
                
                
                960
                
                
                865Net
                    interest income after provision for loan losses
                
                
                4,803
                
                
                4,902
                
                
                14,262
                
                
                14,650**Noninterest
                    Income:**Fee
                    income on deposit accounts
                
                
                680
                
                
                742
                
                
                2,026
                
                
                2,157Mortgage
                    banking income
                
                
                239
                
                
                213
                
                
                749
                
                
                406Income
                    on lending activities
                
                
                116
                
                
                146
                
                
                358
                
                
                458Dividends
                    on FHLB stock
                
                
                53
                
                
                58
                
                
                149
                
                
                169Increase
                    in cash value of bank-owned life insurance
                
                
                191
                
                
                166
                
                
                578
                
                
                580Fair
                    value adjustment on deferred compensation assets
                
                
                52
                
                
                101
                
                
                110
                
                
                143Life
                    insurance proceeds, net
                
                
                -
                
                
                -
                
                
                112
                
                
                -Net
                    gain (loss) on sale of assets
                
                
                -
                
                
                8
                
                
                336
                
                
                (40
                )Other
                    noninterest income
                
                
                203
                
                
                209
                
                
                633
                
                
                553Total
                    noninterest income
                
                
                1,534
                
                
                1,643
                
                
                5,051
                
                
                4,426**Noninterest
                    Expense:**Compensation
                    and benefits
                
                
                2,461
                
                
                2,281
                
                
                7,167
                
                
                6,861Fair
                    value adjustment on deferred comp. obligations
                
                
                52
                
                
                101
                
                
                110
                
                
                143Occupancy
                    and equipment expense
                
                
                661
                
                
                610
                
                
                2,001
                
                
                1,990Professional
                    services
                
                
                127
                
                
                116
                
                
                403
                
                
                420Amortization
                    of intangible assets
                
                
                156
                
                
                186
                
                
                483
                
                
                558Impairment
                    of securities
                
                
                -
                
                
                -
                
                
                162
                
                
                -Merger
                    and integration expenses
                
                
                -
                
                
                -
                
                
                -
                
                
                57Other
                    noninterest expense
                
                
                1,097
                
                
                1,094
                
                
                3,130
                
                
                3,186Total
                    noninterest expense
                
                
                4,554
                
                
                4,388
                
                
                13,456
                
                
                13,215Income
                    before income taxes
                
                
                1,783
                
                
                2,157
                
                
                5,857
                
                
                5,861Provision
                    for income taxes
                
                
                434
                
                
                719
                
                
                1,519
                
                
                1,889**Net
                    income**
                
                **$**
                **1,349**
                
                **$**
                **1,438**
                
                **$**
                **4,338**
                
                **$**
                **3,972****Net
                    income per common share:****Basic**
                
                **$**
                **0.18**
                
                **$**
                **0.18**
                
                **$**
                **0.56**
                
                **$**
                **0.49****Diluted**
                
                **$**
                **0.18**
                
                **$**
                **0.18**
                
                **$**
                **0.55**
                
                **$**
                **0.49****Weighted
                    average common shares outstanding:****Basic**
                
                
                **7,627,620**
                
                
                **8,019,286**
                
                
                **7,748,605**
                
                
                **8,042,271****Diluted**
                
                
                **7,691,722**
                
                
                **8,095,750**
                
                
                **7,817,438**
                
                
                **8,119,781**




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




2


**Citizens
      South Banking Corporation**


**Condensed
      Consolidated**  **Statements
      of Comprehensive Income** **(unaudited)**


**(dollars
      in thousands)**


**Nine
                  Months****Ended
                  September****30,****2007**
              
              **2006**Net
                  income
              
              $
              4,338
              
              $
              3,972**Items
                  of other comprehensive (gains) losses:**Items
                  of other comprehensive (gains) losses, before taxUnrealized
                  holding (gains) losses arising during period
              
              
              (88
              )
              
              458Reclassification
                  adjustment for securities losses included in net income
              
              
              79
              
              
              (93
              )Other
                  comprehensive (gain) loss, before tax
              
              
              (9
              )
              
              365Change
                  in deferred income taxes related to change in unrealized gains
                  or
                  losseson
                  securities available for sale
              
              
              4
              
              
              (131
              )Items
                  of other comprehensive (gains) losses, net of tax
              
              
              (5
              )
              
              234Comprehensive
                  income
              
              **$**
              **4,333**
              
              **$**
              **4,206**





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





3


**Citizens
      South Banking Corporation**


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


**(dollars
      in thousands)**


**Nine
                  Months****Ended
                  September 30,****2007**
              
              **2006****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
              
              
              67,439
              
              
              67,049Grant
                  of additional shares from RRP
              
              
              (128
              )
              
              -Vesting
                  of shares for RRP
              
              
              226
              
              
              210Stock-based
                  compensation expense
              
              
              23
              
              
              18At
                  end of period
              
              
              67,560
              
              
              67,277**Unallocated
                  common stock held by ESOP:**At
                  beginning of period
              
              
              (1,430
              )
              
              (1,613
              )Allocation
                  from shares purchased with loan from ESOP
              
              
              137
              
              
              137At
                  end of period
              
              
              (1,293
              )
              
              (1,476
              )**Retained
                  earnings, substantially restricted:**At
                  beginning of period
              
              
              33,031
              
              
              30,311Net
                  income
              
              
              4,338
              
              
              3,972Exercise
                  of options
              
              
              (199
              )
              
              (324
              )Dividends
                  paid
              
              
              (1,855
              )
              
              (1,803
              )At
                  end of period
              
              
              35,315
              
              
              32,156**Accumulated
                  unrealized loss on securities available for sale, net of
                  tax:**At
                  beginning of period
              
              
              (991
              )
              
              (1,567
              )Other
                  comprehensive income, net of tax
              
              
              (5
              )
              
              234At
                  end of period
              
              
              (996
              )
              
              (1,333
              )**Treasury
                  stock:**At
                  beginning of period
              
              
              (12,179
              )
              
              (10,013
              )Grant
                  of additional shares from RRP
              
              
              128
              
              
              -Exercise
                  of options
              
              
              283
              
              
              459Purchase
                  of common stock for treasury
              
              
              (4,531
              )
              
              (1,385
              )At
                  end of period
              
              
              (16,299
              )
              
              (10,939
              )





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





4


**Citizens
      South Banking Corporation**


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


**(dollars
      in thousands)**


**Nine
                  Months****Ended
                  September 30,****2007**
              
              **2006****Cash
                  flows from operating activities:**Net
                  income
              
              $
              4,338
              
              $
              3,972Adjustments
                  to reconcile net income to net cash provided by operating
                  activities:Provision
                  for loan losses
              
              
              960
              
              
              865Depreciation
              
              
              886
              
              
              1,014Impairment
                  on investment securities
              
              
              162
              
              
              -Net
                  gain on sale of investment securities
              
              
              (1
              )
              
              (93
              )Net
                  loss on sale of mortgage-backed securities
              
              
              80
              
              
              -Net
                  gain on sale of loans
              
              
              (5
              )
              
              -Net
                  loss on sale of other real estate owned
              
              
              9
              
              
              103Net
                  (gain) loss on sale of premises and equipment
              
              
              (419
              )
              
              30Deferred
                  loan origination fees
              
              
              (69
              )
              
              (45
              )Allocation
                  of shares to the ESOP
              
              
              137
              
              
              137Stock-based
                  compensation expense
              
              
              23
              
              
              18Vesting
                  of shares for the Recognition and Retention Plan
              
              
              226
              
              
              210Increase
                  in accrued interest receivable
              
              
              (476
              )
              
              (615
              )Amortization
                  of intangible assets
              
              
              483
              
              
              558(Increase)
                  decrease in other assets
              
              
              1,567
              
              
              (222
              )Increase
                  (decrease) in other liabilities
              
              
              (358
              )
              
              576Net
                  cash provided by operating activities
              
              
              7,543
              
              
              6,508**Cash
                  flows from investing activities:**Net
                  increase in loans
              
              
              (33,184
              )
              
              (45,240
              )Proceeds
                  from the sale of investment securities
              
              
              3,000
              
              
              98Proceeds
                  from the sale of mortgage-backed securities
              
              
              3,364
              
              
              -Proceeds
                  from the sale of loans
              
              
              202
              
              
              -Proceeds
                  from the sale of other real estate owned
              
              
              233
              
              
              1,012Proceeds
                  from the sale premise and equipment
              
              
              801
              
              
              28Maturities
                  and prepayments of investment securities
              
              
              9,987
              
              
              5,977Maturities
                  and prepayments of mortgage-backed securities
              
              
              9,608
              
              
              11,698Purchases
                  of investments
              
              
              (9,805
              )
              
              (242
              )Purchases
                  of mortgage-backed securities
              
              
              (18,208
              )
              
              -(Purchases)
                  sale of FHLB stock
              
              
              (205
              )
              
              435Capital
                  expenditures for premises and equipment
              
              
              (1,153
              )
              
              (232
              )Net
                  cash used in investment activities
              
              
              (35,360
              )
              
              (26,466
              )**Cash
                  flows from financing activities:**Net
                  increase in deposits
              
              
              9,312
              
              
              31,455Exercise
                  of options
              
              
              84
              
              
              135Dividends
                  paid
              
              
              (1,855
              )
              
              (1,803
              )Purchase
                  of common stock for treasury
              
              
              (4,531
              )
              
              (1,385
              )Net
                  increase (decrease) in borrowed money
              
              
              10,018
              
              
              (8,996
              )Increase
                  in advances from borrowers for insurance and taxes
              
              
              228
              
              
              261Net
                  cash provided by financing activities
              
              
              13,256
              
              
              19,667Net
                  decrease in cash and cash equivalents
              
              
              (14,561
              )
              
              (291
              )Cash
                  and cash equivalents at beginning of period
              
              
              26,221
              
              
              26,653Cash
                  and cash equivalents at end of period
              
              $
              11,660
              
              $
              26,362


***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- and nine-month periods ended September 30, 2007 and 2006. Amounts as
      of
      December 31, 2006 included in the condensed consolidated financial statements
      and related notes were derived from the audited consolidated financial
      statements. Results for the three- and nine-month periods ended September 30,
      2007, are not necessarily indicative of the results that may be expected for
      future periods, including the year ending December 31, 2007.





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, 2006
      (the “Annual Report”).





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 and nine
      months ended September 30, 2007 and 2006:


**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2007**
              
              **2006**
              
              **2007**
              
              **2006****(dollars
                  in thousands, except per share amounts)**Net
                  income
              
              $
              1,349
              
              $
              1,438
              
              $
              4,338
              
              $
              3,972Weighted
                  average shares outstanding
              
              
              7,627,620
              
              
              8,019,286
              
              
              7,748,605
              
              
              8,042,271Dilutive
                  effect of stock options
              
              
              64,102
              
              
              76,464
              
              
              68,833
              
              
              77,510Weighted
                  average diluted shares outstanding ...
              
              
              7,691,722
              
              
              8,095,750
              
              
              7,817,438
              
              
              8,119,781Diluted
                  earnings per share
              
              $
              0.18
              
              $
              0.18
              
              $
              0.55
              
              $
              0.49





For
      the
      periods ended September 30, 2007 and 2006, there were 571,751 and 553,482
      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:





September
                30, 2007
            
            December
                31, 2006Loan
                commitments:Residential
                mortgage loans
            
            $
            9,541,000
            
            $
            6,193,000Non-residential
                mortgage loans
            
            
            14,874,000
            
            
            34,842,000Commercial
                loans
            
            
            170,000
            
            
            1,535,000Consumer
                loans
            
            
            4,602,000
            
            
            3,857,000Total
                loan commitments
            
            $
            29,187,000
            
            $
            46,427,000Unused
                lines of credit:Commercial
            
            $
            39,903,000
            
            $
            43,424,000Consumer
            
            
            69,103,000
            
            
            61,912,000Total
              unused lines of credit
            
            $
            109,006,000
            
            $
            105,336,000Undisbursed
              construction loan proceeds
            
            $
            3,663,000
            
            $
            8,472,000





**Note
      4 - Dividend Declaration**





On
      October 22, 2007, the Board of Directors of the Company approved and declared
      a
      regular cash dividend of eight cents ($0.08) per share of common stock to
      stockholders of record as of November 1, 2007, payable on November 15, 2007.





**Note
      5 - Stock Repurchase Program**





On
      January 22, 2007, the Board of Directors of the Company authorized the
      repurchase of up to 400,000 shares, or approximately 5% of the Company’s then
      outstanding shares of common stock. These
      repurchases may be carried out through open market purchases, block trades,
      and
      negotiated private transactions. The stock may be repurchased on an ongoing
      basis and will be subject to the availability of stock, general market
      conditions, the trading price of the stock, alternative uses for capital, and
      the Company’s financial performance. Under this plan the Company had repurchased
      a total of 343,448 shares at an average price of $12.90 per share and had 56,552
      shares remaining to be repurchased at September 30, 2007. 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 - Subsequent Events**





On
      October 22, 2007, the Board of Directors authorized the repurchase of up to
      200,000 shares, or approximately 2.5% of the Company’s then outstanding shares
      of stock upon completion of the current stock repurchase program described
      in
      Note 5 above. 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. 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 **.**




7





**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. The Company is currently
      evaluating the impact of the adoption of SFAS No. 157 on its financial
      position and results of operations, including the valuation methods and support
      for the assumptions that underlie the valuation.





In
      February 2007, FASB issued SFAS No. 159, “ *The
      Fair Value Option for Financial Assets and Financial
      Liabilities* ”
(“SFAS
      No. 159”), which permits entities to choose and measure many financial
      instruments and certain other items at fair value. The
      objective of this Statement is to improve financial reporting by providing
      entities with the opportunity to mitigate volatility in reported earnings caused
      by measuring related assets and liabilities differently without having to apply
      complex hedge accounting provisions. This Statement is effective for fiscal
      years beginning after November 15, 2007, with early adoption permitted
      under certain circumstances. The Company has chosen not to early adopt the
      provisions of SFAS No. 159, so this Statement will be effective for the Company
      on January 1, 2008. The Company has evaluated this statement and does not
      believe it will have a material effect on the Company’s consolidated financial
      statements.




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 Company is currently evaluating the
      impact of EITF Issue 06-4 on its financial position and results of
      operations.





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
      Company is currently evaluating the impact of EITF Issue 06-11 on its financial
      position and results of operations.





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 and nine-month periods ended September 30,
      2007
      and September 30, 2006. 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
              September
                30, 2007
            
            Three
                months ended
              September
                30, 2006
            
            %
                Change
            
            Nine
                months ended
              September
                30, 2007
            
            Nine
                months ended
              September
                30, 2006
            
            %
                Change**Earnings:**Net
                interest income
            
            $
            5,103
            
            $
            5,202
            
            
            1.90
            %
            $
            15,222
            
            $
            15,515
            
            
            (1.89)
            %Provision
                for loan losses
            
            
            (300
            )
            
            (300
            )
            
            0.00
            
            
            (960
            )
            
            (865
            )
            
            10.98Noninterest
                income
            
            
            1,534
            
            
            1,643
            
            
            (6.63
            )
            
            5,051
            
            
            4,426
            
            
            14.12Noninterest
                expense
            
            
            (4,554
            )
            
            (4,388
            )
            
            3.78
            
            
            (13,456
            )
            
            (13,215
            )
            
            1.82Income
                tax expense
            
            
            (434
            )
            
            (719
            )
            
            (39.64
            )
            
            (1,519
            )
            
            (1,889
            )
            
            (19.59
            )**Net
                Income**
            
            **$**
            **1,349**
            
            **$**
            **1,438**
            
            
            **(6.19**
            **)**
            **$**
            **4,338**
            
            **$**
            **3,972**
            
            
            **9.21****Per
                Share Data:**Avg.
                common shares outstanding, basic
            
            
            7,627,620
            
            
            8,019,286
            
            
            (4.88)
            %
            
            7,748,605
            
            
            8,042,271
            
            
            (3.65)
            %Basic
                net income
            
            $
            0.18
            
            $
            0.18
            
            
            0.00
            
            $
            0.56
            
            $
            0.49
            
            
            14.29Avg.
                common shares outstanding, diluted
            
            
            7,691,722
            
            
            8,095,750
            
            
            (4.99)
            %
            
            7,817,438
            
            
            8,119,781
            
            
            (3.72)
            %Diluted
                net income
            
            $
            0.18
            
            $
            0.18
            
            
            0.00
            
            $
            0.55
            
            $
            0.49
            
            
            12.24Cash
                dividends paid
            
            $
            0.08
            
            $
            0.075
            
            
            6.67
            %
            $
            0.235
            
            $
            0.22
            
            
            6.67
            %Period-end
                book value
            
            
            10.86
            
            
            10.46
            
            
            3.82
            
            
            10.86
            
            
            10.46
            
            
            3.82**Financial
                Ratios**(annualized)**:**Return
                on average stockholders’ equity
            
            
            6.37
            %
            
            6.70
            %
            
            (4.93)
            %
            
            6.83
            %
            
            6.26
            %
            
            9.11
            %Return
                on average assets
            
            
            0.70
            
            
            0.79
            
            
            (5.34
            )
            
            0.78
            
            
            0.75
            
            
            0.68Efficiency
                ratio
            
            
            68.61
            
            
            64.11
            
            
            (11.39
            )
            
            66.37
            
            
            66.27
            
            
            4.00Net
                interest margin
            
            
            3.13
            
            
            3.31
            
            
            (5.44
            )
            
            3.20
            
            
            3.39
            
            
            (2.53
            )Average
                equity to average assets
            
            
            11.06
            
            
            11.81
            
            
            (6.35
            )
            
            11.37
            
            
            11.92
            
            
            0.15**Asset
                Quality Data:**Allowance
                for loan losses
            
            $
            6,292
            
            $
            5,560
            
            
            13.17
            %
            $
            6,292
            
            $
            5,560
            
            
            13.17
            %Nonperforming
                loans
            
            
            2,528
            
            
            1,925
            
            
            31.32
            
            
            2,528
            
            
            1,925
            
            
            31.32Nonperforming
                assets
            
            
            3,164
            
            
            2,070
            
            
            52.85
            
            
            3,164
            
            
            2,070
            
            
            52.85Net
                charge-offs
            
            
            135
            
            
            154
            
            
            (12.34
            )
            
            432
            
            
            409
            
            
            5.32Allowance
                for loan losses to total loans
            
            
            1.15
            %
            
            1.07
            %
            
            7.48
            
            
            1.15
            %
            
            1.07
            %
            
            7.48Nonperforming
                loans to total loans
            
            
            0.46
            
            
            0.37
            
            
            24.32
            
            
            0.46
            
            
            0.37
            
            
            24.32Nonperforming
                assets to total assets
            
            
            0.42
            
            
            0.29
            
            
            44.83
            
            
            0.42
            
            
            0.29
            
            
            44.83**Average
                Balances:**Total
                assets
            
            $
            759,132
            
            $
            721,204
            
            
            5.26
            %
            $
            746,974
            
            $
            711,344
            
            
            5.01
            %Loans,
                net of unearned income
            
            
            532,902
            
            
            503,491
            
            
            5.84
            
            
            519,132
            
            
            487,860
            
            
            6.41Interest-earning
                assets
            
            
            668,671
            
            
            628,548
            
            
            6.38
            
            
            653,662
            
            
            616,516
            
            
            6.03Deposits
            
            
            579,141
            
            
            540,201
            
            
            7.21
            
            
            573,374
            
            
            528,988
            
            
            8.39Interest-bearing
                liabilities
            
            
            625,128
            
            
            588,402
            
            
            6.24
            
            
            612,301
            
            
            582,538
            
            
            5.11Stockholders’
                equity
            
            
            83,984
            
            
            85,178
            
            
            (1.40
            )
            
            83,984
            
            
            84,813
            
            
            (0.98
            )**At
                Period End:**Total
                assets
            
            $
            760,987
            
            $
            725,908
            
            
            4.83
            %
            $
            760,987
            
            $
            725,908
            
            
            4.83
            %Loans,
                net of unearned income
            
            
            548,026
            
            
            512,652
            
            
            6.90
            
            
            548,026
            
            
            512,652
            
            
            6.90Interest-earning
                assets
            
            
            676,874
            
            
            639,054
            
            
            5.92
            
            
            676,874
            
            
            639,054
            
            
            5.92Deposits
            
            
            572,114
            
            
            548,999
            
            
            4.21
            
            
            572,114
            
            
            548,999
            
            
            4.21Interest-bearing
                liabilities
            
            
            628,084
            
            
            593,183
            
            
            5.88
            
            
            628,084
            
            
            593,183
            
            
            5.88Stockholders’
                equity
            
            
            84,378
            
            
            85,776
            
            
            (1.63
            )
            
            84,378
            
            
            85,776
            
            
            (1.63
            )




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 investment securities and the allowance for loan
      losses.





**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
      June 30, 2007, management evaluated the Company’s investment portfolio and
      determined that a $162,000 “other-than-temporary” impairment existed on a
      $305,000 equity investment in a closely held company. The impairment was
      considered to be “other-than-temporary” due to the company’s continuing
      operating losses and deteriorating book value. The Company’s remaining equity
      interest in the company amounts to $143,000. Effective September 30, 2007 and
      2006, management evaluated the Company’s investment portfolio and determined
      that all unrealized losses were the direct result of temporary changes in
      interest rates and that such losses may be recovered in the foreseeable future.
      As a result, management did not consider any unrealized losses as
“other-than-temporary” at September 30, 2007 and 2006.




11





**Comparison
      of Financial Condition**





*Assets.* Total
      assets of the Company increased by $17.6 million, or 2.4%, from $743.4 million
      at December 31, 2006, to $761.0 million at September 30, 2007. This increase
      was
      primarily due to a $32.6 million increase in loans and a $5.6 million increase
      in mortgage-backed securities. This increase was partly offset by a $14.6
      million decrease in cash and cash equivalents and a $3.8 million decrease in
      investment securities.





Loans
      receivable increased by $32.6 million, or 6.3%, to $548.0 million at September
      30, 2007. The growth in loans was primarily comprised of a $22.4 million, or
      8.8%, increase in commercial real estate loans to $276.7 million. Also during
      the nine-month period, construction loans increased by $7.6 million, or 9.9%
      to
      $83.8 million, consumer loans increased by $2.1 million, or 3.0%, to $72.2
      million and commercial business loans increased by $849,000, or 2.6%, to $32.8
      million. These increases in loans were partly offset by a $4.1 million, or
      5.0%,
      decrease in residential mortgage loans to $78.9 million. Loan production has
      been strong during 2007, totaling $66.9 million during the first quarter, $86.4
      million during the second quarter and $81.3 million during the third quarter.
      As
      a result of increased production, loans outstanding increased by $3.5 million
      in
      the first quarter, $16.9 million in the second quarter and $12.2 million in the
      third quarter. In order to increase loan growth for the remainder of 2007 and
      2008, the Company has added several experienced lenders and an additional credit
      officer. The local economy remains vibrant compared to most of the country;
      however, housing starts and demand for commercial real estate have slowed during
      the year as evidenced by the $17.2 million decrease in loan commitments
      outstanding at December 31, 2006, compared to September 30, 2007. 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 safe and sound manner
      with
      an emphasis on adjustable-rate loans and shorter-term fixed rate loans. As
      of
      September 30, 2007, $262.9 million, or 48.4%, of the Company’s loan portfolio,
      was scheduled to reprice in one month. This sensitivity to falling interest
      rates was a factor in the Company’s margin compression during the third quarter
      of 2007 as the prime interest rate decreased by 50 basis points during the
      quarter. Decreasing short-term interest rates will cause short-term margin
      compression, as these adjustable-rate loans will 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 will decrease and the Company’s
      net interest margin should begin to expand.





Cash
      and
      cash equivalents decreased by $14.6 million, or 55.5%, from $26.2 million at
      December 31, 2006, to $11.7 million at September 30, 2007. This decrease was
      primarily attributable to loan growth of $32.6 million outpacing growth in
      deposits and borrowed money of $19.3 million. Management expects that the level
      of cash and cash equivalents will remain stable through the end of 2007.
      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 and / or additional borrowings.





During
      the nine-month period ended September 30, 2007, mortgage-backed securities
      (“MBS”) increased $5.6 million, or 9.2%, to $66.3 million and investment
      securities decreased by $3.8 million, or 5.8%, to $61.5 million. The increase
      in
      MBS was due to the purchase of $18.2 million of MBS during the period, the
      effects of which were partly offset by the sale of $3.4 million in MBS and
      by
      $9.6 million of normal principal amortization. The decrease in investment
      securities was primarily due to the normal maturities of $10.0 million and
      the
      sale of $3.0 million during the period, the effects of which were partly offset
      by the purchase of $9.8 million in investment securities. Management expects
      the
      investment and mortgage-backed securities portfolios to decrease as a percentage
      of total assets as the cash flows generated from these investments are used
      to
      fund loan growth, repay borrowings and repurchase common stock. This
      restructuring 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.




12





Other
      real estate owned, which consists of ten one-to-four family residential
      dwellings acquired by the Bank through foreclosure, increased by $497,000 to
      $636,000 at September 30, 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.





*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
      September 30, 2007, the allowance for loan losses was $6.3 million, or 1.15%
      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 incurred losses inherent in the remaining loan portfolio. Although
      management believes that it uses the best information available to make such
      determinations, future adjustments to the allowance for loan losses may be
      necessary and results of operations could be significantly adversely affected
      if
      circumstances differ substantially from the assumptions used in making the
      determinations. The following table presents an analysis of changes in the
      allowance for loan losses for the periods and information with respect to
      nonperforming assets at the dates indicated.


**At
                  and For the Three**
              
              **At
                  and For the Nine****Months
                  Ended September 30,**
              
              **Months
                  Ended September 30,****2007**
              
              **2006**
              
              **2007**
              
              **2006**(dollars
                  in thousands)
              
              (dollars
                  in thousands)**Allowance
                  for loan losses:**Beginning
                  of period
              
              $
              6,128
              
              $
              5,414
              
              $
              5,764
              
              $
              5,104Add:Provision
                  for loan losses
              
              
              300
              
              
              300
              
              
              960
              
              
              865Recoveries
              
              
              66
              
              
              7
              
              
              86
              
              
              10Less:Charge-offs
              
              
              202
              
              
              161
              
              
              518
              
              
              419End
                  of period
              
              $
              6,292
              
              $
              5,560
              
              $
              6,292
              
              $
              5,560Nonaccrual
                  loans
              
              $
              2,528
              
              $
              1,925
              
              $
              2,528
              
              $
              1,925Real
                  estate owned
              
              
              636
              
              
              145
              
              
              636
              
              
              145Nonperforming
                  assets
              
              $
              3,164
              
              $
              2,070
              
              $
              3,164
              
              $
              2,070Allowance
                    for loan losses as a percentage of total loans
              
              
              1.15
              %
              
              1.07
              %
              
              1.15
              %
              
              1.07
              %Nonperforming
                    loans to total loans
              
              
              0.46
              %
              
              0.37
              %
              
              0.46
              %
              
              0.37
              %Nonperforming
                    assets to total assets
              
              
              0.42
              %
              
              0.29
              %
              
              0.42
              %
              
              0.29
              %




Premises
      and equipment decreased by $165,000, or 0.9%, to $18.1 million at September
      30,
      2007. During the first quarter of 2007, the Company opened a loan production
      office in Waxhaw, North Carolina. The loan production office is located in
      leased office space and is staffed by a local mortgage originator. This
      represents the Company’s third loan production office. Management also plans to
      open a full service office in Rock Hill, South Carolina by first quarter of
      2008
      in a leased facility. This will replace the current loan production office
      in
      Rock Hill that was opened in February 2006. During 2007, the Company also
      purchased a lot in Indian Trail, North Carolina for future branch expansion.
      These capital expenditures were partly offset by the sale of the vacant
      operations center of the former Citizens Bank in Salisbury, North Carolina
      for
      $414,000 and the sale of a right of way parcel from the Mooresville, North
      Carolina property for $387,000, as well as normal depreciation of buildings
      and
      equipment.




13





*Liabilities* .
      Total
      liabilities increased by $19.2 million, or 2.9%, from $657.4 million at December
      31, 2006, to $676.6 million at September 30, 2007. This increase was primarily
      due to a $9.3 million increase in total deposits and a $10.0 million increase
      in
      borrowed money.





While
      total deposits increased by $9.3 million, or 1.7%, to $572.1 million at
      September 30, 2007, core deposits (which exclude time deposits) increased by
      $6.2 million, or 2.7%, to $230.4 million at September 30, 2007. During the
      nine-month period ended September 30, 2007, demand deposit accounts (checking
      accounts) increased by $2.6 million, or 2.9%, to $93.2 million and money market
      deposit accounts increased by $6.7 million, or 5.7%, to $124.3 million. The
      increase in these core deposits was primarily due to a continued emphasis on
      increasing the Company’s number of retail and business checking account
      customers. This increase was partially offset by a $3.1 million, or 19.5%,
      decrease in savings accounts to $12.9 million at September 30, 2007. The
      decrease in savings accounts was largely due to customers moving these
      lower-yielding deposit accounts to higher-yielding accounts such as time
      deposits or money market deposit accounts. Management has always focused on
      increasing deposits by building customer relationships and typically avoids
      growing deposits by offering the highest rates in the market. However, if loan
      growth significantly outpaces deposit growth in the future, management may
      be
      more aggressive in attracting more retail deposits, which may increase the
      Company’s cost of funds. In addition, management may use brokered deposits to
      fund future loan growth if additional liquidity is needed. During the nine-month
      period ended September 30, 2007, time deposits increased by $3.1 million, or
      0.9%, to $341.7 million. Brokered deposits totaled only $3.5 million, or 0.6%
      of
      total deposits at September 30, 2007.





Borrowed
      money increased by $10.0 million, or 11.7%, to $96.0 million at September 30,
      2007. This increase was primarily due to additional Federal Home Loan Bank
      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 decreased by $1.6 million, or 1.8%, from $86.0 million at
      December 31, 2006, to $84.4 million at September 30, 2007. The decrease in
      stockholders’ equity was primarily due to the repurchase of 351,438 shares of
      common stock for $4.5 million, at an average cost of $12.89 per share. On
      January 22, 2007, the Board of Directors authorized the repurchase of up to
      400,000 shares, or approximately 5%, of the then outstanding shares of common
      stock. As of September 30, 2007, the Company had repurchased a total of 343,448
      shares under the current program at an average price of $12.90 per share and
      had
      56,552 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 $1.9 million during the
      period, representing $0.235 per share. Also during the nine-month period, the
      unrealized losses on available-for-sale securities increased by $5,000. These
      unrealized losses were primarily due to an increase in market interest rates
      during the period. These decreases in stockholders’ equity were partly offset by
      $4.3 million in net income during the nine-month period ended September 30,
      2007.





**Comparison
      of Results of Operations for the Three Months Ended September 30, 2007 and
      2006**





*General* .
      Net
      income for the three months ended September 30, 2007, amounted to $1.3 million,
      or $0.18 per diluted share, as compared to $1.4 million, or $0.18 per diluted
      share, for the three months ended September 30, 2006. This represented a 6.2%
      decrease in net income and no change in diluted earnings per share for the
      comparable periods.





*Net
      interest income.* During
      the comparable quarters, interest income increased by $817,000, or 7.4%, to
      $11.9 million for the third quarter of 2007, primarily as a result of organic
      loan growth and higher interest rates. Average interest-earning assets increased
      by $40.1 million, or 6.4%, to $668.7 million for the three months ended
      September 30, 2007. The increase in average interest-earning assets was
      primarily the result of a $29.4 million, or 5.8%, increase in average
      outstanding loans to $532.9 million. The Company’s average yield on earning
      assets increased by 15 basis points to 7.18% for the quarter ended September
      30,
      2007. Interest expense increased by $917,000, or 15.5%, for the comparable
      quarters to $6.8 million for the third quarter of 2007. This increase in
      interest expense was largely due to increased deposits and higher interest
      rates. The Company experienced a $36.7 million, or 6.2%, increase in the average
      balance of interest-bearing liabilities to $625.1 million for the three months
      ended September 30, 2007. Average interest-bearing liabilities increased
      primarily as a result of a $37.3 million, or 7.4%, increase in average
      interest-bearing deposits, the effects of which were partly offset by a
      $649,000, or 0.8%, decrease in average borrowed money. In addition, the average
      cost of funds increased by 35 basis points to 4.34% for the quarter ended
      September 30, 2007.




14





Net
      interest income decreased by $100,000, or 1.9%, to $5.1 million for the three
      months ended September 30, 2007. In addition, the tax-equivalent net interest
      margin decreased by 18 basis points to 3.13% for the quarter ended September
      30,
      2007, compared to 3.31% for the quarter ended September 30, 2006. This decrease
      in the net interest margin was primarily the result of funding costs rising
      at a
      faster rate than yields on earnings assets, resulting from the continued flat
      /
      inverted yield curve and the effects of a 50 basis point decrease in the prime
      lending rate during the third quarter 2007. On a linked-quarter basis, the
      Company’s tax-equivalent net interest margin decreased nine basis points from
      3.22% for the second quarter of 2007 to 3.13% for the third quarter of 2007.
      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 50 basis points in the third quarter of 2007 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 twelve months and reprice at a lower cost to the
      Company.





*Provision
      for loan losses.* The
      provision for loan losses amounted to $300,000 for both the three months ended
      September 30, 2007, and the three months ended September 30, 2006. While the
      provision for loan losses was flat during the comparable periods, the allowance
      for loan losses was $6.3 million, or 1.15% of total loans as of September 30,
      2007, compared to $5.6 million, or 1.07% of total loans as of September 30,
      2006. The Company continues to emphasize commercial real estate loans and its
      ratio of nonperforming loans to total loans was 0.46% on September 30, 2007,
      compared to 0.37% on September 30, 2006. A substantial portion of the Company’s
      nonperforming loans at September 30, 2007, was secured by real estate located
      in
      the Company’s normal lending market.




*Noninterest
      income.* Noninterest
      income decreased by $109,000, or 6.6%, to $1.5 million for the three months
      ended September 30, 2007, as compared to $1.6 million for the three months
      ended
      September 30, 2006. This decrease was largely attributable to a $62,000, or
      8.4%, decrease in fee income on deposit accounts, a $30,000, or 20.7%, decrease
      in fee income on lending activities and a $49,000 decrease in the fair value
      adjustment on deferred compensation assets. The decrease in fee income on
      deposit accounts follows a continuing trend of lower fees generated from checks
      returned for non-sufficient funds (“NSFs”). Management expects that this
      declining trend will continue for the remainder of 2007. Fees generated by
      lending activities decreased for the second straight quarter due in part to
      fewer loan originations of construction and acquisition and development loans
      which generally generate larger loan fees. Management expects that fee income
      from lending activities will improve in the short-term, due in part to the
      additional commercial lenders that were hired during the second quarter of
      2007.
      The $49,000 decrease in the fair value adjustment on deferred compensation
      assets was directly offset by a corresponding decrease in noninterest expense,
      resulting in no net impact to the Company.





These
      decreases in noninterest income were partly offset by a $26,000, or 12.2%,
      increase in mortgage banking income and a $24,000, or 14.7%, increase in cash
      value of bank-owned life insurance. During the 12 months ended September 30,
      2007, the Company increased its number of commission-based mortgage loan
      originators resulting in an increase in mortgage-banking revenues. Continued
      expansion of the mortgage banking area is expected in 2008. In December 2006,
      the Company exchanged a large portion of its bank-owned life insurance contracts
      to obtain a more favorable crediting rate. As a result, the cash value of these
      policies increased by $24,000 during the comparable periods.




15





The
      Company did not recognize any significant net gains from the sale of assets
      during the quarter ended September 30, 2007. During the quarter ended September
      30, 2006, the Company realized a net gain of $8,000 from the sale of $103,000
      in
      residential real estate owned and from the sale of $98,000 in equity securities.





*Noninterest
      expense.* Noninterest
      expense increased by $166,000, or 3.8%, to $4.6 million for the quarter ended
      September 30, 2007, compared to $4.4 million for the quarter ended September
      30,
      2006. The primary reason was a $181,000, or 7.9%, increase in compensation
      and
      benefits, a $51,000, or 8.4%, increase in occupancy and equipment expense and
      an
      $11,000, or 9.3%, increase in professional services. 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 beginning in 2008. The Company opened its
      third loan production office in 2007 and plans to open its fifteenth
      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. The $11,000 increase in professional services was primarily
      associated with miscellaneous services provided to management in various areas
      of operations.





These
      increases in noninterest expense were partly offset by a $49,000 decrease in
      the
      fair value adjustment on deferred compensation and a $30,000 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 $434,000, or 24.4% of taxable income, for the quarter ended
      September 30, 2007, as compared to $719,000, or 33.4% of taxable income, for
      the
      quarter ended September 30, 2006. The decrease in the effective tax rate during
      the comparable periods was primarily due to a $356,000 increase in nontaxable
      income from the third quarter 2006 to the third quarter 2007. This 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.





**Comparison
      of Results of Operations for the Nine Months Ended September 30, 2007 and
      2006**





*General* .
      Net
      income for the nine months ended September 30, 2007 amounted to $4.3 million,
      or
      $0.55 per diluted share, as compared to $4.0 million, or $0.49 per diluted
      share, for the nine months ended September 30, 2006. This represented a 9.2%
      increase in net income and a 12.2% increase in diluted earnings per share for
      the comparable periods.





*Net
      interest income.* Interest
      income increased by $3.4 million, or 10.9%, to $34.9 million for the nine-month
      period ending September 30, 2007, primarily as a result of organic loan growth
      and higher interest rates. Average interest-earning assets increased by $37.1
      million, or 6.0%, to $653.7 million for the nine months ended September 30,
      2007. The increase in average interest-earning assets was primarily the result
      of a $31.3 million, or 6.4%, increase in average outstanding loans to $519.1
      million. The Company’s average yield on earning assets increased by 40 basis
      points to 7.22% for the nine months ended September 30, 2007. Interest expense
      increased by $3.7 million, or 23.3%, for the comparable nine-month periods.
      This
      increase in interest expense was largely due to increased deposits and higher
      interest rates. The Company experienced a $29.8 million, or 5.1%, increase
      in
      the average balance of interest-bearing liabilities to $612.3 million for the
      nine months ended September 30, 2007. Average interest-bearing liabilities
      increased primarily as a result of a $39.6 million, or 8.0%, increase in average
      interest-bearing deposits, the effects of which were partly offset by a $9.9
      million, or 11.2%, decrease in average borrowed money during the period. Also,
      the average cost of funds increased by 63 basis points to 4.29% for the nine
      months ended September 30, 2007.





Net
      interest income decreased by $294,000, or 1.9%, to $15.2 million for the nine
      months ended September 30, 2007. In addition, the net interest margin decreased
      by 19 basis points to 3.20% for the nine months ended September 30, 2007,
      compared to 3.39% for the nine months ended September 30, 2006. This decrease
      in
      the net interest margin was primarily the result of rising funding costs
      resulting from the continued flat / inverted yield curve coupled with the
      effects of a 50 basis point decrease in the prime lending rate during the third
      quarter 2007.




16





*Provision
      for loan losses.* The
      provision for loan losses amounted to $960,000 for the nine months ended
      September 30, 2007, compared to $865,000 for the nine months ended September
      30,
      2006. The increase in the provision for loan losses was primarily attributable
      to the continued growth in the commercial real estate portfolio. The allowance
      for loan losses was $6.3 million, or 1.15% of total loans, as of September
      30,
      2007, compared to $5.6 million, or 1.07% of total loans, as of September 30,
      2006.




*Noninterest
      income.* Noninterest
      income increased by $625,000, or 14.1%, to $5.1 million for the nine months
      ended September 30, 2007, as compared to $4.4 million for the nine months ended
      September 30, 2006. This increase was largely attributable to the $343,000,
      or
      84.6%, increase in mortgage banking income and an $80,000, or 14.5%, increase
      in
      other noninterest income. During the 12 months ended September 30, 2007, the
      Company increased its number of commission-based mortgage loan originators
      located throughout the Company’s normal lending area, resulting in a material
      increase in mortgage-banking revenues. Continued expansion of the mortgage
      banking area is expected in 2008. However, continued weakness in the housing
      market could have a negative impact on the Company’s ability to grow or maintain
      the level of mortgage-banking revenues. Other noninterest income increased,
      in
      part, due to increased commissions on the sale of financial products, higher
      merchant fee income, and increased early withdrawal fees on time
      deposits.





The
      Company also experienced a $336,000 net gain on the sale of assets during the
      first nine months of 2007 and $112,000 of net income generated from life
      insurance proceeds payable to the Company. The net gain on the sale of assets
      included the sale of the vacant operations center of the former Citizens Bank
      in
      Salisbury, North Carolina for $414,000 and the sale of a right of way parcel
      from the Mooresville, North Carolina property for $387,000. These sales resulted
      in a net gain of $419,000. Additional net gains of $6,000 were incurred from
      the
      sale of $3.0 million in investment securities and $202,000 from the sale of
      loans. Offsetting a portion of these gains were net losses of $80,000 from
      the
      sale of $3.4 million in mortgage-backed securities and $9,000 from the sale
      of
      various parcels of foreclosed properties. The $112,000 of net life insurance
      proceeds was the result of the untimely death of one of the Bank’s officers
      after a courageous fight with cancer. During the nine months ended September
      30,
      2006, the Company recognized a net loss of $40,000 from the sale of various
      parcels of residential properties acquired through foreclosure totaling $1.0
      million, the sale of $98,000 in investment securities and the sale of
      miscellaneous fixed assets totaling $28,000.





These
      increases in noninterest income were partly offset by a $130,000, or 6.1%,
      reduction in fee income on deposit accounts, a $100,000, or 21.8%, decrease
      in
      fee income on lending activities, a $19,000, or 11.4% decrease in dividends
      on
      FHLB stock, and a $34,000 decrease in the fair value adjustment on deferred
      compensation assets. The decrease in fee income on deposit accounts follows
      a
      continuing trend of lower fees generated from checks returned for non-sufficient
      funds. Management expects that this declining trend will continue for the
      remainder of 2007. Fee income generated by lending activities decreased during
      the comparable periods due, in part, to a reduction of commercial construction
      loan originations which generally generate larger loan fees. Management expects
      that fee income from lending activities will improve, due in part to the
      additional commercial lenders that were hired during the second quarter of
      2007.
      The $19,000 decrease in dividends on FHLB stock was due to having fewer shares
      of FHLB stock. The Company’s shares of FHLB stock were partly based on the
      outstanding amount of FHLB borrowing, which had a lower average outstanding
      balance from September 30, 2006 to September 30, 2007. The decrease in the
      fair
      value adjustment on deferred compensation assets was directly offset by a
      corresponding increase in noninterest expense, resulting in no net impact to
      the
      Company.





*Noninterest
      expense.* Noninterest
      expense increased by $241,000, or 1.8%, to $13.5 million for the nine months
      ended September 30, 2007, compared to $13.2 million for the nine months ended
      September 30, 2006. The primary reason was a $307,000, or 4.5% increase in
      compensation and benefits and a$12,000, or 0.6%, increase in occupancy and
      equipment expense. Management hired several experienced lenders and one
      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 beginning in 2008. The Company opened its third loan production office
      in 2007 and plans to open its fifteenth 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.




17





Effective
      June 30, 2007, management evaluated the Company’s investment portfolio and
      determined that a $162,000 “other-than-temporary” impairment existed on a
      $305,000 equity investment in a closely held company. The impairment was
      considered to be “other-than-temporary” due to the company’s continuing
      operating losses and deteriorating book value. The Company’s remaining equity
      interest in the company amounted to $143,000 at September 30, 2007. Management
      will continue to evaluate the value of the Company’s remaining investment and
      make any necessary adjustments as conditions dictate. Management determined
      that
      there were no unrealized losses that were considered “other-than-temporary” at
      September 30, 2007, or September 30, 2006.





These
      increases in noninterest expense were partly offset by a $75,000, or 13.4%,
      decrease in the amortization of intangible assets, a $17,000, or 4.1%, decrease
      in professional services, a $34,000 decrease in the fair value adjustment on
      deferred compensation expense, and a $57,000, or 1.8%, decrease in other
      noninterest expenses. The amortization of intangible assets will continue to
      decrease as the amount of the core deposit intangible is amortized on an
      accelerated basis. Professional expense decreased due to higher than normal
      expenses experienced during the first quarter of 2006 related to the integration
      of the Trinity Bank back-office functions. The decrease in the fair value
      adjustment on deferred compensation assets is directly offset by a corresponding
      increase in noninterest expense, resulting in no net impact to the Company.
      Other noninterest expense decreased primarily due to fewer expenses and
      charge-offs related to checking account overdrafts. Management expects that
      this
      declining trend will continue for the remainder of 2007 as the number of
      overdrafts continues to decrease. Also, as a result of the Trinity Bank
      acquisition in October 2005, the Company experienced merger-related expenses
      of
      $57,000 during the first quarter of 2006. These were one-time expenses and
      as
      such, no such expenses were incurred during 2007.




*Income
      taxes.* Income
      taxes amounted to $1.5 million, or 25.9% of taxable income, for the nine months
      ended September 30, 2007, as compared to $1.9 million, or 32.2% of taxable
      income, for the nine months ended September 30, 2006. The decrease in income
      tax
      expense during the nine months period ending September 30, 2007, was primarily
      due to a $790,000 increase in nontaxable income generated primarily from
      bank-qualified municipal securities and loans and $171,000 of non-taxable life
      insurance proceeds payable to the Company. The Company invests in tax-advantaged
      sources of income to reduce its overall tax burden. As the Company continues
      to
      increase the amount of income derived from interest income on loans and fee
      income on loans and deposits, the effective tax rate is expected to increase.





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





The
      objectives of the Company’s liquidity management policy include providing
      adequate funds to meet the cash needs of both borrowers and depositors, to
      provide for the on-going operations of the Company, and to capitalize on
      opportunities for expansion. Liquidity management addresses the Company’s
      ability to meet deposit withdrawals on demand or at contractual maturity, to
      repay borrowings as they mature, and to fund new loans and investments as
      opportunities arise. The primary sources of internally generated funds are
      principal and interest payments on loans receivable, increases in local
      deposits, cash flows generated from operations, and cash flows generated by
      investments. If the Company requires funds beyond its internal funding
      capabilities, it may rely upon external sources of funds such as brokered
      deposits, repurchase agreements, and advances. The Company has $97.4 million
      available to draw from its line of credit with the Federal Home Loan Bank of
      Atlanta (“FHLB”). The FHLB functions as a central reserve bank providing credit
      for member financial institutions. As a member of the FHLB, we are required
      to
      own capital stock in the FHLB and we are authorized to apply for advances on
      the
      security of such stock and certain of our mortgage loans and other assets
      (principally securities that are obligations of, or guaranteed by, U.S.
      Government Agencies) provided certain creditworthiness standards have been
      met.
      Advances are made pursuant to several different credit programs. Each credit
      program has its own interest rate and range of maturities. Depending on the
      program, limitations on the amount of advances are based on the financial
      condition of the member institution and the adequacy of collateral pledged
      to
      secure the credit. The Company also has $13.6 million available from a $20.0
      million unsecured federal funds accommodation with The Bankers Bank (“TBB”). TBB
      is the Company’s primary correspondent bank. The federal funds accommodation is
      for a term of 12 months and is used for the purpose of providing daily liquidity
      as needed by the Company. Outstanding advances made under this accommodation
      are
      generally repaid on a daily basis at a rate determined by TBB based on their
      marginal cost of funds. Advances are limited to not more than 14 days in any
      calendar month. Interest on any advances made over the established line or
      beyond the 14-day limit will be at a higher rate. The Company may also solicit
      brokered deposits for providing funds for asset growth. As of September 30,
      2007, the Company had outstanding brokered deposits of $3.5 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.




18





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 September
      30,
      2007, the Company had loan commitments of $29.2 million, unused lines of credit
      of $109.0 million, and undisbursed construction loan proceeds of $3.7 million.
      The Company believes that it has adequate resources to fund loan commitments
      and
      lines of credit as they arise. The Company does not have any special purpose
      entities or other similar forms of off-balance-sheet financing.





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





The
      Bank
      is subject to various regulatory capital requirements administered by the
      banking regulatory agencies. As of September 30, 2007, the Bank’s capital
      exceeded all applicable regulatory requirements. The Bank's Tier I capital
      was
      $65.2 million, or 8.9% 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.





**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.





19





**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, 2006.





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





During
      the three-month period ended September 30, 2007, the Company repurchased 116,725
      shares of common stock for $1.5 million, at an average cost of $12.73 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**July
            
            
            80,525
            
            $
            12.77
            
            
            307,248
            
            
            92,752August
            
            
            22,000
            
            $
            12.61
            
            
            329,248
            
            
            70,752September
            
            
            14,200
            
            $
            12.66
            
            
            343,448
            
            
            56,552**Total**
            
            
            **116,725**
            
            **$**
            **12.73**
            
            
            **343,448**
            
            
            **56,552**





On
      January 22, 2007, the Board of Directors of the Company authorized the
      repurchase of up to 400,000 shares, or approximately 5%, of the Company’s
      then-outstanding shares of common stock. These repurchases may be carried out
      through open market purchases, block trades, and negotiated private
      transactions. The stock may be repurchased on an ongoing basis and will be
      subject to the availability of stock, general market conditions, the trading
      price of the stock, alternative uses for capital, and the Company’s financial
      performance. As of September 30, 2007, the Company had repurchased a total
      of
      343,448 shares at an average price of $12.90 per share and had 56,552 shares
      remaining to be repurchased under this plan. Management will consider
      repurchasing additional shares of common stock of the Company at prices
      management considers to be attractive and in the best interests of both the
      Company and its stockholders. Any repurchased shares will be held as treasury
      stock and will be available for general corporate purposes **.**





**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 September 30,
      2007.





20





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





Not
      applicable.




**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:
              November 8, 2007
            By:
            /s/
              Kim
              S. PriceKim
              S. PricePresident
                and Chief Executive Officer


Date:
              November 8, 2007
            By:
            /s/
              Gary
              F. HoskinsGary
              F. HoskinsExecutive
                Vice
                President, Chief Financial
              Officer
                and Treasurer





21