**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,
                2008**





**OR**





o
            **Transitional
                report pursuant to Section 13 or 15 (d) of the Securities Exchange
                Act of
                1934**
              **For
                the transition period from ______
                to _____**




**Commission
      File Number 0-23971**




**Citizens
      South Banking Corporation**


(Exact
      name of registrant as specified in its charter)





**Delaware**
            
            **54-2069979**(State
                or other jurisdiction of
            
            (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, a non-accelerated filer, or a smaller reporting company.
      See
      definitions of “accelerated filer”, “large accelerated filer” and “small
      reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filer  o  **Accelerated
      filer**  þ N on-accelerated
      filer  o  **Smaller Reporting Company** **** **þ**




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**


**7,516,816
      shares outstanding as of August 11, 2008**









**Citizens
      South Banking Corporation**


**Index**




Page**PART
                I. — Financial Information**Item
                1.   Condensed Consolidated Financial
                Statements:Condensed
                Consolidated Statements of Financial Condition June 30, 2008 and
                December
                31, 2007
            1Condensed
                Consolidated Statements of Operations for the three and six months
                ended
                June 30, 2008 and 2007
            2Condensed
                Consolidated Statements of Comprehensive Income for the six months
                ended
                June 30, 2008 and 2007
            3Condensed
                Consolidated Statements of Changes in Stockholders’ Equity for the six
                months ended June 30, 2008 and 2007
            4Condensed
                Consolidated Statements of Cash Flows for the six months ended June
                30,
                2008 and 2007
            5Notes
                to Condensed Consolidated Financial Statements
            6Item
                2.  Management's Discussion and Analysis of Financial Condition
                and Results of Operations
            9Item
                3. Quantitative and Qualitative Disclosures About Market
                Risk
            20Item
                4. Controls and Procedures
            20**PART
                II — Other Information**
            20Item
                1. Legal Proceedings
            20Item
                1A. Risk Factors
            20Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            21Item
                3. Defaults Upon Senior Securities
            21Item
                4. Submission of Matters to a Vote of Security Holders
            22Item
                5. Other Information
            22Item
                6. Exhibits
            22Signatures
            23









**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,**
            
            **December
                31,****2008**
            
            **2007****(unaudited)****Assets:**Cash
                and cash equivalents:Cash
                and due from banks
            
            $
            14,131
            
            $
            14,285Interest-earning
                bank balances
            
            
            1,683
            
            
            15,454Total
                cash and cash equivalents
            
            
            15,814
            
            
            29,739Investment
                securities available-for-sale, at fair value
            
            
            34,587
            
            
            46,519Mortgage-backed
                and related securities available-for-sale, at fair value
            
            
            83,026
            
            
            69,893Loans:Loans
                receivable, net of unearned income
            
            
            604,855
            
            
            559,956Allowance
                for loan losses
            
            
            (6,757
            )
            
            (6,144
            )Net
                loans
            
            
            598,098
            
            
            553,812Other
                real estate owned
            
            
            635
            
            
            529Premises
                and equipment, net
            
            
            17,604
            
            
            17,965Accrued
                interest receivable
            
            
            2,739
            
            
            3,254Federal
                Home Loan Bank stock
            
            
            5,338
            
            
            4,236Intangible
                assets
            
            
            30,761
            
            
            31,037Cash
                value of bank-owned life insurance policies
            
            
            16,456
            
            
            16,099Other
                assets
            
            
            6,767
            
            
            6,057Total
                assets
            
            $
            811,825
            
            $
            779,140**Liabilities
                and Stockholders’ Equity:**Deposits:Demand
                deposit accounts
            
            $
            114,289
            
            $
            101,981Money
                market deposit accounts
            
            
            116,059
            
            
            129,688Savings
                accounts
            
            
            11,660
            
            
            12,037Time
                deposits
            
            
            342,793
            
            
            347,059Total
                deposits
            
            
            584,801
            
            
            590,765Borrowed
                money
            
            
            137,278
            
            
            96,284Deferred
                compensation
            
            
            5,006
            
            
            5,389Other
                liabilities
            
            
            2,245
            
            
            2,669Total
                liabilities
            
            
            729,330
            
            
            695,107Stockholders’
                Equity:Preferred
                stock, 10,000,000 shares authorized, none issued
            
            
            -
            
            
            -Common
                stock, $0.01 par value, 20,000,000 shares authorized;Issued:
                9,062,727 shares;Outstanding:
                  7,524,016 shares at June 30, 2008 and 7,610,017 shares at December
                  31,
                  2007
            
            
            91
            
            
            91Additional
                paid-in-capital
            
            
            67,887
            
            
            67,718Unallocated
                common stock held by Employee Stock Ownership Plan
            
            
            (1,156
            )
            
            (1,247
            )Retained
                earnings
            
            
            36,494
            
            
            36,028Accumulated
                other comprehensive loss, net of deferred income taxes
            
            
            (1,837
            )
            
            (343
            )Treasury
                stock of 1,538,711 shares at June 30, 2008, and 1,452,710 shares
                at
                December 31, 2007, at cost
            
            
            (18,984
            )
            
            (18,214
            )Total
                stockholders’ equity
            
            
            82,495
            
            
            84,033Total
                liabilities and stockholders’ equity
            
            $
            811,825
            
            $
            779,140




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




1




**Citizens
      South Banking Corporation**


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


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




**Three
                Months**
            
            **Six
                Months****Ended
                June 30,**
            
            **Ended
                June 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007****Interest
                Income:**Loans
            
            $
            9,143
            
            $
            10,061
            
            $
            18,745
            
            $
            19,954Investment
                securities
            
            
            356
            
            
            691
            
            
            769
            
            
            1,359Interest-bearing
                deposits
            
            
            42
            
            
            137
            
            
            136
            
            
            270Mortgage-backed
                and related securities
            
            
            942
            
            
            696
            
            
            1,805
            
            
            1,367Total
                interest income
            
            
            10,483
            
            
            11,585
            
            
            21,455
            
            
            22,950**Interest
                Expense:**Deposits
            
            
            4,334
            
            
            5,591
            
            
            9,400
            
            
            10,931Borrowed
                funds
            
            
            1,237
            
            
            922
            
            
            2,356
            
            
            1,900Total
                interest expense
            
            
            5,571
            
            
            6,513
            
            
            11,756
            
            
            12,831Net
                interest income
            
            
            4,912
            
            
            5,072
            
            
            9,699
            
            
            10,119Provision
                for loan losses
            
            
            750
            
            
            330
            
            
            1,095
            
            
            660Net
                interest income after provision for loan losses
            
            
            4,162
            
            
            4,742
            
            
            8,604
            
            
            9,459**Noninterest
                Income:**Fee
                income on deposit accounts
            
            
            776
            
            
            693
            
            
            1,454
            
            
            1,347Mortgage
                banking income
            
            
            278
            
            
            277
            
            
            481
            
            
            510Income
                on lending activities
            
            
            102
            
            
            133
            
            
            213
            
            
            242Dividends
                on FHLB stock
            
            
            65
            
            
            46
            
            
            128
            
            
            96Increase
                in cash value of bank-owned life insurance
            
            
            188
            
            
            178
            
            
            376
            
            
            387Fair
                value adjustment on deferred compensation assets
            
            
            (39
            )
            
            21
            
            
            (53
            )
            
            58Life
                insurance proceeds, net
            
            
            -
            
            
            112
            
            
            -
            
            
            112Net
                gain on sale of assets
            
            
            19
            
            
            332
            
            
            261
            
            
            336Other
                noninterest income
            
            
            203
            
            
            196
            
            
            413
            
            
            429Total
                noninterest income
            
            
            1,592
            
            
            1,988
            
            
            3,273
            
            
            3,517**Noninterest
                Expense:**Compensation
                and benefits
            
            
            2,545
            
            
            2,363
            
            
            5,100
            
            
            4,706Fair
                value adjustment on deferred comp. obligations
            
            
            (39
            )
            
            21
            
            
            (53
            )
            
            58Occupancy
                and equipment expense
            
            
            676
            
            
            672
            
            
            1,351
            
            
            1,340Professional
                services
            
            
            237
            
            
            153
            
            
            438
            
            
            276Amortization
                of intangible assets
            
            
            135
            
            
            162
            
            
            276
            
            
            327Reorganization
                expenses
            
            
            -
            
            
            -
            
            
            220
            
            
            -Impairment
                of securities
            
            
            -
            
            
            162
            
            
            -
            
            
            162Other
                noninterest expense
            
            
            1,148
            
            
            1,084
            
            
            2,253
            
            
            2,033Total
                noninterest expense
            
            
            4,702
            
            
            4,617
            
            
            9,585
            
            
            8,902Income
                before income taxes
            
            
            1,052
            
            
            2,113
            
            
            2,292
            
            
            4,074Provision
                for income taxes
            
            
            190
            
            
            524
            
            
            460
            
            
            1,085**Net
                income**
            
            **$**
            **862**
            
            **$**
            **1,589**
            
            **$**
            **1,832**
            
            **$**
            **2,989****Net
                income per common share:****Basic**
            
            **$**
            **0.12**
            
            **$**
            **0.21**
            
            **$**
            **0.25**
            
            **$**
            **0.38****Diluted**
            
            **$**
            **0.12**
            
            **$**
            **0.20**
            
            **$**
            **0.25**
            
            **$**
            **0.38****Weighted
                average common shares outstanding:****Basic**
            
            
            **7,369,964**
            
            
            **7,750,385**
            
            
            **7,391,338**
            
            
            **7,810,089****Diluted**
            
            
            **7,434,006**
            
            
            **7,816,793**
            
            
            **7,443,803**
            
            
            **7,881,287**





***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,****2008**
            
            **2007**Net
                income
            
            $
            1,832
            
            $
            2,989**Items
                of other comprehensive income:**Items
                of other comprehensive income, before taxUnrealized
                holding losses arising during period
            
            
            2,713
            
            
            1,216Reclassification
                adjustment for securities (gains) losses included in net
                income
            
            
            (283
            )
            
            80Other
                comprehensive income, before tax
            
            
            2,430
            
            
            1,296Change
                in deferred income taxes related to changes in unrealized gains or
                losseson
                securities available for sale
            
            
            (936
            )
            
            (500
            )Items
                of other comprehensive income, net of tax
            
            
            1,494
            
            
            796Comprehensive
                income
            
            **$**
            **3,326**
            
            **$**
            **3,785**




***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,****2008**
            
            **2007****Common
                stock, $0.01 par value:**At
                beginning of period
            
            $
            91
            
            $
            91Issuance
                of common stock
            
            
            -
            
            
            -At
                end of period
            
            
            91
            
            
            91**Additional
                paid-in-capital:**At
                beginning of period
            
            
            67,718
            
            
            68,578Vesting
                of shares for RRP
            
            
            154
            
            
            150Stock-based
                compensation expense
            
            
            15
            
            
            14At
                end of period
            
            
            67,887
            
            
            68,742**Unallocated
                common stock held by ESOP:**At
                beginning of period
            
            
            (1,247
            )
            
            (1,430
            )Allocation
                from shares purchased with loan from ESOP
            
            
            91
            
            
            91At
                end of period
            
            
            (1,156
            )
            
            (1,339
            )**Retained
                earnings, substantially restricted:**At
                beginning of period
            
            
            36,028
            
            
            31,892Net
                income
            
            
            1,832
            
            
            2,989Grant
                of additional shares from Recognition and Retention Plan
                (“RRP”)
            
            
            -
            
            
            (128
            )Exercise
                of options
            
            
            (126
            )
            
            (199
            )Dividends
                paid
            
            
            (1,240
            )
            
            (1,235
            )At
                end of period
            
            
            36,494
            
            
            33,319**Accumulated
                unrealized loss on securities available for sale, net of
                tax:**At
                beginning of period
            
            
            (343
            )
            
            (991
            )Other
                comprehensive income, net of tax
            
            
            (1,494
            )
            
            (796
            )At
                end of period
            
            
            (1,837
            )
            
            (1,787
            )**Treasury
                stock:**At
                beginning of period
            
            
            (18,214
            )
            
            (12,179
            )Exercise
                of options
            
            
            181
            
            
            283Grant
                of additional shares from RRP
            
            
            -
            
            
            128Purchase
                of common stock for treasury
            
            
            (951
            )
            
            (3,047
            )At
                end of period
            
            
            (18,984
            )
            
            (14,815
            )





***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,****2008**
            
            **2007****Cash
                flows from operating activities:**Net
                income
            
            $
            1,832
            
            $
            2,989Adjustments
                to reconcile net income to net cash provided by operating
                activities:Provision
                for loan losses
            
            
            1,095
            
            
            660Depreciation
            
            
            554
            
            
            604Impairment
                on investment securities
            
            
            -
            
            
            162Net
                gain on sale of investment securities
            
            
            (124
            )
            
            -Net
                (gain) loss on sale of mortgage-backed securities
            
            
            (159
            )
            
            80Net
                gain on sale of loans
            
            
            -
            
            
            (5
            )Net
                loss on sale of other real estate owned
            
            
            22
            
            
            8Net
                gain on sale of premises and equipment
            
            
            -
            
            
            (419
            )Deferred
                loan origination fees (costs)
            
            
            44
            
            
            (19
            )Allocation
                of shares to the ESOP
            
            
            91
            
            
            91Stock-based
                compensation expense
            
            
            15
            
            
            14Vesting
                of shares for the Recognition and Retention Plan
            
            
            154
            
            
            150Increase
                (decrease) in accrued interest receivable
            
            
            516
            
            
            (111
            )Amortization
                of intangible assets
            
            
            276
            
            
            327(Increase)
                decrease in other assets
            
            
            (441
            )
            
            1,534Increase
                (decrease) in other liabilities
            
            
            (1,085
            )
            
            79Net
                cash provided by operating activities
            
            
            2,790
            
            
            6,144**Cash
                flows from investing activities:**Net
                increase in loans
            
            
            (45,425
            )
            
            (20,772
            )Proceeds
                from the sale of investment securities
            
            
            13,402
            
            
            -Proceeds
                from the sale of mortgage-backed securities
            
            
            12,485
            
            
            3,364Proceeds
                from the sale of loans
            
            
            -
            
            
            202Proceeds
                from sale of other real estate owned
            
            
            183
            
            
            182Proceeds
                from sale of premises and equipment
            
            
            -
            
            
            801Maturities
                and prepayments of investment securities
            
            
            1,549
            
            
            5,970Maturities
                and prepayments of mortgage-backed securities
            
            
            7,845
            
            
            6,783Purchases
                of investments
            
            
            (3,659
            )
            
            (9,435
            )Purchases
                of mortgage-backed securities
            
            
            (34,970
            )
            
            (15,204
            )(Purchases)
                sale of FHLB stock
            
            
            (1,102
            )
            
            358Capital
                expenditures for premises and equipment
            
            
            (194
            )
            
            (1,059
            )Net
                cash used in investment activities
            
            
            (49,886
            )
            
            (28,810
            )**Cash
                flows from financing activities:**Net
                increase (decrease) in deposits
            
            
            (5,964
            )
            
            20,743Exercise
                of options
            
            
            55
            
            
            84Dividends
                paid
            
            
            (1,240
            )
            
            (1,235
            )Purchase
                of common stock for treasury
            
            
            (951
            )
            
            (3,047
            )Net
                increase (decrease) in borrowed money
            
            
            40,994
            
            
            (7,265
            )Increase
                in advances from borrowers for insurance and taxes
            
            
            277
            
            
            309Net
                cash provided by financing activities
            
            
            33,171
            
            
            9,589Net
                decrease in cash and cash equivalents
            
            
            (13,925
            )
            
            (13,077
            )Cash
                and cash equivalents at beginning of period
            
            
            29,739
            
            
            26,221Cash
                and cash equivalents at end of period
            
            $
            15,814
            
            $
            13,144




***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, 2008 and 2007. Amounts as of
      December 31, 2007, included in the condensed consolidated financial statements
      and related notes were derived from the audited consolidated financial
      statements. Results for the three- and six-month periods ended June 30, 2008,
      are not necessarily indicative of the results that may be expected for future
      periods, including the year ending December 31, 2008.





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





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





**Note
      2** **–
      Earnings per Share**





Basic
      earnings per share is calculated by dividing net income by the weighted average
      number of common shares outstanding. Diluted earnings per share is calculated
      by
      dividing net income by the sum of the weighted average number of common shares
      outstanding and potential common stock. Potential common stock consists of
      additional common stock that would have been outstanding as a result of the
      exercise of dilutive stock options. In determining the number of shares of
      potential common stock, the treasury stock method was applied. This method
      assumes that the number of shares issuable upon exercise of the stock options
      is
      reduced by the number of common shares assumed purchased at market prices with
      the proceeds from the assumed exercise of the common stock options plus any
      tax
      benefits received as a result of the assumed exercise. The following is a
      summary of the diluted earnings per share calculation for the six months ended
      June 30, 2008 and 2007:





**Three Months**
              **Ended June 30,**
            ****
            **Six Months******
              **Ended June 30,**
            ********
            ****
            **2008**
            ****
            **2007**
            ****
            **2008**
            ****
            **2007****(dollars
                in thousands, except per share amounts)**Net
                income
            
            $
            862
            
            $
            1,589
            
            $
            1,832
            
            $
            2,989Weighted
                average shares outstanding
            
            
            7,369,964
            
            
            7,750,385
            
            
            7,391,338
            
            
            7,810,089Dilutive
                effect of stock options
            
            
            64,042
            
            
            66,408
            
            
            52,465
            
            
            71,198Weighted
                average diluted shares outstanding
            
            
            7,434,006
            
            
            7,816,793
            
            
            7,443,803
            
            
            7,881,287Diluted
                earnings per share
            
            $
            0.12
            
            $
            0.20
            
            $
            0.25
            
            $
            0.38





For
      the
      periods ended June 30, 2008 and 2007, there were 662,290 and 557,751 shares,
      respectively, attributed to stock options that were excluded from the
      calculation of diluted earnings per share because their inclusion would have
      been anti-dilutive because the average market price of the stock was below
      the
      strike price on these options.




6


**Note
      3 – Commitments to Extend Credit**





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





June 30, 2008
            
            December 31, 2007Loan
                commitments:Residential
                mortgage loans
            
            $
            9,885,167
            
            $
            7,160,455Non-residential
                mortgage loans
            
            
            8,882,921
            
            
            20,987,431Commercial
                loans
            
            
            1,882,150
            
            
            6,559,700Consumer
                loans
            
            
            5,648,300
            
            
            6,840,137Total
                loan commitments
            
            $
            26,298,538
            
            $
            41,547,723Unused
                lines of credit:Commercial
            
            $
            37,015,143
            
            $
            38,120,483Consumer
            
            
            76,521,882
            
            
            71,831,349Total
                unused lines of credit
            
            $
            113,537,025
            
            $
            109,951,832





**Note
      4** **–
      Dividend Declaration**





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





**Note
      5** **–
      Stock Repurchase Program**





On
      October 22, 2007, the Board of Directors of the Company authorized the
      repurchase of up to 200,000 shares, or approximately 2.5% of the Company’s then
      outstanding shares of common stock. In June 2008, the Company completed the
      repurchase plan with the purchase of 200,000 shares of common stock at an
      average price of $10.77. As a result, an additional repurchase plan was
      authorized on June 16, 2008, by the Board of Directors of the Company. The
      new
      plan also authorized the repurchase of 200,000 shares, or approximately 2.7%
      of
      the Company’s then outstanding shares of common stock. These repurchases may be
      carried out through open market purchases, block trades, and negotiated private
      transactions. The stock may be repurchased on an ongoing basis and will be
      subject to the availability of stock, general market conditions, the trading
      price of the stock, alternative uses for capital, and the Company’s financial
      performance. Under this plan the Company had repurchased a total of 2,276 shares
      at an average price of $7.85 per share and had 197,724 shares remaining to
      be
      repurchased at June 30, 2008. The Company will consider repurchasing additional
      shares of common stock of the Company at prices management considers to be
      attractive and in the best interests of both the Company and its stockholders.
      Any repurchased shares will be held as treasury stock and will be available
      for
      general corporate purposes **.**





**Note
      6 - Recent Accounting Pronouncements**





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





On
      June
      16, 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
      Position (“FSP”) EITF 03-6-1, *“Determining
      Whether Instruments Granted in Share-Based Payment Transactions Are
      Participating Securities.”* This
      FSP
      addresses whether instruments granted in share-based payment transactions are
      participating securities prior to vesting and, therefore, need to be included
      in
      the earnings allocation in computing earnings per share under the two-class
      method described in paragraphs 60 and 61 of FASB Statement No. 128,
“ *Earnings
      per Share.”* EITF
      03-6-1 will be effective for the Company on January 1, 2009. The Company is
      currently evaluating the impact, if any, the adoption of EITF 03-6-1 will have
      on its consolidated financial statements.




7





Effective
      January 1, 2008, the Company adopted Statement of Financial Accounting Standards
      (“SFAS”) No. 157, “ *Fair
      Value Measurements* ”
(“SFAS
      No. 157”), which provides a framework for measuring fair value under GAAP
      and enhances disclosures about fair value measurements. This Statement defines
      fair value as the exchange price that would be received for an asset or paid
      to
      transfer a liability in
      the
      most advantageous market for the asset or liability in an orderly transaction
      between market participants on the measurement date. The Company utilizes fair
      value measurements to record fair value adjustments to certain assets and to
      determine fair value disclosures. The Company has not elected the fair value
      option for liabilities. Available-for-sale securities are recorded at fair
      value
      on a recurring basis. Additionally, the Company may be required to record at
      fair value other assets on a nonrecurring basis. These nonrecurring fair value
      adjustments typically involve the application of lower of cost or market
      accounting of these other assets. At June 30, 2008, the Company did not have
      any
      loans held for sale.





In
      accordance with SFAS No. 157, when measuring fair value, the Company uses
      valuation techniques that are appropriate and consistently applied. A hierarchy
      is used to prioritize valuation inputs into the following three levels to
      determine fair value:




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


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


Level
      3:  Unobservable
      inputs.





Following
      is a description of valuation methodologies used for assets recorded at fair
      value.





Investment
      Securities Available for Sale





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





The
      fair
      value measurement as of June 30, 2008, for investment securities
      available-for-sale are summarized below:




Fair
                Value Measurement UsingLevel
                1
            
            Level
                2
            
            Level
                3
            
            Total(in
                thousands)Securities
                available for sale
            
            $
            -
            
            $
            115,522
            
            $
            873
            
            $
            116,395




8




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




**Forward
      Looking Statements**





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




9


**Overview**





Management’s
      Discussion and Analysis is provided to assist in understanding and evaluating
      the Company’s results of operations and financial condition. The following
      discussion is designed to provide a general overview of the Company’s
      performance for the three- and six-month periods ended June 30, 2008 and 2007.
      Readers seeking a more in-depth analysis should read the detailed discussions
      below, as well as the condensed consolidated financial statements and related
      notes. Financial highlights are presented in the table below.


Three months
                ended
                June 30, 2008
              
              Three months
                ended
                June 30, 2007
              
              % Change
              
              Six months
                ended
                June 30, 2008
              
              Six months
                ended
                June 30, 2007
              
              % Change**Earnings:**Net
                  interest income
              
              $
              4,912
              
              $
              5,072
              
              
              (3.15)
              %
              $
              9,699
              
              $
              10,119
              
              
              (4.15)
              %Provision
                  for loan losses
              
              
              (750
              )
              
              (330
              )
              
              127.27
              
              
              (1,095
              )
              
              (660
              )
              
              65.91Noninterest
                  income
              
              
              1,592
              
              
              1,988
              
              
              (19.92
              )
              
              3,273
              
              
              3,517
              
              
              (6.94
              )Noninterest
                  expense
              
              
              (4,702
              )
              
              (4,617
              )
              
              1.84
              
              
              (9,585
              )
              
              (8,902
              )
              
              7.67Income
                  tax expense
              
              
              (190
              )
              
              (524
              )
              
              (63.74
              )
              
              (460
              )
              
              (1,085
              )
              
              (57.60
              )**Net
                  Income**
              
              **$**
              **862**
              
              **$**
              **1,589**
              
              
              **(45.75**
              **)**
              **$**
              **1,832**
              
              **$**
              **2,989**
              
              
              **(38.71**
              **)****Per
                  Share Data:**Avg.
                  common shares outstanding, basic
              
              
              7,369,964
              
              
              7,750,385
              
              
              (4.91)
              %
              
              7,391,338
              
              
              7,810,089
              
              
              (5.36)
              %Basic
                  net income
              
              $
              0.12
              
              $
              0.21
              
              
              (42.86
              )
              $
              0.25
              
              $
              0.38
              
              
              (34.21
              )Avg.
                  common shares outstanding, diluted
              
              
              7,434,006
              
              
              7,816,793
              
              
              (4.90)
              %
              
              7,443,803
              
              
              7,881,287
              
              
              (5.55)
              %Diluted
                  net income
              
              $
              0.12
              
              $
              0.20
              
              
              (40.00
              )
              $
              0.25
              
              $
              0.38
              
              
              (34.21
              )Cash
                  dividends paid
              
              $
              0.085
              
              $
              0.08
              
              
              6.25
              %
              $
              0.17
              
              $
              0.16
              
              
              6.25
              %Period-end
                  book value
              
              
              10.96
              
              
              10.69
              
              
              2.53
              
              
              10.96
              
              
              10.69
              
              
              2.53**Financial
                  Ratios**(annualized)**:**Return
                  on average stockholders’ equity
              
              
              4.13
              %
              
              7.50
              %
              
              (44.93)
              %
              
              4.38
              %
              
              7.06
              %
              
              (37.96)
              %Return
                  on average assets
              
              
              0.44
              
              
              0.86
              
              
              (48.84
              )
              
              0.47
              
              
              0.81
              
              
              (41.98
              )Efficiency
                  ratio
              
              
              72.29
              
              
              65.40
              
              
              10.54
              
              
              73.89
              
              
              65.28
              
              
              13.13Net
                  interest margin
              
              
              2.91
              
              
              3.22
              
              
              (9.63
              )
              
              2.90
              
              
              3.23
              
              
              (10.22
              )Average
                  equity to average assets
              
              
              10.62
              
              
              11.44
              
              
              (7.17
              )
              
              10.75
              
              
              11.51
              
              
              (6.60
              )**Asset
                  Quality Data:**Allowance
                  for loan losses
              
              $
              6,757
              
              $
              6,128
              
              
              10.26
              %
              $
              6,757
              
              $
              6,128
              
              
              10.26
              %Nonperforming
                  loans
              
              
              3,880
              
              
              2,461
              
              
              57.66
              
              
              3,880
              
              
              2,461
              
              
              57.66Nonperforming
                  assets
              
              
              4,515
              
              
              2,910
              
              
              55.15
              
              
              4,514
              
              
              2,910
              
              
              55.12Net
                  charge-offs
              
              
              421
              
              
              225
              
              
              87.11
              
              
              483
              
              
              296
              
              
              63.18Allowance
                  for loan losses to total loans
              
              
              1.12
              %
              
              1.14
              %
              
              (1.75
              )
              
              1.12
              %
              
              1.14
              %
              
              (1.75
              )Nonperforming
                  loans to total loans
              
              
              0.64
              
              
              0.46
              
              
              39.13
              
              
              0.64
              
              
              0.46
              
              
              39.13Nonperforming
                  assets to total assets
              
              
              0.56
              
              
              0.39
              
              
              43.59
              
              
              0.56
              
              
              0.39
              
              
              43.59**Average
                  Balances:**Total
                  assets
              
              $
              790,625
              
              $
              742,910
              
              
              6.42
              %
              $
              783,148
              
              $
              741,242
              
              
              5.65
              %Loans,
                  net of unearned income
              
              
              588,868
              
              
              524,660
              
              
              12.24
              
              
              577,953
              
              
              522,501
              
              
              10.61Interest-earning
                  assets
              
              
              695,151
              
              
              647,089
              
              
              7.43
              
              
              687,820
              
              
              646,158
              
              
              6.45Deposits
              
              
              578,469
              
              
              576,250
              
              
              0.39
              
              
              624,136
              
              
              570,490
              
              
              9.40Interest-bearing
                  liabilities
              
              
              655,533
              
              
              608,380
              
              
              7.75
              
              
              646,204
              
              
              605,888
              
              
              6.65Stockholders’
                  equity
              
              
              83,965
              
              
              84,967
              
              
              (1.18
              )
              
              84,205
              
              
              85,342
              
              
              (1.33
              )**At
                  Period End:**Total
                  assets
              
              $
              811,825
              
              $
              755,486
              
              
              7.46
              %
              $
              811,825
              
              $
              755,486
              
              
              7.46
              %Loans,
                  net of unearned income
              
              
              604,855
              
              
              535,699
              
              
              12.91
              
              
              604,855
              
              
              535,699
              
              
              12.91Interest-earning
                  assets
              
              
              720,270
              
              
              668,138
              
              
              7.80
              
              
              720,270
              
              
              668,138
              
              
              7.80Deposits
              
              
              584,801
              
              
              583,545
              
              
              0.22
              
              
              584,801
              
              
              583,545
              
              
              0.22Interest-bearing
                  liabilities
              
              
              677,616
              
              
              623,449
              
              
              8.69
              
              
              677,616
              
              
              623,449
              
              
              8.69Stockholders’
                  equity
              
              
              82,495
              
              
              84,211
              
              
              (2.04
              )
              
              82,495
              
              
              84,211
              
              
              (2.04
              )
  10


**Critical
      Accounting Policies**





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





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





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





**Other-Than-Temporary
      Impairment of Securities.** Management
      periodically reviews all investment securities with significant declines in
      fair
      value for potential other-than-temporary impairment pursuant to the guidance
      provided by SFAS No. 115, “ *Accounting
      for Certain Investments in Debt and Equity Securities”.* In
      November 2006, the 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, 2008, management evaluated the Company’s investment portfolio and
      determined that all unrealized losses were the direct result of temporary
      changes in interest rates and market conditions and that such losses may be
      recovered in the foreseeable future. The Company has the ability to hold these
      investments to maturity if necessary in order to recover any temporary losses
      that may presently exist. As a result, management did not consider any
      additional unrealized losses as “other-than-temporary” as of June 30, 2008.




11





**Comparison
      of Financial Condition**





*Assets.* Total
      assets of the Company increased by $32.7 million, or 4.2%, from $779.1 million
      at December 31, 2007, to $811.8 million at June 30, 2008. This increase was
      primarily due to a $44.9 million, or 8.0%, increase in loans receivable to
      $604.9 million at June 30, 2008. The growth in loans was primarily comprised
      of
      a $16.6 million, or 20.3%, increase in consumer loans to $98.7 million, an
      $8.5
      million, or 9.5%, increase in residential and commercial construction loans
      to
      $97.8 million, a $11.1 million, or 4.0%, increase in commercial real estate
      loans to $284.8 million and a $2.9 million, or 3.7%, increase in residential
      loans to $80.9 million. These increases in loans were partly offset by a slight
      decrease in commercial business loans to $33.2 million. Loan production remained
      strong during the first half of 2008, totaling $158.8 million, compared to
      $153.3 million during the first half of 2007. The economy in the Charlotte
      region remains relatively strong compared to other regions of the country;
      however, housing starts and demand for commercial real estate have slowed during
      the past 12 months. As a result, management expects that loan growth will slow
      during the second half of 2008, as compared to the level of growth realized
      during the first half of 2008. Management will seek to continue to grow the
      loan
      portfolio in a prudent manner with an emphasis on borrowers that have a
      demonstrated capacity to meet their debt obligations, even if the local economy
      slows.





As
      of
      June 30, 2008, $256.2 million, or 43.2%, of the Company’s loan portfolio, was
      scheduled to reprice in one month. Decreasing short-term interest rates will
      cause margin compression, as these adjustable-rate loans reprice at lower
      interest rates at a faster pace than the Company’s funding costs. This
      sensitivity to falling short-term interest rates was a factor in the Company’s
      margin compression during the first quarter of 2008 as the prime rate decreased
      by 200 basis points during the quarter. However, during the second quarter
      of
      2008 a large number of time deposits repriced at lower rates, resulting in
      a
      decreased cost of funds. As a result, the Company’s net interest margin improved
      from 2.89% for the first quarter of 2008 to 2.91% for the second quarter of
      2008. Additional margin expansion is expected for the remainder of 2008 if
      short-term rates remain stable as more time deposits reprice at lower
      rates.





Cash
      and
      cash equivalents decreased by $13.9 million, or 46.8%, from $29.7 million at
      December 31, 2007, to $15.8 million at June 30, 2008. This decrease was
      primarily attributable to loan growth of $44.9 million, a $13.1 million increase
      in mortgage-backed securities (“MBS”) and deposit decreases of $6.0 million.
      These outlays of cash were partly offset by an $11.9 million decrease in
      investment securities and a $41.0 million increase in borrowed money. Management
      expects that the level of cash and cash equivalents will remain relatively
      stable through 2008. Proceeds needed to fund future loan growth will be
      generated from expected growth in deposits, maturing investments and MBS and
      /
      or additional borrowings.





During
      the six-month period ended June 30, 2008, investment securities decreased by
      $11.9 million, or 25.7%, to $34.6 million. The decrease in investment securities
      was primarily due to normal maturities of $1.5 million and the sale of $13.4
      million of investment securities during the period. These decreases in
      investment securities were partly offset by the purchase of $3.7 million of
      investment securities during the period. MBS increased $13.1 million, or 18.8%,
      to $83.0 million. The increase in MBS was due to the purchase of $35.0 million
      of MBS during the period, the effects of which were partly offset by the sale
      of
      $12.5 million in MBS and by $7.8 million of normal principal amortization.
      The
      investment securities and MBS were primarily sold to fund loan growth.
      Management expects the investment and MBS portfolios to decrease as a percentage
      of total assets as the cash flows generated from these investments and MBS
      are
      used to fund loan growth, repay borrowings and repurchase common stock. This
      rebalancing of the balance sheet from lower-yielding cash and cash equivalents,
      investments, and MBS to higher-yielding loans is expected to be a positive
      factor in improving the Company’s net interest margin.





Other
      real estate owned, which consisted of 13 one-to-four family residential
      dwellings acquired by the Bank through foreclosure, totaled $635,000 at June
      30,
      2008, compared to $529,000 at December 31, 2007. All foreclosed properties
      are
      written down to their estimated fair value at acquisition, and are currently
      located in the Bank’s primary lending area. Management will continue to
      aggressively market foreclosed properties for a timely disposition.




12





*Allowance
      for loan losses and nonperforming assets.* The
      Company has established a systematic methodology for determining the adequacy
      of
      the allowance for loan losses. This methodology is set forth in a formal policy
      and considers all loans in the portfolio. Specific allowances are established
      for certain individual loans that management considers impaired. The remainder
      of the portfolio is segmented into groups of loans with similar risk
      characteristics for evaluation and analysis. Management’s periodic evaluation of
      the allowance is consistently applied and based on inherent losses in the
      portfolio, past loan loss experience, risks inherent in the different types
      of
      loans, the estimated value of any underlying collateral, current economic
      conditions, the borrower’s financial position, and other relevant internal and
      external factors that may affect loan collectibility. The allowance for loan
      losses is increased by charging provisions for loan losses against income.
      As of
      June 30, 2008, the allowance for loan losses was $6.8 million, or 1.12% of
      total
      loans. Management believes that this amount meets the requirement for losses
      on
      loans that management considers to be impaired, for known losses, and for losses
      inherent in the remaining loan portfolio. Although management believes that
      it
      uses the best information available to make such determinations, future
      adjustments to the allowance for loan losses may be necessary and results of
      operations could be significantly adversely affected if circumstances differ
      substantially from the assumptions used in making the determinations. The
      following table presents an analysis of changes in the allowance for loan losses
      for the comparable periods and information with respect to nonperforming assets
      at the dates indicated.





**At and For the Three**
            
            **At and For the Six****Months Ended June 30,**
            
            **Months Ended June 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**(dollars in
                thousands)
            
            (dollars
                in thousands)Allowance
                for loan losses:Beginning
                of period
            
            $
            6,427
            
            $
            6,023
            
            $
            6,145
            
            $
            5,764Add:Provision
                for loan losses
            
            
            750
            
            
            330
            
            
            1,095
            
            
            660Recoveries
            
            
            34
            
            
            8
            
            
            48
            
            
            20Less:Charge-offs
            
            
            455
            
            
            233
            
            
            531
            
            
            316End
                of period
            
            $
            6,757
            
            $
            6,128
            
            $
            6,757
            
            $
            6,128Nonaccrual
                loans
            
            $
            3,880
            
            $
            2,461
            
            $
            3,880
            
            $
            2,461Real
                estate owned
            
            
            635
            
            
            449
            
            
            635
            
            
            449Nonperforming
                assets
            
            $
            4,515
            
            $
            2,910
            
            $
            4,515
            
            $
            2,910Allowance
                for loan losses as a percentage of total loans
            
            
            1.12
            %
            
            1.14
            %
            
            1.12
            %
            
            1.14
            %Nonperforming
                loans to total loans
            
            
            0.64
            %
            
            0.46
            %
            
            0.64
            %
            
            0.46
            %Nonperforming
                assets to total assets
            
            
            0.56
            %
            
            0.39
            %
            
            0.56
            %
            
            0.39
            %





Premises
      and equipment decreased by $361,000, or 2.0%, to $17.6 million at June 30,
      2008.
      During 2008, the Company opened a full-service office located in a leased
      facility in Rock Hill, South Carolina. Also during 2008, the Company closed
      its
      mortgage loan production office in Waxhaw, North Carolina and consolidated
      the
      operations of its two commercial loan production offices into existing branch
      facilities. As a result, there were no loan production offices operating as
      of
      June 30, 2008. This consolidation of loan production offices was a cost cutting
      measure that was done as a part of the Company’s reorganization efforts during
      the first quarter of 2008. No significant changes to the Company’s premises and
      equipment are anticipated for the remainder of 2008.




13





*Liabilities* .
      Total
      liabilities increased by $34.2 million, or 4.9%, from $695.1 million at December
      31, 2007, to $729.3 million at June 30, 2008. This increase was primarily due
      to
      a $41.0 million increase in borrowed money which was partly offset by a $6.0
      million decrease in total deposits.





While
      total deposits decreased by $6.0 million, or 1.0%, to $584.8 million at June
      30,
      2008, demand deposits (checking accounts) increased by $12.3 million, or 12.1%,
      to $114.3 million at June 30, 2008. The increase in demand deposits was
      primarily due to a continued emphasis on increasing the Company’s number of
      retail and business customers through employee incentive plans and enhanced
      treasury service products. The increase in demand deposit accounts was offset
      by
      a $13.6 million, or 10.5%, decrease in money market demand deposit accounts
      to
      $116.1 million, a $4.3 million, or 1.2%, decrease in time deposits to $342.8
      million, and a $377,000, or 3.1%, decrease in savings accounts to $11.7 million
      at the end of the period. The decrease in these interest-sensitive deposit
      accounts was largely due to the Company’s action to aggressively lower its
      deposit rates more quickly than some of its competitors in response to the
      Federal Reserve Board’s actions to lower the federal funds rate by 225 basis
      points during the six-month period ended June 30, 2008. The Company will
      continue to actively market the Company’s deposit products at pricing points
      that management believes to be profitable. Management has always focused on
      increasing deposits by building customer relationships and typically avoids
      growing deposits by offering the highest rates in the market. However, if loan
      growth continues to significantly outpace deposit growth, management may be
      more
      aggressive in pricing retail deposits, which may increase the Company’s cost of
      funds. In addition, management may use brokered deposits to fund future loan
      growth if additional liquidity is needed. Brokered deposits totaled $15.8
      million, or 2.7% of total deposits, at June 30, 2008.





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





Borrowed
      money increased by $41.0 million, or 42.6%, to $137.3 million at June 30, 2008.
      This increase was primarily due to additional Federal Home Loan Bank (“FHLB”)
      advances that were obtained primarily for the purpose of funding loan growth
      and
      $20.0 million in repurchase agreements with Citigroup Global Market, Inc. that
      were used to purchase MBS. 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 $1.5 million, or 1.8%, from $84.0 million at
      December 31, 2007, to $82.5 million at June 30, 2008. The decrease in
      stockholders’ equity was primarily due to a $1.5 million increase in unrealized
      losses on available-for-sale investment securities and MBS. This increase in
      unrealized losses was primarily due to increases in long-term interest rates
      and
      higher spreads resulting from increased volatility in the securities markets.
      Management expects that these losses are temporary in nature and that the market
      value of the securities portfolio will recover in the foreseeable future.





Also,
      during the six-month period the Company repurchased 95,628 shares of common
      stock for $951,000, at an average cost of $9.94 per share. On October 22, 2007,
      the Board of Directors authorized the repurchase of up to 200,000 shares, or
      approximately 2.5%, of the then outstanding shares of common stock. This
      repurchase plan was completed in June 2008. As a result, an additional
      repurchase plan was authorized on June 16, 2008, by the Board of Directors
      of
      the Company. The new plan also authorized the repurchase of 200,000 shares,
      or
      approximately 2.7% of the Company’s then outstanding shares of common stock.
      These repurchases may be carried out through open market purchases, block
      trades, and negotiated private transactions. The stock may be repurchased on
      an
      ongoing basis and will be subject to the availability of stock, general market
      conditions, the trading price of the stock, alternative uses for capital, and
      the Company’s financial performance. Under this plan the Company had repurchased
      a total of 2,276 shares at an average price of $7.85 per share and had 197,724
      shares remaining to be repurchased at June 30, 2008. The Company will consider
      repurchasing additional shares of common stock of the Company at prices
      management considers to be attractive and in the best interests of both the
      Company and its stockholders. Any repurchased shares will be held as treasury
      stock and will be available for general corporate purposes **.**




14





In
      addition, the Company paid cash dividends totaling $1.2 million during the
      six-month period, representing $0.17 per outstanding share. These decreases
      were
      partly offset by $1.8 million in net income during the six-month period ending
      June 30, 2008.





**Comparison
      of Results of Operations for the Three Months Ended June 30, 2008 and
      2007**





*General* .
      Net
      income for the three months ended June 30, 2008, amounted to $862,000, or $0.12
      per diluted share, as compared to $1.6 million, or $0.20 per diluted share,
      for
      the three months ended June 30, 2007. This represented a 45.8% decrease in
      net
      income and a 40.0% decrease in diluted earnings per share for the comparable
      periods. This decrease was largely due to net interest margin compression caused
      primarily by the Federal Reserve Board’s actions to decrease short-term interest
      rates by 275 basis points during the 12-month period ending June 30, 2008.
      This
      resulted in lower yields on assets tied to the prime lending rate and other
      short-term indices.





*Net
      interest income.* Interest
      income decreased by $1.1 million, or 9.5%, to $10.5 million for the second
      quarter of 2008, primarily as a result of a lower market rates due to a 275
      basis point decrease in short-term interest rates from June 30, 2007 to June
      30,
      2008. As of June 30, 2008, approximately 43% of the Company’s loan portfolio was
      scheduled to reprice on a monthly basis. Average interest-earning assets
      increased by $48.1 million, or 7.4%, to $695.1 million for the three months
      ended June 30, 2008. The increase in average interest-earning assets was
      primarily the result of a $64.2 million, or 12.2%, increase in average
      outstanding loans to $588.9 million for the quarter ending June 30, 2008. The
      increase in average loans was partly offset by a $17.3 million, or 12.7%,
      decrease in average investments and MBS. The Company’s average yield on earning
      assets decreased by 114 basis points to 6.12% for the quarter ended June 30,
      2008. Interest expense decreased by $942,000, or 14.5%, for the comparable
      quarters to $5.6 million for the second quarter of 2008. This decrease in
      interest expense was largely due to lower market interest rates. As a result,
      the average cost of funds decreased by 88 basis points to 3.41% for the quarter
      ended June 30, 2008. The benefits of lower market rates were partly offset
      by a
      $47.2 million, or 7.8%, increase in the average balance of interest-bearing
      liabilities to $655.5 million for the three months ended June 30, 2008. Average
      interest-bearing liabilities increased primarily as a result of a $46.5 million,
      or 64.6%, increase in average borrowed money coupled with a $695,000, or 0.13%,
      increase in average interest-bearing deposits.





As
      a
      result of the decrease in interest rates during the comparable periods, the
      tax-equivalent net interest margin decreased by 31 basis points to 2.91% for
      the
      quarter ended June 30, 2008, compared to 3.22% for the quarter ended June 30,
      2007. This decrease in the net interest margin was primarily the result of
      yields on earning assets falling at a faster rate than the cost of funds. On
      a
      linked-quarter basis, the Company’s tax-equivalent net interest margin increased
      two basis points from 2.89% for the first quarter of 2008 to 2.91% for the
      second quarter of 2008. While the Company maintains a relatively neutral
      interest rate risk position on a cumulative one-year basis, a decrease in
      short-term interest rates have a more pronounced negative impact in the first
      three months following the decrease. The short-term negative effects of a
      decrease in interest rates are expected to be mostly offset by time deposits
      that mature over the next 12 months and reprice at a lower cost to the Company.





*Provision
      for loan losses.* The
      provision for loan losses amounted to $750,000 for the second quarter of 2008
      compared to $330,000 for the second quarter of 2007, representing a $420,000
      increase. The primary reason for the increase was a $375,000 write-off that
      was
      realized during the second quarter of 2008 on a non-real estate loan. The loan
      was secured by various automobiles that were held under a floor planning line
      of
      credit. The loss was incurred as the result of a combination of insufficient
      collateral value on some of the automobiles and the lack of a perfected lien
      position on other vehicles. The loan is in the process of collection by the
      Company. As a result of this write-off, the Company increased the amount of
      the
      provision for loan losses in order to maintain the level of the allowance for
      loan losses. The allowance for loan losses was $6.8 million, or 1.12% of total
      loans as of June 30, 2008, compared to $6.1 million, or 1.14% of total loans
      as
      of June 30, 2007. Credit quality continues to compare favorably with industry
      peers with a ratio of nonperforming loans to total loans of 0.64% on June 30,
      2008, compared to 0.46% on June 30, 2007. A substantial portion of the Company’s
      nonperforming loans at June 30, 2008, was secured by real estate located in
      the
      Company’s normal lending market. In addition, the Company’s ratio of
      nonperforming assets to total assets was 0.56% at June 30, 2008, compared to
      0.39% at June 30, 2007. Net chargeoffs totaled $421,000, or 0.07% of average
      loans, during the second quarter of 2008 compared to $225,000, or 0.04% of
      average loans, during the second quarter of 2007.




15




*Noninterest
      income.* Noninterest
      income decreased by $396,000, or 19.9%, to $1.6 million for the three months
      ended June 30, 2008, as compared to $2.0 million for the three months ended
      June
      30, 2007. This decrease was largely attributable to a $313,000 decrease in
      the
      net gain on sale of assets and a $112,000 decrease in net life insurance
      proceeds payable to the Company. The Company recognized $19,000 in net gains
      from the sale of assets during the quarter ended June 30, 2008, compared to
      $332,000 during the quarter ended June 30, 2007. During the second quarter
      of
      2008 the Company sold $117,000 of equity securities at a net gain of $41,000
      and
      $183,000 of other real estate owned at a loss of $22,000. During the quarter
      ended June 30, 2007, the Company sold a small portion of land from an existing
      branch office site and a vacant building that was previously used as the
      operations center for the former Citizens Bank that was acquired in 2001. These
      sales resulted in a net gain of $419,000. Offsetting a portion of these gains
      were losses of $79,000 from the sale of $3.3 million in mortgage-backed
      securities and $8,000 from the sale of various parcels of foreclosed properties.
      During the second quarter of 2007, an officer of the Company passed away,
      resulting in net life insurance proceeds of $112,000 that were paid to the
      Company. In addition, during the comparable periods, the Company realized a
      $31,000, or 23.3%, decrease in fee income on lending activities and a $60,000
      decrease in the fair value adjustment on deferred compensation assets. The
      decrease in fee income on lending activities was largely the result of
      originating fewer construction and acquisition and development loans during
      the
      second quarter of 2008. These loans typically generate higher fee income than
      other types of loans. The decrease in the fair value on deferred compensation
      assets is directly offset by a decrease in noninterest expense, resulting in
      no
      net impact on the earnings of the Company.





These
      decreases in noninterest income were partly offset by an $83,000, or 12.0%,
      increase in fee income on deposit accounts, a $19,000, or 41.3%, increase in
      dividends on Federal Home Loan Bank stock, a $10,000, or 5.6%, increase in
      the
      cash value of bank-owned life insurance, and a $7,000, or 3.6%, increase in
      other noninterest income. An increase in the number of demand deposit customers
      contributed to the improvement in deposit fee income, while an increased number
      of shares of FHLB stock resulting from higher borrowing balances contributed
      to
      the increase in dividends on FHLB stock. Other noninterest income increased
      as a
      result increased fees from miscellaneous items.





*Noninterest
      expense.* Noninterest
      expense increased by $85,000, or 1.9%, to $4.7 million for the quarter ended
      June 30, 2008, compared to $4.6 million for the quarter ended June 30, 2007.
      The
      primary reasons were a $182,000, or 7.7%, increase in compensation and benefits,
      a $4,000, or 0.6%, increase in occupancy and equipment expense, an $84,000,
      or
      54.9%, increase in professional services, and a $64,000, or a 5.9%, increase
      in
      other noninterest expenses. Management hired several experienced lenders and
      an
      experienced credit officer during 2007 which contributed to the increase in
      compensation and benefits. However, we expect that the additional loan growth
      associated with these new positions will cover the additional compensation
      expense in 2008. The Company also opened its 15th full-service office in Rock
      Hill, South Carolina, during the first quarter 2008. As a result, office
      occupancy and equipment expense is expected to continue to increase in 2008.
      However, this increase will be tempered by the consolidation of the Company’s
      three loan production offices into existing branch facilities. The increase
      in
      professional services was primarily associated with higher audit-related costs,
      consulting fees and legal services. Management expects that these expenses
      will
      decrease for the remainder of 2008. Other noninterest expenses increased as
      a
      result of higher expenses related to data processing, deposit operations, and
      loan administration. A portion of the increase was related to the opening of
      a
      new office during the first quarter of 2008.





These
      increases in noninterest expense were partly offset by a $60,000 decrease in
      the
      fair value adjustment on deferred compensation, a $27,000, or 16.7%, decrease
      in
      the amortization expense of intangible assets and a $162,000 decrease in
      impairment on securities. The decrease in the fair value adjustment on deferred
      compensation during the comparable quarters was directly offset by a
      corresponding decrease to noninterest income, resulting in no net impact to
      the
      Company. The amortization of intangible assets is expected to continue to
      decrease as the amount of the core deposit intangible decreases. Effective
      June
      30, 2007, management evaluated the Company’s investment portfolio and determined
      that a $162,000 impairment existed on a $305,000 equity investment that was
      considered to be other-than-temporary, resulting in a $162,000 charge to
      earnings in the 2007 period.




16




*Income
      taxes.* Income
      taxes amounted to $190,000, or 18.1% of taxable income, for the quarter ended
      June 30, 2008, as compared to $524,000, or 24.8% of taxable income, for the
      quarter ended June 30, 2007. The decrease in the effective tax rate during
      the
      comparable periods was primarily due to a $1.0 million decrease in income before
      taxes. In addition, tax equivalent adjustments increased from 23.8% of net
      income for the quarter ended June 30, 2007, to 46.4% of net income for the
      quarter ended June 30, 2008. This nontaxable income was primarily generated
      from
      interest earned on bank-qualified municipal securities and loans. The Company
      invests in tax-advantaged sources of income to reduce its overall tax burden.
      However, as the Company continues to increase the amount of income derived
      from
      interest income on loans and fee income on loans and deposits, the effective
      tax
      rate is expected to increase.





**Comparison
      of Results of Operations for the Six Months Ended June 30, 2008 and
      2007**





*General* .
      Net
      income for the six months ended June 30, 2008, amounted to $1.8 million, or
      $0.25 per diluted share, as compared to $3.0 million, or $0.38 per diluted
      share, for the six months ended June 30, 2007. This represented a 38.7% decrease
      in net income and a 34.2% decrease in diluted earnings per share for the
      comparable periods. This decrease was largely due to net interest margin
      compression caused primarily by the Federal Reserve Board’s actions to decrease
      short-term interest rates by 275 basis points from June 30, 2007, to June 30,
      2008. This resulted in lower yields on assets tied to the prime lending rate
      and
      other short-term indices.





*Net
      interest income.* Interest
      income decreased by $1.5 million, or 6.5%, to $21.4 million for the six months
      ending June 30, 2008, primarily as a result of lower short-term interest rates.
      As of June 30, 2008, approximately 43% of the Company’s loan portfolio was
      scheduled to reprice on a monthly basis. Average interest-earning assets
      increased by $41.7 million, or 6.5%, to $687.9 million for the six months ended
      June 30, 2008. The increase in average interest-earning assets was primarily
      the
      result of a $55.5 million, or 10.6%, increase in average outstanding loans
      to
      $578.0 million. This increase was partly offset by a $15.5 million, or 11.3%,
      decrease in average investments and MBS during the comparable periods. The
      Company’s average yield on earning assets decreased by 90 basis points to 6.33%
      for the six months ended June 30, 2008. Interest expense decreased by $1.1
      million, or 8.4%, for the comparable periods to $11.8 million for the six months
      ending June 30, 2008. This decrease in interest expense was largely due to
      lower
      market interest rates. As a result, the average cost of funds decreased by
      88
      basis points to 3.41% for the six months ended June 30, 2008. The Company
      experienced a $40.3 million, or 6.7%, increase in the average balance of
      interest-bearing liabilities to $646.2 million for the six months ended June
      30,
      2008. Average interest-bearing liabilities increased primarily as a result
      of a
      $33.0 million, or 44.2%, increase in borrowed money coupled with a $7.3 million,
      or 1.4%, increase in average interest-bearing deposits.





As
      a
      result of the decrease in interest rates during the comparable periods, the
      tax-equivalent net interest margin decreased by 33 basis points to 2.90% for
      the
      six months ending June 30, 2008, compared to 3.23% for the six months ending
      June 30, 2007. This decrease in the net interest margin was primarily the result
      of yields on earning assets falling at a faster rate than the cost of funds.
      While the Company maintains a relatively neutral interest rate risk position
      on
      a cumulative one-year basis, decreases in short-term interest rates have a
      more
      pronounced negative impact in the first three months. The short-term negative
      effects of a decrease in interest rates are expected to be mostly offset by
      time
      deposits that mature over the next 12 months and reprice at a lower cost to
      the
      Company.





*Provision
      for loan losses.* The
      provision for loan losses amounted to $1.1 million for the six months ending
      June 30, 2008, compared to $660,000 for the six months ending June 30, 2007,
      representing a $435,000 increase. The primary reason for the increase was a
      $375,000 write-off that was realized during the second quarter of 2008 on a
      non-real estate loan. The loan was secured by various automobiles that were
      held
      under a floor planning line of credit. The loss was incurred as the result
      of a
      combination of insufficient collateral value on some of the automobiles and
      the
      lack of a perfected lien position on other vehicles. The loan is in the process
      of collection by the Company. As a result of this write-off, the Company
      increased the amount of the provision for loan losses in order to maintain
      the
      level of the allowance for loan losses at a reasonable level. The allowance
      for
      loan losses was $6.8 million, or 1.12% of total loans as of June 30, 2008,
      compared to $6.1 million, or 1.14% of total loans as of June 30, 2007. Credit
      quality continues to compare favorably with industry peers with a ratio of
      nonperforming loans to total loans of 0.64% on June 30, 2008, compared to 0.46%
      on June 30, 2007. A substantial portion of the Company’s nonperforming loans at
      June 30, 2008, was secured by real estate located in the Company’s normal
      lending market. In addition, the Company’s ratio of nonperforming assets to
      total assets was 0.56% at June 30, 2008, compared to 0.39% at June 30, 2007.
      Net
      chargeoffs totaled $484,000, or 0.08% of average loans, for the six months
      ending June 30, 2008, compared to $296,000, or 0.06% of average loans, for
      the
      six months ending June 30, 2007.




17




*Noninterest
      income.* Noninterest
      income decreased by $244,000, or 7.0%, to $3.3 million for the six months ending
      June 30, 2008, as compared to $3.5 million for the six months ending June 30,
      2007. This decrease was largely attributable to a $75,000 decrease in the net
      gain on sale of assets and an $112,000 decrease in net life insurance proceeds
      payable to the Company. The Company recognized $261,000 in net gains from the
      sale of assets during the six months ended June 30, 2008, compared to $336,000
      during the six months ended June 30, 2007. During the first half of 2008 the
      Company sold $13.4 million of investment securities at a net gain of $124,000
      and $12.5 million of mortgage-backed securities at a net gain of $159,000.
      These
      securities were primarily sold to generate proceeds to fund loan growth. In
      addition, during the six months ending June 30, 2008, the Company sold $183,000
      in other real estate owned at a loss of $22,000. During the six months ended
      June 30, 2007, the Company sold $801,000 in real estate including a small
      portion of land from an existing branch office site and a vacant building that
      was previously used as the operations center for the former Citizens Bank that
      was acquired in 2001. These sales resulted in a net gain of $419,000. Offsetting
      a portion of these gains were losses of $80,000 from the sale of $3.4 million
      in
      mortgage-backed securities and $8,000 from the sale of various parcels of
      foreclosed properties. During the second quarter of 2007, an officer of the
      Company passed away, resulting in net life insurance proceeds of $112,000 that
      were paid to the Company. In addition, the Company realized a $29,000, or 12.0%,
      decrease in fee income on lending activities, a $29,000, or 5.7%, decrease
      in
      mortgage banking income, an $11,000, or 2.8%, decrease in cash value on
      bank-owned life insurance, a $16,000, or 3.7%, decrease in other noninterest
      income and a $111,000 decrease in the fair value adjustment on deferred
      compensation assets. The decrease in fee income on lending activities was
      largely the result of originating fewer construction and acquisition and
      development loans during the second half of 2008. These loans typically generate
      higher fee income that other types of loans. The income generated from mortgage
      banking activities decreased due to a reduction in mortgage lending activity
      in
      the Charlotte region. However, the residential real estate market in the
      Charlotte region remains active and is expected to provide the Company with
      continued opportunities for growth in 2008. Cash value on bank owned life
      insurance decreased slightly due to lower market rates during the comparable
      periods. The decrease in other noninterest income was primarily due to lower
      penalties on early withdrawal on certificates of deposit and other miscellaneous
      items. The decrease in the fair value on deferred compensation assets is
      directly offset by a decrease in noninterest expense, resulting in no net impact
      on the earnings of the Company.





The
      2008
      period included a $107,000, or 7.9%, increase in fee income on deposit accounts
      and a $32,000, or 33.3%, increase in dividends on Federal Home Loan Bank stock.
      An increase in the number of demand deposit customers contributed to the
      improvement in deposit fee income, while an increased number of shares of FHLB
      stock resulting from higher borrowing balances contributed to the increase
      in
      dividends on FHLB stock.





*Noninterest
      expense.* Noninterest
      expense increased by $683,000, or 7.7%, to $9.6 million for the six months
      ended
      June 30, 2008, compared to $8.9 million for the six months ended June 30, 2007.
      This resulted from a $394,000, or 8.4%, increase in compensation and benefits,
      an $11,000, or 0.8%, increase in occupancy and equipment expense, a $162,000,
      or
      58.7%, increase in professional services, a $220,000, or a 10.8%, increase
      in
      other noninterest expenses and a $220,000 increase in restructuring expenses.
      Management hired several experienced lenders and an experienced credit officer
      during 2007 which contributed to the increase in compensation and benefits.
      However, we expect that the additional loan growth associated with these new
      positions will cover the additional compensation expense in 2008. The Company
      also opened its 15th full-service office in Rock Hill, South Carolina, during
      the first quarter 2008. As a result, office occupancy and equipment expense
      is
      expected to continue to increase in 2008. However, this increase will be
      tempered by the consolidation of the Company’s three loan production offices
      into existing branch facilities. The increase in professional services was
      primarily associated with higher audit-related costs, consulting fees and legal
      services. Management expects that these expenses will decrease for the remainder
      of 2008. Other noninterest expenses increased as a result of higher expenses
      related to marketing, data processing, deposit operations, and loan
      administration. A portion of the increase was related to the opening of a new
      office during the first quarter of 2008. The $220,000 in restructuring expense
      was attributable to severance payments made to various employees whose positions
      were eliminated during the first quarter of 2008. No additional expenses are
      expected in conjunction with the reorganization.




18





These
      increases in noninterest expense were partly offset by a $111,000 decrease
      in
      the fair value adjustment on deferred compensation, a $51,000, or 15.6%,
      decrease in the amortization expense of intangible assets and a $162,000
      decrease in impairment on securities. The decrease in the fair value adjustment
      on deferred compensation during the comparable quarters was directly offset
      by a
      corresponding decrease to noninterest income, resulting in no net impact to
      the
      Company. The amortization of intangible assets is expected to continue to
      decrease as the amount of the core deposit intangible decreases. Effective
      June
      30, 2007, management evaluated the Company’s investment portfolio and determined
      that a $162,000 impairment existed on a $305,000 equity investment that was
      considered to be other-than-temporary, resulting in a $162,000 charge to
      earnings.





*Income
      taxes.* Income
      taxes amounted to $460,000, or 20.1% of taxable income, for the six months
      ended
      June 30, 2008, as compared to $1.1 million, or 26.6% of taxable income, for
      the
      six months ended June 30, 2007. The decrease in the effective tax rate during
      the comparable periods was primarily due to a $1.8 million decrease in income
      before taxes. In addition, tax equivalent adjustments increased from 23.0%
      of
      net income for the six-month period ended June 30, 2007, to 41.8% of net income
      for the six months ended June 30, 2008. This nontaxable income was primarily
      generated from interest earned on bank-qualified municipal securities and loans.
      The Company invests in tax-advantaged sources of income to reduce its overall
      tax burden. However, as the Company continues to increase the amount of income
      derived from interest income on loans and fee income on loans and deposits,
      the
      effective tax rate is expected to increase.





**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 $77.1 million
      available to draw from its line of credit with the FHLB. The FHLB functions
      as a
      central reserve bank providing credit for member financial institutions. As
      a
      member of the FHLB, we are required to own capital stock in the FHLB and we
      are
      authorized to apply for advances on the security of such stock and certain
      of
      our mortgage loans and other assets (principally securities that are obligations
      of, or guaranteed by, U.S. Government Agencies) provided certain
      creditworthiness standards have been met. Advances are made pursuant to several
      different credit programs. Each credit program has its own interest rate and
      range of maturities. Depending on the program, limitations on the amount of
      advances are based on the financial condition of the member institution and
      the
      adequacy of collateral pledged to secure the credit. The Company also has $20.0
      million available from an unsecured federal funds accommodation with Silverton
      Bank (“Silverton”). Silverton is the Company’s primary correspondent bank. The
      federal funds accommodation is for a term of 12 months and is used for the
      purpose of providing daily liquidity as needed by the Company. Outstanding
      advances made under this accommodation are generally repaid on a daily basis
      at
      a rate determined by Silverton based on their marginal cost of funds. Advances
      are limited to not more than 14 days in any calendar month. Interest on any
      advances made over the established line or beyond the 14-day limit will be
      at a
      higher rate. The Company may also solicit brokered deposits for providing funds
      for asset growth. As of June 30, 2008, the Company had outstanding brokered
      deposits of $15.8 million, or 2.7% of total deposits. The Company believes
      that
      it has sufficient sources of liquidity to fund the cash needs of both borrowers
      and depositors, to provide for the ongoing operations of the Company, and to
      capitalize on opportunities for expansion.





In
      the
      normal course of business, various commitments are outstanding that are not
      reflected in the consolidated financial statements. Commitments to extend credit
      and undisbursed advances on customer lines of credit are agreements to lend
      to a
      customer as long as there is no violation of any condition established in the
      contract. The funding of these commitments and previously approved undisbursed
      lines of credit could affect the Company's liquidity position. At June 30,
      2008,
      the Company had loan commitments of $26.3 million, unused lines of credit of
      $113.5 million, and undisbursed construction loan proceeds of $6.0 million.
      The
      Company believes that it has adequate resources to fund loan commitments and
      lines of credit as they arise. The Company does not have any special purpose
      entities or other similar forms of off-balance-sheet financing.




19





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





The
      Bank
      is subject to various regulatory capital requirements administered by the
      banking regulatory agencies. As of June 30, 2008, the Bank’s capital exceeded
      all applicable regulatory requirements and was in the “well capitalized”
category for all regulatory capital measurements. The Bank's Tier I capital
      was
      $66.4 million, or 8.5% of adjusted total assets. The minimum Tier I capital
      ratio is 4.00%. Failure to meet minimum capital requirements can result in
      certain mandatory and possibly discretionary actions by the regulators that,
      if
      undertaken, could have a direct material effect on the Bank’s financial
      statements. Under capital adequacy guidelines and the regulatory framework
      for
      prompt corrective action, the Bank must meet specific capital guidelines that
      involve quantitative measures of the Bank’s assets, liabilities, and certain
      off-balance-sheet items as calculated under regulatory accounting practices.
      The
      Bank’s capital amounts and classifications are subject to qualitative judgments
      by the regulators about components, risk-weightings, and other factors.





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





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





**ITEM
      4. Controls and Procedures**





Under
      the
      supervision and with the participation of the Company’s management, including
      the Company’s Principal Executive Officer and Principal Financial Officer, the
      Company has evaluated the effectiveness of the design and operation of its
      disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
      under the Exchange Act) as of the end of the period covered by this report.
      Based upon that evaluation, the Principal Executive Officer and Principal
      Financial Officer concluded that, as of the end of the period covered by this
      report, the Company’s disclosure controls and procedures were
      effective.





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





**PART
      II. OTHER INFORMATION**





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





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





**Item
      1A. Risk Factors**





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




20





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





**a.**
            Not
                applicable.





**b.**
            Not
                applicable.





**c.**
            During
                the three-month period ended June 30, 2008, the Company repurchased
                28,628
                shares of common stock for $275,000, at an average cost of $9.00
                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
            
            
            15,000
            
            $
            9.75
            
            
            -
            
            
            -May
            
            
            0
            
            $
            0.00
            
            
            -
            
            
            -June
            
            
            13,628
            
            $
            8.17
            
            
            2,276
            
            
            197,724**Total**
            
            
            **28,628**
            
            **$**
            **9.00**
            
            
            **2,276**
            
            
            **197,724**





As
      of
      June 30, 2008, the Company had repurchased a total of 3,206,711 shares, or
      35.4%
      of the original outstanding shares of common stock, at an average price of
      $13.07. This stock was repurchased under a series of repurchase programs that
      have been authorized by the Board of Directors over the past several years.
      The
      most recent repurchase authorization was granted by the Board of Directors
      on
      June 16, 2008, for the repurchase of up to 200,000 shares, or approximately
      2.7%
      of the Company’s then outstanding shares of common stock. These repurchases may
      be carried out through open market purchases, block trades, and negotiated
      private transactions. The stock may be repurchased on an ongoing basis and
      will
      be subject to the availability of stock, general market conditions, the trading
      price of the stock, alternative uses for capital, and the Company’s financial
      condition and/or performance. As of June 30, 2008, the Company had repurchased
      a
      total of 2,276 shares at an average price of $7.85 per share and had 197,724
      shares remaining to be repurchased under this plan. The Company will consider
      repurchasing additional shares of common stock of the Company at prices
      management considers to be attractive and in the best interests of both the
      Company and its stockholders. Any repurchased shares will be held as treasury
      stock and will be available for general corporate purposes **.**





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





Not
      applicable.




21


**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 12, 2008:





Proposal
      1: The
      election of two Directors to the Board of Directors.





James
                J. Fuller
            For
            6,160,263
            Withheld
            9,704Charles
                D. Massey`
            For
            6,159,032
            Withheld
            10,935





Proposal
      2: The
      approval of the Citizens South Banking Corporation 2008 Equity Incentive
      Plan.





For
            4,227,327
            Against
            404,489
            Abstain
            49,192





Proposal
      3: The
      ratification of the appointment of Cherry, Bekaert & Holland, L.L.P. as the
      independent registered public accounting firm for the Company for the fiscal
      year ending December 31, 2008.





For
            6,156,789
            Against
            5,716
            Abstain
            7,462





**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.




22


**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 11, 2008
            By:
            /s/
                Kim S. PriceKim
                S. PricePresident
                and Chief Executive OfficerDate:
                August 11, 2008
            By:
            /s/
                Gary F. HoskinsGary
                F. HoskinsExecutive
                Vice President, Chief Financial Officer and Treasurer




23