With 2005 being another record year for our company, the foundation which Cooperative has built for over 100 years,
continues to grow. Total assets increased 35.7%, primarily as a result of continued loan growth since December 31, 2004, and at year end 2005, were $746.3 million. This record increase in growth was largely due to an increase in the banks loan
portfolio which increased 41.9% from December 31, 2004 to December 31, 2005. The majority of this loan growth occurred in construction and land development loans which grew $65 million, or 101.7%. Commercial real estate loans which grew $40.1
million, 36.9%, and one to four family residential loans which grew $68.9 million, or 30.3% during the period. This phenomenal loan growth is primarily attributable to continued strength in the economy of the markets in which the company conducts
its business, and a continued emphasis on increased loan production.

Net income for the twelve months ended December 31, 2005 was $5.5 million, or $1.26
per diluted share, a 17.5% increase in net income compared to last year. Net income for the twelve months ended December 31, 2004 was $4.7 million, or $1.07 per diluted share.

On January 19th, 2005 the Board declared a 3-for-2 stock split in the form of a 50%
stock dividend. The additional shares were distributed February 24, 2005 to shareholders of record as of February 8, 2005.

On July 1, 2005 Cooperative
Bankshares was included in the Russell MicrocapTMIndex. This new index is comprised of the smallest 1,000
securities in the small-cap Russell 2000TMalong with the next smallest 1,000 companies, based on a ranking of all
U. S. equities by market capitalization.

On August 1, 2005 Cooperative Bank celebrated the opening of a new office at 3701 Shipyard Boulevard in
Wilmington. This branch represented a relocation of the banks former office at 2405 South College Road.

On August 31, 2005 Cooperative Bankshares
announced that we had completed the issuance of a trust preferred securities financing in the amount of $15 million. The securities will be used for general corporate purposes and to increase the regulatory capital of the bank. The company offered
the Trust Preferred Securities in a private placement offering.

On May 31, 2005, the bank moved into its new operations and training center in the Dutch
Square Office Complex in Wilmington. This new facility provides us with a larger, more improved operations building with greater security capabilities. In addition, with the growing need to provide continuous training for our staff, we dedicated a
portion of the building to a training facility which will provide employees with state of the art audio, visual and computer equipment to further enhance their skills in an effort to better serve our customers.

On December 30, 2005 the bank closed its Ogden Branch for the last time and reopened January 3, 2006 in a new facility at Porters Neck in northern New Hanover
County. This new facility is considerably larger and more modern than the former location, and also provides easier access to and from the rapidly developing Market Street corridor in the northern part of the county.

In summary, the year 2005 was an extremely exciting time in the history of the bank. Record growth in loans, assets and deposits reflected the publics growing
acceptance of Cooperative as its bank of choice in our market areas, and further confirms that the four new offices which were opened in 2003 and the relocations in 2005 have proved to be a strategic success in both tapping new markets and better
serving existing markets. In addition, we constantly upgrade existing facilities, and during the year 2005, completed renovations of our downtown Washington office and have started renovations for our downtown Jacksonville office. Additional
renovations of older offices will continue in the future in an effort to better serve our customers.

As I look into the year 2006 and beyond, I am
confident that the bank, the markets it serves, and our customer base will continue to grow and prosper, and I look forward with a great deal of optimism. Thank you for your continued support.



Sincerely yours,Frederick Willetts, IIIPresident




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SELECTED FINANCIAL AND OTHER DATA



|                                               |  |                      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|---------------------------------------------- |  | -------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|At December 31,                                |  | 2005                 |         |   | 2004 |   |         | 2003 |  |   | 2002    |   |  | 2001 |        
|                                               |  | Dollars in Thousands |        
|Selected Financial Condition Data:             |  |                      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Assets                                         |  | $                    | 746,266 |   |      | $ | 550,107 |      |  | $ | 502,437 |   |  | $    | 504,220 |   |  | $ | 458,114 |  
|Loans, net                                     |  |                      | 636,964 |   |      |   | 449,417 |      |  |   | 401,373 |   |  |      | 390,886 |   |  |   | 373,458 |  
|Securities                                     |  |                      | 44,410  |   |      |   | 47,195  |      |  |   | 47,419  |   |  |      | 49,935  |   |  |   | 47,970  |  
|FHLB stock                                     |  |                      | 5,829   |   |      |   | 4,519   |      |  |   | 4,154   |   |  |      | 4,055   |   |  |   | 4,155   |  
|Deposits                                       |  |                      | 564,990 |   |      |   | 414,758 |      |  |   | 367,202 |   |  |      | 357,264 |   |  |   | 339,830 |  
|Borrowed funds                                 |  |                      | 125,344 |   |      |   | 85,426  |      |  |   | 89,505  |   |  |      | 104,678 |   |  |   | 83,097  |  
|Stockholders equity                           |  |                      | 51,096  |   |      |   | 46,910  |      |  |   | 43,143  |   |  |      | 38,448  |   |  |   | 33,618  |  
|                                               |  |                      |         |   |     
|Year Ended December 31,                        |  | 2005                 |         |   | 2004 |   |         | 2003 |  |   | 2002    |   |  | 2001 |        
|                                               |  | Dollars in Thousands |        
|Selected Operations Data:                      |  |                      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Interest income                                |  | $                    | 39,258  |   |      | $ | 27,603  |      |  | $ | 27,975  |   |  | $    | 29,650  |   |  | $ | 31,173  |  
|Interest expense                               |  |                      | 16,159  |   |      |   | 9,205   |      |  |   | 10,686  |   |  |      | 13,875  |   |  |   | 18,916  |  
|Net interest income                            |  |                      | 23,099  |   |      |   | 18,398  |      |  |   | 17,289  |   |  |      | 15,775  |   |  |   | 12,257  |  
|Provision for loan losses                      |  |                      | 2,485   |   |      |   | 970     |      |  |   | 740     |   |  |      | 740     |   |  |   | 460     |  
|Noninterest income                             |  |                      | 5,947   |   |      |   | 5,183   |      |  |   | 6,486   |   |  |      | 4,600   |   |  |   | 1,984   |  
|Noninterest expenses                           |  |                      | 17,302  |   |      |   | 15,586  |      |  |   | 15,041  |   |  |      | 11,888  |   |  |   | 9,303   |  
|Income before income taxes                     |  |                      | 9,259   |   |      |   | 7,025   |      |  |   | 7,994   |   |  |      | 7,747   |   |  |   | 4,478   |  
|Net income                                     |  |                      | 5,502   |   |      |   | 4,681   |      |  |   | 5,404   |   |  |      | 4,944   |   |  |   | 2,889   |  
|Selected Financial Ratios and Other Data:      |  |                      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Return on average assets                       |  |                      | 0.84    | % |      |   | 0.89    | %    |  |   | 1.07    | % |  |      | 1.05    | % |  |   | 0.67    | %
|Return on average equity                       |  |                      | 11.28   | % |      |   | 10.54   | %    |  |   | 13.16   | % |  |      | 13.70   | % |  |   | 8.91    | %
|Average stockholders equity to average assets |  |                      | 7.48    | % |      |   | 8.49    | %    |  |   | 8.17    | % |  |      | 7.64    | % |  |   | 7.57    | %
|Non-performing assets to total assets          |  |                      | 0.01    | % |      |   | 0.04    | %    |  |   | 0.05    | % |  |      | 0.24    | % |  |   | 0.84    | %
|Allowance for loan losses to total loans       |  |                      | 1.04    | % |      |   | 0.94    | %    |  |   | 0.84    | % |  |      | 0.70    | % |  |   | 0.67    | %
|Dividend payout ratio                          |  |                      | 15.65   | % |      |   | 15.89   | %    |  |   | 10.54   | % |  |      | 11.47   | % |  |   | 19.49   | %
|*Per Share Data:                               |  |                      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Earnings per:                                  |  |                      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Common share - basic                           |  | $                    | 1.28    |   |      | $ | 1.09    |      |  | $ | 1.27    |   |  | $    | 1.16    |   |  | $ | 0.69    |  
|Common share - diluted                         |  | $                    | 1.26    |   |      | $ | 1.07    |      |  | $ | 1.24    |   |  | $    | 1.15    |   |  | $ | 0.68    |  
|Cash dividends declared                        |  | $                    | 0.20    |   |      | $ | 0.17    |      |  | $ | 0.13    |   |  | $    | 0.13    |   |  | $ | 0.13    |  
|Book value                                     |  | $                    | 11.87   |   |      | $ | 10.93   |      |  | $ | 10.09   |   |  | $    | 9.04    |   |  | $ | 7.90    |  



|* | Per Share Data has been adjusted to reflect the effects of a 3-for-2 stock split in the form of a 50% stock dividend declared on January 19, 2005 and distributed on
February 24, 2005.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Managements Discussion and Analysis of Financial Condition and Results of Operations

General

Cooperative Bankshares, Inc. (Bankshares) is a
registered bank holding company incorporated in North Carolina in 1994. The Company is the parent company of Cooperative Bank (the Bank), a North Carolina chartered commercial bank. The Bank, headquartered in Wilmington, North Carolina
was chartered in 1898. The Bank provides financial services through 21 offices in Eastern North Carolina. The Banks subsidiary, Lumina Mortgage Company, Inc. (Lumina) is a mortgage banking firm originating and selling residential
mortgage loans through three offices in North Carolina, an office in North Myrtle Beach, South Carolina and an office in Virginia Beach, Virginia. The Banks other subsidiary, CS&L Holdings, Inc. (Holdings), is a holding company
incorporated in Virginia for CS&L Real Estate Trust, Inc. (the REIT), which is a real estate investment trust. Bankshares, the Bank and the Banks subsidiaries are collectively referred to as the Company. Accordingly, the
information set forth in this report, including financial statements and related data, relates primarily to the Bank and its subsidiaries.

The following
is managements discussion and analysis presented to assist in understanding the Companys financial condition and results of operations. This discussion should be read in conjunction with the consolidated financial statements and
accompanying notes presented in this Annual Report.

Critical Accounting Policies

The preparation of our audited consolidated financial statements and the information included in managements discussion and analysis is governed by policies that are based on accounting principles generally
accepted in the United States of America and general practices within the banking industry. Among the more significant policies are those that govern accounting for allowance for loan losses and goodwill. These policies are discussed in Note 1 of
the Notes to Consolidated Financial Statements included in this Annual Report.

A critical accounting policy is one that is both very important
to the portrayal of the Companys financial condition and results, 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. Estimates and judgments are integral to our accounting for certain items, and those estimates and judgments affect the reported amounts of assets, liabilities, revenues, expenses and related
disclosure of contingent assets and liabilities. The Company periodically evaluates its estimates, including those related to the reserve for loan losses and goodwill. While we base our estimates on historical experience and on various other
assumptions that we believe to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or conditions. Further information regarding the accounting policies that we consider to be critical is
provided below.

Allowance for loan losses. The Companys most significant critical accounting policy is the determination of its allowance for
loan losses. The allowance for loan losses reflects the estimated losses that will result from the inability of our customers to make required payments. The allowance for loan losses is the



---

product of managements evaluation of the risk characteristics of the loan portfolio under current economic conditions and considers such factors as the
financial condition of the borrower, fair market value of collateral and other items that, in our opinion, deserve current recognition in estimating probable credit losses. Our evaluation process is based on historical evidence and current trends
among delinquencies, defaults and nonperforming assets. Our estimate of the allowance for loan losses does not include the impact of events that might occur in the future.

Management considers the established allowance adequate to absorb losses that relate to loans outstanding at December 31, 2005, although future additions to the allowance may be necessary based on changes in
economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require adjustments to the allowance based on
their judgments of information available to them at the time of their examination. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, our estimates would be updated and
additional provisions may be required. For further information on the allowance for loan losses, see Financial Condition in Managements Discussion and Analysis and Note 3 of the Notes to Consolidated Financial
Statements included in this Annual Report.

Goodwill. Goodwill, which represents the excess of the purchase price over the fair value of net
assets acquired in a business combination, is tested at least annually for impairment. The impairment test is a two-step process that begins with a comparison of book value and stock price. If the initial evaluation suggests that an impairment of
the asset value exists, the second step would determine the amount of the impairment, if any. If the tests conclude that goodwill is impaired, the carrying value would be adjusted, and an impairment loss would be recorded.

Management Strategy

Through its offices, the Bank provides a wide
range of banking products, including interest-bearing and noninterest-bearing checking accounts, certificates of deposit, savings accounts and individual retirement accounts. It offers an array of loan products; commercial, consumer, agricultural,
real estate, residential mortgage and home equity loans. Also offered are safe deposit boxes and automated banking services through ATMs and Access24 Phone Banking. The Bank also offers free Online Banking and Bill Pay for personal accounts. In
addition, through the Banks third party partnership with UVEST Financial Services, clients have access to a wide array of financial and wealth management solutions, including services such as professional money management, retirement and
education planning, and investment products including stocks, bonds, mutual funds, annuities and insurance products.

The Banks lending activities
have traditionally concentrated on the origination of loans for the purpose of constructing, financing or refinancing residential properties. In recent years the Bank has placed more emphasis on the origination of nonresidential real estate loans,
equity lines of credit, and secured and unsecured consumer and business loans, growing these portfolios from $118.0 million, $16.0 million, $6.2 million and $14.6 million respectively at December 31, 2003 to $167.7 million, $23.8 million, $7.4
million



---

and $18.2 million respectively at December 31, 2005. As of December 31, 2005 approximately $452.5 million, or 70.1% of the Banks loan
portfolio, which excludes loans held for sale, consisted of loans secured by residential properties as compared to $309.1 million, or 67.9% of the Banks loan portfolio at December 31, 2004. The amount at December 31, 2005 includes
$110.3 million of loans classified as construction and land development as compared to $48.6 million in the prior year. The increase in the percentage of residential properties was primarily due to the increase in residential construction and land
development loans and lot loans. These increases are primarily the result of the growth and economic expansion in the Banks market area. Also contributing to the growth are factors such as, hiring additional loan officers, the opening of new
branches in 2003 and the relocation of a branch in 2005. The Bank originates adjustable rate and fixed rate loans. As of December 31, 2005, adjustable rate and fixed rate loans totaled approximately 63.7% and 36.3%, respectively, of the
Banks total loan portfolio as compared to 66.4% and 33.6% respectively, of the Banks total loan portfolio as of December 31, 2004. The increase in fixed rate commercial loans the Bank was making in 2005 was the primary cause for
this change.

The Bank has chosen to sell a large percentage of its fixed rate mortgage loan originations in the secondary market and through brokered
arrangements. This enables the Bank to invest its funds in commercial loans, while increasing fee income and reducing interest rate risk. In 2005 the Bank sold $7.1 million, as compared to $7.2 million in 2004, in loans in the secondary market where
the Bank retained the servicing of the loans and receives a fee payable monthly of up to 1/4% per annum of the
unpaid balance of each loan. In addition, the Bank sold $7.3 million in the secondary market and $15.8 million through a brokered arrangement where the Bank released the servicing of the loans during 2005. In 2004 the Bank sold $5.0 million in the
secondary market and $9.5 million through a brokered arrangement with servicing released. Lumina sold $141.6 million in the secondary market during 2005 as compared to $159.1 million in 2004.

The growth in the loan portfolio was concentrated in one-to-four family residential loans and real estate-backed commercial loans, including construction and land
development loans. The commercial loans generally involve a higher level of credit risk than one-to-four family residential lending due to the concentration of principal in a limited number of loans and borrowers, the effects of general economic
conditions and the volatility of the collateral. This increased risk, along with the growth in the loan portfolio, were the primary reasons for the increase in the allowance for loan losses over the past several years.

On January 19, 2005, Bankshares declared a 3-for-2 stock split in the form of a 50% stock dividend. This split increased the number of common shares outstanding at
that time to 4,291,115. All references to per share results and weighted average common and common equivalent shares outstanding have been adjusted to reflect the effects of this stock split.

The Bank opened its new Shipyard office on August 1, 2005, which was a relocation of its Wilmington Long Leaf branch. The Bank also opened another Wilmington branch
at Porters Neck on January 3,



---

2006 and in conjunction the Bank closed its Ogden office on December 30, 2005. The Bank began utilizing its new Operations and Training Center in May
2005. This facility will house the Companys computer operations, as well as, a state of the art training center to further enhance the skills of the employees in an effort to better serve our customers. On August 10, 2005, Lumina opened a
mortgage office in Charlotte, North Carolina. Lumina also opened an office in Surf City, North Carolina, a growing coastal community, in February 2005. Bankshares formed Cooperative Bankshares Capital Trust I (the Trust) on
August 30, 2005 for the sole purpose of issuing $15.0 million of trust preferred securities and investing the proceeds from the sale of such trust preferred securities in debentures issued by Bankshares to the Trust. Bankshares owns 100% of the
Trusts outstanding common securities and unconditionally guarantees the Trusts financial obligations. Bankshares issued junior subordinated debentures to the Trust in exchange for the proceeds of the trust preferred issuance. With the
proceeds from the trust preferred offering, Bankshares made a $10.0 million capital contribution to the Bank to fund loan growth and invested $5.0 million in interest earning assets. The debentures held by the Trust are the sole assets of the Trust.
The debentures and the trust preferred securities bear an interest rate of 5.74% for the first five years, and thereafter bear an interest rate equal to 142 basis points over the three-month LIBOR (London Inter-Bank Offered Rate). The trust
preferred securities generally rank equal to the trust common securities in priority of payment, but will rank prior to trust common securities if, and so long as, Bankshares fails to make principal or interest payments on the debentures.
Concurrently with the issuance of the debentures and the trust preferred securities, Bankshares entered into a Guaranty Agreement, dated August 30, 2005, related to the trust preferred securities for the benefit of the holders. The debentures
and trust preferred securities each have 30-year lives and will each be callable by Bankshares or the Trust, at their option, after five years. Bankshares has the option to defer interest for up to five years on the debentures. The debentures
qualify as Tier I capital under Federal Reserve Board guidelines. The Trust is not consolidated in these financial statements in accordance with the provisions of FASB Interpretation No. (FIN) 46, Consolidation of Variable Interest Entities. The
junior subordinated debentures issued by Bankshares to the Trust were included in long-term obligations and Bankshares equity interest in the Trust was included in other assets.

Interest Rate Sensitivity Analysis

Interest rate sensitivity refers to the change in interest spread resulting from
changes in interest rates. To the extent that interest income and interest expense do not respond equally to changes in interest rates, or that all rates do not change uniformly, earnings will be affected. Interest rate sensitivity, at a point in
time, can be analyzed using a static gap analysis that measures the match in balances subject to repricing between interest-earning assets and interest-bearing liabilities. Gap is considered positive when interest rate sensitive assets exceed
interest rate sensitive liabilities. Gap is considered negative when interest rate sensitive liabilities exceed interest rate sensitive assets. At December 31, 2005, the Company had a one-year positive gap position of 6.8%. During a period of
rising interest rates, a positive gap would tend to result in an increase in net interest income, while a negative gap would tend to adversely affect net interest income. During a period of falling interest rates, a positive gap would tend to
adversely affect net interest income while a negative gap would tend to result in an increase in net interest income. It is important to note that certain shortcomings are inherent in static gap analysis. Although



---

certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates.
For example, part of the Companys adjustable-rate mortgage loans are indexed to the National Monthly Median Cost of Funds to SAIF-insured institutions. This index is considered a lagging index that may lag behind changes in market rates.
Experience has shown that the Company sees relatively modest repricing of checking, savings and money market deposit accounts. Management takes this into consideration in determining acceptable levels of interest rate risk.

When Lumina gives a rate lock commitment to a customer, there is a concurrent lock-in for the loan with a secondary market investor under a best efforts
delivery mechanism. Therefore, interest rate risk is mitigated because any commitments to fund loans available for sale are concurrently hedged by a commitment from an investor to purchase the loan under the same terms. Loans are usually sold within
60 days after closing.

The following table indicates the time periods in which interest-earning assets and interest-bearing liabilities will mature or
reprice in accordance with their contractual terms. The table assumes prepayments and scheduled principal amortization of fixed-rate loans, mortgage-backed securities and callable securities and borrowings. The table also assumes that adjustable
rate loans will reprice at contractual repricing intervals and transaction and savings accounts will gradually run off and reprice.

INTEREST RATE
SENSITIVITY ANALYSIS



|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|--------------------------------------------------------------------------- |  | ---------------------- | ------- | - | --------------------------- | - | ------- | --------------------------- |  | - | -------------- | - |  | ----- | ------ | - |  | - | -------
|December 31, 2005                                                           |  | One Year or Less       |         |   | Over One Through Five
Years |   |         | Over Five Through Ten Years |  |   | Over Ten Years |   |  | Total
|                                                                            |  | (Dollars in thousands)
|Interest-earning assets:                                                    |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Securities                                                                  |  | $                      | 8,183   |   |                             | $ | 32,675  |                             |  | $ | 2,136          |   |  | $     | 1,416  |   |  | $ | 44,410 
|Interest-bearing bank balances                                              |  |                        | 5,038   |   |                             |   |        |                             |  |   |               |   |  |       |       |   |  |   | 5,038  
|Federal Home Loan Bank stock                                                |  |                        | 5,829   |   |                             |   |        |                             |  |   |               |   |  |       |       |   |  |   | 5,829  
|All loans                                                                   |  |                        | 461,582 |   |                             |   | 166,727 |                             |  |   | 13,021         |   |  |       | 7,291  |   |  |   | 648,621
|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Total                                                                       |  | $                      | 480,632 |   |                             | $ | 199,402 |                             |  | $ | 15,157         |   |  | $     | 8,707  |   |  | $ | 703,898
|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Interest-bearing liabilities:                                               |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Deposits                                                                    |  | $                      | 373,272 |   |                             | $ | 129,956 |                             |  | $ | 11,620         |   |  | $     |       |   |  | $ | 514,848
|Borrowed funds                                                              |  |                        | 56,805  |   |                             |   | 60,473  |                             |  |   | 8,013          |   |  |       | 53     |   |  |   | 125,344
|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Total                                                                       |  | $                      | 430,077 |   |                             | $ | 190,429 |                             |  | $ | 19,633         |   |  | $     | 53     |   |  | $ | 640,192
|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Interest rate sensitivity gap                                               |  | $                      | 50,555  |   |                             | $ | 8,973   |                             |  | $ | (4,476         | ) |  | $     | 8,654  |   |  | $ | 63,706 
|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Cumulative interest rate sensitivity gap                                    |  | $                      | 50,555  |   |                             | $ | 59,528  |                             |  | $ | 55,052         |   |  | $     | 63,706 |   |  |   |        
|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Cumulative ratio of interest-earning assets to interest-bearing liabilities |  |                        | 111.8   | % |                             |   | 109.6   | %                           |  |   | 108.6          | % |  |       | 110.0  | % |  |   |        
|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        
|Ratio of cumulative gap to total assets                                     |  |                        | 6.8     | % |                             |   | 8.0     | %                           |  |   | 7.4            | % |  |       | 8.5    | % |  |   |        
|                                                                            |  |                        |         |   |                             |   |         |                             |  |   |                |   |  |       |        |   |  |   |        



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Market Risk

The
Companys primary market risk is interest rate risk. Interest rate risk is the result of differing maturities or repricing intervals of interest-earning assets and interest-bearing liabilities and the fact that rates on these financial
instruments do not change uniformly. These conditions may impact the earnings generated by the Companys interest-earning assets or the cost of its interest-bearing liabilities, thus directly impacting the Companys overall earnings. The
Companys management actively monitors and manages interest rate risk. One way this is accomplished is through the development of, and adherence to, the Companys asset/liability policy. This policy sets forth managements strategy
for matching the risk characteristics of the Companys interest-earning assets and interest-bearing liabilities so as to mitigate the effect of changes in the rate environment.

One way to measure the Companys potential exposure to interest rate risk is to estimate the effect of a change in rates on the Companys economic value of equity (EVE). EVE is the net present
value of the Companys portfolio of assets and liabilities. By marking-to-market the components of the balance sheet, management can compute the EVE. As rates change over time, the market values of the Companys assets and liabilities will
change, with longer-term products fluctuating more than short-term products. In most cases, rate-sensitive assets and liabilities will not have the same maturity characteristics. Therefore, as rates vary, the market value of the rate-sensitive
assets will not change equally with the market value of rate-sensitive liabilities. This will cause the EVE to vary. The focus of the EVE is to determine the percentage decline in the net economic value of equity caused by a 1% or 2% increase or
decrease in interest rates, whichever produces the larger decline. A large value indicates a large percentage decline in the EVE due to changes in interest rates and, thus, higher interest rate sensitivity. A low value indicates a small percentage
decline in the EVE due to changes in interest rates and, thus, lower interest rate sensitivity. The results are compared to limits set by the Board of Directors and are monitored to identify unfavorable trends. At December 31, 2005, the
percentage of negative estimated change in EVE decreased in the rising rate environments as compared to the estimated change at December 31, 2004. The percentage of negative estimated change in EVE increased in a declining rate environment from
December 31, 2004 to December 31, 2005. These changes indicate that, as of December 31, 2005, the Company has a lower interest rate sensitivity in a rising rate environment and a higher interest rate sensitivity in a declining rate
environment as compared to December 31, 2004. The following table sets forth information relating to the Companys EVE and the estimated changes under various interest rate change scenarios as of December 31, 2005 and 2004.



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Market Risk Table



|                         |  |                          |  |                    |   |  |                    |  
|------------------------ |  | ------------------------ |  | ------------------ | - |  | ------------------ | -
|(Dollars in thousands)   |  | December 31, 2005        | 
|Change in Interest Rates |  | Economic Value of Equity |  | Estimated $ Change |   |  | Estimated % Change |  
|200 basis point rise     |  | 49,447                   |  | (3,776             | ) |  | -7                 | %
|100 basis point rise     |  | 52,780                   |  | (443               | ) |  | -1                 | %
|Base Scenario            |  | 53,223                   |  |                   |   |  |                   |  
|100 basis point decline  |  | 50,363                   |  | (2,860             | ) |  | -5                 | %
|200 basis point decline  |  | 43,885                   |  | (9,338             | ) |  | -18                | %
|                         | 
|                         |  | December 31, 2004        | 
|Change in Interest Rates |  | Economic Value of Equity |  | Estimated $ Change |   |  | Estimated % Change |  
|200 basis point rise     |  | 43,445                   |  | (7,188             | ) |  | -14                | %
|100 basis point rise     |  | 47,290                   |  | (3,343             | ) |  | -7                 | %
|Base Scenario            |  | 50,633                   |  |                   |   |  |                   |  
|100 basis point decline  |  | 51,521                   |  | 888                |   |  | 2                  | %
|200 basis point decline  |  | 49,939                   |  | (694               | ) |  | -1                 | %

Computation of prospective effects of hypothetical interest rate changes, such as the above computations, are
based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions management
could undertake in response to sudden changes in interest rates.

Liquidity

The Companys goal is to maintain adequate liquidity to meet potential funding needs of loan and deposit customers, pay operating expenses, and meet regulatory liquidity requirements. Maturing securities,
principal repayments of loans and securities, proceeds from loan sales, growth in deposits, income from operations and borrowings are the main sources of liquidity. The Bank has been granted a line of credit by the Federal Home loan Bank of Atlanta
(FHLB) in an amount of up to 25% of the Banks total assets. At December 31, 2005, the Banks borrowed funds from the FHLB equaled 14.1% of its total assets. Scheduled loan repayments are a relatively predictable source of
funds, unlike deposits and loan prepayments that are significantly influenced by general interest rates, economic conditions and competition. Additionally, during 2005 the Company received brokered deposits of $20.7 million and net proceeds of
approximately $15.0 million from an offering of trust preferred securities on August 30, 2005.

At December 31, 2005, the estimated market value
of liquid assets (cash, cash equivalents, marketable securities and loans held for sale) was approximately $73.1 million, representing 10.6% of deposits and borrowed funds as compared to $70.8 million or 14.2% of deposits and borrowed funds at
December 31, 2004. The increase in liquid assets was primarily due to an increase in cash, primarily as a result of the increase in deposits and borrowed funds. The decrease in the liquidity percentage was due to increases



---

in deposits and long-term obligations to fund the increase in loans. Management maintains a portfolio generally consisting of mortgage-backed securities and
securities with short-term maturities (securities that mature within 6 years) and call dates, consistent with the Banks focus on liquidity. Investment securities available for sale are recorded at their fair value, with the unrealized gain or
loss included as a component of stockholders equity, net of deferred taxes.

The Companys securities portfolio consists of U.S. Treasury, U.S.
Government agency, mortgage-backed and other permissible securities including preferred stock from the Federal Home Loan Mortgage Corporation (FHLMC) and a Household Finance Corporation note. Fannie Mae (FNMA) and FHLMC
guarantee the mortgage-backed securities. Mortgage-backed securities entitle the Company to receive a pro rata portion of the cash flows from an identified pool of mortgages. Although mortgage-backed securities generally offer lower yields than the
loans for which they are exchanged, they present substantially lower credit risk by virtue of the guarantees that back them. Mortgage-backed securities are more liquid than individual mortgage loans and may be used to collateralize borrowings or
other obligations of the Company.

The mortgage-backed and related securities owned by the Company are subject to repayment by the mortgagors of the
underlying collateral at any time. These repayments may be affected by a rising or declining interest rate environment. During a rising or declining interest rate environment, repayments and the interest rate caps may subject the Companys
mortgage-backed and related securities to yield and/or price volatility.

The Companys primary uses of liquidity are to fund loans and to purchase
investments. At December 31, 2005, outstanding off-balance sheet commitments to extend credit totaled $71.2 million, and the undisbursed portion of construction loans was $78.4 million. Management considers current liquidity levels adequate to
meet the Companys cash flow requirements; however if the loan portfolio continues to grow as it did in 2005, additional funding sources, such as increased brokered deposits, additional borrowings or loan sales may need to be considered.

Off-Balance Sheet Arrangements

The Company does not
have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on the Companys financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors except as disclosed in Note 3 of Notes To Consolidated Financial Statements.

Contractual Obligations and Commitments

The Bank enters into agreements that obligate it to make future payments under contracts, such as
debt and lease agreements. In addition, the Bank commits to lend funds in the future such as credit lines and loan commitments. Below is a table of such contractual obligations and commitments at December 31, 2005.



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|                                                                                                     |  |                                            |         |                  |   |           |  |           |         |              |   |        |  |   |       
|---------------------------------------------------------------------------------------------------- |  | ------------------------------------------ | ------- | ---------------- | - | --------- |  | --------- | ------- | ------------ | - | ------ |  | - | ------
|(Dollars in thousands)                                                                               |  | Payments Due by Period                    
|Contractual Obligations                                                                              |  | Total                                      |         | Less than 1 year |   | 1-3 years |  | 4-5 years |         | Over 5 years
|Borrowed Funds                                                                                       |  | $                                          | 125,344 |                  | $ | 21,803    |  | $         | 30,000  |              | $ | 40,000 |  | $ | 33,541
|Lease Obligations                                                                                    |  |                                            | 8,766   |                  |   | 665       |  |           | 1,042   |              |   | 960    |  |   | 6,099 
|Deposits                                                                                             |  |                                            | 564,990 |                  |   | 475,626   |  |           | 89,364  |              |   |       |  |   |      
|                                                                                                     |  |                                            |         |                  |   |           |  |           |         |              |   |        |  |   |       
|Total Contractual Cash Obligations                                                                   |  | $                                          | 699,100 |                  | $ | 498,094   |  | $         | 120,406 |              | $ | 40,960 |  | $ | 39,640
|                                                                                                     |  |                                            |         |                  |   |           |  |           |         |              |   |        |  |   |       
|                                                                                                     | 
|                                                                                                     |  | Amount of Commitment Expiration Per Period
|Other Commitments                                                                                    |  | Total Amounts Committed                    |         | Less than 1 year |   | 1-3 years |  | 4-5 years |         | Over 5 years
|Undisbursed portion of home equity collateralized primarily by junior liens on 1-4 family properties |  | $                                          | 40,595  |                  | $ | 411       |  | $         | 19,798  |              | $ | 1,080  |  | $ | 19,306
|Other commitments and credit lines                                                                   |  |                                            | 18,342  |                  |   | 1,902     |  |           | 9,814   |              |   | 64     |  |   | 6,562 
|Undisbursed portion of construction loans                                                            |  |                                            | 78,358  |                  |   | 78,358    |  |           |        |              |   |       |  |   |      
|Available for sale mortgage loan commitments                                                         |  |                                            | 10,806  |                  |   | 10,806    |  |           |        |              |   |       |  |   |      
|Fixed-rate mortgage loan commitments                                                                 |  |                                            | 492     |                  |   | 492       |  |           |        |              |   |       |  |   |      
|Adjustable-rate mortgage loan commitments                                                            |  |                                            | 959     |                  |   | 959       |  |           |        |              |   |       |  |   |      
|                                                                                                     |  |                                            |         |                  |   |           |  |           |         |              |   |        |  |   |       
|Total Commitments                                                                                    |  | $                                          | 149,552 |                  | $ | 92,928    |  | $         | 29,612  |              | $ | 1,144  |  | $ | 25,868
|                                                                                                     |  |                                            |         |                  |   |           |  |           |         |              |   |        |  |   |       

In the normal course of business, the Company may enter into purchase agreements for goods or services. In
managements opinion, the dollar amount of such agreements at December 31, 2005 is immaterial and has not been included in the previous table.

Capital Resources

Stockholders equity at December 31, 2005, was $51.1 million, up $4.2 million, or 8.9%, from $46.9 million at
December 31, 2004. The improved capital position during the year 2005 reflects the impact of earnings retention after the declaration of cash dividends of $861,000 and the proceeds from issuance of 18,723 shares of common stock upon the
exercise of stock options. Stockholders equity at December 31, 2005 includes an unrealized loss net of tax of $462,000 as compared to an unrealized gain net of tax of $68,000 at December 31, 2004, on securities available for sale
marked to estimated fair market value.

Under the capital regulations of the Federal Deposit Insurance Corporation (FDIC), the Bank must
satisfy minimum leverage ratio requirements and risk-based capital requirements. Banks supervised by the FDIC must maintain a minimum leverage ratio of core (Tier I) capital to average adjusted assets ranging from 3% to 5%. At December 31,
2005, the Banks leverage capital ratio was 8.37%. The FDICs risk-based capital rules require banks supervised by the FDIC to maintain risk-based capital to risk-weighted assets of at least 8.00%. Risk-based capital for the Bank is
defined as Tier I capital plus the



---

balance of the allowance for loan losses. At December 31, 2005, the Bank had a ratio of qualifying total capital to risk-weighted assets of 10.85%.

The Company, as a bank holding company, is also subject, on a consolidated basis, to the capital adequacy guidelines of the Board of Governors of the
Federal Reserve (the Federal Reserve Board). The capital requirements of the Federal Reserve Board are similar to those of the FDIC governing the Bank.

As of December 31, 2005, the Company exceeded all of its capital requirements. Management expects the Company to continue to exceed these capital requirements without altering current operations or strategies. If the Bank continues to
grow at a pace similar to the growth in 2005, additional steps may be necessary to augment capital to risk-weighted assets, such as through the additional issuance of trust preferred securities. For further information, see Note 7 of Notes to
Consolidated Financial Statements.

On January 19, 2005, the Company declared a 3-for-2 stock split in the form of a 50% stock dividend, which
was distributed February 24, 2005, to shareholders of record on February 8, 2005. This split increased the number of common shares outstanding to 4,291,115 at the time of distribution.

On November 15, 2005, Bankshares Board of Directors approved a quarterly cash dividend on its common stock of $.05 per share. The dividend was payable
January 17, 2006, to shareholders of record on January 2, 2006. Any future payment of dividends is dependent on the financial condition and capital needs of the Company, requirements of regulatory agencies and economic conditions in the
marketplace.

Related Party Transactions

The Bank has
had, and expects to have in the future, banking transactions in the ordinary course of business with directors, officers and their associates (Related Parties) on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with others. Those transactions neither involve more than normal risk of collectibility, nor present any unfavorable features. The one exception is officers can participate in the Banks
employee loan program which offers a six month adjustable rate that is 1% above the Banks cost of funds rounded up to the next 1/4%. An employee can only have one property at any given time that qualifies for the employee rate program. The interest rate and a reduced origination fee are the only favorable terms. Officers do not receive preferential
treatment in this program over other employees. For further information, see Note 3 of Notes to Consolidated Financial Statements included in this Annual Report and the section captioned Transactions with Management in the
Companys Proxy Statement for its 2006 Annual Meeting of Stockholders.

FINANCIAL CONDITION

The Companys total assets increased 35.7% to $746.3 million at December 31, 2005, as compared to $550.1 million at December 31, 2004. The increase in
assets is primarily the result of an increase of $190.0 million (41.9%) in loans which can be largely attributed to continued economic strength in the



---

markets in which the Company conducts its business and a continued emphasis on increased loan production. These factors also allowed the Bank to attract an
increase in deposits of $150.2 million (36.2%). The majority of the loan growth occurred in construction and land development loans which grew $65.0 million (101.7%), commercial real estate loans which grew $40.1 million (36.9%) and one-to-four
family residential loans which grew $68.9 million (30.3%) during this period. The deposit growth was a result of the economic expansion in the Banks market area, along with the Bank offering competitive promotional rates and cross-selling
deposit products to loan customers. The increase in deposits, retained net income and an increase in long-term obligations of $50.5 million (95.1%) helped fund the loan production and enabled the Bank to reduce its short-term borrowings by
$10.5 million (32.6%) and increase its total cash and cash equivalents by $7.4 million (45.3%). Loans held for sale decreased $2.3 million (32.4%) caused by a reduction in volume from Lumina Mortgage during December 2005, which was a
result of increased mortgage rates and the loss of several loan officers. The decrease in securities of $2.8 million (5.9%) was a result of the payments from mortgage backed securities. Accrued interest receivable increased $1.3 million
(60.4%) due to the increase in loans. The increase in premises and equipment of $1.9 million (22.6%) was primarily the result of building and furnishing two new branches and the operations and training center. Other assets increased $1.8
million (13.4%) largely due to an increase in deferred taxes of $1.4 million which was caused primarily by the provision for loan losses. Accrued expenses and other liabilities increased $1.2 million (46.8%) mainly due to the additional
accrual associated with the state tax audit. The Companys nonperforming assets (nonaccrual loans, accruing loans 90 days or more delinquent and foreclosed real estate) were $58,000, or 0.01% of assets, at December 31, 2005, compared to
$207,000 or 0.04% of assets, at December 31, 2004. The Company assumes an aggressive position in collecting delinquent loans and disposing of foreclosed assets to minimize balances of nonperforming assets and continues to evaluate the loan and
real estate portfolios to provide loss reserves as considered necessary. The change in the loan portfolio, which increases risk, along with the growth in the loan portfolio, were the primary reasons for the increase in the allowance for loan losses
over the past several years. While there can be no guarantee, in the opinion of management, the allowance for loan losses of $6.8 million at December 31, 2005 is adequate to cover probable losses inherent in the loan portfolio. For further
information see Results of Operation-Provision for Loan Losses.

Management considers a variety of factors in establishing the appropriate
levels for the provision and the allowance for loan losses. Consideration is given to, among other things, the impact of current economic conditions, the diversification of the loan portfolio, historical loss experience, the review of loans by loan
review personnel, the individual borrowers financial and managerial strengths and the adequacy of underlying collateral.

The process used to
allocate the allowance for loan losses considers, among other factors, whether the borrower is a mortgage, retail or commercial customer, whether the loan is secured or unsecured, and whether the loan is an open or closed-end agreement. Generally,
loans are reviewed and risk graded among groups of loans with similar characteristics. An independent third party annually reviews our risk grades for appropriateness. The probable loss projections for each risk grade group are the basis for the



---

allowance allocation. The loss estimates are based on prior experience, general risk associated with each loan group and current economic conditions. The
unallocated allowance for loan losses primarily represents the impact of certain conditions and other factors that were not considered in allocating the allowance to the specific components of the loan portfolio.

RESULTS OF OPERATION

The net income of the Company depends primarily
upon net interest income. Net interest income is the difference between the interest earned on loans, securities and interest bearing deposits in other banks offset by the cost of funds, consisting principally of the interest paid on deposits and
borrowings. The Companys operations are materially affected by general economic conditions, the monetary and fiscal policies of the Federal government and the policies of regulatory authorities.

Net Income

Net income increased 17.5% to $5.5 million for 2005, as
compared to $4.7 million for 2004 and $5.4 million in 2003. The following analysis of the Companys results of operations will explain the changes that had an effect on net income for the three years under review.

Interest Income

Interest income amounted to $39.3 million during
2005, an $11.7 million (42.2%) increase from 2004 levels, which decreased $371,000 (1.3%) from 2003 levels. The increase in interest income during 2005 resulted from the average balance of interest-earning assets increasing 25.7% and the
yield increasing 73 basis points as compared to 2004. The increase in loans was the cause of the increase in interest-earning assets. The yield increased due to the increase in short-term market interest rates following the increase in the federal
funds rate by the U.S. Federal Reserve. The Federal Reserves actions continued to cause adjustable rate loans to adjust up and new loans to be made at a higher rate. During 2004, the decrease in interest income was due to the yield on average
interest-earning assets decreasing 35 basis points because of interest rate cuts by the Federal Reserve. The average balance of interest-earning assets increased 5.0% in 2004 as compared to 2003. The yield on average interest-earning assets for the
year 2005 increased to 6.30% as compared to 5.57% for 2004 and 5.92% for 2003.

Interest Expense

Interest expense amounted to $16.2 million during 2005, a $7.0 million (75.5%) increase from 2004 levels, compared to a $1.5 million (13.9%) decrease from 2004
to 2003. The increase in interest expense during 2005 resulted from both growth in and a higher cost of interest-bearing liabilities. During 2005, the average balance of interest-bearing liabilities increased 25.2% and the cost increased 83 basis
points as compared to 2004. The increased cost of interest bearing liabilities was primarily the result of an increase in market interest rates and, to a lesser extent, an increase in the interest rates we are paying on our deposit accounts in order
to attract new deposits and retain existing deposit relationships. In addition, higher priced borrowed funds were used to fund loan growth. During 2004 the decrease in interest expense was due to a 39 basis point drop in the average rate paid
against a 2.3% increase in the average



---

balance of interest-bearing liabilities as compared to 2003. The average cost of interest-bearing liabilities for the year 2005 increased to 2.90% as
compared to 2.07% for 2004 and 2.46% for 2003.

Net Interest Income

Net interest income totaled $23.1 million during 2005, an increase of $4.7 million, or 25.6% over 2004, when net interest income was $18.4 million. During 2004, net interest income increased $1.1 million or 6.4% over
the $17.3 million recorded during 2003. The Average Yield/Cost Analysis table analyzes the interest-earning assets and interest-bearing liabilities for the three years ending December 31, 2005. As stated above, the increase in average yield was
primarily the result of increases in market interest rates. The Rate/Volume Analysis table identifies the causes for changes in interest income and interest expense for 2005 and 2004. The interest rate spread was 3.40% for 2005, compared to 3.50%
for 2004 and 3.47% for 2003. The decrease in 2005 was primarily caused by the cost of interest-bearing liabilities going up 10 basis points more than the yield on interest-earning assets. This can be primarily attributed to the need of the Bank to
generate significant liquidity in order to fund its large loan growth by paying higher rates of return on our deposit accounts in order to attract new deposits and retain existing deposit accounts and on higher cost borrowed funds. The increase in
2004 as compared to 2003 was due to interest-earning assets increasing more than interest-bearing liabilities. In addition, there were larger decreases in the cost of liabilities versus the yield on assets. This can be attributed to the Banks
success in obtaining both low and no cost deposits during 2004 as compared to 2003. The net yield on interest-earning assets was 3.71% for 2005 compared to 3.71% for 2004 and 3.66% for 2003.



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Average Yield/Cost Analysis

The following table contains information relating to the Companys average balance sheets and reflects the average yield on earning assets and average cost of interest-bearing liabilities for the periods indicated. Such yields and
costs are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. The average loan portfolio balances include nonaccrual loans.



|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|------------------------------------------------------------------------------------- |  | ------------------ | ------- | -------- | ----------------- | ----------------- |  | ----------------- | -------------- |  | -------- | ------- | ----------------- | - | ------ | -------------- | ----- | -------- |  | ----------------- | ------- |  | - | ------ |  | ----- | -
|                                                                                      |  | For the year ended |        
|                                                                                      |  | DECEMBER 31, 2005  |         |          | DECEMBER 31, 2004 |                   |  | DECEMBER 31, 2003 |               
|(Dollars in thousands)                                                                |  | AverageBalance     |         | Interest |                   | AverageYield/Cost |  |                   | AverageBalance |  | Interest |         | AverageYield/Cost |   |        | AverageBalance |       | Interest |  | AverageYield/Cost |        
|ASSETS                                                                                |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Interest-earning assets:                                                              |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Interest-bearing deposits in other banks                                              |  | $                  | 4,870   |          | $                 | 172               |  | 3.53              | %              |  | $        | 4,029   |                   | $ | 49     |                | 1.22  | %        |  | $                 | 4,315   |  | $ | 47     |  | 1.09  | %
|Securities:                                                                           |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Available for sale                                                                    |  |                    | 43,628  |          |                   | 1,997             |  | 4.58              | %              |  |          | 46,156  |                   |   | 2,057  |                | 4.46  | %        |  |                   | 40,658  |  |   | 1,868  |  | 4.59  | %
|Held to maturity                                                                      |  |                    | 2,384   |          |                   | 110               |  | 4.61              | %              |  |          | 3,205   |                   |   | 161    |                | 5.02  | %        |  |                   | 6,164   |  |   | 253    |  | 4.10  | %
|FHLB stock                                                                            |  |                    | 5,269   |          |                   | 217               |  | 4.12              | %              |  |          | 4,230   |                   |   | 150    |                | 3.55  | %        |  |                   | 3,855   |  |   | 147    |  | 3.81  | %
|All loans                                                                             |  |                    | 567,114 |          |                   | 36,762            |  | 6.48              | %              |  |          | 438,296 |                   |   | 25,186 |                | 5.75  | %        |  |                   | 417,216 |  |   | 25,660 |  | 6.15  | %
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Total interest-earning assets                                                         |  |                    | 623,265 |          |                   | 39,258            |  | 6.30              | %              |  |          | 495,916 |                   |   | 27,603 |                | 5.57  | %        |  |                   | 472,208 |  |   | 27,975 |  | 5.92  | %
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Noninterest-earning assets                                                            |  |                    | 28,863  |          |                   |                   |  |                   |                |  |          | 27,200  |                   |   |        |                |       |          |  |                   | 30,878  |  |   |        |  |       |  
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Total assets                                                                          |  | $                  | 652,128 |          |                   |                   |  |                   |                |  | $        | 523,116 |                   |   |        |                |       |          |  | $                 | 503,086 |  |   |        |  |       |  
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|LIABILITIES AND                                                                       |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|STOCKHOLDERS EQUITY                                                                  |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Interest-bearing liabilities:                                                         |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Deposits                                                                              |  | $                  | 452,099 |          |                   | 12,002            |  | 2.65              | %              |  | $        | 356,036 |                   |   | 6,426  |                | 1.80  | %        |  | $                 | 343,471 |  |   | 7,291  |  | 2.12  | %
|Borrowed funds                                                                        |  |                    | 105,331 |          |                   | 4,157             |  | 3.95              | %              |  |          | 89,221  |                   |   | 2,779  |                | 3.11  | %        |  |                   | 91,767  |  |   | 3,395  |  | 3.70  | %
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Total interest-bearing liabilities                                                    |  |                    | 557,430 |          |                   | 16,159            |  | 2.90              | %              |  |          | 445,257 |                   |   | 9,205  |                | 2.07  | %        |  |                   | 435,238 |  |   | 10,686 |  | 2.46  | %
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Noninterest-bearing liabilities                                                       |  |                    | 45,913  |          |                   |                   |  |                   |                |  |          | 33,459  |                   |   |        |                |       |          |  |                   | 26,778  |  |   |        |  |       |  
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Total liabilities                                                                     |  |                    | 603,343 |          |                   |                   |  |                   |                |  |          | 478,716 |                   |   |        |                |       |          |  |                   | 462,016 |  |   |        |  |       |  
|Stockholders equity                                                                  |  |                    | 48,785  |          |                   |                   |  |                   |                |  |          | 44,400  |                   |   |        |                |       |          |  |                   | 41,070  |  |   |        |  |       |  
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Total liabilities and stockholders equity                                            |  | $                  | 652,128 |          |                   |                   |  |                   |                |  | $        | 523,116 |                   |   |        |                |       |          |  | $                 | 503,086 |  |   |        |  |       |  
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Net interest income                                                                   |  |                    |         |          | $                 | 23,099            |  |                   |                |  |          |         |                   | $ | 18,398 |                |       |          |  |                   |         |  | $ | 17,289 |  |       |  
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Interest rate spread                                                                  |  |                    |         |          |                   |                   |  | 3.40              | %              |  |          |         |                   |   |        |                | 3.50  | %        |  |                   |         |  |   |        |  | 3.46  | %
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Net yield on interest-earning assets                                                  |  |                    |         |          |                   |                   |  | 3.71              | %              |  |          |         |                   |   |        |                | 3.71  | %        |  |                   |         |  |   |        |  | 3.66  | %
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  
|Percentage of average interest-earning assets to average interest-bearing liabilities |  |                    |         |          |                   |                   |  | 111.8             | %              |  |          |         |                   |   |        |                | 111.4 | %        |  |                   |         |  |   |        |  | 108.5 | %
|                                                                                      |  |                    |         |          |                   |                   |  |                   |                |  |          |         |                   |   |        |                |       |          |  |                   |         |  |   |        |  |       |  



---

Rate/Volume Analysis

The table below provides information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes
attributable to (i) changes in volume (change in volume multiplied by old rate) and (ii) changes in rates (change in rate multiplied by old volume). The changes attributable to changes in rate-volume have been allocated to the other
categories based on relative absolute values.



|                                         |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  
|---------------------------------------- |  | ---------------------------------------------------------------------------------- | ----- | - | ---------------------------------------------------------------------------------- | - | ----- | ----- |  | - | ------ | - |  | ---- | ----- | - | ----- | - | ------ | - |  | - | ------ | -
|                                         |  | For the year endedDecember 31, 2004 vs. December 31, 2005Increase
(Decrease)Due to |       |   | For the year endedDecember 31, 2003 vs. December 31, 2004Increase
(Decrease)Due to |  
|(Dollars in thousands)                   |  | Volume                                                                             |       |   | Rate                                                                               |   |       | Total |  |   | Volume |   |  | Rate |       |   | Total |  
|Interest income:                         |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  
|Interest-bearing deposits in other banks |  | $                                                                                  | 12    |   |                                                                                    | $ | 111   |       |  | $ | 123    |   |  | $    | (4    | ) |       | $ | 6      |   |  | $ | 2      |  
|Securities:                              |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  
|Available for sale                       |  |                                                                                    | (115  | ) |                                                                                    |   | 55    |       |  |   | (60    | ) |  |      | 243   |   |       |   | (54    | ) |  |   | 189    |  
|Held to maturity                         |  |                                                                                    | (39   | ) |                                                                                    |   | (12   | )     |  |   | (51    | ) |  |      | (141  | ) |       |   | 49     |   |  |   | (92    | )
|FHLB stock                               |  |                                                                                    | 41    |   |                                                                                    |   | 26    |       |  |   | 67     |   |  |      | 13    |   |       |   | (10    | ) |  |   | 3      |  
|All loans                                |  |                                                                                    | 8,083 |   |                                                                                    |   | 3,493 |       |  |   | 11,576 |   |  |      | 1,252 |   |       |   | (1,726 | ) |  |   | (474   | )
|                                         |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  
|Total interest-earning assets            |  |                                                                                    | 7,982 |   |                                                                                    |   | 3,673 |       |  |   | 11,655 |   |  |      | 1,363 |   |       |   | (1,735 | ) |  |   | (372   | )
|                                         |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  
|Interest expense:                        |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  
|Deposits                                 |  |                                                                                    | 2,028 |   |                                                                                    |   | 3,548 |       |  |   | 5,576  |   |  |      | 260   |   |       |   | (1,125 | ) |  |   | (865   | )
|Borrowed funds                           |  |                                                                                    | 552   |   |                                                                                    |   | 826   |       |  |   | 1,378  |   |  |      | (92   | ) |       |   | (524   | ) |  |   | (616   | )
|                                         |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  
|Total interest-bearing liabilities       |  |                                                                                    | 2,580 |   |                                                                                    |   | 4,374 |       |  |   | 6,954  |   |  |      | 168   |   |       |   | (1,649 | ) |  |   | (1,481 | )
|                                         |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  
|Net interest income                      |  | $                                                                                  | 5,402 |   |                                                                                    | $ | (701  | )     |  | $ | 4,701  |   |  | $    | 1,195 |   |       | $ | (86    | ) |  | $ | 1,109  |  
|                                         |  |                                                                                    |       |   |                                                                                    |   |       |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |        |  

Provision for Loan Losses

The provision for loan losses charged to operations was $2.5 million during 2005 compared to $970,000 and $740,000 during 2004 and 2003 respectively. We have grown our commercial loan portfolio in recent years and
intend to continue to emphasize these types of lending. These types of loans generally expose a lender to greater risk of nonpayment and loss than one-to-four family residential mortgage loans because repayment of these loans often depends on the
successful operation of the property and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. This
expansion, together with the significant growth in the overall loan portfolio and hurricane related collateral impairment are the primary reasons the provision for loan losses increased in 2005. The growth in the commercial loan portfolio is the
primary cause for the increase in the provision from 2003 to 2004. Non-performing assets at December 31, 2005 were $58,000 compared to $207,000 at December 31, 2004 and $267,000 at December 31, 2003. Net charge-offs for 2005 were
$75,000 compared to $64,000 during 2004 and $230,000 during 2003. At December 31, 2005, the allowance for loan losses was 1.04% of total loans as compared to 0.94% for 2004 and 0.84% for 2003. The allowance for loan losses increased to $6.8
million at December 31, 2005 compared to $4.4 million at December 31, 2004 and $3.4 million at December 31, 2003 due to the provision for loan losses, partially offset by net chargeoffs. Management considers this



---

level to be appropriate based on lending volume, the current level and types of delinquencies and other nonperforming assets, historical charge off patterns,
overall economic conditions and other factors. Future increases to the allowance may be necessary due to changes in loan composition or loan volume, changes in economic or market area conditions and other factors. Additionally, various regulatory
agencies, as an integral part of their examination process, periodically review the Companys allowance for loan losses. Such agencies may require the recognition of adjustments to the allowance for loan losses based on their judgments of
information available to them at the time of their examination.

Noninterest Income

Total noninterest income increased to $5.9 million during 2005, an increase of $764,000 or 14.7% from 2004. This compares to $5.2 million and $6.5 million during 2004 and 2003, respectively. In December 2005 there was
a $428,000 gain realized on the sale of an unoccupied former branch office. There were no similar transactions during 2004 and 2003. Service charges and fees on loans increased to $772,000 (52.6%) in 2005 as compared to $506,000 and $567,000 in
2004 and 2003 respectively. These fluctuations are primarily caused by changes in fees received for loan settlement services on brokered loans. In addition, during 2005 a higher percentage of loans were closed under a brokers agreement versus
selling them in the secondary market which also accounts for some of the reduction in gain on sale of loans to $2.4 million (4.0%) in 2005 from $2.5 million in 2004, which was a reduction from $4.0 million in 2003. The reduction in 2004 can be
primarily attributed to diminished mortgage banking activities caused by lower refinancing volumes. Deposit-related fees increased to $1.8 million (13.3%) in 2005 as compared to $1.6 million and $1.3 million in 2004 and 2003 respectively. These
increases were principally caused by increases in service charges on deposit accounts (including fees for accounts with non-sufficient funds that was initiated in April 2003) and ATM fees resulting from increases in new deposit accounts.
Banked-owned life insurance earnings were $348,000, $317,000 and $370,000 in 2005, 2004 and 2003 respectively. The changes were due to the fluctuation in interest rates earned on the underlying policies. Other income decreased to $190,000
(20.7%) in 2005 versus $240,000 in 2004 and $197,000 in 2003. The majority of other income changes can be attributed to the change in commissions for annuity sales and mutual funds sold through UVEST Investment Services each year.

Noninterest Expense

Total noninterest expense was $17.3 million
during the year 2005, an increase of $1.7 million or 11.0% from 2004. The major increase in noninterest expense during the year 2005 can be attributed to compensation and fringe benefits increasing to $10.4 million (11.3%) in 2005 as compared
to $9.3 million (0.7%) in 2004 and $9.3 million in 2003. In 2005, incentive pay increased due to the growth in the Bank, especially in the loan area. In addition, there were increases due to the rise in the costs of benefits, staffing levels and
normal increases in salaries. In 2004, incentive pay decreased after increasing in 2003 because of the higher refinancing volumes. Other noninterest expense was $2.4 million during 2005, an increase of 17.1% as compared to $2.0 million in 2004 and
$2.1 million in 2003. The majority of the increase in 2005 was due to the accrual of a tax penalty of $219,000 associated with an ongoing state tax audit. The Bank intends to dispute this penalty but believes it was proper to accrue the expense.
There were also increases in ATM-debit card expenses and franchise and sales tax expenses. Occupancy and



---

equipment costs increased 8.8% to $3.6 million in 2005 versus $3.3 million and $2.8 million in 2004 and 2003 respectively. The increase in 2005 was due
primarily to opening the Banks new Operations and Training Center in May 2005 and relocating its Shipyard office on August 1, 2005. In addition, Lumina opened offices in Charlotte and Surf City, North Carolina. The increase in 2004 was
mainly due to the Bank opening four new financial centers since May of 2003. Professional and examination fees decreased to $447,000 (2.9%) as compared to $460,000 and $365,000 in 2004 and 2003 respectively. The increased cost in 2005 and 2004
were due to higher audit and consulting fees. Advertising costs for the year 2005 were $574,000, an increase of 9.2%, as compared to $525,000 in 2004 and $579,000 in 2003.

Income Taxes

The effective tax rate for the years ended December 31, 2005, 2004 and 2003 was 40.6%, 33.4% and
32.4%, respectively. The higher rate in 2005 resulted from the provision for income taxes being increased as a result of an announcement by the state taxing authority with respect to its proposed treatment regarding certain dividends received from
entities such as the real estate investment trust controlled by the Company. While the Company is currently undergoing a state tax audit, it believes that, as of December 31, 2005, it has accrued for the possible effect of the states
announced tax position other than interest that may accrue after December 31, 2005. The Company estimates that its effective tax rate will decrease to approximately 37% in 2006.

Recent Accounting Pronouncements

See Note 1 to the Notes to Consolidated Financial Statements for a full
description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

Note Regarding Forward-Looking Statements

This document, as well as other written communications made from time to time by Cooperative
Bankshares, Inc. and subsidiaries and oral communications made from time to time by authorized officers of the Company, may contain statements relating to the future results of the Company (including certain projections, such as earnings
projections, necessary tax provisions and business trends) that are considered forward looking statements as defined in the Private Securities Litigation Reform Act of 1995 (the PSLRA). Such forward-looking statements may be identified
by the use of such words as intend, believe, expect, should, planned, estimated and potential. For these statements, the Company claims the protection of the safe
harbor for forward-looking statements contained in the PSLRA. The Companys ability to predict future results is inherently uncertain and the Company cautions you that a number of important factors could cause actual results to differ
materially from those currently anticipated in any forward-looking statement. These factors include among others, changes in market interest rates and general and regional economic conditions, changes in government regulations, changes in accounting
principles and the quality or composition of the loan and investment portfolios and other factors that may be described under Item 1A. Risk Factors in the Companys quarterly reports on Form 10-Q and in its annual report on Form
10-K, each filed with the Securities and Exchange Commission,



---

which are available at the Securities and Exchange Commissions Internet website (www.sec.gov) and to which reference is hereby made. These factors
should be considered in evaluating the forward-looking statements. Stockholders are cautioned not to place undue reliance on such statements, which speak only as of the date of those documents. All subsequent written and oral forward-looking
statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. Except to the extent required by applicable law or regulation, the Company does not undertake any
obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made.

SELECTED QUARTERLY DATA

The following table contains selected financial data for the Company on a quarterly basis for the previous eight
quarters.



|                                               |  |                      |         |   |       |   |         |        |  |   |         |   |  |        |         |   |       |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|---------------------------------------------- |  | -------------------- | ------- | - | ----- | - | ------- | ------ |  | - | ------- | - |  | ------ | ------- | - | ----- | - | ------- | ------ |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                               |  | 2005                 |         |   | 2004  |  
|                                               |  | Fourth               |         |   | Third |   |         | Second |  |   | First   |   |  | Fourth |         |   | Third |   |         | Second |  |   | First   |  
|                                               |  | Dollars in Thousands |        
|Selected Quarter-End Balances:                 |  |                      |         |   |       |   |         |        |  |   |         |   |  |        |         |   |       |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Assets                                         |  | $                    | 746,266 |   |       | $ | 715,581 |        |  | $ | 667,080 |   |  | $      | 596,336 |   |       | $ | 550,107 |        |  | $ | 544,696 |   |  | $ | 527,876 |   |  | $ | 518,882 |  
|Loans, net                                     |  |                      | 636,964 |   |       |   | 610,010 |        |  |   | 529,210 |   |  |        | 493,658 |   |       |   | 449,417 |        |  |   | 443,897 |   |  |   | 430,904 |   |  |   | 411,619 |  
|Securities                                     |  |                      | 44,410  |   |       |   | 44,751  |        |  |   | 45,939  |   |  |        | 46,133  |   |       |   | 47,195  |        |  |   | 48,235  |   |  |   | 48,561  |   |  |   | 52,221  |  
|FHLB stock                                     |  |                      | 5,829   |   |       |   | 5,424   |        |  |   | 5,334   |   |  |        | 5,289   |   |       |   | 4,519   |        |  |   | 4,554   |   |  |   | 4,654   |   |  |   | 4,354   |  
|Deposits                                       |  |                      | 564,990 |   |       |   | 542,009 |        |  |   | 512,097 |   |  |        | 441,985 |   |       |   | 414,758 |        |  |   | 399,463 |   |  |   | 380,595 |   |  |   | 376,450 |  
|Borrowed funds                                 |  |                      | 125,344 |   |       |   | 118,962 |        |  |   | 102,398 |   |  |        | 103,365 |   |       |   | 85,426  |        |  |   | 96,503  |   |  |   | 99,445  |   |  |   | 95,135  |  
|Stockholders equity                           |  |                      | 51,096  |   |       |   | 49,929  |        |  |   | 48,966  |   |  |        | 47,480  |   |       |   | 46,910  |        |  |   | 45,802  |   |  |   | 44,391  |   |  |   | 44,227  |  
|                                               | 
|                                               |  | Dollars in Thousands |        
|Selected Operations Data:                      |  |                      |         |   |       |   |         |        |  |   |         |   |  |        |         |   |       |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Interest income                                |  | $                    | 11,608  |   |       | $ | 10,506  |        |  | $ | 9,285   |   |  | $      | 7,859   |   |       | $ | 7,341   |        |  | $ | 7,016   |   |  | $ | 6,693   |   |  | $ | 6,553   |  
|Interest expense                               |  |                      | 5,214   |   |       |   | 4,465   |        |  |   | 3,680   |   |  |        | 2,800   |   |       |   | 2,514   |        |  |   | 2,348   |   |  |   | 2,164   |   |  |   | 2,179   |  
|Net interest income                            |  |                      | 6,394   |   |       |   | 6,041   |        |  |   | 5,605   |   |  |        | 5,059   |   |       |   | 4,827   |        |  |   | 4,668   |   |  |   | 4,529   |   |  |   | 4,374   |  
|Provision for loan losses                      |  |                      | 935     |   |       |   | 575     |        |  |   | 650     |   |  |        | 325     |   |       |   | 225     |        |  |   | 225     |   |  |   | 300     |   |  |   | 220     |  
|Noninterest income                             |  |                      | 1,705   |   |       |   | 1,458   |        |  |   | 1,528   |   |  |        | 1,256   |   |       |   | 1,285   |        |  |   | 1,396   |   |  |   | 1,357   |   |  |   | 1,145   |  
|Noninterest expenses                           |  |                      | 4,563   |   |       |   | 4,364   |        |  |   | 4,224   |   |  |        | 4,151   |   |       |   | 3,846   |        |  |   | 3,916   |   |  |   | 3,924   |   |  |   | 3,900   |  
|Income before income taxes                     |  |                      | 2,601   |   |       |   | 2,560   |        |  |   | 2,259   |   |  |        | 1,839   |   |       |   | 2,041   |        |  |   | 1,923   |   |  |   | 1,662   |   |  |   | 1,399   |  
|Net income                                     |  |                      | 1,457   |   |       |   | 1,506   |        |  |   | 1,391   |   |  |        | 1,148   |   |       |   | 1,353   |        |  |   | 1,286   |   |  |   | 1,124   |   |  |   | 918     |  
|Selected Financial Ratios and Other Data:      |  |                      |         |   |       |   |         |        |  |   |         |   |  |        |         |   |       |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Return on average assets                       |  |                      | 0.80    | % |       |   | 0.88    | %      |  |   | 0.87    | % |  |        | 0.81    | % |       |   | 1.00    | %      |  |   | 0.97    | % |  |   | 0.87    | % |  |   | 0.73    | %
|Return on average equity                       |  |                      | 11.41   | % |       |   | 12.06   | %      |  |   | 11.49   | % |  |        | 10.04   | % |       |   | 11.61   | %      |  |   | 11.38   | % |  |   | 10.03   | % |  |   | 8.98    | %
|Average stockholders equity to average assets |  |                      | 7.05    | % |       |   | 7.30    | %      |  |   | 7.61    | % |  |        | 8.11    | % |       |   | 8.62    | %      |  |   | 8.50    | % |  |   | 8.65    | % |  |   | 8.17    | %
|*Per Share Data:                               |  |                      |         |   |       |   |         |        |  |   |         |   |  |        |         |   |       |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Earnings per:                                  |  |                      |         |   |       |   |         |        |  |   |         |   |  |        |         |   |       |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Common share - basic                           |  | $                    | 0.34    |   |       | $ | 0.35    |        |  | $ | 0.32    |   |  | $      | 0.27    |   |       | $ | 0.32    |        |  | $ | 0.30    |   |  | $ | 0.26    |   |  | $ | 0.21    |  
|Common share - diluted                         |  | $                    | 0.33    |   |       | $ | 0.34    |        |  | $ | 0.32    |   |  | $      | 0.26    |   |       | $ | 0.31    |        |  | $ | 0.30    |   |  | $ | 0.26    |   |  | $ | 0.21    |  
|Cash dividends declared                        |  | $                    | 0.05    |   |       | $ | 0.05    |        |  | $ | 0.05    |   |  | $      | 0.05    |   |       | $ | 0.05    |        |  | $ | 0.05    |   |  | $ | 0.05    |   |  | $ | 0.03    |  
|Book value                                     |  | $                    | 11.87   |   |       | $ | 11.60   |        |  | $ | 11.39   |   |  | $      | 11.06   |   |       | $ | 10.93   |        |  | $ | 10.67   |   |  | $ | 10.34   |   |  | $ | 10.31   |  



|* | Per share data has been adjusted to reflect the effects of a 3-for-2 stock split in the form of a 50% stock dividend declared on January 19, 2005 and distributed on
February 24, 2005.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



---

COOPERATIVE BANKSHARES, INC.

Consolidated Financial Statements

December 31, 2005, 2004 and 2003



---

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors

Cooperative Bankshares, Inc.

We have audited the accompanying consolidated
statements of financial condition of Cooperative Bankshares, Inc. and subsidiary (the Company) as of December 31, 2005 and 2004 and the related consolidated statements of operations, comprehensive income, stockholders equity,
and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Companys
internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cooperative
Bankshares, Inc. and subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with accounting principles
generally accepted in the United States of America.

LOGO

Sanford, North Carolina

March 8, 2006



- 1 -



---

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Financial Condition

December 31, 2005 and 2004



|                                                                                                         |  |      |             |   |      |   |            
|-------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | -----------
|                                                                                                         |  | 2005 |             |   | 2004
|Assets                                                                                                   |  |      |             |   |      |   |            
|Cash and due from banks, noninterest-bearing                                                             |  | $    | 18,784,582  |   |      | $ | 12,031,627 
|Interest-bearing deposits in other banks                                                                 |  |      | 5,037,911   |   |      |   | 4,360,960  
|                                                                                                         |  |      |             |   |      |   |            
|Total cash and cash equivalents                                                                          |  |      | 23,822,493  |   |      |   | 16,392,587 
|Securities:                                                                                              |  |      |             |   |      |   |            
|Available for sale (amortized cost of $43,133,174 in 2005 and $44,432,476 in 2004)                       |  |      | 42,380,655  |   |      |   | 44,535,010 
|Held to maturity (estimated market value of $1,980,533 in 2005 and $2,678,860 in 2004)                   |  |      | 2,029,445   |   |      |   | 2,659,595  
|FHLB stock                                                                                               |  |      | 5,828,800   |   |      |   | 4,518,500  
|Loans held for sale                                                                                      |  |      | 4,893,564   |   |      |   | 7,239,131  
|Loans                                                                                                    |  |      | 643,727,167 |   |      |   | 453,769,733
|Less allowance for loan losses                                                                           |  |      | 6,763,238   |   |      |   | 4,353,227  
|                                                                                                         |  |      |             |   |      |   |            
|Net loans                                                                                                |  |      | 636,963,929 |   |      |   | 449,416,506
|Other real estate owned                                                                                  |  |      | 26,291      |   |      |   |           
|Accrued interest receivable                                                                              |  |      | 3,345,444   |   |      |   | 2,085,164  
|Premises and equipment, net                                                                              |  |      | 10,537,095  |   |      |   | 8,597,015  
|Goodwill                                                                                                 |  |      | 1,461,543   |   |      |   | 1,461,543  
|Other assets                                                                                             |  |      | 14,976,781  |   |      |   | 13,202,393 
|                                                                                                         |  |      |             |   |      |   |            
|Total assets                                                                                             |  | $    | 746,266,040 |   |      | $ | 550,107,444
|                                                                                                         |  |      |             |   |      |   |            
|                                                                                                         |  |     
|Liabilities and Stockholders Equity                                                                     |  |      |             |   |      |   |            
|Deposits                                                                                                 |  | $    | 564,989,604 |   |      | $ | 414,757,904
|Short-term borrowings                                                                                    |  |      | 21,802,964  |   |      |   | 32,342,878 
|Escrow deposits                                                                                          |  |      | 561,120     |   |      |   | 194,408    
|Accrued interest payable                                                                                 |  |      | 417,565     |   |      |   | 190,689    
|Accrued expenses and other liabilities                                                                   |  |      | 3,857,534   |   |      |   | 2,629,188  
|Long-term obligations                                                                                    |  |      | 103,541,295 |   |      |   | 53,082,676 
|                                                                                                         |  |      |             |   |      |   |            
|Total liabilities                                                                                        |  |      | 695,170,082 |   |      |   | 503,197,743
|                                                                                                         |  |      |             |   |      |   |            
|Commitments and contingencies                                                                            |  |      |             |   |      |   |            
|Stockholders equity:                                                                                    |  |      |             |   |      |   |            
|Preferred stock, $1 par value: 3,000,000 shares authorized, no shares issued and outstanding             |  |      |            |   |      |   |           
|Common stock, $1 par value: 14,000,000 shares authorized, 4,305,316 and 2,860,764 issued and outstanding |  |      | 4,305,316   |   |      |   | 2,860,764  
|Additional paid-in capital                                                                               |  |      | 2,734,611   |   |      |   | 2,673,233  
|Accumulated other comprehensive income (loss)                                                            |  |      | (462,423    | ) |      |   | 67,672     
|Retained earnings                                                                                        |  |      | 44,518,454  |   |      |   | 41,308,032 
|                                                                                                         |  |      |             |   |      |   |            
|Total stockholders equity                                                                               |  |      | 51,095,958  |   |      |   | 46,909,701 
|                                                                                                         |  |      |             |   |      |   |            
|Total liabilities and stockholders equity                                                               |  | $    | 746,266,040 |   |      | $ | 550,107,444
|                                                                                                         |  |      |             |   |      |   |            

See accompanying notes to consolidated financial statements.



- 2 -



---

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Operations

Years Ended December 31, 2005, 2004 and 2003



|                                                    |  |      |            |      |   |            |      |  |   |           
|--------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | ---- |  | - | ----------
|                                                    |  | 2005 |            | 2004 |   |            | 2003
|Interest and dividend income:                       |  |      |            |      |   |            |      |  |   |           
|Loans                                               |  | $    | 36,761,753 |      | $ | 25,185,437 |      |  | $ | 25,660,073
|Securities                                          |  |      | 2,107,163  |      |   | 2,218,150  |      |  |   | 2,120,292 
|Other                                               |  |      | 171,612    |      |   | 49,436     |      |  |   | 47,017    
|Dividends on FHLB stock                             |  |      | 217,490    |      |   | 150,172    |      |  |   | 147,184   
|                                                    |  |      |            |      |   |            |      |  |   |           
|Total interest and dividend income                  |  |      | 39,258,018 |      |   | 27,603,195 |      |  |   | 27,974,566
|                                                    |  |      |            |      |   |            |      |  |   |           
|Interest expense:                                   |  |      |            |      |   |            |      |  |   |           
|Deposits                                            |  |      | 12,001,466 |      |   | 6,425,637  |      |  |   | 7,290,985 
|Borrowed funds                                      |  |      | 4,157,410  |      |   | 2,779,271  |      |  |   | 3,394,792 
|                                                    |  |      |            |      |   |            |      |  |   |           
|Total interest expense                              |  |      | 16,158,876 |      |   | 9,204,908  |      |  |   | 10,685,777
|                                                    |  |      |            |      |   |            |      |  |   |           
|Net interest income                                 |  |      | 23,099,142 |      |   | 18,398,287 |      |  |   | 17,288,789
|Provision for loan losses                           |  |      | 2,485,000  |      |   | 970,000    |      |  |   | 740,000   
|                                                    |  |      |            |      |   |            |      |  |   |           
|Net interest income after provision for loan losses |  |      | 20,614,142 |      |   | 17,428,287 |      |  |   | 16,548,789
|                                                    |  |      |            |      |   |            |      |  |   |           
|Noninterest income:                                 |  |      |            |      |   |            |      |  |   |           
|Gain on sale of loans                               |  |      | 2,421,946  |      |   | 2,523,246  |      |  |   | 3,971,046 
|Net gain on sale of securities                      |  |      |           |      |   | 9,600      |      |  |   | 50,663    
|Service charges and fees on loans                   |  |      | 772,001    |      |   | 505,986    |      |  |   | 567,380   
|Deposit-related fees                                |  |      | 1,802,838  |      |   | 1,591,762  |      |  |   | 1,330,370 
|Gain (loss) on disposal of premises and equipment   |  |      | 411,544    |      |   | (4,412     | )    |  |   |          
|Bank-owned life insurance earnings                  |  |      | 348,481    |      |   | 317,377    |      |  |   | 369,996   
|Other income, net                                   |  |      | 190,271    |      |   | 239,969    |      |  |   | 196,942   
|                                                    |  |      |            |      |   |            |      |  |   |           
|Total noninterest income                            |  |      | 5,947,081  |      |   | 5,183,528  |      |  |   | 6,486,397 
|                                                    |  |      |            |      |   |            |      |  |   |           
|Noninterest expenses:                               |  |      |            |      |   |            |      |  |   |           
|Compensation and fringe benefits                    |  |      | 10,371,057 |      |   | 9,322,226  |      |  |   | 9,259,464 
|Occupancy and equipment                             |  |      | 3,550,056  |      |   | 3,262,622  |      |  |   | 2,761,391 
|Professional and examination fees                   |  |      | 446,881    |      |   | 460,084    |      |  |   | 364,522   
|Advertising                                         |  |      | 573,852    |      |   | 525,341    |      |  |   | 579,314   
|Other                                               |  |      | 2,359,965  |      |   | 2,016,063  |      |  |   | 2,076,150 
|                                                    |  |      |            |      |   |            |      |  |   |           
|Total noninterest expenses                          |  |      | 17,301,811 |      |   | 15,586,336 |      |  |   | 15,040,841
|                                                    |  |      |            |      |   |            |      |  |   |           
|Income before income taxes                          |  |      | 9,259,412  |      |   | 7,025,479  |      |  |   | 7,994,345 
|Income tax expense                                  |  |      | 3,757,874  |      |   | 2,344,304  |      |  |   | 2,590,119 
|                                                    |  |      |            |      |   |            |      |  |   |           
|Net income                                          |  | $    | 5,501,538  |      | $ | 4,681,175  |      |  | $ | 5,404,226 
|                                                    |  |      |            |      |   |            |      |  |   |           
|Net income per share:                               |  |      |            |      |   |            |      |  |   |           
|Basic                                               |  | $    | 1.28       |      | $ | 1.09       |      |  | $ | 1.27      
|Diluted                                             |  | $    | 1.26       |      | $ | 1.07       |      |  | $ | 1.24      
|Weighted average common shares outstanding:         |  |      |            |      |   |            |      |  |   |           
|Basic                                               |  |      | 4,298,561  |      |   | 4,289,187  |      |  |   | 4,271,351 
|Diluted                                             |  |      | 4,376,281  |      |   | 4,366,478  |      |  |   | 4,348,361 

See accompanying notes to consolidated financial statements.



- 3 -



---

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Comprehensive Income

Years Ended December 31, 2005, 2004 and 2003



|                                        |  |      |           |   |      |   |           |      |  |   |           |  
|--------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                        |  | 2005 |           |   | 2004 |   |           | 2003 | 
|Net income                              |  | $    | 5,501,538 |   |      | $ | 4,681,175 |      |  | $ | 5,404,226 |  
|                                        |  |      |           |   |      |   |           |      |  |   |           |  
|Other comprehensive income:             |  |      |           |   |      |   |           |      |  |   |           |  
|Unrealized loss arising during the year |  |      | (855,053  | ) |      |   | (320,065  | )    |  |   | (558,941  | )
|Tax effect                              |  |      | 324,958   |   |      |   | 108,822   |      |  |   | 242,130   |  
|Reclassification to realized gain       |  |      |          |   |      |   | (9,600    | )    |  |   | (50,663   | )
|Tax effect                              |  |      |          |   |      |   | 3,264     |      |  |   | 17,225    |  
|                                        |  |      |           |   |      |   |           |      |  |   |           |  
|Other comprehensive loss                |  |      | (530,095  | ) |      |   | (217,579  | )    |  |   | (350,249  | )
|                                        |  |      |           |   |      |   |           |      |  |   |           |  
|Comprehensive income                    |  | $    | 4,971,443 |   |      | $ | 4,463,596 |      |  | $ | 5,053,977 |  
|                                        |  |      |           |   |      |   |           |      |  |   |           |  

See accompanying notes to consolidated financial statements.



- 4 -



---

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Stockholders Equity

Years Ended December 31, 2005, 2004 and 2003



|                                                  |  |                         |           |   |                          |   |           |                                            |  |   |                  |   |  |                          |            |   |  |   |            |  
|------------------------------------------------- |  | ----------------------- | --------- | - | ------------------------ | - | --------- | ------------------------------------------ |  | - | ---------------- | - |  | ------------------------ | ---------- | - |  | - | ---------- | -
|                                                  |  | Commonstock $1 parvalue |           |   | Additionalpaid-incapital |   |           | Accumulatedothercomprehensiveincome (loss) |  |   | Retainedearnings |   |  | Totalstockholdersequity |           
|Balance, December 31, 2002                        |  | $                       | 2,835,947 |   |                          | $ | 2,440,645 |                                            |  | $ | 635,500          |   |  | $                        | 32,536,169 |   |  | $ | 38,448,261 |  
|Exercise of stock options                         |  |                         | 13,500    |   |                          |   | 173,590   |                                            |  |   |                 |   |  |                          |           |   |  |   | 187,090    |  
|Tax benefit of stock options exercised            |  |                         |          |   |                          |   | 23,809    |                                            |  |   |                 |   |  |                          |           |   |  |   | 23,809     |  
|Other comprehensive loss, net of taxes            |  |                         |          |   |                          |   |          |                                            |  |   | (350,249         | ) |  |                          |           |   |  |   | (350,249   | )
|Net income                                        |  |                         |          |   |                          |   |          |                                            |  |   |                 |   |  |                          | 5,404,226  |   |  |   | 5,404,226  |  
|Cash dividends ($.13 per share)                   |  |                         |          |   |                          |   |          |                                            |  |   |                 |   |  |                          | (569,739   | ) |  |   | (569,739   | )
|                                                  |  |                         |           |   |                          |   |           |                                            |  |   |                  |   |  |                          |            |   |  |   |            |  
|Balance, December 31, 2003                        |  |                         | 2,849,447 |   |                          |   | 2,638,044 |                                            |  |   | 285,251          |   |  |                          | 37,370,656 |   |  |   | 43,143,398 |  
|Exercise of stock options                         |  |                         | 14,000    |   |                          |   | 104,625   |                                            |  |   |                 |   |  |                          |           |   |  |   | 118,625    |  
|Stock traded to exercise options (2,683 shares)   |  |                         | (2,683    | ) |                          |   | (69,436   | )                                          |  |   |                 |   |  |                          |           |   |  |   | (72,119    | )
|Other comprehensive loss, net of taxes            |  |                         |          |   |                          |   |          |                                            |  |   | (217,579         | ) |  |                          |           |   |  |   | (217,579   | )
|Net income                                        |  |                         |          |   |                          |   |          |                                            |  |   |                 |   |  |                          | 4,681,175  |   |  |   | 4,681,175  |  
|Cash dividends ($.17 per share)                   |  |                         |          |   |                          |   |          |                                            |  |   |                 |   |  |                          | (743,799   | ) |  |   | (743,799   | )
|                                                  |  |                         |           |   |                          |   |           |                                            |  |   |                  |   |  |                          |            |   |  |   |            |  
|Balance, December 31, 2004                        |  |                         | 2,860,764 |   |                          |   | 2,673,233 |                                            |  |   | 67,672           |   |  |                          | 41,308,032 |   |  |   | 46,909,701 |  
|Exercise of stock options                         |  |                         | 18,723    |   |                          |   | 117,335   |                                            |  |   |                 |   |  |                          |           |   |  |   | 136,058    |  
|Stock traded to exercise options (4,522 shares)   |  |                         | (4,522    | ) |                          |   | (80,944   | )                                          |  |   |                 |   |  |                          |           |   |  |   | (85,466    | )
|Tax benefit of stock options exercised            |  |                         |          |   |                          |   | 24,987    |                                            |  |   |                 |   |  |                          |           |   |  |   | 24,987     |  
|3-for-2 stock split in the form of a 50% dividend |  |                         | 1,430,351 |   |                          |   |          |                                            |  |   |                 |   |  |                          | (1,430,351 | ) |  |   |           |  
|Other comprehensive loss, net of taxes            |  |                         |          |   |                          |   |          |                                            |  |   | (530,095         | ) |  |                          |           |   |  |   | (530,095   | )
|Net income                                        |  |                         |          |   |                          |   |          |                                            |  |   |                 |   |  |                          | 5,501,538  |   |  |   | 5,501,538  |  
|Cash dividends ($.20 per share)                   |  |                         |          |   |                          |   |          |                                            |  |   |                 |   |  |                          | (860,765   | ) |  |   | (860,765   | )
|                                                  |  |                         |           |   |                          |   |           |                                            |  |   |                  |   |  |                          |            |   |  |   |            |  
|Balance, December 31, 2005                        |  | $                       | 4,305,316 |   |                          | $ | 2,734,611 |                                            |  | $ | (462,423         | ) |  | $                        | 44,518,454 |   |  | $ | 51,095,958 |  
|                                                  |  |                         |           |   |                          |   |           |                                            |  |   |                  |   |  |                          |            |   |  |   |            |  

See accompanying notes to consolidated financial statements.



- 5 -



---

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

Years Ended December 31, 2005, 2004 and 2003



|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  
|---------------------------------------------------------------------------------------- |  | ---- | ------------ | - | ---- | - | ------------ | ---- |  | - | ------------ | -
|                                                                                         |  | 2005 |              |   | 2004 |   |              | 2003 | 
|Net income                                                                               |  | $    | 5,501,538    |   |      | $ | 4,681,175    |      |  | $ | 5,404,226    |  
|Adjustments to reconcile net income to net cash provided (used) by operating activities: |  |      |              |   |      |   |              |      |  |   |              |  
|Net accretion and amortization                                                           |  |      | (1,031       | ) |      |   | 37,333       |      |  |   | 395,330      |  
|Depreciation                                                                             |  |      | 992,513      |   |      |   | 941,052      |      |  |   | 880,767      |  
|Net gain on sale of securities                                                           |  |      |             |   |      |   | (9,600       | )    |  |   | (50,663      | )
|Gain on sale of loans                                                                    |  |      | (2,421,946   | ) |      |   | (2,523,246   | )    |  |   | (4,248,884   | )
|Earnings on bank-owned life insurance                                                    |  |      | (348,481     | ) |      |   | (317,377     | )    |  |   | (369,996     | )
|Deferred tax benefit                                                                     |  |      | (1,064,432   | ) |      |   | (384,856     | )    |  |   | (188,149     | )
|(Gain) loss on disposal of premises and equipment                                        |  |      | (411,544     | ) |      |   | 4,412        |      |  |   |             |  
|(Gain) loss on sales of other real estate owned                                          |  |      |             |   |      |   | (6,486       | )    |  |   | 63,890       |  
|Valuation losses on other real estate owned                                              |  |      | 12,886       |   |      |   |             |      |  |   | 8,663        |  
|Provision for loan losses                                                                |  |      | 2,485,000    |   |      |   | 970,000      |      |  |   | 740,000      |  
|Proceeds from sales of loans                                                             |  |      | 158,473,757  |   |      |   | 173,826,604  |      |  |   | 275,871,442  |  
|Loan originations held for sale                                                          |  |      | (153,702,130 | ) |      |   | (172,177,430 | )    |  |   | (252,499,961 | )
|Changes in assets and liabilities:                                                       |  |      |              |   |      |   |              |      |  |   |              |  
|Accrued interest receivable                                                              |  |      | (1,260,280   | ) |      |   | (232,798     | )    |  |   | 387,460      |  
|Other assets                                                                             |  |      | 427,482      |   |      |   | 356,299      |      |  |   | 95,324       |  
|Accrued interest payable                                                                 |  |      | 226,876      |   |      |   | 10,622       |      |  |   | (104,501     | )
|Accrued expenses and other liabilities                                                   |  |      | 1,238,395    |   |      |   | 764,404      |      |  |   | (1,611,639   | )
|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  
|Net cash provided by operating activities                                                |  |      | 10,148,603   |   |      |   | 5,940,108    |      |  |   | 24,773,309   |  
|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  
|Purchases of securities available for sale                                               |  |      | (499,141     | ) |      |   | (20,492,484  | )    |  |   | (26,936,750  | )
|Purchases of securities held to maturity                                                 |  |      |             |   |      |   |             |      |  |   | (2,981,945   | )
|Purchase of Lumina Mortgage Company                                                      |  |      |             |   |      |   | (400,000     | )    |  |   | (400,000     | )
|Proceeds from maturity of securities available for sale                                  |  |      |             |   |      |   | 10,200,000   |      |  |   | 13,900,000   |  
|Proceeds from sale of securities available for sale                                      |  |      |             |   |      |   | 5,000,000    |      |  |   | 1,060,000    |  
|Proceeds from maturities of securities held to maturity                                  |  |      |             |   |      |   |             |      |  |   | 5,000,000    |  
|Repayments of mortgage-backed securities available for sale                              |  |      | 1,799,008    |   |      |   | 4,012,721    |      |  |   | 9,654,231    |  
|Repayments of mortgage-backed securities held to maturity                                |  |      | 630,616      |   |      |   | 1,147,247    |      |  |   | 1,865,872    |  
|Loan originations, net of principal repayments                                           |  |      | (189,573,387 | ) |      |   | (49,096,504  | )    |  |   | (11,364,256  | )
|Proceeds from disposals of foreclosed real estate                                        |  |      | 14,870       |   |      |   | 106,569      |      |  |   | 854,428      |  
|Purchases of premises and equipment                                                      |  |      | (3,073,089   | ) |      |   | (878,981     | )    |  |   | (3,140,041   | )
|Proceeds from sales of premises and equipment                                            |  |      | 42,040       |   |      |   | 2,200        |      |  |   |             |  
|Net expenditures on foreclosed real estate                                               |  |      | (7,196       | ) |      |   | (9,487       | )    |  |   | (8,236       | )
|Purchases of FHLB stock                                                                  |  |      | (8,037,900   | ) |      |   | (7,473,700   | )    |  |   | (2,149,900   | )
|Proceeds from redemption of FHLB stock                                                   |  |      | 6,727,600    |   |      |   | 7,109,600    |      |  |   | 2,050,200    |  
|Investment in unconsolidated trust                                                       |  |      | (464,000     | ) |      |   |             |      |  |   |             |  
|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  
|Net cash used in investing activities                                                    |  |      | (192,440,579 | ) |      |   | (50,772,819  | )    |  |   | (12,596,397  | )
|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  
|Net increase in deposits                                                                 |  |      | 150,231,700  |   |      |   | 47,555,471   |      |  |   | 9,937,859    |  
|Net proceeds (repayments) on short-term borrowings                                       |  |      | (10,539,914  | ) |      |   | (9,073,907   | )    |  |   | (35,169,042  | )
|Repayments on long-term obligations                                                      |  |      | (5,381       | ) |      |   | (5,094       | )    |  |   | (4,822       | )
|Proceeds received on long-term obligations                                               |  |      | 50,464,000   |   |      |   | 5,000,000    |      |  |   | 20,000,000   |  
|Proceeds from issuance of common stock, net                                              |  |      | 50,592       |   |      |   | 46,506       |      |  |   | 187,090      |  
|Dividends paid                                                                           |  |      | (845,827     | ) |      |   | (686,018     | )    |  |   | (569,064     | )
|Net change in escrow deposits                                                            |  |      | 366,712      |   |      |   | (5,025       | )    |  |   | (24,171      | )
|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  
|Net cash provided (used) by financing activities                                         |  |      | 189,721,882  |   |      |   | 42,831,933   |      |  |   | (5,642,150   | )
|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  
|Increase (decrease) in cash and cash equivalents                                         |  |      | 7,429,906    |   |      |   | (2,000,778   | )    |  |   | 6,534,762    |  
|Cash and cash equivalents:                                                               |  |      |              |   |      |   |              |      |  |   |              |  
|Beginning of year                                                                        |  |      | 16,392,587   |   |      |   | 18,393,365   |      |  |   | 11,858,603   |  
|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  
|End of year                                                                              |  | $    | 23,822,493   |   |      | $ | 16,392,587   |      |  | $ | 18,393,365   |  
|                                                                                         |  |      |              |   |      |   |              |      |  |   |              |  

See accompanying notes to consolidated financial statements.



- 6 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(Continued)

Years Ended December 31, 2005, 2004 and 2003



|                                                                         |  |      |            |   |      |   |            |      |  |   |            |  
|------------------------------------------------------------------------ |  | ---- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                         |  | 2005 |            |   | 2004 |   |            | 2003 | 
|Cash paid for:                                                           |  |      |            |   |      |   |            |      |  |   |            |  
|Interest                                                                 |  | $    | 15,872,575 |   |      | $ | 9,194,286  |      |  | $ | 10,790,278 |  
|Income taxes                                                             |  |      | 4,020,015  |   |      |   | 2,310,700  |      |  |   | 3,278,665  |  
|                                                                         |  |      |           
|Summary of noncash investing and financing activities:                   |  |      |            |   |      |   |            |      |  |   |            |  
|Transfer from loans to other real estate owned                           |  |      | 46,851     |   |      |   | 394,660    |      |  |   | 479,462    |  
|Loans to facilitate the sale of foreclosed real estate                   |  |      |           |   |      |   | 301,086    |      |  |   | 72,000     |  
|Unrealized gains (losses) on securities available for sale, net of taxes |  |      | (530,095   | ) |      |   | (217,579   | )    |  |   | (350,249   | )
|Accrual of goodwill for purchase of Lumina Mortgage Company              |  |      |           |   |      |   |           |      |  |   | 400,000    |  
|Long-term obligations reclassified to short-term borrowings              |  |      |           |   |      |   | 10,000,000 |      |  |   | 15,000,000 |  
|Loan to finance sale of branch building                                  |  |      | 510,000    |   |      |   |           |      |  |   |           |  
|Sale and leaseback of premises and equipment:                            |  |      |            |   |      |   |            |      |  |   |            |  
|Increase in other receivable for proceeds on sale                        |  |      |           |   |      |   |           |      |  |   | 733,942    |  
|Deferred gain on sale                                                    |  |      |           |   |      |   |           |      |  |   | 121,147    |  

See accompanying notes to consolidated financial statements.



- 7 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(1) | Basis of Presentation and Significant Accounting Policies
|--- | ---------------------------------------------------------

Basis of Presentation

The consolidated financial statements include the accounts and transactions of Cooperative
Bankshares, Inc. (Bankshares), a bank holding company incorporated under the laws of the State of North Carolina, and its wholly owned subsidiary, Cooperative Bank (the Bank), and the Banks wholly owned subsidiaries, Lumina Mortgage Company,
Inc. (Lumina) and CS&L Holdings, Inc. (Holdings) and Holdings majority owned subsidiary, CS&L Real Estate Trust, Inc. (REIT). Bankshares, the Bank and the Banks subsidiaries are collectively referred to as the Company. All
significant intercompany transactions have been eliminated. The Company formed Cooperative Bankshares Capital Trust I (the Trust) on August 30, 2005, which is wholly owned by the Company to facilitate the issuance of trust preferred
securities totaling $15.0 million. The Trust is not consolidated in these financial statements due to the adoption of FASB Interpretation No. (FIN) 46, Consolidation of Variable Interest Entities. The junior subordinated
debentures issued by the Company to the Trust are included in long-term obligations and the Companys equity interest in the Trust is included in other assets.

Nature of Operations

The Company operates 24 offices (including 20 full service branches) in
North Carolina, North Myrtle Beach, South Carolina, and Virginia Beach, Virginia, and offers a wide range of banking services including deposits, bankcards, and alternative investment products. Funds obtained are used primarily for the extension of
credit through home loans, commercial loans, consumer loans, and other installment credit such as home equity loans, auto and boat loans, and overdraft protection. The Companys primary source of revenue is interest income from its loan and
securities portfolios.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities in the financial statements and accompanying notes. Actual results could differ from those estimates. The
most significant estimates made by the Company in the preparation of the consolidated financial statements are the determination of the reserve for loan losses and fair value estimates.

Effects of Stock Split

On
January 19, 2005, the Company declared a 3-for-2 stock split in the form of a 50% stock dividend. All references to per share results and weighted average common and common equivalent shares outstanding have been adjusted to reflect the effects
of this stock split.

Reclassifications

Certain items included in prior years consolidated financial statements have been reclassified to conform to the current year presentation. These reclassifications have no effect on the net income or
stockholders equity as previously reported.

Significant Accounting Policies

The significant accounting policies of the Company are summarized below:



| | (a) | Cash and Cash Equivalents
| | --- | -------------------------

Cash and cash
equivalents include cash on hand and deposits with original maturities of ninety days or less at other institutions.



- 8 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(1) | Basis of Presentation and Significant Accounting Policies (Continued)
|--- | ---------------------------------------------------------------------



| | (a) | Cash and Cash Equivalents (continued)
| | --- | -------------------------------------



Federal regulations require institutions to set aside specified amounts of cash as reserves against
transaction and time deposits. As of December 31, 2005, the daily average gross reserve requirement was $3,670,000.



| | (b) | Securities
| | --- | ----------

Investments in certain
securities are classified into three categories and accounted for as follows: (1) debt securities that the entity has the positive intent and the ability to hold to maturity are classified as held to maturity and reported at amortized cost;
(2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings;
(3) debt and equity securities not classified as either held to maturity securities or trading securities are classified as available for sale securities and reported at fair value, with unrealized gains and losses excluded from net income and
reported as other comprehensive income and included as a separate component of stockholders equity.

Premiums are amortized and
discounts are accreted using the effective interest method over the remaining terms of the related securities. Gains and losses on the sales of securities are determined using the specific-identification method and are included in noninterest income
at the time of sale.



| | (c) | FHLB Stock
| | --- | ----------

The Company, as a member of the
Federal Home Loan Bank (FHLB) System, is required to maintain an investment in capital stock of the FHLB of Atlanta in an amount equal to the sum of 0.20% of total assets as of December 31, 2004 and 4.50% of its outstanding FHLB advances. No
ready market exists for FHLB stock, and it has no quoted market value. The FHLB stock is carried at cost. Because of the redemption provisions of the FHLB, the fair value of this investment is believed to equal its cost.



| | (d) | Loans Held for Sale
| | --- | -------------------

As a part of its normal
business operations, the Company originates mortgage loans that have been approved by secondary investors. The Company issues a rate lock commitment to a customer and concurrently locks in with a secondary market investor under a best
efforts delivery mechanism. The terms of the loan are set by the secondary investors and are transferred within several weeks of the Company initially funding the loan. The Company receives origination fees from borrowers and servicing release
premiums from the investors that are recognized on the Statement of Operations in the line item gain on sale of loans. Between the initial funding of the loans by the Company and the subsequent purchase by the investor, the Company
carries the loans on its balance sheet at cost, which approximates fair value.



| | (e) | Loans and Allowance for Loan Losses
| | --- | -----------------------------------

Loans
are stated at the amount of unpaid principal, reduced by an allowance for loan losses, unearned discounts and net deferred loan origination fees and costs. Interest income on loans is recorded on the accrual basis based upon the principal amount
outstanding. Deferred loan fees and costs and unearned discounts are amortized to interest income over the contractual life of the loan using the interest method. If a loan is sold, the remaining deferred loan fees and costs are included in gain on
sale of loans in the period the loan is sold.



- 9 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(1) | Basis of Presentation and Significant Accounting Policies (Continued)
|--- | ---------------------------------------------------------------------



| | (e) | Loans and Allowance for Loan Losses (Continued)
| | --- | -----------------------------------------------



The Company evaluates its loan portfolio in accordance with Statement of Financial Accounting
Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan  Income Recognition and Disclosure. Under these
standards, a loan is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan
agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the original contractual interest rate, while all collateral-dependent loans are measured for impairment based on
the fair value of the collateral. Smaller-balance homogeneous loans which consist primarily of residential mortgages and consumer loans are evaluated collectively and reserves are established based on historical loss experience.

The Company uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of
significant loans and lending relationships and the accumulation of related data. This data includes loan payment status, borrowers financial data and borrowers operating factors such as cash flows and operating income or loss.

The allowance for loan losses is established through a provision charged to income. The allowance is an amount that management believes
will be adequate to absorb probable losses on existing loans, based on the evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the
loan portfolio quality, review of specific problem loans, current economic conditions and trends that may affect the borrowers ability to pay. It is possible that such factors in managements evaluations of the adequacy of the allowance
for loan losses will change. Thus, future adjustments to the allowance may be necessary based on the impact of changes in economic conditions.

Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Companys allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments
of information available to them at the time of their examination.



| | (f) | Income Recognition on Impaired and Nonaccrual Loans
| | --- | ---------------------------------------------------

Loans, including impaired loans, are generally classified as nonaccrual if they are past due for a payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection.
Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent cash payments are received.

Loans may be returned to accrual status
when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) by
the borrower, in accordance with the contractual terms of interest and principal.

When the future collectibility of the recorded loan
balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded
loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.



- 10 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(1) | Basis of Presentation and Significant Accounting Policies (Continued)
|--- | ---------------------------------------------------------------------



| | (g) | Transfers and Servicing of Financial Assets
| | --- | -------------------------------------------

Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and foreclosure processing. Loan servicing income is recorded on the cash basis less the amortized
amount for retained servicing rights and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees.



| | (h) | Other Real Estate Owned
| | --- | -----------------------

Other real estate
owned is recorded initially at the lower of the loan balance or estimated fair value of the property less estimated costs to sell at the date of foreclosure and subsequently reduced by additional allowances which are charged to earnings if the
estimated fair value declines below its initial value plus any capitalized costs. Costs related to the improvement of the property are capitalized, whereas those related to holding the property are expensed.



| | (i) | Premises and Equipment
| | --- | ----------------------

Premises and
equipment are carried at cost less accumulated depreciation and amortization. The provision for depreciation is computed using the straight-line method over the estimated useful lives of the various classes of assets. Useful lives range from 15 to
40 years for buildings and 3 to 10 years for furniture and equipment. The cost of leasehold improvements is amortized on the straight-line method over the lesser of the lives of the improvements or the terms of the leases. Repairs and maintenance
are charged to expense as incurred.



| | (j) | Goodwill
| | --- | --------

The Companys recorded
goodwill consists solely of goodwill resulting from the acquisition of Lumina Mortgage Company, Inc. in 2002, which is not amortized but is tested for impairment annually or more often if an event or circumstance indicates that an impairment loss
has been incurred.



| | (k) | Income Taxes
| | --- | ------------

Deferred tax asset and
liability balances are determined by application to temporary differences of the tax rate expected to be in effect when taxes become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and
their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years.



| | (l) | Stock-Based Compensation
| | --- | ------------------------

On January 1,
1996 the Company adopted SFAS No. 123, Accounting for StockBased Compensation. As permitted by SFAS No. 123, the Company has chosen to continue to apply APB Opinion No. 25, Accounting for Stock Issued to
Employees and related interpretations. The option exercise price is the market price of the common stock on the date the option is granted. Accordingly, no compensation cost has been recognized for options granted under the Option Plan. Had
compensation cost for the Companys Option Plan been determined based on the fair value at the grant dates for awards under the Option Plan consistent with the method of SFAS No. 123 as amended by SFAS No. 148, the Companys net
income and net income per share would have been reduced to the pro forma amounts as follows:



- 11 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(1) | Basis of Presentation and Significant Accounting Policies (Continued)
|--- | ---------------------------------------------------------------------



| | (l) | Stock-Based Compensation (Continued)
| | --- | ------------------------------------



|                                                                                                                                            |  |                         |           |   |      |   |           |      |  |   |          
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | --------- | - | ---- | - | --------- | ---- |  | - | ---------
|                                                                                                                                            |  | Year ended December 31,
|                                                                                                                                            |  | 2005                    |           |   | 2004 |   |           | 2003
|Net income, as reported                                                                                                                     |  | $                       | 5,501,538 |   |      | $ | 4,681,175 |      |  | $ | 5,404,226
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                         | (261,841  | ) |      |   | (369,794  | )    |  |   |         
|                                                                                                                                            |  |                         |           |   |      |   |           |      |  |   |          
|Proforma net income                                                                                                                         |  | $                       | 5,239,697 |   |      | $ | 4,311,381 |      |  | $ | 5,404,226
|                                                                                                                                            |  |                         |           |   |      |   |           |      |  |   |          
|Earnings per share:                                                                                                                         |  |                         |           |   |      |   |           |      |  |   |          
|Basic - as reported                                                                                                                         |  | $                       | 1.28      |   |      | $ | 1.09      |      |  | $ | 1.27     
|                                                                                                                                            |  |                         |           |   |      |   |           |      |  |   |          
|Basic - proforma                                                                                                                            |  | $                       | 1.22      |   |      | $ | 1.01      |      |  | $ | 1.27     
|                                                                                                                                            |  |                         |           |   |      |   |           |      |  |   |          
|Diluted - as reported                                                                                                                       |  | $                       | 1.26      |   |      | $ | 1.07      |      |  | $ | 1.24     
|                                                                                                                                            |  |                         |           |   |      |   |           |      |  |   |          
|Diluted - proforma                                                                                                                          |  | $                       | 1.20      |   |      | $ | .99       |      |  | $ | 1.24     
|                                                                                                                                            |  |                         |           |   |      |   |           |      |  |   |          

The fair value of each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for grants in 2005 and 2004. The weighted average fair values of options granted in 2005 and 2004 were $6.91 and $5.88, respectively, after giving effect to the 3-for-2 stock
split discussed in Note 1. No options were granted in 2003.



|                          |  |      |   |  |      |  
|------------------------- |  | ---- | - |  | ---- | -
|                          |  | 2005 |   |  | 2004 |  
|Risk-free interest rate   |  | 4.38 | % |  | 3.90 | %
|Dividend yield            |  | 0.97 | % |  | 1.02 | %
|Expected volatility       |  | 23   | % |  | 24   | %
|Expected lives (in years) |  | 8    |   |  | 8    |  



| | (m) | Comprehensive Income
| | --- | --------------------

The Company reports as
comprehensive income all changes in stockholders equity during the year from nonowner sources. Other comprehensive income refers to all components (revenues, expenses, gains, and losses) of comprehensive income that are excluded from net
income. The Companys only component of accumulated other comprehensive income is unrealized gains and losses on securities available for sale.



| | (n) | Segment Information
| | --- | -------------------

SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information, requires that public business enterprises report certain information about operating segments. It also requires that the public business enterprises report related
disclosures and descriptive information about products and services provided by significant segments, geographic areas, and major customers, differences between the measurements used in reporting segments and those used in the enterprises
general-purpose financial statements, and changes in the measurement of segment amounts from period to period.



- 12 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(1) | Basis of Presentation and Significant Accounting Policies (Continued)
|--- | ---------------------------------------------------------------------



| | (n) | Segment Information (Continued)
| | --- | -------------------------------



The Company has determined that it operates primarily in one operating segment providing general
commercial financial services to customers located in the single geographic area of North Carolina, Southeastern Virginia and Northeastern South Carolina. The various products are those generally offered by community banks, and the allocation of
resources is based on the overall performance of the institution, versus the individual branches or products.



| | (o) | New Accounting Pronouncements
| | --- | -----------------------------

On
December 12, 2003, the American Institute of Certified Public Accountants (AICPA) released Statement of Position (SOP) 03-03, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. This
statement of position addresses accounting for differences between contractual cash flows and cash flows expected to be collected from investors initial investment in loans or debt securities (loans) acquired in a transfer if those differences
are attributable, at least in part, to credit quality. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The adoption of SOP 03-3 on January 1, 2005 did not have a material impact on the
consolidated financial statements.

In November 2003, the Emerging Issues Task Force (EITF) issued EITF Issue
No. 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03- 01). EITF 03-01 provided guidance for evaluating whether an investment is other-than-temporarily impaired and
requires certain disclosures with respect to these investments. In September 2004, the Financial Accounting Standards Board (FASB) issued a FASB Staff Position (FSP EITF 03-1-b) to delay the requirement to record
impairment losses in accordance with EITF 03-01. The guidance also included accounting considerations subsequent to the recognition of an other-than-temporary impairment and requirements for disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1, which addresses the determination as to when an investment is considered impaired. This FSP nullifies certain requirements of EITF
03-01 and supersedes EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. This FSP is to be applied to reporting periods beginning after
December 15, 2005. The Company does not expect the impact of this FSP to have a material effect on its consolidated financial statements.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123(r) (SFAS No. 123(r)), Share-Based Payment, which is a revision of FASB Statement No. 123 Accounting for
Stock-Based Compensation and supersedes APB Opinion No. 25 Accounting for Stock Issued to Employees. SFAS No. 123(r) requires companies to recognize in the income statement the grant-date fair value of stock options and
other equity-based compensation issued to employees over the period during which an employee is required to provide service in exchange for the award, which will often be the shorter of the vesting period or the period the employee will be
retirement eligible. SFAS No. 123(r) sets accounting requirements for share-based compensation to employees, including employee-stock purchase plans (ESPPs). Awards to most nonemployee directors will be accounted for as
employee awards. This Statement was to be effective for public companies that do not file as small business issuers as of the beginning of interim or annual reporting periods beginning after June 15, 2005. In April 2005, the Securities and
Exchange Commission (SEC) issued Release No. 2005-57, which defers the effective date of SFAS No. 123(r) for many registrants. Registrants that do not file as small business users must adopt SFAS No. 123(r) as of the
beginning of their first annual period beginning after June 15, 2005. Accordingly, the Company will adopt SFAS No. 123(r) on January 1, 2006. If we had included the cost of employee stock option compensation in our consolidated
financial statements, our net income for the fiscal years ended December 31, 2005, 2004 and 2003 would have decreased by approximately $262,000, $370,000 and $0, respectively. Accordingly, the adoption of SFAS No. 123(r) may have a
material effect on our consolidated financial statements.



- 13 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(1) | Basis of Presentation and Significant Accounting Policies (Continued)
|--- | ---------------------------------------------------------------------



| | (o) | New Accounting Pronouncements (Continued)
| | --- | -----------------------------------------



In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107),
which contains guidance on applying the requirements in SFAS No. 123(r). SAB 107 provides guidance on valuation techniques, development of assumptions used in valuing employee share options and related MD&A disclosures. SAB 107 is effective
for the period in which SFAS No. 123(r) is adopted. The Company will adopt SAB 107 on January 1, 2006, and is currently evaluating the effect on its consolidated financial statements.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (SFAS No. 154), Accounting Changes and
Error Corrections, which replaces APB Opinion No. 20 Accounting Changes and FASB Statement No. 3 Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements for the
accounting for and reporting of a change in an accounting principle. SFAS No. 154 requires retrospective application for voluntary changes in an accounting principle unless it is impracticable to do so. SFAS No. 154 is effective for
accounting changes made in fiscal years beginning after December 15, 2005. The Company will adopt SFAS No. 154 on January 1, 2006 with no expected material effect on its consolidated financial statements.

From time to time, the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment
from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and
monitors the status of changes to and proposed effective dates of exposure drafts.



|(2) | Securities
|--- | ----------

Securities as of December 31, 2005
and 2004 are summarized as follows:



|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           
|------------------------------------- |  | ------------- | ---------- | -------------------- | - | --------------------- |  | --------------------- | ------- |  | - | ----------
|                                      |  | 2005         
|                                      |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedMarket Value
|Securities available for sale:        |  |               |            |                      |   |                       |  |                       |         |  |   |           
|U.S. Government and agency securities |  | $             | 30,961,725 |                      | $ |                      |  | $                     | 593,358 |  | $ | 30,368,367
|Mortgage-backed securities            |  |               | 5,745,520  |                      |   | 53,809                |  |                       | 173,691 |  |   | 5,625,638 
|Marketable equity securities          |  |               | 4,975,000  |                      |   |                      |  |                       | 39,800  |  |   | 4,935,200 
|Corporate bonds                       |  |               | 1,450,929  |                      |   | 521                   |  |                       |        |  |   | 1,451,450 
|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           
|Total                                 |  | $             | 43,133,174 |                      | $ | 54,330                |  | $                     | 806,849 |  | $ | 42,380,655
|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           
|Securities held to maturity:          |  |               |            |                      |   |                       |  |                       |         |  |   |           
|Mortgage-backed securities            |  | $             | 2,029,445  |                      | $ |                      |  | $                     | 48,912  |  | $ | 1,980,533 
|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           
|Total                                 |  | $             | 2,029,445  |                      | $ |                      |  | $                     | 48,912  |  | $ | 1,980,533 
|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           



- 14 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(2) | Securities (Continued)
|--- | ----------------------



|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           
|------------------------------------- |  | ------------- | ---------- | -------------------- | - | --------------------- |  | --------------------- | ------- |  | - | ----------
|                                      |  | 2004         
|                                      |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedMarket Value
|Securities available for sale:        |  |               |            |                      |   |                       |  |                       |         |  |   |           
|U.S. Government and agency securities |  | $             | 30,455,543 |                      | $ | 76,346                |  | $                     | 18,688  |  | $ | 30,513,201
|Mortgage-backed securities            |  |               | 7,539,850  |                      |   | 136,359               |  |                       | 155,231 |  |   | 7,520,978 
|Marketable equity securities          |  |               | 4,975,000  |                      |   | 26,865                |  |                       |        |  |   | 5,001,865 
|Corporate bonds                       |  |               | 1,462,083  |                      |   | 36,883                |  |                       |        |  |   | 1,498,966 
|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           
|Total                                 |  | $             | 44,432,476 |                      | $ | 276,453               |  | $                     | 173,919 |  | $ | 44,535,010
|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           
|Securities held to maturity:          |  |               |            |                      |   |                       |  |                       |         |  |   |           
|Mortgage-backed securities            |  | $             | 2,659,595  |                      | $ | 19,858                |  | $                     | 593     |  | $ | 2,678,860 
|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           
|Total                                 |  | $             | 2,659,595  |                      | $ | 19,858                |  | $                     | 593     |  | $ | 2,678,860 
|                                      |  |               |            |                      |   |                       |  |                       |         |  |   |           

The following table shows investments gross unrealized losses and fair value, aggregated by
investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2005.



|                                      |  |                     |            |                   |   |           |  |                  |            |           |   |                  |  |   |            |  |   |        
|------------------------------------- |  | ------------------- | ---------- | ----------------- | - | --------- |  | ---------------- | ---------- | --------- | - | ---------------- |  | - | ---------- |  | - | -------
|                                      |  | Less Than 12 Months |            | 12 Months or More |   | Total    
|                                      |  | Fairvalue           |            | Unrealizedlosses  |   | Fairvalue |  | Unrealizedlosses |            | Fairvalue |   | Unrealizedlosses
|Securities available for sale:        |  |                     |            |                   |   |           |  |                  |            |           |   |                  |  |   |            |  |   |        
|U.S. Government and agency securities |  | $                   | 20,098,285 |                   | $ | 363,440   |  | $                | 9,970,082  |           | $ | 229,918          |  | $ | 30,068,367 |  | $ | 593,358
|Mortgage-backed securities            |  |                     | 1,362,132  |                   |   | 31,316    |  |                  | 2,522,307  |           |   | 142,375          |  |   | 3,884,439  |  |   | 173,691
|Marketable equity securities          |  |                     | 4,935,200  |                   |   | 39,800    |  |                  |           |           |   |                 |  |   | 4,935,200  |  |   | 39,800 
|                                      |  |                     |            |                   |   |           |  |                  |            |           |   |                  |  |   |            |  |   |        
|Total                                 |  |                     | 26,395,617 |                   |   | 434,556   |  |                  | 12,492,389 |           |   | 372,293          |  |   | 38,888,006 |  |   | 806,849
|Securities held to maturity:          |  |                     |            |                   |   |           |  |                  |            |           |   |                  |  |   |            |  |   |        
|Mortgage-backed securities            |  |                     | 1,980,533  |                   |   | 48,912    |  |                  |           |           |   |                 |  |   | 1,980,533  |  |   | 48,912 
|                                      |  |                     |            |                   |   |           |  |                  |            |           |   |                  |  |   |            |  |   |        
|Total temporarily impaired securities |  | $                   | 28,376,150 |                   | $ | 483,468   |  | $                | 12,492,389 |           | $ | 372,293          |  | $ | 40,868,539 |  | $ | 855,761
|                                      |  |                     |            |                   |   |           |  |                  |            |           |   |                  |  |   |            |  |   |        

At December 31, 2005, temporarily impaired securities, 12 months or more, consisted of three
U.S. Government and agency securities and one agency backed collateralized mortgage obligation, which do not have premiums associated with them. Therefore, the Company believes the impairment relates to the current interest rate environment and
there is not a permanent impairment. The remaining securities that have an unrealized loss have been impaired for less than 12 months, which includes five U.S. Government and agency securities, three mortgage-backed securities and one marketable
equity security. All of these securities are agency backed and have no premiums. Therefore, the Company believes these impairments are temporary and relate to the current interest rate environment. It is managements opinion that none of the
impairments are permanent.



- 15 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(2) | Securities (Continued)
|--- | ----------------------



The following table shows the investment securities with an unrealized loss, its fair value and the
length of time that the security has been in a continuous unrealized loss position, at December 31, 2004.



|                                      |  |                     |           |                   |   |           |  |                  |           |           |   |                  |  |   |            |  |   |        
|------------------------------------- |  | ------------------- | --------- | ----------------- | - | --------- |  | ---------------- | --------- | --------- | - | ---------------- |  | - | ---------- |  | - | -------
|                                      |  | Less Than 12 Months |           | 12 Months or More |   | Total    
|                                      |  | Fairvalue           |           | Unrealizedlosses  |   | Fairvalue |  | Unrealizedlosses |           | Fairvalue |   | Unrealizedlosses
|Securities available for sale:        |  |                     |           |                   |   |           |  |                  |           |           |   |                  |  |   |            |  |   |        
|U.S. Government and agency securities |  | $                   | 5,481,851 |                   | $ | 18,688    |  | $                |          |           | $ |                 |  | $ | 5,481,851  |  | $ | 18,688 
|Mortgage-backed securities            |  |                     | 1,484,638 |                   |   | 486       |  |                  | 3,324,132 |           |   | 154,745          |  |   | 4,808,770  |  |   | 155,231
|                                      |  |                     |           |                   |   |           |  |                  |           |           |   |                  |  |   |            |  |   |        
|Total                                 |  |                     | 6,966,489 |                   |   | 19,174    |  |                  | 3,324,132 |           |   | 154,745          |  |   | 10,290,621 |  |   | 173,919
|Securities held to maturity:          |  |                     |           |                   |   |           |  |                  |           |           |   |                  |  |   |            |  |   |        
|Mortgage-backed securities            |  |                     | 2,432,619 |                   |   | 593       |  |                  |          |           |   |                 |  |   | 2,432,619  |  |   | 593    
|                                      |  |                     |           |                   |   |           |  |                  |           |           |   |                  |  |   |            |  |   |        
|Total temporarily impaired securities |  | $                   | 9,399,108 |                   | $ | 19,767    |  | $                | 3,324,132 |           | $ | 154,745          |  | $ | 12,723,240 |  | $ | 174,512
|                                      |  |                     |           |                   |   |           |  |                  |           |           |   |                  |  |   |            |  |   |        

The maturities of securities at December 31, 2005 are summarized as follows:



|                             |  |               |            |                       |   |           
|---------------------------- |  | ------------- | ---------- | --------------------- | - | ----------
|                             |  | AmortizedCost |            | EstimatedMarket Value
|Held to maturity:            |  |               |            |                       |   |           
|Mortgage-backed securities   |  | $             | 2,029,445  |                       | $ | 1,980,533 
|                             |  |               |            |                       |   |           
|Available for sale:          |  |               |            |                       |   |           
|Within 1 year                |  | $             | 1,950,929  |                       | $ | 1,949,982 
|After 1 year through 5 years |  |               | 30,461,725 |                       |   | 29,869,835
|Marketable equity securities |  |               | 4,975,000  |                       |   | 4,935,200 
|Mortgage-backed securities   |  |               | 5,745,520  |                       |   | 5,625,638 
|                             |  |               |            |                       |   |           
|                             |  | $             | 43,133,174 |                       | $ | 42,380,655
|                             |  |               |            |                       |   |           

Expected maturities for mortgage-backed securities will differ from contractual maturities because
borrowers have the right to prepay obligations without prepayment penalties.

Sales of investment securities resulted in gross realized
gains of approximately $0, $10,000 and $51,000 in the years ended 2005, 2004 and 2003, respectively.

Investment securities having an
aggregate carrying value of $24,442,000 at December 31, 2005 were pledged to secure public funds on deposit. Investment securities having an aggregate carrying value of $697,000 at December 31, 2005 were pledged to secure repurchase
agreements. Investment securities having an aggregate carrying value of $1,451,000 at December 31, 2005 were pledged to secure the Treasury tax and loan account with the Federal Reserve Bank.



- 16 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(3) | Loans
|--- | -----

Loans at December 31, 2005 and 2004 are
summarized as follows (in thousands):



|                                        |  |      |         |   |      |   |         |  
|--------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                        |  | 2005 |         |   | 2004 |  
|Real estate:                            |  |      |         |   |      |   |         |  
|Construction and land development       |  | $    | 128,943 |   |      | $ | 63,938  |  
|Mortgage:                               |  |      |         |   |      |   |         |  
|1-4 family residential                  |  |      | 296,403 |   |      |   | 227,474 |  
|Multi-family residential                |  |      | 21,998  |   |      |   | 14,534  |  
|Commercial                              |  |      | 148,709 |   |      |   | 108,626 |  
|Equity line                             |  |      | 23,785  |   |      |   | 18,440  |  
|Other                                   |  |      | 355     |   |      |   | 442     |  
|                                        |  |      |         |   |      |   |         |  
|Total real estate loans                 |  |      | 620,193 |   |      |   | 433,454 |  
|Commercial, industrial and agricultural |  |      | 18,237  |   |      |   | 15,164  |  
|Consumer                                |  |      | 7,355   |   |      |   | 6,816   |  
|                                        |  |      |         |   |      |   |         |  
|Total gross loans                       |  |      | 645,785 |   |      |   | 455,434 |  
|Unamortized net deferred fees           |  |      | (2,058  | ) |      |   | (1,664  | )
|                                        |  |      |         |   |      |   |         |  
|Loans                                   |  | $    | 643,727 |   |      | $ | 453,770 |  
|                                        |  |      |         |   |      |   |         |  

In the normal course of business, the Company originates loans to related parties. Related parties
include directors, executive officers, principal shareholders of equity securities, or any associate of such persons. The activity with respect to related party loans is summarized below for the year ending December 31, 2005 (in thousands):



|                             |  |   |        |  
|---------------------------- |  | - | ------ | -
|Balance at beginning of year |  | $ | 9,967  |  
|New loans                    |  |   | 1,858  |  
|Repayments                   |  |   | (2,135 | )
|                             |  |   |        |  
|Balance at end of year       |  | $ | 9,690  |  
|                             |  |   |        |  

Activity in the allowance for loan losses for the years ended December 31, 2005, 2004 and 2003
is summarized as follows (in thousands):



|                             |  |      |       |   |      |   |       |      |  |   |       |  
|---------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                             |  | 2005 |       |   | 2004 |   |       | 2003 | 
|Balance at beginning of year |  | $    | 4,353 |   |      | $ | 3,447 |      |  | $ | 2,937 |  
|Provision for loan losses    |  |      | 2,485 |   |      |   | 970   |      |  |   | 740   |  
|Loans charged-off            |  |      | (84   | ) |      |   | (109  | )    |  |   | (237  | )
|Recoveries                   |  |      | 9     |   |      |   | 45    |      |  |   | 7     |  
|                             |  |      |       |   |      |   |       |      |  |   |       |  
|Balance at end of year       |  | $    | 6,763 |   |      | $ | 4,353 |      |  | $ | 3,447 |  
|                             |  |      |       |   |      |   |       |      |  |   |       |  



- 17 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(3) | Loans (Continued)
|--- | -----------------



The following is a summary of nonperforming assets at December 31, 2005 and 2004 (in thousands):



|                                                   |  |      |    |      |   |    
|-------------------------------------------------- |  | ---- | -- | ---- | - | ---
|                                                   |  | 2005 |    | 2004
|Loans 90 days past due and still accruing interest |  | $    | 9  |      | $ | 112
|Nonaccrual loans                                   |  |      | 23 |      |   | 95 
|                                                   |  |      |    |      |   |    
|Total                                              |  | $    | 32 |      | $ | 207
|                                                   |  |      |    |      |   |    

At December 31, 2005 and 2004, the recorded investment in loans considered impaired in
accordance with SFAS No. 114 totaled approximately $1.3 million and $95,000, respectively, with corresponding valuation allowances of approximately $665,000 and $45,000, respectively. For the years ended December 31, 2005 and 2004 the
average recorded investment in impaired loans was approximately $289,000 and $44,000, respectively. The amount of interest recognized on impaired loans during the portion of the year that they were impaired was not material.

In the normal course of business, the Company enters into off-balance sheet commitments to extend credit. The Company maintains the same credit policies
in making off-balance sheet commitments as it does for its on-balance sheet instruments. Commitments to extend credit are agreements to lend which generally have fixed expiration dates or other termination clauses and may require a fee.

The following table summarizes the Companys outstanding off-balance sheet commitments to extend credit at December 31, 2005 and 2004 (in
thousands):



|                                                                                                                     |  |      |         |      |   |        
|-------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | -------
|                                                                                                                     |  | 2005 |         | 2004
|Undisbursed portion of home equity lines of credit collateralized primarily by junior liens on 1-4 family properties |  | $    | 40,595  |      | $ | 25,903 
|Other commitments and credit lines                                                                                   |  |      | 18,342  |      |   | 19,070 
|Undisbursed portion of construction loans                                                                            |  |      | 78,358  |      |   | 55,322 
|Fixed-rate mortgage loan commitments                                                                                 |  |      | 492     |      |   | 1,161  
|Adjustable-rate mortgage loan commitments                                                                            |  |      | 959     |      |   | 6,040  
|Available-for-sale mortgage loan commitments                                                                         |  |      | 10,806  |      |   | 3,762  
|                                                                                                                     |  |      |         |      |   |        
|Total                                                                                                                |  | $    | 149,552 |      | $ | 111,258
|                                                                                                                     |  |      |         |      |   |        

As commitments may expire unused, the total commitment amount does not necessarily represent future
cash requirements.

The Company, through its normal lending activity, originates and maintains loans which are substantially concentrated in
Eastern North Carolina, where most of its offices are located. The Companys policy calls for collateral or other forms of repayment assurance to be received from the borrower at the time of loan origination. Such collateral or other form of
repayment assurance is subject to changes in economic value due to various factors beyond the control of the Company and such changes could be significant.



- 18 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(3) | Loans (Continued)
|--- | -----------------



Loans serviced for others are not included in the accompanying consolidated balance sheets. The
unpaid principal balances of mortgage and other loans serviced for others were approximately $44.9 million and $44.0 million at December 31, 2005 and 2004, respectively. The carrying value of capitalized servicing rights is included in other
assets. Changes in mortgage servicing rights capitalized for the years ended December 31, 2005 and 2004 are as follows:



|                                                            |  |      |         |      |   |        
|----------------------------------------------------------- |  | ---- | ------- | ---- | - | -------
|                                                            |  | 2005 |         | 2004
|Mortgage servicing rights, beginning of year                |  | $    | 211,778 |      | $ | 201,562
|Mortgage servicing rights capitalized                       |  |      | 63,513  |      |   | 64,498 
|                                                            |  |      |         |      |   |        
|                                                            |  |      | 275,291 |      |   | 266,060
|Accumulated amortization                                    |  |      | 67,628  |      |   | 54,282 
|                                                            |  |      |         |      |   |        
|Mortgage servicing rights, end of year, net of amortization |  | $    | 207,663 |      | $ | 211,778
|                                                            |  |      |         |      |   |        

The Company originates both adjustable and fixed interest rate loans. The adjustable-rate loans
have interest rate adjustment limitations and are indexed to various nationally recognized indexes or financial instruments. Future market factors may affect the correlation of the interest rate adjustment with rates the Company pays on the short
term deposits that have been primarily utilized to fund these loans.



|(4) | Premises and Equipment
|--- | ----------------------

Premises and equipment at
December 31, 2005 and 2004 are summarized as follows (in thousands):



|                                               |  |      |         |   |      |   |        |  
|---------------------------------------------- |  | ---- | ------- | - | ---- | - | ------ | -
|                                               |  | 2005 |         |   | 2004 |  
|Land                                           |  | $    | 2,303   |   |      | $ | 2,386  |  
|Buildings                                      |  |      | 7,508   |   |      |   | 6,685  |  
|Leasehold improvements                         |  |      | 1,090   |   |      |   | 1,083  |  
|Furniture and equipment                        |  |      | 9,877   |   |      |   | 7,981  |  
|                                               |  |      |         |   |      |   |        |  
|                                               |  |      | 20,778  |   |      |   | 18,135 |  
|Less accumulated depreciation and amortization |  |      | (10,241 | ) |      |   | (9,538 | )
|                                               |  |      |         |   |      |   |        |  
|Premises and equipment, net                    |  | $    | 10,537  |   |      | $ | 8,597  |  
|                                               |  |      |         |   |      |   |        |  



|(5) | Deposits
|--- | --------

Deposits at December 31, 2005 and
2004 are summarized as follows (in thousands):



|                              |  |      |         |      |   |        
|----------------------------- |  | ---- | ------- | ---- | - | -------
|                              |  | 2005 |         | 2004
|Demand                        |  | $    | 50,142  |      | $ | 32,560 
|Checking with interest        |  |      | 34,704  |      |   | 28,356 
|Money market accounts         |  |      | 37,036  |      |   | 33,399 
|Savings                       |  |      | 23,363  |      |   | 22,404 
|Time deposits of $100 or more |  |      | 202,618 |      |   | 118,572
|Other time deposits           |  |      | 217,127 |      |   | 179,467
|                              |  |      |         |      |   |        
|Total                         |  | $    | 564,990 |      | $ | 414,758
|                              |  |      |         |      |   |        



- 19 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(5) | Deposits (Continued)
|--- | --------------------



At December 31, 2005, the scheduled maturities of time deposits were (in thousands):



|                    |  |   |        
|------------------- |  | - | -------
|2006                |  | $ | 330,381
|2007                |  |   | 87,710 
|2008                |  |   | 1,654  
|                    |  |   |        
|Total time deposits |  | $ | 419,745
|                    |  |   |        



|(6) | Borrowed Funds
|--- | --------------

Borrowed funds consist of
short-term borrowings and long-term obligations. The corresponding weighted average rates (WAR) at December 31, 2005 and 2004 are summarized as follows (in thousands):



|                                              |  |      |         |     |      |   |      |   |        |  |      |  
|--------------------------------------------- |  | ---- | ------- | --- | ---- | - | ---- | - | ------ |  | ---- | -
|                                              |  | 2005 |         | WAR |      |   | 2004 |   | WAR    | 
|Junior Subordinated Debentures                |  | $    | 15,464  |     | 5.74 | % |      | $ |       |  |     | %
|Advances from FHLB                            |  |      | 105,000 |     | 4.13 | % |      |   | 78,000 |  | 3.21 | %
|Affordable Housing Program advances from FHLB |  |      | 77      |     | 3.50 | % |      |   | 83     |  | 3.50 | %
|Advances for loans held for sale              |  |      | 4,597   |     | 6.81 | % |      |   | 7,178  |  | 4.65 | %
|Repurchase agreements                         |  |      | 206     |     | 3.46 | % |      |   | 165    |  | 1.77 | %
|                                              |  |      |         |     |      |   |      |   |        |  |      |  
|Total                                         |  | $    | 125,344 |     |      |   |      | $ | 85,426 |  |      |  
|                                              |  |      |         |     |      |   |      |   |        |  |      |  

The Trust was formed for the sole purpose of issuing trust preferred securities and investing the
proceeds from the sale of such trust preferred securities in junior subordinated debentures. The debentures held by the Trust are the sole assets of the Trust. The Company owns 100% of the Trusts outstanding common securities and
unconditionally guarantees the Trusts financial obligations. The debentures and the trust preferred securities bear an interest rate of 5.74% for the first five years, and thereafter bear an interest rate equal to 142 basis points over the
three-month LIBOR (London Inter-Bank Offered Rate). The trust preferred securities generally rank equal to the trust common securities in priority of payment, but will rank prior to trust common securities if, and so long as, the Company fails to
make principal or interest payment on the debentures. Concurrently with the issuance of the debentures and the trust preferred securities, the Company entered into a Guaranty Agreement, dated August 30, 2005, related to the trust preferred
securities for the benefit of the holders. The debentures and trust preferred securities each have 30-year lives and will each be callable by the Company or the Trust, at their option, after five years. The Company has the option to defer interest
for up to five years on the debentures. The debentures qualify as Tier I capital under Federal Reserve Board guidelines.



- 20 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(6) | Borrowed Funds (Continued)
|--- | --------------------------



Pursuant to a collateral agreement with the FHLB, advances are collateralized by all the
Companys FHLB stock and qualifying first mortgage loans. The balance of qualifying first mortgage loans as of December 31, 2005 was approximately $180.9 million. This agreement with the FHLB provides for a line of credit up to 25% of the
Banks assets. The maximum month end balances were $105.0 million, $93.0 million and $83.0 million during the years ended December 31, 2005, 2004 and 2003, respectively. Annual principal maturities of Federal Home Loan Bank advances for
the years subsequent to December 31, 2005 are as follows (in thousands):



|     |  |   |        
|---- |  | - | -------
|2006 |  | $ | 17,000 
|2007 |  |   | 10,000 
|2008 |  |   | 20,000 
|2009 |  |   | 20,000 
|2010 |  |   | 20,000 
|2011 |  |   | 8,000  
|2014 |  |   | 5,000  
|2015 |  |   | 5,000  
|     |  |   |        
|     |  | $ | 105,000
|     |  |   |        

The Affordable Housing Program advances are funds advanced by the FHLB for the Company to lend to
borrowers who might not otherwise qualify for a home mortgage. These advances have an interest rate of 3.50% and mature at various times between November 2015 and January 2016.

Lumina borrows money on a short-term basis principally from another financial institution to fund its loans that are held for sale. The balance of this
borrowing was $4.5 million and $7.2 million at December 31, 2005 and 2004, respectively. Borrowings for loans that were funded from this line of credit within 60 days were at a rate of 6.64% and borrowings for loans that were funded more than
60 days ($177,000) were at a rate of 11.25%. This borrowing is collateralized by mortgage loans held for sale. When a loan is sold, the proceeds are used to repay the borrowing. Loans are usually sold within 60 days. This borrowing agreement
provides for a maximum line of credit up to $10 million. On December 16, 2005, Lumina entered into a new borrowing agreement with a different financial institution. The terms are similar to the existing agreement including the credit limit of
$10 million. The new agreement will replace the old agreement and the old agreement will be terminated when all of the existing loans on that line of credit are sold. At December 31, 2005, there was a balance of $61,000 at a rate of 6.39% on
the new agreement.

Cooperative enters into agreements with customers to transfer excess funds in a demand account into a repurchase
agreement. Under the repurchase agreement, the Bank sells the customer an interest in securities that are direct obligations of the United States Government. The customers interest in the underlying security shall be repurchased by the Bank at
the opening of the next banking day. The rate fluctuates weekly and is tiered, with the highest rate being .50% below the 90-day Treasury Bill.



|(7) | Regulatory Matters and Capital Requirements
|--- | -------------------------------------------

Bankshares and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct material effect on the Companys consolidated financial statements. Quantitative measures established by regulation to ensure capital adequacy require Bankshares and
the Bank to maintain minimum amounts and ratios, as set forth in the table below. Management believes, as of December 31, 2005, that both Bankshares and the Bank meet all capital adequacy requirements to which they are subject.



- 21 -



---

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(7) | Regulatory Matters and Capital Requirements (Continued)
|--- | -------------------------------------------------------



As of December 31, 2005 and 2004, the most recent notification from the FDIC categorized the
Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum amounts and ratios, as set forth in the table below. There are no conditions or events since
that notification that management believes have changed the Banks category.

The Banks actual capital amounts and ratios are
also presented in the table below (dollars in thousands) as of December 31:



|                                  |  |      |         |   |      |   |         |                                                  |  |       |      |  |       |  
|--------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ------------------------------------------------ |  | ----- | ---- |  | ----- | -
|                                  |  |      |         |   |      |   |         | Minimum Ratio to MaintainWell-Capitalized Status | 
|                                  |  | 2005 |         |   | 2004 |   |         | 2005                                             |  |       | 2004 | 
|Risk-based capital:               |  |      |         |   |      |   |         |                                                  |  |       |      |  |       |  
|Tier I capital                    |  | $    | 60,510  |   |      | $ | 45,524  |                                                  |  |       |      |  |       |  
|Total capital                     |  |      | 67,273  |   |      |   | 49,877  |                                                  |  |       |      |  |       |  
|Risk-adjusted assets              |  |      | 619,753 |   |      |   | 415,498 |                                                  |  |       |      |  |       |  
|Quarterly average tangible assets |  |      | 722,761 |   |      |   | 539,256 |                                                  |  |       |      |  |       |  
|                                  |  |      |         |  
|Tier I capital ratio              |  |      | 9.76    | % |      |   | 10.96   | %                                                |  | 6.00  | %    |  | 6.00  | %
|Total capital ratio               |  |      | 10.85   | % |      |   | 12.00   | %                                                |  | 10.00 | %    |  | 10.00 | %
|Leverage capital ratio            |  |      | 8.37    | % |      |   | 8.44    | %                                                |  | 5.00  | %    |  | 5.00  | %

During 2005, Bankshares issued $15.5 million in junior subordinated debentures that qualifies as
Tier 1 capital. Of this amount, Bankshares invested $10.0 million in the Bank. As a result of these transactions, the regulatory ratios of Bankshares will be in excess of those for the Bank.

A liquidation account was established at the time of conversion to a stock institution in an amount equal to the total net worth of the Bank as of
March 31, 1991. Each eligible deposit account holder is entitled to a proportionate share of this account in the event of a complete liquidation of the Bank, and only in such an event. This share will be reduced if the account holders
eligible deposits fall below the amount on the date of record and will cease to exist if the account is closed. The liquidation account will never be increased despite any increase after the conversion in the related eligible deposit of an account
holder. The liquidation account was $1.6 million at December 31, 2005.

The Bank may not declare or pay a cash dividend, or repurchase
any of its capital stock, if the effect would cause the regulatory net worth of the Bank to fall below the amount required for the liquidation account established in connection with the conversion, or to an amount which is less than the minimum
required by the FDIC and the North Carolina Office of the Commissioner of Banks.



|(8) | Benefit Plans
|--- | -------------

The Bank participates in a
qualified, noncontributory, defined-benefit, multi-employer retirement plan (the Plan) covering substantially all of its employees. The benefits are based on each employees years of service and the employees compensation during the last
five years of employment.

Under the multi-employer plan, the Bank is required to contribute its share of the Plans total pension
liability as determined by the plan administrator. Expenses related to this Plan were approximately $761,000, $447,000, and $367,000 for the years 2005, 2004 and 2003, respectively.



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(8) | Benefit Plans (Continued)
|--- | -------------------------



The Bank maintains a Supplemental Retirement 401(k) Plan (the 401(k)). Employees are able to
contribute the maximum deferral limit permitted by law. The Bank matches employee contributions up to a limit determined annually by the Board of Directors. The Board established the match at 50% up to the first 6% of the employee contribution for
2005, 2004 and 2003.

The compensation expense incurred by the Bank for the 401(k) was approximately $150,000 $123,000, and $105,000 for the
years ended December 31, 2005, 2004 and 2003, respectively.

Lumina also maintains a 401(k) plan for its employees. Participants are
able to contribute the maximum deferral limit permitted by law. The Company does not match employee contributions.

In 2002, the Bank
implemented a non-qualifying deferred compensation plan for certain key executive officers. The Bank has purchased life insurance policies on the participating officers in order to provide future funding of benefit payments. Benefits for each
officer participating in the plan will accrue and vest during the period of employment, and will be paid in monthly benefit payments over the participants life after retirement. The plan also provides for payment of disability or death
benefits in the event a participating officer becomes permanently disabled or dies prior to attainment of retirement age. If the Bank has a change in control before the officer reaches age 65, the participating officer will be entitled to a benefit.
Provisions of approximately $12,000, $0 and $228,000 were expensed for future benefits to be provided under this plan for the years ended December 31, 2005, 2004 and 2003, respectively. The total liability under this plan was approximately
$365,000 and $352,000 at December 31, 2005 and 2004 and is included in accrued expenses and other liabilities in the accompanying consolidated statements of financial condition.

The Bank has entered into Director Retirement Agreements with each of its non-employee directors. Each Agreement provides for a benefit of $19,200
annually for a period of ten years from retirement on or after reaching the normal retirement age of 72. The Director Retirement Agreements provide for a reduced lump sum payment in the event of termination, including a change of control, with the
amount varying depending on the reason for the termination. In order to fund the benefits payable under the Director Retirement Agreements, the Bank has purchased life insurance policies on each director. The policies are designed to offset the
programs costs during the lifetime of the participant and to provide complete recovery of all the programs costs at their death. Expenses related to these agreements were approximately $55,000, $50,000, and $46,000 for the years ended
2005, 2004 and 2003, respectively. The total liability under these agreements was approximately $203,000 and $148,000 at December 31, 2005 and 2004, respectively.

The Company and Bank have each entered into separate Director Deferred Fee Agreements with each non-employee director. Interest on the amount deferred is credited at a rate of 10%. Commencing one month after
retirement at or after age 72, each director will be entitled to receive the balance in his deferral account in 120 monthly installments. Under these agreements, in the event of a change in control, each director will be entitled to receive, in lump
sum payments, the greater of his deferral account balances or $169,748 under his agreement with the Bank and $77,158 under his agreement with the Company. The expense incurred by the Company and Bank for these agreements was approximately $189,000,
$171,000 and $156,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The total liability under these agreements was approximately $657,000 and $468,000 at December 31, 2005 and 2004, respectively.



- 23 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(9) | Earnings Per Share
|--- | ------------------

On January 19, 2005, the
Company declared a 3-for-2 stock split in the form of a 50% stock dividend. All references to per share results and weighted average common and common equivalent shares outstanding have been adjusted to reflect the effects of the stock split.

The following table provides a reconciliation of income available to common stockholders and the average number of shares outstanding for
the years ended December 31, 2005, 2004 and 2003:



|                                     |  |      |           |      |   |           |  |   |          
|------------------------------------ |  | ---- | --------- | ---- | - | --------- |  | - | ---------
|                                     |  | 2005 |           | 2004 |   | 2003     
|Net income (numerator)               |  | $    | 5,501,538 |      | $ | 4,681,175 |  | $ | 5,404,226
|                                     |  |      |           |      |   |           |  |   |          
|Shares for basic EPS (denominator)   |  |      | 4,298,561 |      |   | 4,289,187 |  |   | 4,271,351
|Dilutive effect of stock options     |  |      | 77,720    |      |   | 77,291    |  |   | 77,010   
|                                     |  |      |           |      |   |           |  |   |          
|Shares for diluted EPS (denominator) |  |      | 4,376,281 |      |   | 4,366,478 |  |   | 4,348,361
|                                     |  |      |           |      |   |           |  |   |          

As of December 31, 2005, 2004 and 2003, there were 46,200, 73,800 and 0, respectively, options
outstanding, after giving effect of the stock split, that were antidilutive since the exercise price exceeds the average market price for the year. These options have been omitted from the calculations of the dilutive effect of stock options.



|(10) | Income Taxes
|---- | ------------

Income tax expense consists of the
following components for the years ended December 31, 2005, 2004 and 2003:



|                                |  |      |            |   |      |   |           |      |  |   |           |  
|------------------------------- |  | ---- | ---------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                |  | 2005 |            |   | 2004 |   |           | 2003 | 
|Current tax expense:            |  |      |            |   |      |   |           |      |  |   |           |  
|Federal                         |  | $    | 3,246,800  |   |      | $ | 2,621,041 |      |  | $ | 2,664,960 |  
|State                           |  |      | 1,575,506  |   |      |   | 108,119   |      |  |   | 113,308   |  
|                                |  |      |            |   |      |   |           |      |  |   |           |  
|Total current tax expense       |  |      | 4,822,306  |   |      |   | 2,729,160 |      |  |   | 2,778,268 |  
|                                |  |      |            |   |      |   |           |      |  |   |           |  
|Deferred tax expense (benefit): |  |      |            |   |      |   |           |      |  |   |           |  
|Federal                         |  |      | (649,182   | ) |      |   | (387,764  | )    |  |   | (191,112  | )
|State                           |  |      | (415,250   | ) |      |   | 2,908     |      |  |   | 2,963     |  
|                                |  |      |            |   |      |   |           |      |  |   |           |  
|Total deferred tax benefit      |  |      | (1,064,432 | ) |      |   | (384,856  | )    |  |   | (188,149  | )
|                                |  |      |            |   |      |   |           |      |  |   |           |  
|Total tax expense               |  | $    | 3,757,874  |   |      | $ | 2,344,304 |      |  | $ | 2,590,119 |  
|                                |  |      |            |   |      |   |           |      |  |   |           |  



- 24 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(10) | Income Taxes (Continued)
|---- | ------------------------



The components of the net deferred tax asset at December 31, 2005 and 2004 are as follows:



|                                                 |  |      |           |   |      |   |           |  
|------------------------------------------------ |  | ---- | --------- | - | ---- | - | --------- | -
|                                                 |  | 2005 |           |   | 2004 |  
|Deferred tax assets:                             |  |      |           |   |      |   |           |  
|Allowance for loan losses                        |  | $    | 2,607,228 |   |      | $ | 1,678,169 |  
|Deferred compensation                            |  |      | 478,455   |   |      |   | 386,214   |  
|Unrealized loss on securities available for sale |  |      | 290,096   |   |      |   |          |  
|Other                                            |  |      | 94        |   |      |   | 817       |  
|                                                 |  |      |           |   |      |   |           |  
|Total gross deferred tax assets                  |  |      | 3,375,873 |   |      |   | 2,065,200 |  
|Valuation allowance                              |  |      |          |   |      |   | (168,023  | )
|                                                 |  |      |           |   |      |   |           |  
|Total net deferred tax assets                    |  |      | 3,375,873 |   |      |   | 1,897,177 |  
|                                                 |  |      |           |   |      |   |           |  
|Deferred tax liabilities:                        |  |      |           |   |      |   |           |  
|Deferred loan fees                               |  |      | (89,294   | ) |      |   | (56,997   | )
|FHLB stock                                       |  |      | (11,107   | ) |      |   | (37,796   | )
|Premises and equipment                           |  |      | (504,925  | ) |      |   | (550,230  | )
|Unrealized gain on securities available for sale |  |      |          |   |      |   | (34,862   | )
|Tax amortization of goodwill                     |  |      | (106,433  | ) |      |   | (62,886   | )
|Prepaid expenses                                 |  |      | (120,319  | ) |      |   |          |  
|                                                 |  |      |           |   |      |   |           |  
|Total gross deferred tax liabilities             |  |      | (832,078  | ) |      |   | (742,771  | )
|                                                 |  |      |           |   |      |   |           |  
|Net deferred tax asset                           |  | $    | 2,543,795 |   |      | $ | 1,154,406 |  
|                                                 |  |      |           |   |      |   |           |  

The Company did away with its valuation allowance at December 31, 2005 because management
determined that realization of all deferred tax assets was more likely than not. For the year ended December 31, 2005, the valuation allowance decreased $168,000.

Reconciliations of income taxes computed at the statutory federal income tax rate (34%) to the provisions for income tax for the years ended December 31, 2005, 2004 and 2003 are as follows:



|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|----------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                      |  | 2005 |           |   | 2004 |   |           | 2003 | 
|Income taxes at federal tax rate                      |  | $    | 3,148,200 |   |      | $ | 2,388,663 |      |  | $ | 2,718,077 |  
|Increase (decrease) resulting from:                   |  |      |           |   |      |   |           |      |  |   |           |  
|State income taxes, net of federal income tax benefit |  |      | 765,769   |   |      |   | 73,278    |      |  |   | 76,739    |  
|Cash surrender value of bank owned life insurance     |  |      | (118,484  | ) |      |   | (107,908  | )    |  |   | (125,799  | )
|Tax exempt securities                                 |  |      | (72,701   | ) |      |   | (72,701   | )    |  |   | (72,701   | )
|Other                                                 |  |      | 35,090    |   |      |   | 62,972    |      |  |   | (6,197    | )
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Total                                                 |  | $    | 3,757,874 |   |      | $ | 2,344,304 |      |  | $ | 2,590,119 |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  

In 2005 the Companys principal state taxing authority undertook to collect additional income
taxes from taxpayers owning such entities as the real estate investment trust controlled by the Company, and in connection therewith, commenced a state income tax examination of the Company for the years 2002 through 2004. In anticipation of
additional state income taxes that will be paid as a result of this examination, the Company accrued additional state income taxes of $641,000 in 2005.



- 25 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(10) | Income Taxes (Continued)
|---- | ------------------------



Retained earnings at December 31, 2005 and 2004 includes approximately $5,170,000 representing
pre-1988 tax bad debt reserve base year amounts for which no deferred income tax liability has been provided since these reserves are not expected to reverse and may never reverse. Circumstances that would require an accrual of a portion or all of
this unrecorded tax liability are a reduction in qualifying loan levels relative to the end of 1987, failure to meet the definition of a bank, dividend payments in excess of accumulated tax earnings and profits, or other distributions, dissolution,
liquidation or redemption of the Banks stock.



|(11) | Stock Option Plan
|---- | -----------------

The Company has a Stock Option
Plan (the Option Plan) for selected employees of the Company and for nonemployee directors. The purpose of the Option Plan is to attract and retain the best available personnel for positions of substantial responsibility and to provide additional
incentive to key employees and directors by facilitating their purchase of a stock interest in the Company.

The Option Plan provides for a
term of ten years, after which no awards may be made, unless earlier terminated by the Board of Directors pursuant to the Option Plan. The option exercise price is the market price of the common stock on the date the option is granted. Options are
fully vested and exercisable upon being granted.

A summary of the status of the Option Plan as of December 31, 2005, 2004 and 2003,
and changes during the years then ended is presented below after giving retroactive effect to the 3-for-2 stock split in the form of a 50% stock dividend in 2005:



|                                       |  |         |   |      |                            |       |        |         |   |                            |   |        |  |         |                            |  |   |     
|-------------------------------------- |  | ------- | - | ---- | -------------------------- | ----- | ------ | ------- | - | -------------------------- | - | ------ |  | ------- | -------------------------- |  | - | ----
|                                       |  | 2005    |   | 2004 |                            | 2003 
|                                       |  | Number  |   |      | Weightedaverageoptionprice |       | Number |         |   | Weightedaverageoptionprice |   | Number |  |         | Weightedaverageoptionprice
|Options outstanding, beginning of year |  | 245,465 |   |      | $                          | 10.69 |        | 192,665 |   |                            | $ | 7.34   |  | 212,915 |                            |  | $ | 7.52
|Granted                                |  | 46,200  |   |      |                            | 20.66 |        | 73,800  |   |                            |   | 17.99  |  |        |                            |  |   |    
|Exercised                              |  | (18,723 | ) |      |                            | 7.27  |        | (21,000 | ) |                            |   | 5.65   |  | (20,250 | )                          |  |   | 9.24
|Forfeited                              |  |        |   |      |                            |      |        |        |   |                            |   |       |  |        |                            |  |   |    
|                                       |  |         |   |      |                            |       |        |         |   |                            |   |        |  |         |                            |  |   |     
|Options outstanding, end of year       |  | 272,942 |   |      | $                          | 12.61 |        | 245,465 |   |                            | $ | 10.69  |  | 192,665 |                            |  | $ | 7.34
|                                       |  |         |   |      |                            |       |        |         |   |                            |   |        |  |         |                            |  |   |     

The following table summarizes additional information about the Option Plan at December 31,
2005:



|               |        |                   |         |                          |             |                   |        
|-------------- | ------ | ----------------- | ------- | ------------------------ | ----------- | ----------------- | -------
|Exercise Price |        | NumberOutstanding |         | RemainingContractualLife |             | NumberExercisable
|$              | 7.000  |                   | 5,636   |                          | 1.25 years  |                   | 5,636  
|               | 7.233  |                   | 25,500  |                          | 6.00 years  |                   | 25,500 
|               | 7.293  |                   | 13,500  |                          | 3.70 years  |                   | 13,500 
|               | 7.333  |                   | 5,250   |                          | 4.00 years  |                   | 5,250  
|               | 7.373  |                   | 84,750  |                          | 3.50 years  |                   | 84,750 
|               | 7.667  |                   | 12,000  |                          | 6.00 years  |                   | 12,000 
|               | 13.000 |                   | 6,306   |                          | 2.00 years  |                   | 6,306  
|               | 17.800 |                   | 6,000   |                          | 8.10 years  |                   | 6,000  
|               | 18.000 |                   | 750     |                          | 1.10 years  |                   | 750    
|               | 18.000 |                   | 67,050  |                          | 9.00 years  |                   | 67,050 
|               | 20.660 |                   | 46,200  |                          | 10.00 years |                   | 46,200 
|               |        |                   |         |                          |             |                   |        
|               |        |                   | 272,942 |                          | 6.33 years  |                   | 272,942
|               |        |                   |         |                          |             |                   |        



- 26 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(12) | Parent Company Financial Information
|---- | ------------------------------------

Condensed
financial information of Cooperative Bankshares, Inc., the parent company, at December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004 and 2003 is presented below:

Condensed Statements of Financial Condition



|                                      |  |      |            |      |   |           
|------------------------------------- |  | ---- | ---------- | ---- | - | ----------
|                                      |  | 2005 |            | 2004
|Assets:                               |  |      |            |      |   |           
|Cash                                  |  | $    | 4,847,089  |      | $ | 1,953     
|Equity investment in subsidiaries     |  |      | 61,973,924 |      |   | 47,054,093
|Other assets                          |  |      | 214,669    |      |   | 200,254   
|                                      |  |      |            |      |   |           
|                                      |  | $    | 67,035,682 |      | $ | 47,256,300
|                                      |  |      |            |      |   |           
|Liabilities and stockholders equity: |  |      |            |      |   |           
|Junior subordinated debt              |  | $    | 15,464,000 |      | $ |          
|Other liabilities                     |  |      | 475,724    |      |   | 346,599   
|Stockholders equity                  |  |      | 51,095,958 |      |   | 46,909,701
|                                      |  |      |            |      |   |           
|                                      |  | $    | 67,035,682 |      | $ | 47,256,300
|                                      |  |      |            |      |   |           

Condensed Statements of Operations



|                                                 |  |      |           |   |      |   |           |      |  |   |           |  
|------------------------------------------------ |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                 |  | 2005 |           |   | 2004 |   |           | 2003 | 
|Dividends from subsidiary                        |  | $    | 864,918   |   |      | $ | 722,293   |      |  | $ | 397,649   |  
|Equity in undistributed net income of subsidiary |  |      | 4,985,403 |   |      |   | 4,037,714 |      |  |   | 5,069,903 |  
|Miscellaneous expenses                           |  |      | (348,783  | ) |      |   | (78,832   | )    |  |   | (63,326   | )
|                                                 |  |      |           |   |      |   |           |      |  |   |           |  
|                                                 |  | $    | 5,501,538 |   |      | $ | 4,681,175 |      |  | $ | 5,404,226 |  
|                                                 |  |      |           |   |      |   |           |      |  |   |           |  

Condensed Statements of Cash Flows



|                                                 |  |      |             |   |      |   |            |      |  |   |            |  
|------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                 |  | 2005 |             |   | 2004 |   |            | 2003 | 
|Operating activities:                            |  |      |             |   |      |   |            |      |  |   |            |  
|Net income                                       |  | $    | 5,501,538   |   |      | $ | 4,681,175  |      |  | $ | 5,404,226  |  
|Equity in undistributed net income of subsidiary |  |      | (4,985,403  | ) |      |   | (4,037,714 | )    |  |   | (5,069,903 | )
|Change in other assets                           |  |      | (14,938     | ) |      |   | (57,781    | )    |  |   | (675       | )
|Change in other liabilities                      |  |      | 139,174     |   |      |   | 53,352     |      |  |   | 48,846     |  
|                                                 |  |      |             |   |      |   |            |      |  |   |            |  
|Net cash provided by operating activities        |  |      | 640,371     |   |      |   | 639,032    |      |  |   | 382,494    |  
|                                                 |  |      |             |   |      |   |            |      |  |   |            |  
|Investing activities:                            |  |      |             |   |      |   |            |      |  |   |            |  
|Investment in Trust                              |  |      | (464,000    | ) |      |   |           |      |  |   |           |  
|Investment in Bank                               |  |      | (10,000,000 | ) |      |   |           |      |  |   |           |  
|                                                 |  |      |             |   |      |   |            |      |  |   |            |  
|Net cash used in investment activities           |  |      | (10,464,000 | ) |      |   |           |      |  |   |           |  
|                                                 |  |      |             |   |      |   |            |      |  |   |            |  
|Financing activities:                            |  |      |             |   |      |   |            |      |  |   |            |  
|Proceeds from issuance of common stock, net      |  |      | 50,592      |   |      |   | 46,506     |      |  |   | 187,090    |  
|Proceeds from long-term obligation               |  |      | 15,464,000  |   |      |   |           |      |  |   |           |  
|Cash dividends paid                              |  |      | (845,827    | ) |      |   | (686,018   | )    |  |   | (569,064   | )
|                                                 |  |      |             |   |      |   |            |      |  |   |            |  
|Net cash provided (used) in financing activities |  |      | 14,668,765  |   |      |   | (639,512   | )    |  |   | (381,974   | )
|                                                 |  |      |             |   |      |   |            |      |  |   |            |  
|Increase (decrease) in cash and cash equivalents |  |      | 4,845,136   |   |      |   | (480       | )    |  |   | 520        |  
|Cash and cash equivalents, beginning of year     |  |      | 1,953       |   |      |   | 2,433      |      |  |   | 1,913      |  
|                                                 |  |      |             |   |      |   |            |      |  |   |            |  
|Cash and cash equivalents, end of year           |  | $    | 4,847,089   |   |      | $ | 1,953      |      |  | $ | 2,433      |  
|                                                 |  |      |             |   |      |   |            |      |  |   |            |  



- 27 -



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(13) | Fair Value of Financial Instruments
|---- | -----------------------------------

The following
disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, Disclosures About Fair Value of Financial Instruments. The estimated fair value amounts have been
determined by the Company using the methods and assumptions described below. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate
that value.

Cash and Cash Equivalents

The carrying amount is a reasonable estimate of fair value.

Securities

For investments in debt securities, fair values are based on quoted market prices or dealer quotes. For other securities, fair value equals quoted market
price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

FHLB Stock

The carrying amount is a reasonable estimate of fair value.

Loans Held for Sale

The
carrying amount is a reasonable estimate of fair value since they will be sold in a short period.

Loans

The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities.

Accrued Interest

The carrying amount is a reasonable estimate of fair value.

Bank-Owned Life Insurance

The carrying value of life insurance approximates fair value
because this investment is carried at cash surrender value, as determined by the insurer.

Deposits

The fair value of NOW, savings, and money market deposit accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity
certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowed Funds

Borrowed funds consist of short-term loans and FHLB borrowings with varying maturities. The fair values of these liabilities are
estimated using the discounted values of the contractual cash flows. The discount rate is estimated using the rates currently in effect for similar borrowings.



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(13) | Fair Value of Financial Instruments (Continued)
|---- | -----------------------------------------------



Off-Balance Sheet Financial Instruments

The fair value of off-balance sheet financial instruments is considered immaterial. As discussed in Note 3, these off-balance sheet financial
instruments are commitments to extend credit and are either short term in nature or subject to immediate repricing.

The carrying amounts
and estimated fair values of the Companys financial instruments at December 31, 2005 and 2004 are as follows (in thousands):



|                            |  |                |         |                     |   |                |  |                     |         |  |   |        
|--------------------------- |  | -------------- | ------- | ------------------- | - | -------------- |  | ------------------- | ------- |  | - | -------
|                            |  | 2005           |         | 2004               
|                            |  | CarryingAmount |         | EstimatedFair Value |   | CarryingAmount |  | EstimatedFair Value
|Financial assets:           |  |                |         |                     |   |                |  |                     |         |  |   |        
|Cash and cash equivalents   |  | $              | 23,822  |                     | $ | 23,822         |  | $                   | 16,393  |  | $ | 16,393 
|Securities:                 |  |                |         |                     |   |                |  |                     |         |  |   |        
|Available for sale          |  |                | 42,381  |                     |   | 42,381         |  |                     | 44,535  |  |   | 44,535 
|Held to maturity            |  |                | 2,029   |                     |   | 1,981          |  |                     | 2,660   |  |   | 2,679  
|Loans held for sale         |  |                | 4,894   |                     |   | 4,894          |  |                     | 7,239   |  |   | 7,239  
|Loans, net                  |  |                | 636,964 |                     |   | 629,227        |  |                     | 449,417 |  |   | 446,466
|FHLB stock                  |  |                | 5,829   |                     |   | 5,829          |  |                     | 4,519   |  |   | 4,519  
|Accrued interest receivable |  |                | 3,345   |                     |   | 3,345          |  |                     | 2,085   |  |   | 2,085  
|Bank-owned life insurance   |  |                | 10,523  |                     |   | 10,523         |  |                     | 10,175  |  |   | 10,175 
|Financial liabilities:      |  |                |         |                     |   |                |  |                     |         |  |   |        
|Deposits                    |  |                | 564,990 |                     |   | 563,337        |  |                     | 414,758 |  |   | 413,838
|Borrowed funds              |  |                | 125,344 |                     |   | 126,244        |  |                     | 85,426  |  |   | 84,855 
|Accrued interest payable    |  |                | 418     |                     |   | 418            |  |                     | 191     |  |   | 191    



|(14) | Asset Sale
|---- | ----------

During December 2005, the Company sold
an unoccupied branch office for $600,000. A gain of $428,000 was realized on the sale.

During December 2003, the Company sold the Ogden
branch for $800,000. A gain of $121,147 was deferred because the Company is now leasing this property and another property, under operating leases, from the purchaser of the Ogden branch. This gain will be recognized as a reduction of rental expense
over the lives of these leases.



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COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

December 31, 2005, 2004 and 2003



|(15) | Leases
|---- | ------

The Company has several noncancelable
operating leases, primarily for office space, that expire over the next twenty years. These leases generally contain renewal options for periods ranging from two to five years and require the Company to pay all executory costs such as maintenance
and insurance. Rental expense for operating leases was approximately $625,000, $544,000 and $312,000 during 2005, 2004 and 2003, respectively.

Future minimum lease payments under noncancelable operating leases as of December 31, 2005 are (in thousands):



|                             |  |   |      
|---------------------------- |  | - | -----
|Year ending December 31:     |  |  
|2006                         |  | $ | 665  
|2007                         |  |   | 560  
|2008                         |  |   | 482  
|2009                         |  |   | 479  
|2010                         |  |   | 481  
|After 2010                   |  |   | 6,099
|                             |  |   |      
|Total minimum lease payments |  | $ | 8,766
|                             |  |   |      



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