# U.S.
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549

# FORM 10-QSB

(Mark One)

| | QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
| | ---------------------------------------------------------------------------------

| | For the Quarterly Period Ended September 30, 2006
| | -------------------------------------------------

| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
| | ----------------------------------------------------------------------------------------

| | For the Transition Period from ___________ to _____________
| | -----------------------------------------------------------

Commission file number
000-51896

COMMUNITYSOUTH BANCSHARES, INC.(Exact name of small business issuer as specified in its charter)

|South Carolina               |  | 20-0934786         
|---------------------------- |  | -------------------
|(State or other jurisdiction |  | (I.R.S. Employer   
|of incorporation)            |  | Identification No.)

6650 Calhoun Memorial HighwayEasley, South Carolina 29640
(Address of principal executive offices, including zip code)

(864) 306-2540(Issuers telephone number, including area code)

______________________________

Check
whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of
the Exchange Act during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days.    Yes       No

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

State
the number of shares outstanding of each of the issuers classes of common equity, as
of the latest practicable date: 3,758,079 shares of common stock, par value $.01 per
share, outstanding as of October 20, 2006.

Transitional Small Business Disclosure Format (check one):     
  Yes          No

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# CommunitySouth
Bancshares, Inc.

# Part I  Financial
Information

# Item 1.   Financial
Statements.

# CONSOLIDATED BALANCE
SHEETS

|                                                            | September 30, 2006 | December 31, 2005
|----------------------------------------------------------- | ------------------ | -----------------
|
|Assets                                                      |                    |                  
|Cash and cash equivalents                                   |                    |                  
|Cash and due from bank                                      |                    |                  
|Federal funds sold                                          |                    |                  
|                                                            |                    |                  
|Total cash and cash equivalents                             |                    |                  
|Other investments, at cost                                  |                    |                  
|Loans, net                                                  |                    |                  
|Accrued interest receivable                                 |                    |                  
|Property and equipment, net                                 |                    |                  
|Other assets                                                |                    |                  
|                                                            |                    |                  
|Total assets                                                |                    |                  
|                                                            |                    |                  
|Liabilities and Shareholders Equity                        |                    |                  
|                                                            |                    |                  
|Liabilities                                                 |                    |                  
|Noninterest bearing deposits                                |                    |                  
|Interest bearing deposits                                   |                    |                  
|                                                            |                    |                  
|Total deposits                                              |                    |                  
|Accrued expense                                             |                    |                  
|Accrued interest payable                                    |                    |                  
|Other liabilities                                           |                    |                  
|                                                            |                    |                  
|Total liabilities                                           |                    |                  
|                                                            |                    |                  
|Shareholders Equity                                        |                    |                  
|Preferred stock, par value $.01 per share                   |                    |                  
|10,000,000 shares authorized, no shares issued              |                    |                  
|Common stock, par value $.01 per share                      |                    |                  
|10,000,000 shares authorized 3,758,079 and 3,744,855 issued |                    |                  
|and outstanding at September 30, 2006 and                   |                    |                  
|December 31, 2005, respectively                             |                    |                  
|Additional paid-in capital                                  |                    |                  
|Retained deficit                                            |                    |                  
|                                                            |                    |                  
|Total shareholders' equity                                  |                    |                  
|                                                            |                    |                  
|Total liabilities and shareholders' equity                  |                    |                  
|                                                            |                    |                  

# See notes to
consolidated financial statements.

2

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# CommunitySouth
Bancshares, Inc.

# CONSOLIDATED
STATEMENTS OF OPERATIONS (UNAUDITED)

|                                                    | Three months ended | Three months ended
|--------------------------------------------------- | ------------------ | ------------------
|
|Interest income                                     |                    |                   
|Interest and dividends on investments               |                    |                   
|Interest and fees on loans                          |                    |                   
|                                                    |                    |                   
|Total interest income                               |                    |                   
|                                                    |                    |                   
|Interest expense - deposits                         |                    |                   
|                                                    |                    |                   
|Net interest income                                 |                    |                   
|                                                    |                    |                   
|Provision for loan losses                           |                    |                   
|                                                    |                    |                   
|Net interest income after provision for loan losses |                    |                   
|                                                    |                    |                   
|Noninterest income                                  |                    |                   
|Mortgage origination fees                           |                    |                   
|Other                                               |                    |                   
|                                                    |                    |                   
|Total noninterest income                            |                    |                   
|                                                    |                    |                   
|Noninterest expense                                 |                    |                   
|Salaries and benefits                               |                    |                   
|Professional fees                                   |                    |                   
|Advertising                                         |                    |                   
|Supplies                                            |                    |                   
|Data processing                                     |                    |                   
|Occupancy                                           |                    |                   
|Depreciation                                        |                    |                   
|Equipment maintenance and rental                    |                    |                   
|Telephone                                           |                    |                   
|Other                                               |                    |                   
|                                                    |                    |                   
|Total noninterest expense                           |                    |                   
|                                                    |                    |                   
|Income before income taxes                          |                    |                   
|                                                    |                    |                   
|Income tax expense                                  |                    |                   
|                                                    |                    |                   
|Net income                                          |                    |                   
|                                                    |                    |                   
|Earnings per share (1)                              |                    |                   
|Basic                                               |                    |                   
|Diluted                                             |                    |                   
|                                                    |                    |                   
|Weighted average shares outstanding (1)             |                    |                   
|Basic                                               |                    |                   
|Diluted                                             |                    |                   

(1)  
          Adjusted for 5-for-4 stock split effective January 16, 2006.

# See notes to
consolidated financial statements.

3

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# CommunitySouth
Bancshares, Inc.

# CONSOLIDATED
STATEMENTS OF OPERATIONS(UNAUDITED)

|                                                    | Nine months ended | Nine months ended
|--------------------------------------------------- | ----------------- | -----------------
|
|Interest income                                     |                   |                  
|Interest and dividends on investments               |                   |                  
|Interest and fees on loans                          |                   |                  
|                                                    |                   |                  
|Total interest income                               |                   |                  
|                                                    |                   |                  
|Interest expense - deposits                         |                   |                  
|                                                    |                   |                  
|                                                    |                   |                  
|Net interest income                                 |                   |                  
|                                                    |                   |                  
|Provision for loan losses                           |                   |                  
|                                                    |                   |                  
|Net interest income after provision for loan losses |                   |                  
|                                                    |                   |                  
|Noninterest income                                  |                   |                  
|Mortgage origination fees                           |                   |                  
|Other                                               |                   |                  
|                                                    |                   |                  
|Total noninterest income                            |                   |                  
|                                                    |                   |                  
|Noninterest expense                                 |                   |                  
|Salaries and benefits                               |                   |                  
|Professional fees                                   |                   |                  
|Advertising                                         |                   |                  
|Supplies                                            |                   |                  
|Data processing                                     |                   |                  
|Occupancy                                           |                   |                  
|Depreciation                                        |                   |                  
|Equipment maintenance and rental                    |                   |                  
|Telephone                                           |                   |                  
|Other                                               |                   |                  
|                                                    |                   |                  
|Total noninterest expense                           |                   |                  
|                                                    |                   |                  
|Income (loss) before income taxes                   |                   |                  
|                                                    |                   |                  
|Income tax expense (benefit)                        |                   |                  
|                                                    |                   |                  
|Net income (loss)                                   |                   |                  
|                                                    |                   |                  
|Earnings (loss) per share (1)                       |                   |                  
|Basic                                               |                   |                  
|Diluted                                             |                   |                  
|Weighted average shares outstanding (1)             |                   |                  
|Basic                                               |                   |                  
|Diluted                                             |                   |                  

(1)    
          Adjusted for 5-for-4 stock split effective January 16, 2006.

# See notes to
consolidated financial statements.

4

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# CommunitySouth
Bancshares, Inc.

# CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITYFor the nine month periods
ended September 30, 2006 and September 30, 2005(UNAUDITED)

|                              |  |  |  |           | Total
|----------------------------- |  |  |  | --------- | -----
|
|
|Balance at December 31, 2004  |  |  |  | 3,744,855 |      
|                              |  |  |  |           |      
|Net loss                      |  |  |  | -         |      
|                              |  |  |  |           |      
|Additional offering expenses  |  |  |  | -         |      
|                              |  | 
|Balance at September 30, 2005 |  |  |  | 3,744,855 |      
|                              |  | 

|                                |  |  |  |           | Total
|------------------------------- |  |  |  | --------- | -----
|
|
|Balance at December 31, 2005    |  |  |  | 3,744,855 |      
|                                |  |  |  |           |      
|Net income                      |  |  |  | -         |      
|                                |  |  |  |           |      
|Stock option compensation       |  |  |  | -         |      
|                                |  |  |  |           |      
|Cash paid for fractional shares |  |  |  | -         |      
|                                |  |  |  |           |      
|Stock options exercised         |  |  |  | 13,224    |      
|                                |  | 
|Balance at September 30, 2006   |  |  |  | 3,758,079 |      
|                                |  | 

(1)    
          Adjusted for 5-for-4 stock split effective January 16, 2006.

# See notes to
consolidated financial statements.

5

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# CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)

|                                                                   | Nine Months ended | Nine Months ended
|------------------------------------------------------------------ | ----------------- | -----------------
|
|Operating activities                                               |                   |                  
|Net income (loss)                                                  |                   |                  
|Adjustments to reconcile net income (loss) to net cash provided by |                   |                  
|operating activities:                                              |                   |                  
|Provision for loan losses                                          |                   |                  
|Depreciation and amortization                                      |                   |                  
|Stock option compensation                                          |                   |                  
|Increase in accrued interest receivable                            |                   |                  
|Increase in accrued interest payable                               |                   |                  
|Increase (decrease) in accrued expenses                            |                   |                  
|Increase in other assets                                           |                   |                  
|Decrease in other liabilities                                      |                   |                  
|                                                                   |                   |                  
|Net cash provided by operating activities                          |                   |                  
|                                                                   |                   |                  
|Investing activities                                               |                   |                  
|Net increase in loans outstanding                                  |                   |                  
|Purchase of investments                                            |                   |                  
|Purchase of property and equipment                                 |                   |                  
|                                                                   |                   |                  
|Net cash used in investing activities                              |                   |                  
|                                                                   |                   |                  
|Financing activities                                               |                   |                  
|Net increase in deposit accounts                                   |                   |                  
|Cash paid for fractional shares                                    |                   |                  
|Stock options exercised                                            |                   |                  
|Additional stock offering costs                                    |                   |                  
|Refunds of subscriptions                                           |                   |                  
|                                                                   |                   |                  
|Net cash provided by financing activities                          |                   |                  
|                                                                   |                   |                  
|Net increase in cash and cash equivalents                          |                   |                  
|                                                                   |                   |                  
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                     |                   |                  
|                                                                   |                   |                  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                           |                   |                  
|                                                                   |                   |                  

# See notes to
consolidated financial statements.

6

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# Notes to Unaudited
Consolidated Financial Statements

# NOTE 1  NATURE OF
BUSINESS AND BASIS OF PRESENTATION

Business Activity and Organization
CommunitySouth Bancshares, Inc. (the Company) is a South Carolina
corporation organized for the purpose of owning and controlling all of the capital stock
of CommunitySouth Bank and Trust (the Bank). The Bank is a state chartered
bank organized under the laws of South Carolina in Pickens County, South Carolina. From
inception on March 20, 2004 through January 18, 2005, the Company engaged in
organizational and pre-opening activities necessary to obtain regulatory approvals and to
prepare its subsidiary, the Bank, to commence business as a financial institution. The
Company received approval from the Federal Deposit Insurance Corporation
(FDIC), Federal Reserve (FRB) and the State Board of Financial
Institutions in January 2005.

The Bank began operations on January
18, 2005. The Bank primarily is engaged in the business of accepting deposits insured by
the FDIC, and providing commercial, consumer and mortgage loans to the general public.

The Company sold 3,744,855 shares of
common stock at $8 per share in an initial public offering that was completed on February
15, 2005 (as adjusted for the 5-for-4 stock split effected in the form of a stock dividend
on January 16, 2006 to shareholders of record as of December 15, 2005). The offering
raised $29,430,810, net of offering costs. The directors and officers of the Company
purchased 527,625 shares at $8 per share for a total of $4,221,000.

Basis of Presentation The accompanying financial statements have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the instructions
to Form 10-QSB. Accordingly, they do not include all the information and footnotes
required by generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating results for the
three and nine month periods ended September 30, 2006 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2006. For further
information, refer to the audited consolidated financial statements and footnotes dated
December 31, 2005 included in the Companys Form 10-KSB for the year ended December
31, 2005 as filed with the Securities and Exchange Commission.

The accounting and reporting policies
conform to accounting principles generally accepted in the United States of America and to
general practices in the banking industry. The Company uses the accrual basis of
accounting.

# NOTE 2  SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation The consolidated financial statements include the accounts of CommunitySouth
Bancshares, Inc., the parent company, and CommunitySouth Bank and Trust, its wholly owned
subsidiary. All significant intercompany items have been eliminated in the consolidated
statements.

Managements Estimates
 The preparation of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of income
and expenses during the reporting period. Actual results could differ from those
estimates.

Disclosure Regarding Segments
 The Company reports as one operating segment, as management reviews the results of
operations of the Company as a single enterprise.

Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks, short-term interest bearing deposits and federal funds sold.
Cash and cash equivalents have an original maturity of three months or less.

Concentrations of Credit Risk
 Financial instruments, which potentially subject the Company to concentrations of
credit risk, consist principally of loans receivable, investment securities, federal funds
sold and amounts due from banks.

The Company makes loans to
individuals and small businesses for various personal and commercial purposes primarily in
the upstate region of South Carolina. The Companys loan portfolio is not
concentrated in loans to any single borrower or to a relatively small number of borrowers.
Additionally, management is not aware of any concentrations of loans to classes of
borrowers or industries that would be similarly affected by economic conditions.

7

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In addition to monitoring potential
concentrations of loans to particular borrowers or groups of borrowers, industries and
geographic regions, management monitors exposure to credit risk that could arise from
potential concentrations of lending products and practices such as loans that subject
borrowers to substantial payment increases (e.g. principal deferral periods, loans with
initial interest-only periods, etc), and loans with high loan-to-value ratios.
Additionally, there are industry practices that could subject the Company to increased
credit risk should economic conditions change over the course of a loans life. For
example, the Company makes variable rate loans and fixed rate principal-amortizing loans
with maturities prior to the loan being fully paid (i.e. balloon payment loans). These
loans are underwritten and monitored to manage the associated risks. Management has
determined that there is no concentration of credit risk associated with its lending
policies or practices.

The Company places its deposits and
correspondent accounts with and sells its federal funds to high quality institutions.
Management believes credit risk associated with correspondent accounts is not significant.

Other Investments Other
investments consist primarily of the Companys investment in the stock of the Federal
Home Loan Bank of Atlanta (FHLB). The stock has no quoted market value and no
ready market exists. Investment in the FHLB is a condition of borrowing from the FHLB, and
the stock is pledged to collateralize such borrowings. At September 30, 2006, the
Companys investment in FHLB stock was $271,200. The dividend received on this stock
is included in interest and dividends on investments.

Loans Receivable  Loans
are stated at their unpaid principal balance less an allowance for loan losses and net
deferred loan origination fees. Interest income is computed using the simple interest
method and is recorded in the period earned. Loan origination fees collected and certain
loan origination costs are deferred and the net amount is accreted as income using a
method that approximates the level yield method over the life of the related loans.

When serious doubt exists as to the
collectibility of a loan or when a loan becomes ninety days past due as to principal or
interest, interest income generally is discontinued unless the estimated net realizable
value of collateral exceeds the principal balance and accrued interest. When interest
accruals are discontinued, income earned but not collected is reversed.

The Company identifies impaired loans
through its normal internal loan review process. Loans on the Companys problem loan
watch list are considered potentially impaired loans. These loans are evaluated in
determining whether all outstanding principal and interest are expected to be collected.
Loans are not considered impaired if a minimal payment delay occurs and all amounts due,
including accrued interest at the contractual interest rate for the period of delay, are
expected to be collected. At September 30, 2006, management has determined that the
Company had $283,934 in non-accrual loans.

Allowance for Loan Losses
 The Company provides for loan losses using the allowance method. Provisions for
loan losses are added to the allowance through charges to operating expenses. Loans which
are determined to be uncollectible are charged against the allowance and recoveries on
loans previously charged off are added to the allowance. The provision for loan losses is
the amount deemed appropriate by management to establish an adequate allowance to meet the
present and foreseeable risk characteristics of the current loan portfolio.
Managements judgment is based on periodic and regular evaluation of individual
loans, the overall risk characteristics of the various portfolio segments, delinquency
trends, and prevailing and anticipated economic conditions. While management uses the best
information available to make evaluations, future adjustments to the allowance may be
necessary if economic conditions differ substantially from the assumptions used in making
the evaluation. The allowance for loan losses is subject to periodic evaluation by various
regulatory authorities and may be subject to adjustment upon their examination.

Property and Equipment 
Premises, furniture and equipment are stated at cost, less accumulated depreciation.
Depreciation expense is computed by the straight-line method, based on the estimated
useful lives for furniture and equipment of 5 to 10 years. Leasehold improvements are
amortized over the life of the lease. Maintenance and repairs are charged to current
expense. The costs of major renewals and improvements are capitalized.

Residential Loan Origination
Fees  The Company offers residential loan origination service to its customers
in its immediate market area. The loans are offered on terms and prices offered by the
Companys correspondents and are closed in the name of the correspondents. The
Company receives fees for services it provides in conjunction with the origination
services it provides. The fees are recognized at the time the loans are closed by the
Companys correspondent.

Advertising 
Advertising, promotional, and other business development costs generally are expensed as
incurred. External costs incurred in producing media advertising are expensed the first
time the advertising takes place. External costs relating to direct mailing costs are
expensed in the period in which the direct mailings are sent.

8

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Income Taxes  Income
taxes are the sum of amounts currently payable to taxing authorities and the net changes
in income taxes payable or refundable in future years. Income taxes deferred to future
years are determined utilizing an asset and liability approach. This method gives
consideration to the future tax consequences associated with differences between financial
accounting and tax bases of certain assets and liabilities which are principally the
allowance for loan losses, depreciable premises and equipment, and net operating loss
carryforwards.

Earnings (Loss) Per Share
 Basic earnings (loss) per share represents the net income (loss) allocated to
shareholders divided by the weighted-average number of common shares outstanding during
the period. Dilutive earnings (loss) per share reflects additional common shares that
would have been outstanding if dilutive potential common shares had been issued. Potential
common shares that may be issued by the Company relate to both outstanding warrants and
stock options, and are determined using the treasury stock method.

Stockbased Compensation
 On January 1, 2006, the Company adopted the fair value recognition provisions of
Financial Accounting Standards Board (FASB) Statement of Financial Accounting
Standards (SFAS) No. 123(R), Accounting for Stock-Based Compensation,
to account for compensation costs under its stock option plans. The Company previously
utilized the intrinsic value method under Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (as amended) (APB 25). Under
the intrinsic value method prescribed by APB 25, no compensation costs were recognized for
the Companys stock options because the option exercise price in its plans equals the
market price on the date of grant. Prior to January 1, 2006, the Company only disclosed
the pro forma effects on net income and earnings per share as if the fair value
recognition provisions of SFAS 123(R) had been utilized.

In adopting SFAS No. 123 (R) , the
Company elected to use the modified prospective method to account for the transition from
the intrinsic value method to the fair value recognition method. Under the modified
prospective method, compensation cost is recognized from the adoption date forward for all
new stock options granted and for any outstanding unvested awards as if the fair value
method had been applied to those awards as of the date of grant. The following table
illustrates the effect on net income and earnings per share as if the fair value based
method had been applied to all outstanding and unvested awards in each period. (in
thousands, except per share amounts)

|                                                             | Three Months Ended September 30,
|------------------------------------------------------------ | --------------------------------
|
|Net income as reported                                       |                                 
|Add: Stock-based employee compensation expense included in   |                                 
|reported net income, net of related tax effects              |                                 
|Deduct: Total stock-based employee compensation expense      |                                 
|determined under fair value based method for all awards, net |                                 
|of related tax effects                                       |                                 
|                                                             |                                 
|Pro forma net income (loss) including stock-based            |                                 
|compensation cost based on fair-value method                 |                                 
|                                                             |                                 
|Earnings (loss) per share:                                   |                                 
|Basic--as reported                                           |                                 
|                                                             |                                 
|Basic--pro forma                                             |                                 
|                                                             |                                 
|Diluted--as reported                                         |                                 
|                                                             |                                 
|Diluted--pro forma                                           |                                 
|                                                             |                                 

9

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|                                                             | Nine Months Ended September 30,
|------------------------------------------------------------ | -------------------------------
|
|Net income (loss) as reported                                |                                
|Add: Stock-based employee compensation expense included in   |                                
|reported net income, net of related tax effects              |                                
|Deduct: Total stock-based employee compensation expense      |                                
|determined under fair value based method for all awards, net |                                
|of related tax effects                                       |                                
|                                                             |                                
|Pro forma net income (loss) including stock-based            |                                
|compensation cost based on fair-value method                 |                                
|                                                             |                                
|Earnings (loss) per share:                                   |                                
|Basic--as reported                                           |                                
|                                                             |                                
|Basic--pro forma                                             |                                
|                                                             |                                
|Diluted--as reported                                         |                                
|                                                             |                                
|Diluted--pro forma                                           |                                
|                                                             |                                

Off-Balance-Sheet Financial
Instruments  In the ordinary course of business, the Company enters into
off-balance-sheet financial instruments consisting of commitments to extend credit and
letters of credit. These financial instruments are recorded in the financial statements
when they become payable by the customer.

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

In February 2006, the Financial
Accounting Standards Board (FASB) issued SFAS No. 155, Accounting for
Certain Hybrid Financial Instrumentsan amendment of FASB Statements No. 133 and
140. This Statement amends SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, and SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities. This Statement
resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, Application
of Statement 133 to Beneficial Interests in Securitized Financial Assets. SFAS No.
155 is effective for all financial instruments acquired or issued after the beginning of
an entitys first fiscal year that begins after September 15, 2006. The Company does
not believe that the adoption of SFAS No. 155 will have a material impact on its financial
position, results of operations and cash flows.

In March 2006, the FASB issued SFAS
No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB
Statement No. 140. This Statement amends FASB No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with
respect to the accounting for separately recognized servicing assets and servicing
liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a financial asset by entering
into a servicing contract; requires all separately recognized servicing assets and
servicing liabilities to be initially measured at fair value, if practicable; permits an
entity to choose its subsequent measurement methods for each class of separately
recognized servicing assets and servicing liabilities; at its initial adoption, permits a
one-time reclassification of available-for-sale securities to trading securities by
entities with recognized servicing rights, without calling into question the treatment of
other available-for-sale securities under Statement 115, provided that the
available-for-sale securities are identified in some manner as offsetting the
entitys exposure to changes in fair value of servicing assets or servicing
liabilities that a servicer elects to subsequently measure at fair value; and requires
separate presentation of servicing assets and servicing liabilities subsequently measured
at fair value in the statement of financial position and additional disclosures for all
separately recognized servicing assets and servicing liabilities. An entity should adopt
SFAS No. 156 as of the beginning of its first fiscal year that begins after September 15,
2006. The Company does not believe the adoption of SFAS No. 156 will have a material
impact on its financial position, results of operations and cash flows.

In July 2006, the FASB issued FASB
Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in
an enterprises financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and
measurement attributable for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim periods,

10

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disclosures and transitions. FIN 48
is effective for fiscal years beginning after December 15, 2006. The Company is currently
analyzing the effects of FIN 48.

In September 2006, the FASB issued
SFAS No. 157, Fair Value Measurements. SFAS 157 defines fair value,
establishes a framework for measuring fair value in generally accepted accounting
principles, and expands disclosures about fair value measurements. SFAS 157 is effective
for the Company on January 1, 2008 and is not expected to have a significant impact on the
Companys financial statements.

In September, 2006, The FASB ratified
the consensuses reached by the FASBs Emerging Issues Task Force (EITF) relating to
EITF 06-4 Accounting for the Deferred Compensation and Postretirement Benefit
Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 addresses
employer accounting for endorsement split-dollar life insurance arrangements that provide
a benefit to an employee that extends to postretirement periods should recognize a
liability for future benefits in accordance with FASB Statement of Financial Accounting
Standards (SFAS) No. 106, Employers Accounting for Postretirement Benefits
Other Than Pensions,or Accounting Principles Board (APB) Opinion No. 12,
Omnibus Opinion1967".EITF 06-4 is effective for fiscal years
beginning after December 15, 2006. Entities should recognize the effects of applying this
Issue through either (a) a change in accounting principle through a cumulative-effect
adjustment to retained earnings or to other components of equity or net assets in the
statement of financial position as of the beginning of the year of adoption or (b) a
change in accounting principle through retrospective application to all prior periods. The
Company does not believe the adoption of EITF 06-4 will have a material impact on its
financial position, results of operations and cash flows.

On September 13, 2006, the SEC issued
Staff Accounting Bulleting No. 108 (SAB 108). SAB 108 provides interpretive
guidance on how the effects of the carryover or reversal of prior year misstatements
should be considered in quantifying a potential current year misstatement. Prior to SAB
108, Companies might evaluate the materiality of financial statement misstatements using
either the income statement or balance sheet approach, with the income statement approach
focusing on new misstatements added in the current year, and the balance sheet approach
focusing on the cumulative amount of misstatement present in a companys balance
sheet. Misstatements that would be material under one approach could be viewed as
immaterial under another approach, and not be corrected. SAB 108 now requires that
companies view financial statement misstatements as material if they are material
according to either the income statement or balance sheet approach. The Company has
analyzed SAB 108 and determined that upon adoption it will have no impact on the reported
results of operations or financial conditions.

Other accounting standards that have
been issued or proposed by the FASB or other standards-setting bodies are not expected to
have a material impact on the Companys financial position, results of operations and
cash flows.

Risks and Uncertainties 
In the normal course of its business, the Company encounters two significant types of
risks: economic and regulatory. There are three main components of economic risk: interest
rate risk, credit risk and market risk. The Company is subject to interest rate risk to
the degree that its interest-bearing liabilities mature or reprice at different speeds, or
on different basis, than its interest-earning assets. Credit risk is the risk of default
on the Companys loan portfolio that results from a borrowers inability or
unwillingness to make contractually required payments. Market risk reflects changes in the
value of collateral underlying loans receivable and the valuation of real estate held by
the Company.

The Company is subject to the
regulations of various governmental agencies. These regulations can and do change
significantly from period to period. The Company also undergoes periodic examinations by
the regulatory agencies, which may subject it to further changes with respect to asset
valuations, amounts of required loss allowances and operating restrictions from the
regulators judgments based on information available to them at the time of their
examination.

Reclassifications 
Certain captions and amounts in the 2005 financial statements were reclassified to conform
with the 2006 presentation. Such reclassifications had no effect on previously reported
net loss or shareholders equity.

# NOTE 3  LEASES

Spartanburg location 
The Company has a ten year lease beginning November 15, 2005 for its Spartanburg office
with an initial monthly rental payment of $6,500, which increases over the term of the
lease up to $9,275 in the tenth year. The lease may be renewed for two consecutive
five-year terms with rental payments increasing 3% each year.

Mauldin location  The
Company has a ten year lease beginning November 15, 2005 for its Mauldin office with an
initial monthly rental payment of $2,417, which increases over the life of the lease up to
$2,872 per month in years seven through ten. The lease may be renewed for one five-year
term at a monthly rent of $3,302.

11

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Greer location  The
Company has a ten year lease for its Greer office with an initial monthly rental payment
of $4,200, which will begin upon completion of construction which is anticipated to be
November 13, 2006.

Anderson location  The
Company has a ten year lease beginning September 1, 2005 for its Anderson office with an
initial monthly rental payment of $3,690, which increases over the life of the lease up to
$4,803 per month in years six through ten. The lease may be renewed for two consecutive
five-year terms with rental payments increasing 2% each year.

# NOTE 4  RELATED
PARTY TRANSACTIONS

Certain parties (principally certain
directors and executive officers of the Company, their immediate families and business
interests) (affiliates) are loan customers in the normal course of business
with the Bank. These loans are made on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable transactions with
unrelated persons and do not involve more than the normal risk of collectibility.

# NOTE 5  STOCK
BASED COMPENSATION

Upon completion of the offering, the
Company agreed to issue warrants to the organizing directors for the purchase of one share
of common stock at $8.00 per share for every two shares purchased in the stock offering,
up to a maximum of 12,500 warrants per director. The warrants were fully vested 120 days
after January 18, 2005 and will expire on January 18, 2015. Warrants held by directors of
the Company will expire 90 days after the director ceases to be a director or officer of
the Company (365 days if due to death or disability). The Company issued a total of
137,125 warrants. In addition, the Company has adopted a stock option plan. As of
September 30, 2006 the Company has 590,796 outstanding options to employees and directors.
Under the plan, the company may grant options for up to 21% of its issued shares of common
stock. The exercise price of each option is equal to the market price of the
companys stock on the date of grant. The maximum term is ten years, and they vest in
no greater than five years. When necessary, the company may purchase shares on the open
market to satisfy share option exercises. During the ensuing year, the company is expected
to acquire no shares.

The table set forth below summarizes
stock option activity for the Companys stock compensation plans for the year ended
December 31, 2005 as adjusted for the 5-for-4 stock split.

|                                  | Stock Options | Warrants
|--------------------------------- | ------------- | --------
|
|
|
|Outstanding at December 31, 2005  |               |         
|Granted                           |               |         
|Forfeited                         |               |         
|Exercised                         |               |         
|                                  |               |         
|Outstanding at September 30, 2006 |               |         
|                                  |               |         

The table set forth below summarizes
non-vested stock options as of September 30, 2006.

|                                  | Weighted- Average | 
|--------------------------------- | ----------------- | 
|
|Outstanding at December 31, 2005  |                   | 
|Granted                           |                   | 
|Vested during the year            |                   | 
|Forfeited during the year         |                   | 
|                                  |                   | 
|Outstanding at September 30, 2006 |                   | 
|                                  |                   | 

As of September 30, 2006, there was
$68,761 total unrecognized compensation cost related to nonvested share-based compensation
arrangements, which is expected to be recognized over a weighted average period of 54
months.

The fair value of each option granted
is estimated on the grant date using the Black-Scholes option-pricing model with the
following assumptions: dividend yield of 0%, expected term of 10 years, risk-free interest
rate of 5.0%, expected life of 10 years, and expected volatility of 20%.

12

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The following table summarizes
information about stock options outstanding under the Companys plans at September
30, 2006 as adjusted for the 5-for-4 stock split effective January 16, 2006.

|                                | Outstanding | Exercisable
|------------------------------- | ----------- | -----------
|
|Number of options               |             |            
|Weighted average remaining life |             |            
|Weighted average exercise price |             |            
|High exercise price             |             |            
|Low exercise price              |             |            

Cash received from the exercise of
options during the year was $108,312. The intrinsic value of options exercised during 2006
was $48,673.

# Item 2.   
Managements Discussion and Analysis or Plan of Operation.

The following discussion reviews
our results of operations and assesses our financial condition. You should read the
following discussion and analysis in conjunction with the accompanying consolidated
financial statements. The commentary should be read in conjunction with the discussion of
forward-looking statements, the financial statements, and the related notes and the other
statistical information included in this report.

# DISCUSSION OF
FORWARD-LOOKING STATEMENTS

This report contains
forward-looking statements relating to, without limitation, future economic
performance, plans and objectives of management for future operations, and projections of
revenues and other financial items that are based on the beliefs of management, as well as
assumptions made by and information currently available to management. The words
may, will, anticipate, should,
would, believe, contemplate, expect,
estimate, continue, and intend, as well as other
similar words and expressions of the future, are intended to identify forward-looking
statements. Our actual results may differ materially from the results discussed in the
forward-looking statements, and our operating performance each quarter is subject to
various risks and uncertainties that are discussed in detail in our filings with the
Securities and Exchange Commission, including, without limitation:

| |  | our rapid growth to date and short operating history;
| | - | -----------------------------------------------------

| |  | the  opening of  additional  full-service  branches  and the  resulting  pressure  this could cause on our
management team;
| | - | ---------------------------------------------------------------------------------------------------------------------------

| |  | significant increases in competitive pressure in the banking and financial services industries;
| | - | -----------------------------------------------------------------------------------------------

| |  | changes in the interest rate environment which could reduce anticipated or actual margins;
| | - | ------------------------------------------------------------------------------------------

| |  | changes in political conditions or the legislative or regulatory environment;
| | - | -----------------------------------------------------------------------------

| |  | general economic conditions, either nationally or regionally and especially in our primary
service area, becoming less favorable than expected resulting in, among other things,
a deterioration in credit quality;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | changes occurring in business conditions and inflation;
| | - | -------------------------------------------------------

| |  | changes in technology;
| | - | ----------------------

| |  | changes in monetary and tax policies;
| | - | -------------------------------------

| |  | the lack of seasoning of our loan portfolio, especially given our rapid loan growth;
| | - | ------------------------------------------------------------------------------------

| |  | the level of allowance for loan loss;
| | - | -------------------------------------

| |  | the rate of delinquencies and amounts of charge-offs;
| | - | -----------------------------------------------------

| |  | adverse changes in asset quality and resulting credit risk-related losses and expenses;
| | - | ---------------------------------------------------------------------------------------

| |  | loss of consumer confidence and economic disruptions resulting from terrorist activities;
| | - | -----------------------------------------------------------------------------------------

| |  | changes in the securities markets; and
| | - | --------------------------------------

| |  | other risks and uncertainties detailed from time to time in our filings with the Securities
and Exchange Commission.
| | - | --------------------------------------------------------------------------------------------------------------------

# Overview

CommunitySouth Bancshares, Inc. is a
bank holding company headquartered in Easley, South Carolina. Our subsidiary,
CommunitySouth Bank and Trust, opened for business on January 18, 2005. The principal
business activity of the bank is to provide banking services to domestic markets,
principally in the upstate of South Carolina. The deposits of the bank are insured by the
Federal Deposit Insurance Corporation. All share and per share information in this report
has been adjusted

13

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for the 5-for-4 stock split effected
in the form of a stock dividend paid on January 16, 2006 to shareholders of record as of
December 15, 2005.

Like most community banks, we derive
most of our income from interest we receive on our loans and investments. Our primary
source of funds for making these loans and investments is our deposits, on which we pay
interest. Consequently, one of the key measures of our success is our amount of net
interest income, or the difference between the income on our interest-earning assets, such
as loans and investments, and the expense on our interest-bearing liabilities, such as
deposits. Another key measure is the spread between the yield we earn on these
interest-earning assets and the rate we pay on our interest-bearing liabilities.

Of course, there are risks inherent
in all loans, so we maintain an allowance for loan losses to absorb probable losses on
existing loans that may become uncollectible. We establish and maintain this allowance by
charging a provision for loan losses against our operating earnings. In the following
section we have included a detailed discussion of this process.

In addition to earning interest on
our loans and investments, we earn income through fees and other expenses we charge to our
customers. We describe the various components of this noninterest income, as well as our
noninterest expense, in the following discussion.

# Results of Operations

Three Months ended
September 30, 2006 and 2005

Overview

Our net income was $390,707 for the
three months ended September 30, 2006. Our net income was $3,733 for the three months
ended September 30, 2005. Since we began operations in the first quarter of 2005, we have
experienced significant growth, which has led to a substantial increase in revenues and
expenses. Due to our growth over the past year, we have now attained a level of earning
assets that supports our costs and we are currently operating profitably. For the three
months ended September 30, 2006, we realized $4,147,713 in interest income, of which
$308,060 was from investment activities and $3,839,653 was from loan activities. For the
three months ended September 30, 2005, we realized $1,579,358 in interest income, of which
$127,746 was from investment activities and $1,451,612 was from loan activities. The
substantial increase in our interest income is primarily a result of our rapid loan growth
during our first year of operation. We anticipate the growth in loans will continue to
drive the growth in assets and the growth in interest income. The primary source of
funding for our loan portfolio is deposits that are acquired both locally and via the
national brokered certificate market. We incurred interest expense of $2,134,829 for the
three months ended September 30, 2006. We incurred interest expense of $626,909 in the
second quarter of 2005. All of the interest expense was related to deposit accounts.

Provision for Loan Losses

Our provision for loan losses for the
three months ended September 30, 2006 was $358,000 compared to $269,000 for the comparable
prior year period. The increase was the result of increasing the provision for loan losses
to 1.50% of new loan growth during the three months ended September 30, 2006 compared to
1.35% for the same period in 2005.

Noninterest Income

We had noninterest income of $194,069
and $69,023 for the three-month periods ended September 30, 2006 and September 30, 2005,
respectively. Mortgage origination fee income for the three months ended September 30,
2006 was $158,084. We had $55,999 in mortgage origination fee income in the third quarter
of 2005. The increase was the result of additions to our mortgage lending staff over the
past year. If interest rates continue to rise, we would not anticipate this type of
continued growth.

Noninterest Expense

We incurred noninterest expense of
$1,377,945 during the three months ended September 30, 2006. Included in the expense was
$779,293 of salaries and benefits, $64,830 of occupancy expenses, $28,904 of professional
expense, $98,453 of data processing expense, and $52,409 of advertising expense. We also
incurred $50,300 of expenses related to supplies. The noninterest expense incurred in the
three months ended September 30, 2005 was $747,441. Included in the expense was $408,057
of salaries and benefits, $40,274 of occupancy expenses, $30,412 of professional expense,
$39,902 of data processing expense, and $37,935 of advertising expense. We also incurred
$22,222 of expenses related to supplies.

14

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For the three months ended September
30, 2006, we incurred $116,726 in other fixed asset expenses, which included $108,392 in
depreciation and $8,334 in equipment maintenance and rental. For the three months ended
September 30, 2005, we incurred $56,138 in other fixed asset expense, which included
$45,276 in depreciation and $10,862 in equipment maintenance and rental. We incurred
$64,830 and $40,274 in occupancy expense related to our offices in Easley, Spartanburg,
Mauldin and Greenwood for the three months ended September 30, 2006 and 2005,
respectively. The increase in noninterest expense is the result of the addition of new
branches and personnel over the past year.

As described above under Note 2
 Recently Issued Accounting Standards, beginning with calendar year 2006, SFAS No.
123(R) requires us to measure all employee stock-based compensation awards using a fair
value method and record this expense in our financial statements. Consequently, our
noninterest expense includes a compensation expense of $36,366 for the fair value of stock
options we granted in the three months ended September 30, 2006.

Nine Months ended
September 30, 2006 and 2005

Overview

Our net income was $843,248 for the
nine months ended September 30, 2006. We incurred a net loss of $862,323 for the nine
months ended September 30, 2005. We began operations in the nine-month period ended
September 30, 2005. Since we began operations in the first quarter of 2005, we have
experienced significant growth, which has led to a substantial increase in revenues and
expenses. Due to our growth over the past year, we have now attained a level of earning
assets that supports our costs and we are currently operating profitably. For the nine
months ended September 30, 2006, we realized $10,103,367 in interest income, of which
$693,511 was from investment activities and $9,409,856 was from loan activities. For the
nine months ended September 30, 2005, we realized $2,841,519 in interest income, of which
$256,552 was from investment activities and $2,584,967 was from loan activities. We
incurred interest expense of $4,787,020 for the nine months ended September 30, 2006. We
incurred interest expense of $942,687 in the nine months ended September 30, 2005. All of
the interest expense was related to deposit accounts.

Provision for Loan Losses

Our provision for loan losses for the
nine months ended September 30, 2006 was $1,192,500 compared to $1,226,000 for the
comparable prior year period. As discussed above, we increased the provision for loan
losses to 1.50% of new loan growth during the nine months ended September 30, 2006
compared to 1.35% for the same period in 2005. However, the loan growth for the nine
months ended September 30, 2006 was less than that of the period ended September 30, 2005.
The growth for the period ended September 30, 2005 included the purchase of loans made by
a correspondent bank which were sourced by our management team prior to our bank opening.

Noninterest Income

We had noninterest income of $540,579
and $195,514 for the nine-month periods ended September 30, 2006 and September 30, 2005,
respectively. Mortgage origination fee income for the nine months ended September 30, 2006
was $446,063. We had $173,781 in mortgage origination fee income in the nine month period
ended September 30, 2005. The increase was the result of additions to our mortgage lending
staff over the past year.

Noninterest Expense

We incurred noninterest expense of
$3,643,228 during the nine months ended September 30, 2006. Included in the expense was
$2,037,355 of salaries and benefits, $190,973 of occupancy expenses, $101,375 of
professional expense, $235,500 of data processing expense, and $141,358 of advertising
expense. We also incurred $135,353 of expenses related to supplies. The noninterest
expense incurred in the nine months ended September 30, 2005 was $2,035,760. Included in
the expense was $1,097,979 of salaries and benefits, $102,870 of occupancy expenses,
$85,429 of professional expense, $80,833 of data processing expense, and $161,985 of
advertising expense. We also incurred $81,546 of expenses related to supplies.

For the nine months ended September
30, 2006, we incurred $290,083 in other fixed asset expenses, which included $244,845 in
depreciation and $45,238 in equipment maintenance and rental. For the nine months ended
September 30, 2005, we incurred $145,075 in other fixed asset expense, which included
$109,489 in depreciation and $35,586 in equipment maintenance and rental. We incurred
$190,973 and $102,870 in occupancy expense related to our offices in Easley, Spartanburg,
Mauldin and Greenwood for the nine months ended September 30, 2006 and 2005, respectively.
The increase in noninterest expense is the result of the addition of new branches and
personnel over the past year.

15

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As described above under Note 2
 Recently Issued Accounting Standards, beginning with calendar year 2006, SFAS No.
123(R) requires us to measure all employee stock-based compensation awards using a fair
value method and record this expense in our financial statements. Consequently, our
noninterest expense includes a compensation expense of $128,666 for the fair value of
stock options we granted in the nine months ended September 30, 2006.

# Assets and Liabilities

General

At September 30, 2006, total assets
had increased 73% to $236.4 million as compared to $136.8 million as of December 31, 2005.
Gross loans increased $78.1 million, or 67%, during the first nine months of 2006. Federal
funds sold increased to $33.7 million as of September 30, 2006 compared to $17.5 million
at December 31, 2005. Cash increased $2.7 million, or 161%, since December 31, 2005.
Deposits increased $98.4 million, or 92%, during the first nine months of 2006. At
September 30, 2006, shareholders equity was $29.4 million.

Investment Securities

Other investments increased $288,500,
principally due to the purchase of additional FHLB stock.

Loans

Since loans typically provide higher
interest yields than other types of interest earning assets, we allocate the majority of
our earning assets to our loan portfolio. Gross loans increased by $78.1 million, or 67%,
during the first nine months of 2006. Balances within major loan categories are as
follows:(in thousands)

|                               | September 30, 2006 | December 31, 2005
|------------------------------ | ------------------ | -----------------
|Real estate - construction     |                    |                  
|Real estate - mortgage         |                    |                  
|Commercial and industrial      |                    |                  
|Consumer and other             |                    |                  
|Total loans, gross             |                    |                  
|Less allowance for loan losses |                    |                  
|Total loans, net               |                    |                  

We will discontinue accrual of
interest on a loan when we conclude it is doubtful that we will be able to collect
interest from the borrower. We will reach this conclusion by taking into account factors
such as the borrowers financial condition, economic and business conditions, and the
results of our previous collection efforts. Generally, we will place a delinquent loan in
nonaccrual status when the loan becomes 90 days or more past due. When we place a loan in
nonaccrual status, we will reverse all interest which has been accrued on the loan but
remains unpaid and we will deduct this interest from earnings as a reduction of reported
interest income. We will not accrue any additional interest on the loan balance until we
conclude the collection of both principal and interest is reasonably certain. At September
30, 2006, there was $283,934, or 0.15%, in loans that were non-accruing.

Provision and Allowance
for Loan Losses

We have established an allowance for
loan losses through a provision for loan losses charged to expense on our statement of
income. The allowance for loan losses represents an amount which we believe is adequate to
absorb probable losses on existing loans that may become uncollectible. Our judgment as to
the adequacy of the allowance for loan losses is based on a number of assumptions about
future events, which we believe to be reasonable, but which may or may not prove to be
accurate. Our determination of the allowance for loan losses is based on evaluations of
the collectibility of loans, including consideration of factors such as the balance of
impaired loans, the quality, mix, and size of our overall loan portfolio, economic
conditions that may affect the borrowers ability to repay, the amount and quality of
collateral securing the loans, our historical loan loss experience, and a review of
specific problem loans. We also consider subjective issues such as changes in the lending
policies and procedures, changes in the local/national economy, changes in volume or type
of credits, changes in volume/severity of problem loans, quality of loan review and board
of director oversight, concentrations of credit, and peer group comparisons. Due to our
limited operating history, to date the provision for loan losses has been made primarily
as a result of our assessment of general loan loss risk compared to banks of similar size
and maturity. Due to our

16

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short operating history, the loans in
our loan portfolio and our lending relationships are of very recent origin. In general,
loans do not begin to show signs of credit deterioration or default until they have been
outstanding for some period of time, a process known as seasoning. As a result, a
portfolio of older loans will usually behave more predictably than a newer portfolio.

Because our loan portfolio is new,
the current level of delinquencies and defaults may not be representative of the level
that will prevail when the portfolio becomes more seasoned, which may be higher than
current levels. If delinquencies and defaults increase, we may be required to increase our
provision for loan losses, which would adversely affect our results of operations and
financial condition. Periodically, we adjust the amount of the allowance based on changing
circumstances. We charge recognized losses to the allowance and add subsequent recoveries
back to the allowance for loan losses. There can be no assurance that charge-offs of loans
in future periods will not exceed the allowance for loan losses as estimated at any point
in time or that provisions for loan losses will not be significant to a particular
accounting period.

Deposits

Our primary source of funds for loans
and investments is our deposits. We have chosen to obtain a portion of our certificates of
deposits from areas outside of our market. The deposits obtained outside of our market
area generally have rates comparable to those being offered for certificates of deposits
in our local market. As of September 30, 2006, total deposits had increased by $98.4
million, or 92%, from December 31, 2005. The largest increase was in time deposits less
than $100,000, which increased $45.7 million, or 291%, from December 31, 2005 to September
30, 2006. The increase was attributed to new accounts and the opening of our Spartanburg
branch in January 2006.

Balances within the major deposit
categories are as follows: (in thousands)

|                              | September 30, 2006 | December 31, 2005
|----------------------------- | ------------------ | -----------------
|Non-interest bearing demand   |                    |                  
|Interest bearing demand       |                    |                  
|Savings                       |                    |                  
|Time deposits less than $100  |                    |                  
|Time deposits of $100 or over |                    |                  
|Brokered deposits             |                    |                  
|Total deposits                |                    |                  

# Liquidity

Liquidity is the ability to meet
current and future obligations through liquidation or maturity of existing assets or the
acquisition of liabilities. We manage both assets and liabilities to achieve appropriate
levels of liquidity. Cash and short-term investments are our primary sources of asset
liquidity. These funds provide a cushion against short-term fluctuations in cash flow from
both deposits and loans. Individual and commercial deposits and borrowings are our primary
source of funds for credit activities. At September 30, 2006, we had lines of credit with
unrelated banks totaling $11.1 million. These lines, which are unsecured, are available on
a one-to-seven day basis for general corporate purposes. We believe our liquidity sources
are adequate to meet our operating needs as well as our construction commitments. The
level of liquidity is measured by the cash and cash equivalents-to-total assets ratio,
which was at 16.1% at September 30, 2006.

As members of the Federal Home Loan
Bank of Atlanta, we have credit availability of up to 10% of the banks total assets,
which meant $23.6 million was available as of September 30, 2006. Advances under this
credit facility are subject to qualifying collateral.

# Impact of Off-Balance
Sheet Instruments

Through the operations of our bank,
we have made contractual commitments to extend credit in the ordinary course of our
business activities. These commitments are legally binding agreements to lend money to our
customers at predetermined interest rates for a specified period of time. At September 30,
2006, we had issued commitments to extend credit of $39.7 million through various types of
lending arrangements. We evaluate each customers credit worthiness on a case-by-case
basis. The amount of collateral obtained, if deemed necessary by us upon extension of
credit, is based on our credit evaluation of the borrower. Collateral varies but may
include accounts receivable, inventory, property, plant and equipment, commercial and
residential real estate. We manage the credit risk on these commitments by subjecting them
to normal

17

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underwriting and risk management
processes. The following table summarizes our off-balance-sheet financial instruments
whose contract amounts represent credit risk:

|                             | September 30, 2006 | December 31, 2005
|---------------------------- | ------------------ | -----------------
|
|Commitments to extend credit |                    |                  
|                             |                    |                  
|Standby letters of credit    |                    |                  
|                             |                    |                  

# Capital Resources

Total shareholders equity
increased from $28.3 million at December 31, 2005 to $29.4 million at September 30, 2006.
The increase is principally due to the net income for the period of $843,248.

The Federal Reserve and bank
regulatory agencies require bank holding companies and financial institutions to maintain
capital at adequate levels based on a percentage of assets and off-balance sheet
exposures, adjusted for risk weights ranging from 0% to 100%. The Federal Reserve
guidelines contain an exemption from the capital requirements for small bank holding
companies. On March 31, 2006, the Federal Reserve changed the definition of a small
bank holding company to bank holding companies with less than $500 million in total assets
(an increase from $150 million under the prior rule). However, bank holding companies will
not qualify under the new definition if they (i) are engaged in significant nonbanking
activities either directly or indirectly through a subsidiary, (ii) conduct significant
off-balance sheet activities, including securitizations or managing or administering
assets for third parties, or (iii) have a material amount of debt or equity securities
(including trust preferred securities) outstanding that are registered with the SEC.
Although we have less than $500 million in assets, it is unclear at this point whether we
otherwise meet the requirements for qualifying as a small bank holding
company. According to the Federal Reserve Board, the revision of the criterion to
exclude any bank holding company that has outstanding a material amount of SEC-registered
debt or equity securities reflects the fact that SEC registrants typically exhibit a
degree of complexity of operations and access to multiple funding sources that warrants
excluding them from the new policy statement and subjecting them to the capital
guidelines. In the adopting release for the new rule, the Federal Reserve Board stated
that what constitutes a material amount of SEC-registered debt or equity for a
particular bank holding company depends on the size, activities and condition of the
relevant bank holding company. In lieu of using fixed measurable parameters of materiality
across all institutions, the rule provides the Federal Reserve with supervisory
flexibility in determining, on a case-by-case basis, the significance or materiality of
activities or securities outstanding such that a bank holding company should be excluded
from the policy statement and subject to the capital guidelines. Prior to adoption of this
new rule, our holding company was subject to these capital guidelines, as it had less more
than $150 million in assets. Until the Federal Reserve provides further guidance on the
new rules, it will be unclear whether our holding company will be subject to the exemption
from the capital requirements for small bank holding companies. Regardless, our bank falls
under these minimum capital requirements as set per bank regulatory agencies.

Under the capital adequacy
guidelines, regulatory capital is classified into two tiers. These guidelines require an
institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted
assets. Tier 1 capital consists of common shareholders equity, excluding the
unrealized gain or loss on securities available for sale, minus certain intangible assets.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on
the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1
capital plus the general reserve for loan losses, subject to certain limitations. We are
also required to maintain capital at a minimum level based on total average assets, which
is known as the Tier 1 leverage ratio.

At both the holding company and bank
level, we are subject to various regulatory capital requirements administered by the
federal banking agencies.  To be considered adequately capitalized at
both the holding company and bank level, we must maintain a minimum total risk-based
capital of 8%, with at least 4% being Tier 1 capital. In addition, we must maintain a
minimum Tier 1 leverage ratio of at least 4%. To be considered
well-capitalized, we must maintain total risk-based capital of at least 10%,
Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.

The following table summarizes the
capital amounts and ratios of the bank.

|(dollars in thousands)                 | September 30, 2006 | December 31, 2005
|-------------------------------------- | ------------------ | -----------------
|
|Total capital to risk weighted assets  |                    |                  
|Tier 1 capital to risk weighted assets |                    |                  
|Tier 1 capital to average assets       |                    |                  

18

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# Critical Accounting
Policies

We have adopted various accounting
policies that govern the application of accounting principles generally accepted in the
United States and with general practices within the banking industry in the preparation of
our financial statements. Our significant accounting policies are described in Note 1 to
the financial statements in Item 1.

Certain accounting policies involve
significant judgments and assumptions by us that have a material impact on the carrying
value of certain assets and liabilities. We consider these accounting policies to be
critical accounting policies. The judgment and assumptions we use are based on historical
experience and other factors, which we believe to be reasonable under the circumstances.
Because of the nature of the judgment and assumptions we make, actual results could differ
from these judgments and estimates that could have a material impact on the carrying
values of our assets and liabilities and our results of operations.

We believe the allowance for loan
losses is the critical accounting policy that requires the most significant judgment and
estimates used in preparation of our consolidated financial statements. Some of the more
critical judgments supporting the amount of our allowance for loan losses include
judgments about the credit worthiness of borrowers, the estimated value of the underlying
collateral, the assumptions about cash flow, determination of loss factors for estimating
credit losses, the impact of current events, and conditions, and other factors impacting
the level of probable inherent losses. Under different conditions or using different
assumptions, the actual amount of credit losses incurred by us may be different from
managements estimates provided in our consolidated financial statements. Refer to
the portion of this discussion that addresses our allowance for loan losses for a more
complete discussion of our processes and methodology for determining our allowance for
loan losses.

# Item 3.   Controls and
Procedures.

As
of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our
Chief Executive Officer and Chief Financial Officer have concluded that our current
disclosure controls and procedures are effective as of September 30, 2006. There have been
no significant changes in our internal controls over financial reporting during the fiscal
quarter ended September 30, 2006 that have materially affected, or are reasonably likely
to materially affect, our internal controls over financial reporting.

The
design of any system of controls and procedures is based in part upon certain assumptions
about the likelihood of future events. There can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions, regardless of
how remote.

# Part II  Other
Information

# Item 1.   Legal
Proceedings.

Not Applicable

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

Not applicable

# Item 3.   Defaults Upon
Senior Securities.

Not applicable

# Item 4.   Submission of Matters
to Vote of Security Holders.

Not applicable

19

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# Item 5.   Other
Information.

Not applicable

# Item 6.   Exhibits.

31.1        Rule 13a-14(a) Certification of the Principal Executive Officer.

31.2        Rule 13a-14(a) Certification of the Principal Financial Officer.

32           Section 1350
Certifications.

20

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# SIGNATURES

In accordance with the requirements
of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.

|Date:  November 13, 2006 |  | By:   /s/  C. Allan Ducker, III                     
|------------------------ |  | ----------------------------------------------------
|                         |  | C. Allan Ducker, III                                
|                         |  | Chief Executive Officer(Principal Executive Officer)

|Date:  November 13, 2006 |  | By:   /s/  John W. Hobbs                                           
|------------------------ |  | -------------------------------------------------------------------
|                         |  | John W. Hobbs                                                      
|                         |  | Chief Financial Officer(Principal Financial and Accounting Officer)

21

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# EXHIBIT INDEX

ExhibitNumber
                   Description

31.1        Rule 13a-14(a) Certification of the Principal Executive Officer.

31.2        Rule 13a-14(a) Certification of the Principal Financial Officer.

32           Section 1350
Certifications.

22