**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** **June
      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**


**7,800,932
      shares outstanding as of August 7, 2007**







**Citizens
      South Banking Corporation**


**Index**


Page**PART
                  I. -- Financial Information**Item
                  1.
              Condensed
                  Consolidated Financial Statements:Condensed
                  Consolidated Statements of Financial Condition June 30, 2007 and
                  December
                  31, 2006
              
              1Condensed
                  Consolidated Statements of Operations for the three and six months
                  ended
                  June 30, 2007 and 2006
              
              2Condensed
                  Consolidated Statements of Comprehensive Income for the six months
                  ended
                  June 30, 2007 and 2006
              
              3Condensed
                  Consolidated Statements of Changes in Stockholders’ Equity for the six
                  months ended June 30, 2007 and 2006
              
              4Condensed
                  Consolidated Statements of Cash Flows for the six months ended
                  June 30,
                  2007 and 2006
              
              5Notes
                  to Condensed Consolidated Financial Statements
              
              6Item
                  2.
              Management's
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              
              8Item
                  3.   
                  Quantitative and
                  Qualitative Disclosures About Market Risk
              
              18Item
                  4.
              Controls
                  and Procedures
              
              19**PART
                  II -- Other Information**
              
              19Item
                  1.
              Legal
                  Proceedings
              
              19Item
                  1A.                
                   Risk Factors
              
              19Item
                  2.
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              
              19Item
                  3.
              Defaults
                  Upon Senior Securities
              
              20Item
                  4.
              Submission
                  of Matters to a Vote of Security Holders
              
              20Item
                  5.                    
                   Other Information
              
              20Item
                  6.
              Exhibits
              
              20Signatures
              
              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)


**June
                    30,****2007**
              
              **December
                    31,****2006****(unaudited)****Assets:**Cash
                  and cash equivalents:Cash
                  and due from banks
              
              $
              11,244
              
              $
              17,581Interest-earning
                  bank balances
              
              
              1,746
              
              
              8,433Fed
                  funds sold
              
              
              154
              
              
              207Total
                  cash and cash equivalents
              
              
              13,144
              
              
              26,221Investment
                  securities available-for-sale, at fair value
              
              
              67,833
              
              
              65,326Mortgage-backed
                  and related securities available-for-sale, at fair value
              
              
              65,167
              
              
              60,691Loans:Loans
                  receivable, net of unearned income
              
              
              535,699
              
              
              515,402Allowance
                  for loan losses
              
              
              (6,128
              )
              
              (5,764
              )Net
                  loans
              
              
              529,571
              
              
              509,638Other
                  real estate owned
              
              
              449
              
              
              139Premises
                  and equipment, net
              
              
              18,361
              
              
              18,287Accrued
                  interest receivable
              
              
              3,348
              
              
              3,236Federal
                  Home Loan Bank stock
              
              
              3,223
              
              
              3,581Intangible
                  assets
              
              
              31,339
              
              
              31,666Cash
                  value of bank-owned life insurance policies
              
              
              15,751
              
              
              15,527Other
                  assets
              
              
              7,300
              
              
              9,058Total
                  assets
              
              $
              755,486
              
              $
              743,370**Liabilities
                  and Stockholders’ Equity:**Deposits:Demand
                  deposit accounts
              
              $
              92,564
              
              $
              90,540Money
                  market deposit accounts
              
              
              129,561
              
              
              117,632Savings
                  accounts
              
              
              14,583
              
              
              16,027Time
                  deposits
              
              
              346,837
              
              
              338,603Total
                  deposits
              
              
              583,545
              
              
              562,802Borrowed
                  money
              
              
              78,699
              
              
              85,964Deferred
                  compensation
              
              
              5,172
              
              
              5,723Other
                  liabilities
              
              
              3,859
              
              
              2,920Total
                  liabilities
              
              
              671,275
              
              
              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:
                  7,886,457 shares in 2007 and 8,111,659 shares in 2006
              
              
              91
              
              
              91Additional
                  paid-in-capital
              
              
              68,592
              
              
              68,578Unallocated
                  common stock held by Employee Stock Ownership Plan
              
              
              (1,339
              )
              
              (1,430
              )Unearned
                  compensation related to Recognition and Retention Plan
              
              
              (1,117
              )
              
              (1,139
              )Retained
                  earnings
              
              
              34,586
              
              
              33,031Accumulated
                  other comprehensive loss, net of deferred income taxes
              
              
              (1,787
              )
              
              (991
              )Treasury
                  stock of 1,176,270 shares at June 30, 2007, and951,068
                  shares at December 31, 2006, at cost
              
              
              (14,815
              )
              
              (12,179
              )Total
                  stockholders’ equity
              
              
              84,211
              
              
              85,961Total
                  liabilities and stockholders’ equity
              
              $
              755,486
              
              $
              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**
              
              **Six
                  Months****Ended
                  June 30,**
              
              **Ended
                  June 30,****2007**
              
              **2006**
              
              **2007**
              
              **2006****Interest
                  Income:**Loans
              
              $
              10,061
              
              $
              9,193
              
              $
              19,954
              
              $
              17,697Investment
                  securities
              
              
              691
              
              
              499
              
              
              1,359
              
              
              991Interest-bearing
                  deposits
              
              
              137
              
              
              124
              
              
              270
              
              
              276Mortgage-backed
                  and related securities
              
              
              696
              
              
              667
              
              
              1,367
              
              
              1,383Total
                  interest income
              
              
              11,585
              
              
              10,483
              
              
              22,950
              
              
              20,347**Interest
                  Expense:**Deposits
              
              
              5,591
              
              
              4,216
              
              
              10,931
              
              
              7,944Borrowed
                  funds
              
              
              922
              
              
              1,053
              
              
              1,900
              
              
              2,090Total
                  interest expense
              
              
              6,513
              
              
              5,269
              
              
              12,831
              
              
              10,034Net
                  interest income
              
              
              5,072
              
              
              5,214
              
              
              10,119
              
              
              10,313Provision
                  for loan losses
              
              
              330
              
              
              280
              
              
              660
              
              
              565Net
                  interest income after provision for loan losses
              
              
              4,742
              
              
              4,934
              
              
              9,459
              
              
              9,748**Noninterest
                  Income:**Fee
                  income on deposit accounts
              
              
              693
              
              
              736
              
              
              1,347
              
              
              1,414Mortgage
                  banking income
              
              
              277
              
              
              115
              
              
              510
              
              
              193Income
                  on lending activities
              
              
              133
              
              
              141
              
              
              242
              
              
              312Dividends
                  on FHLB stock
              
              
              46
              
              
              57
              
              
              96
              
              
              111Increase
                  in cash value of bank-owned life insurance
              
              
              178
              
              
              167
              
              
              387
              
              
              414Fair
                  value adjustment on deferred compensation assets
              
              
              21
              
              
              (21
              )
              
              58
              
              
              43Life
                  insurance proceeds, net
              
              
              112
              
              
              -
              
              
              112
              
              
              -Net
                  gain (loss) on sale of assets
              
              
              332
              
              
              9
              
              
              336
              
              
              (47
              )Other
                  noninterest income
              
              
              196
              
              
              165
              
              
              429
              
              
              343Total
                  noninterest income
              
              
              1,988
              
              
              1,369
              
              
              3,517
              
              
              2,783**Noninterest
                  Expense:**Compensation
                  and benefits
              
              
              2,363
              
              
              2,201
              
              
              4,706
              
              
              4,580Fair
                  value adjustment on deferred comp. obligations
              
              
              21
              
              
              (21
              )
              
              58
              
              
              43Occupancy
                  and equipment expense
              
              
              672
              
              
              667
              
              
              1,340
              
              
              1,379Professional
                  services
              
              
              153
              
              
              134
              
              
              276
              
              
              304Amortization
                  of intangible assets
              
              
              162
              
              
              186
              
              
              327
              
              
              372Impairment
                  of securities
              
              
              162
              
              
              -
              
              
              162
              
              
              -Merger
                  and integration expenses
              
              
              -
              
              
              -
              
              
              -
              
              
              57Other
                  noninterest expense
              
              
              1,084
              
              
              1,114
              
              
              2,033
              
              
              2,092Total
                  noninterest expense
              
              
              4,617
              
              
              4,281
              
              
              8,902
              
              
              8,827Income
                  before income taxes
              
              
              2,113
              
              
              2,022
              
              
              4,074
              
              
              3,704Provision
                  for income taxes
              
              
              524
              
              
              675
              
              
              1,085
              
              
              1,170**Net
                  income**
              
              **$**
              **1,589**
              ****
              **$**
              **1,347**
              ****
              **$**
              **2,989**
              ****
              **$**
              **2,534**
              ********
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ******Net
                  income per common share:**
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ****
              ******Basic**
              ****
              **$**
              **0.21**
              ****
              **$**
              **0.17**
              ****
              **$**
              **0.38**
              ****
              **$**
              **0.31**
              ******Diluted**
              ****
              **$**
              **0.20**
              ****
              **$**
              **0.17**
              ****
              **$**
              **0.38**
              ****
              **$**
              **0.31****Weighted
                  average common shares outstanding:****Basic**
              
              
              **7,750,385**
              
              
              **8,049,042**
              
              
              **7,810,089**
              
              
              **8,053,954****Diluted**
              
              
              **7,816,793**
              
              
              **8,123,232**
              
              
              **7,881,287**
              
              
              **8,131,987**
   ***See
        notes to condensed consolidated financial statements.***
 2


**Citizens
      South Banking Corporation**


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


**(dollars
      in thousands)**


**Six
                  Months****Ended
                  June 30,****2007**
              
              **2006**Net
                  income
              
              $
              2,989
              
              $
              2,534**Items
                  of other comprehensive loss:**Items
                  of other comprehensive loss, before taxUnrealized
                  holding losses arising during period
              
              
              (1,376
              )
              
              (1,144
              )Reclassification
                  adjustment for securities losses included in net income
              
              
              80
              
              
              -Other
                  comprehensive loss, before tax
              
              
              (1,296
              )
              
              (1,144
              )Change
                  in deferred income taxes related to change in unrealized gains
                  or
                  losseson
                  securities available for sale
              
              
              500
              
              
              448Items
                  of other comprehensive loss, net of tax
              
              
              (796
              )
              
              (696
              )Comprehensive
                  income
              
              **$**
              **2,193**
              ****
              **$**
              **1,838**




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




3


**Citizens
      South Banking Corporation**


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


**(dollars
      in thousands)**


**Six
                  Months****Ended
                  June 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
              
              
              68,578
              
              
              68,468Stock-based
                  compensation expense
              
              
              14
              
              
              12At
                  end of period
              
              
              68,592
              
              
              68,480**Unallocated
                  common stock held by ESOP:**At
                  beginning of period
              
              
              (1,430
              )
              
              (1,613
              )Allocation
                  from shares purchased with loan from ESOP
              
              
              91
              
              
              91At
                  end of period
              
              
              (1,339
              )
              
              (1,522
              )**Unearned
                  compensation related to Recognition and Retention
                  Plan:**At
                  beginning of period
              
              
              (1,139
              )
              
              (1,419
              )Grant
                  of additional shares from plan
              
              
              (128
              )
              
              -Vesting
                  of shares for plan
              
              
              150
              
              
              140At
                  end of period
              
              
              (1,117
              )
              
              (1,279
              )**Retained
                  earnings, substantially restricted:**At
                  beginning of period
              
              
              33,031
              
              
              30,311Net
                  income
              
              
              2,989
              
              
              2,534Exercise
                  of options
              
              
              (199
              )
              
              (270
              )Dividends
                  paid
              
              
              (1,235
              )
              
              (1,191
              )At
                  end of period
              
              
              34,586
              
              
              31,384**Accumulated
                  unrealized loss on securities available for sale, net of
                  tax:**At
                  beginning of period
              
              
              (991
              )
              
              (1,567
              )Other
                  comprehensive income, net of tax
              
              
              (796
              )
              
              (696
              )At
                  end of period
              
              
              (1,787
              )
              
              (2,263
              )**Treasury
                  stock:**At
                  beginning of period
              
              
              (12,179
              )
              
              (10,013
              )Grant
                  of additional shares from RRP
              
              
              128
              
              
              -Exercise
                  of options
              
              
              283
              
              
              383Purchase
                  of common stock for treasury
              
              
              (3,047
              )
              
              (731
              )At
                  end of period
              
              
              (14,815
              )
              
              (10,361
              )


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


4


**Citizens
      South Banking Corporation**


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


**(dollars
      in thousands)**


**Six
                  Months****Ended
                  June 30,****2007**
              
              **2006****Cash
                  flows from operating activities:**Net
                  income
              
              $
              2,989
              
              $
              2,534Adjustments
                  to reconcile net income to net cash provided by operating
                  activities:Provision
                  for loan losses
              
              
              660
              
              
              565Depreciation
              
              
              604
              
              
              686Impairment
                  on investment securities
              
              
              162
              
              
              -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
              
              
              8
              
              
              47Net
                  gain on sale of premises and equipment
              
              
              (419
              )
              
              -Deferred
                  loan origination fees
              
              
              (19
              )
              
              (93
              )Allocation
                  of shares to the ESOP
              
              
              91
              
              
              91Stock-based
                  compensation expense
              
              
              14
              
              
              12Vesting
                  of shares for the Recognition and Retention Plan
              
              
              150
              
              
              140Increase
                  in accrued interest receivable
              
              
              (111
              )
              
              (78
              )Amortization
                  of intangible assets
              
              
              327
              
              
              372(Increase)
                  decrease in other assets
              
              
              1,534
              
              
              (589
              )Increase
                  (decrease) in other liabilities
              
              
              79
              
              
              (235
              )Net
                  cash provided by operating activities
              
              
              6,144
              
              
              3,452**Cash
                  flows from investing activities:**Net
                  increase in loans
              
              
              (20,772
              )
              
              (36,739
              )Proceeds
                  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
              
              
              182
              
              
              1,062Proceeds
                  from the sale premise and equipment
              
              
              801
              
              
              -Maturities
                  and prepayments of investment securities
              
              
              5,970
              
              
              1,857Maturities
                  and prepayments of mortgage-backed securities
              
              
              6,783
              
              
              7,971Purchases
                  of investments
              
              
              (9,435
              )
              
              -Purchases
                  of mortgage-backed securities
              
              
              (15,204
              )
              
              -Sale
                  of FHLB stock
              
              
              358
              
              
              143Capital
                  expenditures for premises and equipment
              
              
              (1,059
              )
              
              (197
              )Net
                  cash used in investment activities
              
              
              (28,810
              )
              
              (25,903
              )**Cash
                  flows from financing activities:**Net
                  increase in deposits
              
              
              20,743
              
              
              18,721Exercise
                  of options
              
              
              84
              
              
              113Dividends
                  paid
              
              
              (1,235
              )
              
              (1,191
              )Purchase
                  of common stock for treasury
              
              
              (3,047
              )
              
              (731
              )Net
                  decrease in borrowed money
              
              
              (7,265
              )
              
              (4,045
              )Increase
                  in advances from borrowers for insurance and taxes
              
              
              309
              
              
              353Net
                     cash provided by financing activities
              
              
              9,589
              
              
              13,220Net
                  decrease in cash and cash equivalents
              
              
              (13,077
              )
              
              (9,231
              )Cash
                  and cash equivalents at beginning of period
              
              
              26,221
              
              
              26,653Cash
                  and cash equivalents at end of period
              
              $
              13,144
              
              $
              17,422***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 six-month periods ended June 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 six-month periods ended June 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 six
      months ended June 30, 2007 and 2006:


**Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30,**
              
              **June
                  30,****2007**
              
              **2006**
              
              **2007**
              
              **2006****(dollars
                  in thousands, except per share amounts)**Net
                  income
              
              $
              1,589
              
              $
              1,347
              
              $
              2,989
              
              $
              2,534Weighted
                  average shares outstanding
              
              
              7,750,385
              
              
              8,049,042
              
              
              7,810,089
              
              
              8,053,954Dilutive
                  effect of stock options
              
              
              66,408
              
              
              74,190
              
              
              71,198
              
              
              78,033Weighted
                  average diluted shares outstanding ...
              
              
              7,816,793
              
              
              8,123,232
              
              
              7,881,287
              
              
              8,131,987Diluted
                  earnings per share
              
              $
              0.20
              
              $
              0.17
              
              $
              0.38
              
              $
              0.31





For
      the
      periods ended June 30, 2007 and 2006, there were 557,751 and 578,751 shares,
      respectively, attributed to stock options that were excluded from the
      calculation of diluted earnings per share because their inclusion would have
      been anti-dilutive because the average market price of the stock was in excess
      of 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:





June 30, 2007
            
            December
                31, 2006Loan
                commitments:Residential
                mortgage loans
            
            $
            4,214,000
            
            $
            6,193,000Non-residential
                mortgage loans
            
            
            17,125,000
            
            
            34,842,000Commercial
                loans
            
            
            969,000
            
            
            1,535,000Consumer
                loans
            
            
            7,330,000
            
            
            3,857,000Total
                loan commitments
            
            $
            29,638,000
            
            $
            46,427,000Unused
                lines of credit:Commercial
            
            $
            42,973,000
            
            $
            43,424,000Consumer
            
            
            65,619,000
            
            
            61,912,000Total
                unused lines of credit
            
            $
            108,592,000
            
            $
            105,336,000Undisbursed
                construction loan proceeds
            
            $
            4,407,000
            
            $
            8,472,000





**Note
      4 - Dividend Declaration**





On
      July
      23, 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 August 1, 2007, payable on August 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 226,723 shares at an average price of $12.99 per share and had
      173,277 shares remaining to be repurchased at June 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
      July
      19, 2007, the Company registered 2,000,000 shares of its common stock, $0.01
      par
      value, to be used for a Dividend Reinvestment Plan (“the Plan”). The purpose of
      the Plan is to provide participants with a simple, convenient, and economical
      method of investing cash dividends paid on shares of common stock of the Company
      for the purchase of additional shares of common stock in the Company. To be
      eligible to participate in the Plan, a participant must hold at least 100 shares
      of common stock of the Company in registered form and must complete an
      Authorization Form at least five business days prior to the record date for
      a
      dividend payment. The Plan will be effective with the dividend payment having
      a
      record date of August 1, 2007, and will administered by Registrar and Transfer
      Company, the Company’s transfer agent. Additional information may be obtained
      from the Company’s Form S-3 Registration Statement filed with the Securities and
      Exchange Commission on July 19, 2007.




7





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





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. The Statement is effective for financial statements
      issued for fiscal years beginning after November 15, 2007, and interim
      periods within those fiscal years. The
      Company will be required to adopt SFAS No. 157 effective 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.





During
      the first quarter of 2007, FASB issued SFAS No. 159, “ *The
      Fair Value Option for Financial Assets and Financial
      Liabilities* ”
(“SFAS
      159”), which permits entities to choose and measure many financial instruments
      and certain other items at fair value. The
      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
      provision of SFAS 159. 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.





**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.


8







**Overview**





Management’s
      Discussion and Analysis is provided to assist in understanding and evaluating
      the Company’s results of operations and financial condition. The following
      discussion is designed to provide a general overview of the Company’s
      performance for the three-month period ended June 30, 2007. Readers seeking
      a
      more in-depth analysis should read the detailed discussions below, as well
      as
      the condensed consolidated financial statements and related notes. Financial
      highlights are presented in the table below.


Three
                  months ended
                June
                  30, 2007
              
              Three
                  months ended
                June
                  30, 2006
              
              %
                  Change
              
              Six
                  months ended
                June
                  30, 2007
              
              Six
                  months ended
                June
                  30, 2006
              
              %
                  Change**Earnings:**Net
                  interest income
              
              $
              5,072
              
              $
              5,214
              
              
              (2.72)
              %
              $
              10,119
              
              $
              10,313
              
              
              (1.88)
              %Provision
                  for loan losses
              
              
              (330
              )
              
              (280
              )
              
              17.86
              
              
              (660
              )
              
              (565
              )
              
              16.81Noninterest
                  income
              
              
              1,988
              
              
              1,369
              
              
              45.22
              
              
              3,517
              
              
              2,783
              
              
              26.37Noninterest
                  expense
              
              
              (4,617
              )
              
              (4,281
              )
              
              7.85
              
              
              (8,902
              )
              
              (8,827
              )
              
              0.85Income
                  tax expense
              
              
              (524
              )
              
              (675
              )
              
              (22.37
              )
              
              (1,085
              )
              
              (1,170
              )
              
              (7.26
              )**Net
                  Income**
              
              **$**
              **1,589**
              
              **$**
              **1,347**
              
              
              **17.97**
              
              **$**
              **2,989**
              
              **$**
              **2,534**
              
              
              **17.96****Per
                  Share Data:**Avg.
                  common shares outstanding, basic
              
              
              7,750,385
              
              
              8,049,042
              
              
              (3.71)
              %
              
              7,810,089
              
              
              8,053,954
              
              
              (3.03)
              %Basic
                  net income
              
              $
              0.21
              
              $
              0.17
              
              
              23.53
              
              $
              0.38
              
              $
              0.31
              
              
              22.58Avg
                  common shares outstanding, diluted
              
              
              7,816,793
              
              
              8,123,232
              
              
              (3.77)
              %
              
              7,881,287
              
              
              8,131,987
              
              
              (3.08)
              %Diluted
                  net income
              
              $
              0.20
              
              $
              0.17
              
              
              17.65
              
              $
              0.38
              
              $
              0.31
              
              
              22.58Cash
                  dividends paid
              
              $
              0.08
              
              $
              0.075
              
              
              6.67
              %
              $
              0.16
              
              $
              0.15
              
              
              6.67
              %Period-end
                  book value
              
              
              10.69
              
              
              10.24
              
              
              4.39
              
              
              10.69
              
              
              10.24
              
              
              4.39**Financial
                  Ratios**(annualized)**:**Return
                  on average stockholders’ equity
              
              
              7.50
              %
              
              6.37
              %
              
              17.74
              %
              
              7.06
              %
              
              6.05
              %
              
              16.69
              %Return
                  on average assets
              
              
              0.86
              
              
              0.75
              
              
              14.67
              
              
              0.81
              
              
              0.72
              
              
              12.50Efficiency
                  ratio
              
              
              65.40
              
              
              65.04
              
              
              0.55
              
              
              65.29
              
              
              67.40
              
              
              (3.13
              )Net
                  interest margin
              
              
              3.14
              
              
              3.41
              
              
              (7.92
              )
              
              3.16
              
              
              3.41
              
              
              (7.33
              )Average
                  equity to average assets
              
              
              11.44
              
              
              11.90
              
              
              (3.87
              )
              
              11.51
              
              
              11.97
              
              
              (3.84
              )**Asset
                  Quality Data:**Allowance
                  for loan losses
              
              $
              6,128
              
              $
              5,414
              
              
              13.19
              %
              $
              6,128
              
              $
              5,414
              
              
              13.19
              %Nonperforming
                  loans
              
              
              2,461
              
              
              1,974
              
              
              24.67
              
              
              2,461
              
              
              1,974
              
              
              24.67Nonperforming
                  assets
              
              
              2,910
              
              
              2,653
              
              
              9.69
              
              
              2,910
              
              
              2,653
              
              
              9.69Net
                  charge-offs
              
              
              225
              
              
              129
              
              
              74.42
              
              
              296
              
              
              255
              
              
              16.08Allowance
                  for loan losses to total loans
              
              
              1.14
              %
              
              1.06
              %
              
              7.55
              
              
              1.14
              %
              
              1.06
              %
              
              7.55Nonperforming
                  loans to total loans
              
              
              0.46
              
              
              0.39
              
              
              17.95
              
              
              0.46
              
              
              0.39
              
              
              17.95Nonperforming
                  assets to total assets
              
              
              0.39
              
              
              0.37
              
              
              5.41
              
              
              0.39
              
              
              0.37
              
              
              5.41**Average
                  Balances:**Total
                  assets
              
              $
              742,910
              
              $
              710,799
              
              
              4.52
              %
              $
              741,242
              
              $
              706,683
              
              
              4.89
              %Loans,
                  net of unearned income
              
              
              512,746
              
              
              487,137
              
              
              5.26
              
              
              512,247
              
              
              480,045
              
              
              6.71Interest-earning
                  assets
              
              
              647,389
              
              
              613,899
              
              
              5.46
              
              
              646,158
              
              
              610,500
              
              
              5.84Deposits
              
              
              576,250
              
              
              495,004
              
              
              16.41
              
              
              570,490
              
              
              490,332
              
              
              16.35Interest-bearing
                  liabilities
              
              
              608,380
              
              
              583,864
              
              
              4.20
              
              
              605,888
              
              
              579,606
              
              
              4.53Stockholders’
                  equity
              
              
              84,967
              
              
              84,613
              
              
              0.42
              
              
              85,342
              
              
              84,564
              
              
              0.92**At
                  Period End:**Total
                  assets
              
              $
              755,486
              
              $
              716,160
              
              
              5.49
              %
              $
              755,486
              
              $
              716,160
              
              
              5.49
              %Loans,
                  net of unearned income
              
              
              535,699
              
              
              504,499
              
              
              6.18
              
              
              535,699
              
              
              504,499
              
              
              6.18Interest-earning
                  assets
              
              
              668,138
              
              
              626,109
              
              
              6.71
              
              
              668,138
              
              
              626,109
              
              
              6.71Deposits
              
              
              583,545
              
              
              536,265
              
              
              8.82
              
              
              583,545
              
              
              536,265
              
              
              8.82Interest-bearing
                  liabilities
              
              
              623,449
              
              
              588,234
              
              
              5.99
              
              
              623,449
              
              
              588,234
              
              
              5.99Stockholders’
                  equity
              
              
              84,211
              
              
              84,530
              
              
              (0.38
              )
              
              84,211
              
              
              84,530
              
              
              (0.38
              )
 9


**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. Management will continue to
      evaluate the value of the Company’s remaining investment and make any necessary
      adjustments as conditions dictate. There were no other unrealized losses that
      were considered “other-than-temporary” at June 30, 2007.




10




**Comparison
      of Financial Condition**





*Assets.* Total
      assets of the Company increased by $12.1 million, or 1.6%, from $743.4 million
      at December 31, 2006, to $755.5 million at June 30, 2007. This increase was
      primarily due to a $20.3 million increase in loans and a $7.0 million increase
      in investment and mortgage-backed securities. This increase was partly offset
      by
      a $13.1 million decrease in cash and cash equivalents.





Loans
      receivable increased by $20.3 million, or 3.9%, to $535.7 million at June 30,
      2007. The growth in loans was primarily comprised of a $23.2 million, or 9.1%,
      increase in commercial real estate loans to $277.5 million. Also during the
      six-month period, commercial business loans increased by $955,000, or 3.0%,
      to
      $32.9 million. These increases in loans were partly offset by a $5.1 million,
      or
      6.2%, decrease in residential mortgage loans to $77.9 million, a $2.0 million,
      or 2.9%, decrease in consumer loans to $68.1 million and a $537,000, or 0.7%,
      decrease in construction loans to $75.7 million. Loan production has steadily
      improved during 2007, totaling $66.9 million during the first quarter and $86.4
      million during the second quarter. As a result of increased production, loans
      outstanding increased by $3.5 million in the first quarter and $17.2 million
      in
      the second quarter. In order to increase loan growth for the remainder of 2007,
      the Company added two experienced commercial lenders in the Union County and
      York County markets (two of the Company’s fastest growing markets) and one
      additional credit officer during the second quarter of 2007. However, a slowdown
      in the local economy could have a negative impact on the Company’s ability to
      increase the current level of loan growth.





Management
      will seek to continue to grow the loan portfolio in a safe and sound manner
      with
      an emphasis on adjustable-rate loans and shorter-term fixed rate loans. As
      of
      June 30, 2007, $267.6 million, or 50.4%, of the Company’s loan portfolio, was
      scheduled to reprice in one month. This sensitivity to rising interest rates
      was
      a driving factor in the Company’s margin expansion during the first half of 2006
      as the prime interest rate steadily increased. However, decreasing interest
      rates could cause margin compression, as these adjustable-rate loans will
      reprice at lower interest rates at a faster pace than the Company’s funding
      costs.





Cash
      and
      cash equivalents decreased by $13.1 million, or 50.0%, from $26.2 million at
      December 31, 2006, to $13.1 million at June 30, 2007. This decrease was
      primarily attributable to a $7.3 million reduction of borrowed money coupled
      with a $7.0 million increase in investment and mortgage-backed securities.
      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
      and
      / or additional borrowings.





During
      the six-month period ended June 30, 2007, mortgage-backed securities (“MBS”)
      increased $4.5 million, or 7.4%, to $65.2 million and investment securities
      increased by $2.5 million, or 3.8%, to $67.8 million. The increase in MBS was
      due to the purchase of $15.2 million of MBS during the period, the effects
      of
      which were partly offset by the sale of $3.4 million in MBS and by $6.8 million
      of normal principal amortization. The increase in investment securities was
      primarily due to the purchase of $9.4 million in investment securities, the
      effects of which were partly offset by $6.1 million of normal maturities during
      the period. Funds used to increase the amount of investment securities and
      MBS
      were generally obtained from existing cash and cash equivalents. 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.





Other
      real estate owned, which consists of six residential dwellings acquired by
      the
      Bank through foreclosure, increased by $310,000 to $449,000 at June 30, 2007.
      All foreclosed properties are written down to their 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.




11




*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
      June 30, 2007, the allowance for loan losses was $6.1 million, or 1.14% 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 Six**
              ********
              ****
              **Months
                  Ended June 30,**
              ****
              **Months
                  Ended June 30**
              ********
              ****
              **2007**
              ****
              **2006**
              ****
              **2007**
              ****
              **2006**(dollars
                  in thousands)
              
              (dollars
                  in thousands)**Allowance
                  for loan losses:**Beginning
                  of period
              
              $
              6,023
              
              $
              5,263
              
              $
              5,764
              
              $
              5,104Add:Provision
                  for loan losses
              
              
              330
              
              
              280
              
              
              660
              
              
              565Recoveries
              
              
              8
              
              
              2
              
              
              20
              
              
              3Less:Charge-offs
              
              
              233
              
              
              131
              
              
              316
              
              
              258End
                  of period
              
              $
              6,128
              
              $
              5,414
              
              $
              6,128
              
              $
              5,414Nonaccrual
                  loans
              
              $
              2,461
              
              $
              1,974
              
              $
              2,461
              
              $
              1,974Real
                  estate owned
              
              
              449
              
              
              679
              
              
              449
              
              
              679Nonperforming
                  assets
              
              $
              2,910
              
              $
              2,653
              
              $
              2,910
              
              $
              2,653Allowance
                  for loan losses as apercentage
                  of total loans
              
              
              1.14
              %
              
              1.06
              %
              
              1.14
              %
              
              1.06
              %Nonperforming
                  loans tototal
                  loans
              
              
              0.46
              %
              
              0.39
              %
              
              0.46
              %
              
              0.39
              %Nonperforming
                  assets tototal
                  assets
              
              
              0.39
              %
              
              0.37
              %
              
              0.39
              %
              
              0.37
              %


****


Premises
      and equipment increased by $74,000, or 0.4%, to $18.4 million at June 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 the end of 2007 in a leased
      facility. This will replace the current loan production office in Rock Hill
      that
      was opened in February 2006. The Company also purchased a lot in Indian Trail,
      North Carolina for future expansion in 2008. 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.




12




*Liabilities* .
      Total
      liabilities increased by $13.9 million, or 2.1%, from $657.4 million at December
      31, 2006 to $671.3 million at June 30, 2007. This increase was primarily due
      to
      a $20.7 million increase in total deposits, which was partly offset by a $7.3
      million reduction in borrowed money.





While
      total deposits increased by $20.7 million, or 3.7%, to $583.5 million at June
      30, 2007, core deposits (which exclude time deposits) increased by $12.5
      million, or 5.6%, to $236.7 million at June 30, 2007. During the six-month
      period ended June 30, 2007, demand deposit accounts (checking accounts)
      increased by $2.0 million, or 2.2%, to $92.6 million and money market deposit
      accounts increased by $11.9 million, or 10.1%, to $129.6 million. The increase
      in these core deposits was primarily due to a continued emphasis on increasing
      the Company’s number of retail and business checking account customers. This
      increase was partially offset by a $1.4 million, or 9.0%, decrease in savings
      accounts to $14.6 million at June 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 six-month period ended June 30, 2007, time
      deposits decreased by $8.2 million, or 2.4%, to $346.8 million. Brokered
      deposits totaled only $5.5 million, or 0.9% of total deposits at June 30, 2007.





Borrowed
      money decreased by $7.3 million, or 8.5%, to $78.7 million at June 30, 2007.
      This decrease was primarily due to normal maturities of Federal Home Loan Bank
      advances. 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 $1.8 million, or 2.0%, from $86.0 million at
      December 31, 2006, to $84.2 million at June 30, 2007. The decrease in
      stockholders’ equity was primarily due to the repurchase of 234,712 shares of
      common stock for $3.0 million, at an average cost of $12.98 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 June 30, 2007, the Company had repurchased a total of 226,723
      shares under the current program at an average price of $12.99 per share and
      had
      173,277 shares remaining to be repurchased. The Company will consider
      repurchasing additional shares of common stock at prices that management
      considers to be attractive and in the best interests of both the Company and
      its
      stockholders. Any repurchased shares will be held as treasury stock and will
      be
      available for general corporate purposes **.** In
      addition, the Company paid cash dividends totaling $1.2 million during the
      period, representing $0.175 per share. Also during the six-month period, the
      unrealized losses on available-for-sale securities increased by $796,000. 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
      $3.0 million in net income during the six-month period ended June 30,
      2007.





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





*General* .
      Net
      income for the three months ended June 30, 2007, amounted to $1.6 million,
      or
      $0.20 per diluted share, as compared to $1.3 million, or $0.17 per diluted
      share, for the three months ended June 30, 2006. This represented an 18.0%
      increase in net income and a 17.6% increase in diluted earnings per share for
      the comparable periods.





*Net
      interest income.* Interest
      income increased by $1.1 million, or 10.5%, to $11.6 million, primarily as
      a
      result of organic loan growth and higher interest rates. Average
      interest-earning assets increased by $33.2 million, or 5.4%, to $647.1 million
      for the three months ended June 30, 2007. The increase in average
      interest-earning assets was primarily the result of a $25.6 million, or 17.6%,
      increase in average outstanding loans to $512.7 million. The Company’s average
      yield on earning assets increased by 41 basis points to 7.26% for the quarter
      ended June 30, 2007. Interest expense increased by $1.2 million, or 23.6%,
      for
      the comparable quarters. This increase in interest expense was largely due
      to
      increased deposits and higher interest rates. The average cost of funds
      increased by 67 basis points to 4.29% for the quarter ended June 30, 2007.
      In
      addition, the Company experienced a $24.5 million, or 4.2%, increase in the
      average balance of interest-bearing liabilities to $608.4 million for the three
      months ended June 30, 2007. Average interest-bearing liabilities increased
      primarily as a result of a $41.4 million, or 8.4%, increase in average
      interest-bearing deposits, the effects of which were partly offset by a $16.9
      million, or 19.1%, decrease in average borrowed money.




13




Net
      interest income decreased by $142,000, or 2.7%, to $5.1 million for the three
      months ended June 30, 2007. In addition, the net interest margin decreased
      by 27
      basis points to 3.14% for the quarter ended June 30, 2007, compared to 3.41%
      for
      the quarter ended June 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.
      On a
      linked-quarter basis, the Company’s net interest margin decreased four basis
      points from 3.18% for the first quarter of 2007 to 3.14% for the second quarter
      of 2007. The net interest margin improved one basis point on a linked-quarter
      basis from the fourth quarter of 2006 to the first quarter of 2007. However,
      margin compression was more severe during the last two quarters of 2006 totaling
      14 basis points and 10 basis points, respectively.





*Provision
      for loan losses.* The
      provision for loan losses amounted to $330,000 for the three months ended June
      30, 2007, compared to $280,000 for the three months ended June 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 $6.1 million, or 1.14% of total loans as of June 30, 2007, compared
      to $5.4 million, or 1.06% of total loans as of June 30, 2006. While the Company
      continues to emphasize commercial real estate loans, the Company’s ratio of
      nonperforming loans to total loans was 0.46% of total loans on June 30, 2007,
      compared to 0.39% of total loans on June 30, 2006. A substantial portion of
      the
      Company’s nonperforming loans at June 30, 2007 was secured by real estate
      located in the Company’s normal lending market.




*Noninterest
      income.* Noninterest
      income increased by $619,000, or 45.2%, to $2.0 million for the three months
      ended June 30, 2007, as compared to $1.4 million for the three months ended
      June
      30, 2006. This increase was largely attributable to the $162,000, or 141.8%,
      increase in mortgage banking income, an $11,000, or 6.3%, increase in cash
      value
      of bank-owned life insurance, a $42,000 increase in the fair value adjustment
      on
      deferred compensation assets, and a $31,000, or 18.9%, increase in other
      noninterest income. During the past 12 months the Company significantly
      increased its number of commission-based mortgage loan originators located
      throughout the Company’s normal lending area, resulting in a significant
      increase in mortgage-banking revenues. Continued expansion of the mortgage
      banking area is expected in 2007. 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 $11,000, or 6.3%, during the comparable periods. The $42,000
      increase 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. Other noninterest income increased by $31,000,
      in
      part, due to increased commissions on the sale of financial products, higher
      merchant fee income, and increased early withdrawal fees on time deposits.





During
      the second quarter of 2007, the Company recognized a $332,000 net gain on the
      sale of assets and $112,000 of income generated from net 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 ales resulted in a
      net
      gain of $419,000. Offsetting a portion of these gains were losses of $80,000
      from the sale of $3.3 million in mortgage-backed securities and $8,000 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.





These
      increases in noninterest income were partly offset by a $43,000, or 5.9%,
      reduction in fee income on deposit accounts, an $8,000, or 5.8%, decrease in
      fee
      income on lending activities, and an $11,000, or 18.4% decrease in dividends
      on
      FHLB stock. 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 slightly
      during the second quarter of 2007, as compared to the second quarter of 2006,
      due in part to a reduction of commercial construction loan originations which
      generally generate larger loan fees. Management expects that fee income from
      lending activities will increase during 2007, due in part to the additional
      commercial lenders that were hired during the second quarter of 2007. The
      decrease in dividends on FHLB stock was due to having fewer shares of FHLB
      stock. The Company’s shares of FHLB stock was partly based on the outstanding
      amount of FHLB borrowings, which has decreased during the past 12
      months.





14




*Noninterest
      expense.* Noninterest
      expense increased by $336,000, or 7.8%, to $4.6 million for the quarter ended
      June 30, 2007, compared to $4.3 million for the quarter ended June 30, 2006.
      The
      primary reason was a $162,000, or 7.4% increase in compensation and benefits,
      a
      $42,000 increase in the fair value adjustment on deferred compensation and
      a
      $19,000, or 13.6%, increase in professional services. Management hired two
      experienced commercial lenders and one experienced credit officer during the
      second quarter of 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 also has plans to add a full-service office in Rock Hill,
      South Carolina, and possibly a new loan production office by the end of 2007,
      resulting in increased compensation and office occupancy and equipment expense
      by the end of 2007. The $42,000 increase in the fair value adjustment on
      deferred compensation during the comparable quarters was directly offset by
      a
      corresponding increase to noninterest income, resulting in no net impact to
      the
      Company. The $19,000 increase in professional services was primarily associated
      with services provided to assist management with the compliance of the new
      disclosures requirements for the 2006 proxy statement.





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. Management will continue to
      evaluate the value of the Company’s remaining investment and make any necessary
      adjustments as conditions dictate. There were no other unrealized losses that
      were considered “other-than-temporary” at June 30, 2007.





These
      increases in noninterest expense were partly offset by a $24,000, or 12.9%,
      decrease in the amortization of intangible assets and a $30,000, or 2.7%,
      decrease in other noninterest expense. The amortization of intangible assets
      is
      expected to continue to decrease as the amount of the core deposit intangible
      decreases. Other noninterest expense decreased by $30,000 to $1.1 million during
      the second quarter of 2007. This decrease was 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
      charge-offs related to overdrafts continues to decrease.




*Income
      taxes.* Income
      taxes amounted to $524,000, or 24.8% of taxable income, for the quarter ended
      June 30, 2007, as compared to $675,000, or 33.4% of taxable income, for the
      quarter ended June 30, 2006. The decrease in income tax expense during the
      second quarter of 2007 was primarily due to a $212,000 increase in nontaxable
      income generated from municipal securities 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. These tax-advantaged sources
      primarily include bank-qualified municipal securities and bank-owned life
      insurance contracts. As the Company continues to increase the amount of income
      derived from interest income on loans and fee income on loans and deposits,
      the
      effective tax rate is expected to increase.





**Comparison
      of Results of Operations for the Six Months Ended June 30, 2007 and
      2006**





*General* .
      Net
      income for the six months ended June 30, 2007 amounted to $3.0 million, or
      $0.38
      per diluted share, as compared to $2.5 million, or $0.31 per diluted share,
      for
      the six months ended June 30, 2006. This represented an 18.0% increase in net
      income and a 22.6% increase in diluted earnings per share for the comparable
      periods.





*Net
      interest income.* Interest
      income increased by $2.6 million, or 12.8%, to $23.0 million, primarily as
      a
      result of organic loan growth and higher interest rates. Average
      interest-earning assets increased by $35.7 million, or 5.8%, to $646.2 million
      for the six months ended June 30, 2007. The increase in average interest-earning
      assets was primarily the result of a $32.2 million, or 6.7%, increase in average
      outstanding loans to $512.2 million. The Company’s average yield on earning
      assets increased by 51 basis points to 7.23% for the six months ended June
      30,
      2007. Interest expense increased by $2.8 million, or 27.9%, for the comparable
      periods. This increase in interest expense was largely due to increased deposits
      and higher interest rates. The average cost of funds increased by 78 basis
      points to 4.27% for the six months ended June 30, 2007. In addition, the Company
      experienced a $26.3 million, or 4.5%, increase in the average balance of
      interest-bearing liabilities to $605.9 million for the six months ended June
      30,
      2007. Average interest-bearing liabilities increased primarily as a result
      of a
      $40.8 million, or 8.3%, increase in average interest-bearing deposits, the
      effects of which were partly offset by a $14.5 million, or 16.2%, decrease
      in
      borrowed money.




15




Net
      interest income decreased by $194,000, or 1.9%, to $10.1 million for the six
      months ended June 30, 2007. In addition, the net interest margin decreased
      by 25
      basis points to 3.16% for the six months ended June 30, 2007, compared to 3.41%
      for the six months ended June 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.





*Provision
      for loan losses.* The
      provision for loan losses amounted to $660,000 for the six months ended June
      30,
      2007, compared to $565,000 for the six months ended June 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 $6.1 million, or 1.14% of total loans, as of June 30, 2007, compared to
      $5.4
      million, or 1.06% of total loans, as of June 30, 2006. While the Company
      continues to emphasize commercial loans and consumer loans that are generally
      secured by real estate, the Company’s ratio of nonperforming loans to total
      loans was 0.46% of total loans on June 30, 2007, compared to 0.39% of total
      loans on June 30, 2006. A substantial portion of the Company’s nonperforming
      loans at June 30, 2007 was secured by real estate.




*Noninterest
      income.* Noninterest
      income increased by $734,000, or 26.4%, to $3.5 million for the six months
      ended
      June 30, 2007, as compared to $2.8 million for the six months ended June 30,
      2006. This increase was largely attributable to the $317,000, or 164.4%,
      increase in mortgage banking income, a $15,000 increase in the fair value
      adjustment on deferred compensation assets, and an $86,000, or 25.1%, increase
      in other noninterest income. During the past 12 months the Company increased
      its
      number of commission-based mortgage loan originators located throughout the
      Company’s normal lending area, resulting in a significant increase in
      mortgage-banking revenues. Continued expansion of the mortgage banking area
      is
      expected in 2007. The $15,000 increase 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 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 half 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. Offsetting a portion of these gains were net losses of $80,000
      from the sale of $3.3 million in mortgage-backed securities and $3,000 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.





These
      increases in noninterest income were partly offset by a $67,000, or 4.8%,
      reduction in fee income on deposit accounts, a $70,000, or 22.3%, decrease
      in
      fee income on lending activities, a $15,000, or 13.0% decrease in dividends
      on
      FHLB stock, and a $27,000, or 6.6%, decrease in cash value on bank-owned life
      insurance contracts. 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 second half of 2007, as compared to the second half of 2006, due in part
      to
      a reduction of commercial construction loan originations which generally
      generate larger loan fees. Management expects that fee income from lending
      activities will increase during 2007, due in part to the additional commercial
      lenders that were hired during the second quarter of 2007. The $15,000 decrease
      in dividends on FHLB stock is due to having fewer shares of FHLB stock. The
      Company’s shares of FHLB stock was partly based on the outstanding amount of
      FHLB borrowing, which has decreased during the past 12 months. The cash value
      on
      bank-owned insurance contracts decreased slightly due to an adjustment made
      in
      2006 to increase the cash value to the appropriate balance.




16




*Noninterest
      expense.* Noninterest
      expense increased by $75,000, or 0.9%, to $8.9 million for the six months ended
      June 30, 2007, compared to $8.8 million for the six months ended June 30, 2006.
      The primary reason was a $126,000, or 2.8% increase in compensation and benefits
      and a $15,000 increase in the fair value adjustment on deferred compensation
      obligations. Management hired two experienced commercial lenders and one
      experienced credit officer during the second quarter of 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 also has plans
      to
      add a full-service office in Rock Hill, South Carolina, and possibly a new
      loan
      production office by the end of 2007, resulting in increased compensation and
      office occupancy and equipment expense by the end of 2007. The $15,000 increase
      in the fair value adjustment on deferred compensation obligations is directly
      offset by a corresponding increase in noninterest income, resulting in no net
      impact to the Company.





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. Management will continue to
      evaluate the value of the Company’s remaining investment and make any necessary
      adjustments as conditions dictate. There were no other unrealized losses that
      were considered “other-than-temporary” at June 30, 2007.





These
      increases in noninterest expense were partly offset by a $45,000, or 12.1%,
      decrease in the amortization of intangible assets, a $39,000, or 2.8%, decrease
      in office occupancy expense, a $28,000, or 9.1%, decrease in professional
      services, and a $59,000, or 2.8%, 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. Occupancy and
      equipment expense decreased by $39,000 primarily due to normal depreciation
      of
      premises and equipment. 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. Other noninterest expense decreased
      by $59,000, or 2.8%, to $2.0 million during the first half of 2007. This
      decrease was 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 $1.1 million, or 26.6% of taxable income, for the six months
      ended June 30, 2007, as compared to $1.2 million, or 31.6% of taxable income,
      for the six months ended June 30, 2006. The decrease in income tax expense
      during the second half of 2007 was primarily due to a $377,000 increase in
      nontaxable income generated from municipal securities 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. These
      tax-advantaged sources primarily include bank-qualified municipal securities
      and
      bank-owned life insurance contracts. As the Company continues to increase the
      amount of income derived from interest income on loans and fee income on loans
      and deposits, the effective tax rate is expected to increase.





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





The
      objectives of the Company’s liquidity management policy include providing
      adequate funds to meet the cash needs of both borrowers and depositors, to
      provide for the on-going operations of the Company, and to capitalize on
      opportunities for expansion. Liquidity management addresses the Company’s
      ability to meet deposit withdrawals on demand or at contractual maturity, to
      repay borrowings as they mature, and to fund new loans and investments as
      opportunities arise. The primary sources of internally generated funds are
      principal and interest payments on loans receivable, increases in local
      deposits, cash flows generated from operations, and cash flows generated by
      investments. If the Company requires funds beyond its internal funding
      capabilities, it may rely upon external sources of funds such as brokered
      deposits, repurchase agreements, and advances. The Company has $109.3 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 $17.0 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 June 30, 2007,
      the
      Company had outstanding brokered deposits of $5.5 million, or 0.9% 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.





17




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 June 30,
      2007,
      the Company had loan commitments of $29.6 million, unused lines of credit of
      $108.6 million, and undisbursed construction loan proceeds of $4.4 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 June 30, 2007, the Bank’s capital exceeded
      all applicable regulatory requirements. The Bank's Tier I capital was $65.4
      million, or 9.0% of adjusted total assets. The minimum Tier I capital ratio
      is
      4.00%. Failure to meet minimum capital requirements can initiate certain
      mandatory and possibly discretionary actions by the regulators that, if
      undertaken, could have a direct material effect on the Bank’s financial
      statements. Under capital adequacy guidelines and the regulatory framework
      for
      prompt corrective action, the Bank must meet specific capital guidelines that
      involve quantitative measures of the Bank’s assets, liabilities, and certain
      off-balance-sheet items as calculated under regulatory accounting practices.
      The
      Bank’s capital amounts and classifications are subject to qualitative judgments
      by the regulators about components, risk-weightings, and other factors.




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





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





18





**ITEM
      4. Controls and Procedures**





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





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





**PART
      II. OTHER INFORMATION**





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





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





**Item
      1A. Risk Factors**





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





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





During
      the three-month period ended June 30, 2007, the Company repurchased 120,000
      shares of common stock for $1.5 million, at an average cost of $12.88 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**April
              
              
              39,000
              
              $
              12.88
              
              
              165,723
              
              
              254,277May
              
              
              59,000
              
              $
              12.91
              
              
              204,723
              
              
              195,277June
              
              
              22,000
              
              $
              12.80
              
              
              226,723
              
              
              173,277**Total**
              
              
              **120,000**
              
              **$**
              **12.88**
              
              
              **226,723**
              
              
              **173,277**





On
      January 22, 2007, the Board of Directors of the Company authorized the
      repurchase of up to 400,000 shares, or approximately 5%, of the Company’s
      then-outstanding shares of common stock. These repurchases may be carried out
      through open market purchases, block trades, and negotiated private
      transactions. The stock may be repurchased on an ongoing basis and will be
      subject to the availability of stock, general market conditions, the trading
      price of the stock, alternative uses for capital, and the Company’s financial
      performance. As of June 30, 2007, the Company had repurchased a total of 226,723
      shares at an average price of $12.99 per share and had 173,277 shares remaining
      to be repurchased under this plan. Management will consider repurchasing
      additional shares of common stock of the Company at prices management considers
      to be attractive and in the best interests of both the Company and its
      stockholders. Any repurchased shares will be held as treasury stock and will
      be
      available for general corporate purposes **.**





19




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





Not
      applicable.




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





The
      following proposals were considered and acted upon at the Annual Meeting of
      Stockholders of the Company held on May 14, 2007:




Proposal
      1: To
      consider the election of two Directors to the Board of Directors.


Kim
                    S. Price
                For
                6,404,584
                Withheld
                171,014Eugene
                    R. Matthews II
                For
                6,393,045
                Withheld
                182,553





Proposal
      2: To
      consider the ratification of the appointment of Cherry, Bekaert & Holland,
      L.L.P. as independent registered public accountants for the Company for the
      fiscal year ending December 31, 2007.




For
              6,426,223
              Against
              142,882
              Abstain
              6,493


**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.





20




**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:
              August 8, 2007
            By:
            /s/
              Kim
              S. PriceKim
                S. PricePresident
                and Chief Executive Officer Date: August 8, 2007
            By:
            /s/
              Gary
              F. HoskinsGary
                F. HoskinsExecutive
                Vice President, Chief Financial Officer and
                Treasurer




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