** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(MARKONE)**

 

| **x**                                                  | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**       |
|--------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                   |                                                                                                     |
| **For the Quarterly Period ended March 31, 2008** |
|                                                   |                                                                                                     |
| **OR**                                                 |
|                                                   |                                                                                                     |
| **o**                                                  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the Transition Period from                  to                  **

 

**Commission File No. 000-51896**

 

**COMMUNITYSOUTH FINANCIAL CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**6602 Calhoun Memorial Highway**

**Easley,South Carolina 29640**

(Address of principal executive offices)

 

**(864) 306-2540**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large  accelerated filer o                     |   | Accelerated  filer o         |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer o                       |   | Smaller  reporting company x |
| (Do not check if  a smaller reporting company) |   |                              |

 

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

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date: 4,698,697 shares of common stock, $0.01 par value per share, were issued andoutstanding as of May 15, 2008.

 

 

----

 

**CommunitySouthFinancial Corporation**

 

**Part I- Financial Information**

 

## **Item 1. FinancialStatements**.

## ** **

**CONSOLIDATED BALANCE SHEETS**

** **
| ** **                                                                                                                                                                             | ** ** | **March 31, 2008** | ** **  | **December 31, 2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|-------------|---------------------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **(Unaudited)**              | ** **  | **(Audited)**                   | ** ** |
|                                                                                                                                                                                   |       |                         |        |                            |       |
| **Assets**                                                                                                                                                                             |       |                         |        |                            |       |
| Cash and cash  equivalents                                                                                                                                                             |       |                         |        |                            |       |
| Cash and due  from bank                                                                                                                                                                |       | $                            | 5,715,992   |                            | $          | 6,486,676 |   |
| Federal funds  sold                                                                                                                                                                    |       | 2,495,000                    |        | 33,665,005                      |       |
| Total cash and  cash equivalents                                                                                                                                                       |       | 8,210,992                    |        | 40,151,681                      |       |
| Investment  securities, available for sale                                                                                                                                             |       | 54,182,057                   |        | 24,844,007                      |       |
| Other  investments, at cost                                                                                                                                                            |       | 905,200                      |        | 446,800                         |       |
| Loans, net                                                                                                                                                                             |       | 305,381,190                  |        | 298,720,357                     |       |
| Accrued interest  receivable                                                                                                                                                           |       | 1,760,490                    |        | 2,092,066                       |       |
| Property and  equipment, net                                                                                                                                                           |       | 4,987,527                    |        | 5,073,685                       |       |
| Bank-owned life  insurance                                                                                                                                                             |       | 5,282,318                    |        | 5,226,806                       |       |
| Other assets                                                                                                                                                                           |       | 1,634,468                    |        | 1,311,799                       |       |
|                                                                                                                                                                                   |       |                         |        |                            |       |
| Total assets                                                                                                                                                                           |       | $                            | 382,344,242 |                            | $          | 377,867,201 |   |
|                                                                                                                                                                                   |       |                         |        |                            |       |
| **Liabilities and Shareholders’ Equity**                                                                                                                                          |       |                         |        |                            |       |
|                                                                                                                                                                                   |       |                         |        |                            |       |
| **Liabilities**                                                                                                                                                                        |       |                         |        |                            |       |
| Deposits                                                                                                                                                                               |       |                         |        |                            |       |
| Non-interest  bearing                                                                                                                                                                  |       | $                            | 22,409,342  |                            | $          | 24,464,433 |   |
| Interest bearing                                                                                                                                                                       |       | 287,962,335                  |        | 303,199,212                     |       |
| Total deposits                                                                                                                                                                         |       | 310,371,677                  |        | 327,663,645                     |       |
| Repurchase  agreements                                                                                                                                                                 |       | 30,000,000                   |        | 15,000,000                      |       |
| FHLB advances                                                                                                                                                                          |       | 5,000,000                    |        | —                          |       |
| Accrued interest  payable                                                                                                                                                              |       | 4,726,913                    |        | 3,238,298                       |       |
| Accrued expenses                                                                                                                                                                       |       | 254,488                      |        | 427,380                         |       |
| Other  liabilities                                                                                                                                                                     |       | 74,836                       |        | 66,742                          |       |
|                                                                                                                                                                                   |       |                         |        |                            |       |
| Total  liabilities                                                                                                                                                                     |       | 350,427,914                  |        | 346,396,065                     |       |
|                                                                                                                                                                                   |       |                         |        |                            |       |
| **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, 4,698,697 and  4,698,697 issued and outstanding at March 31, 2008 and December 31,  2007, respectively |       | 46,987                       |        | 46,987                          |       |
| Additional  paid-in capital                                                                                                                                                            |       | 29,709,360                   |        | 29,691,467                      |       |
| Accumulated  other comprehensive income                                                                                                                                                |       | 237,858                      |        | 152,050                         |       |
| Retained  earnings                                                                                                                                                                     |       | 1,922,123                    |        | 1,580,632                       |       |
| Total shareholders’  equity                                                                                                                                                       |       | 31,916,328                   |        | 31,471,136                      |       |
|                                                                                                                                                                                   |       |                         |        |                            |       |
| Total  liabilities and shareholders’ equity                                                                                                                                       |       | $                            | 382,344,242 |                            | $          | 377,867,201 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

2

----

 

**CommunitySouth Financial Corporation**

 

**CONSOLIDATED STATEMENTS OF INCOME**

**(UNAUDITED)**

 
| ** **                                           | ** ** | **Three months ended** | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **March 31, 2008**     | ** ** | **March 31, 2007**     | ** ** |
| **Interest  income**                                 |       |                             |       |                             |       |
| Interest and  fees on loans                          |       | $                                | 5,546,847  |                             | $          | 4,604,653 |   |
| Interest and  dividends on investments               |       | 731,109                          |       | 310,156                          |       |
| Total interest  income                               |       | 6,277,956                        |       | 4,914,809                        |       |
|                                                 |       |                             |       |                             |       |
| **Interest  expense - deposits**                     |       | 3,653,138                        |       | 2,764,563                        |       |
| ** **                                           |       |                             |       |                             |       |
| Net interest  income                                 |       | 2,624,818                        |       | 2,150,246                        |       |
|                                                 |       |                             |       |                             |       |
| **Provision  for loan losses**                       |       | 125,000                          |       | 362,000                          |       |
| ** **                                           |       |                             |       |                             |       |
| Net interest  income after provision for loan losses |       | 2,499,818                        |       | 1,788,246                        |       |
|                                                 |       |                             |       |                             |       |
| **Non-interest  income**                             |       |                             |       |                             |       |
| Mortgage  origination fees                           |       | 162,895                          |       | 245,736                          |       |
| Other                                                |       | 177,880                          |       | 98,947                           |       |
| Total  non-interest income                           |       | 340,775                          |       | 344,683                          |       |
|                                                 |       |                             |       |                             |       |
| **Non-interest  expense**                            |       |                             |       |                             |       |
| Salaries and  benefits                               |       | 1,234,585                        |       | 993,220                          |       |
| Data processing                                      |       | 190,782                          |       | 120,860                          |       |
| Occupancy                                            |       | 162,534                          |       | 131,899                          |       |
| Depreciation                                         |       | 181,214                          |       | 131,047                          |       |
| Equipment  maintenance and rental                    |       | 47,624                           |       | 30,273                           |       |
| Advertising                                          |       | 11,163                           |       | 30,869                           |       |
| Professional  fees                                   |       | 78,104                           |       | 42,211                           |       |
| Office supplies                                      |       | 27,784                           |       | 52,182                           |       |
| Telephone                                            |       | 36,058                           |       | 39,472                           |       |
| FDIC assessment                                      |       | 52,500                           |       | 8,392                            |       |
| Other                                                |       | 293,654                          |       | 208,910                          |       |
| Total  non-interest expense                          |       | 2,316,002                        |       | 1,789,335                        |       |
|                                                 |       |                             |       |                             |       |
| **Income  before income taxes**                      |       | 524,591                          |       | 343,594                          |       |
|                                                 |       |                             |       |                             |       |
| **Income  tax expense**                              |       | 183,100                          |       | 135,222                          |       |
| ** **                                           |       |                             |       |                             |       |
| **Net  income**                                      |       | $                                | 341,491    |                             | $          | 208,372 |   |
| ** **                                           |       |                             |       |                             |       |
| **Earnings  per share (1)**                          |       |                             |       |                             |       |
| Basic                                                |       | $                                | 0.07       |                             | $          | 0.04 |   |
| Diluted                                              |       | $                                | 0.07       |                             | $          | 0.04 |   |
|                                                 |       |                             |       |                             |       |
| **Weighted  average shares outstanding (1)**         |       |                             |       |                             |       |
| Basic                                                |       | 4,698,697                        |       | 4,698,441                        |       |
| Diluted                                              |       | 4,910,736                        |       | 5,216,400                        |       |

 

----

(1)  Adjusted for 5-for-4 stock split effective January 16,2007.

 

The accompanying notes are an integral part ofthe consolidated financial statements.

 

3

----

 

**CommunitySouth FinancialCorporation**

 

**CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’EQUITY**

**For the three month periods ended March 31,2008 and March 31, 2007**

**(UNAUDITED)**

 
| ** **                                                       | ** ** | **Common Stock**  | ** ** | **Additional  Paid-in** | ** ** | **Accumulated   Other   Comprehensive** | ** ** | **Retained** | ** ** | **Total  Shareholders’** | ** ** | **Total  Comprehensive** | ** ** |
|------------------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|-----------------------------------------|------------|--------------|------------|-------------------------------|------------|--------------------------|------------|
| ** **                                                       | ** ** | **Shares****(1)** | ** ** | **Amount (1)**          | ** ** | **Capital (1)**                         | ** ** | **Income**   | ** ** | **Earnings**                  | ** ** | **Equity**               | ** ** | **Income** | ** ** |
| Balance at  December 31, 2007                               |       | 4,698,697         |       | $                       | 46,987     |                                    | $          | 29,691,467   |       | $                             | 152,050    |                     | $          | 1,580,632 |   | $ | 31,471,136 |   |   |   |
|                                                             |       |              |       |                    |       |                                    |       |         |       |                          |       |                     |       |   |   |
| Net income                                                       |       | —            |       | —                  |       | —                                  |       | —       |       | 341,491                       |       | 341,491                  |       | $ | 341,491 |   |
|                                                             |       |              |       |                    |       |                                    |       |         |       |                          |       |                     |       |   |   |
| Other  comprehensive income:                                     |       |              |       |                    |       |                                    |       |         |       |                          |       |                     |       |   |   |
|                                                             |       |              |       |                    |       |                                    |       |         |       |                          |       |                     |       |   |   |
| Unrealized gains  on securities, net of income taxes of $139,200 |       | —            |       | —                  |       | —                                  |       | 85,808       |       | —                        |       | 85,808                   |       | 85,808 |   |
|                                                             |       |              |       |                    |       |                                    |       |         |       |                          |       |                     |       |   |   |
| Total  comprehensive income                                      |       |              |       |                    |       |                                    |       |         |       |                          |       | $                        | 427,299    |   |
|                                                             |       |              |       |                    |       |                                    |       |         |       |                          |       |                     |       |   |   |
| Stock option compensation                                        |       | —            |       | —                  |       | 17,893                                  |       | —       |       | —                        |       | 17,893                   |       |   |   |
|                                                             |       |              |       |                    |       |                                    |       |         |       |                          |       |                     |       |   |   |
| Balance at March 31, 2008                                   |       | 4,698,697         |       | $                       | 46,987     |                                    | $          | 29,709,360   |       | $                             | 237,858    |                     | $          | 1,922,123 |   | $ | 31,916,328 |   |   |   |

 
| ** **                                            | ** ** | **Common Stock**  | ** ** | **Additional  Paid-in** | ** ** | **Accumulated   Other   Comprehensive** | ** ** | **Retained** | ** ** | **Total  Shareholders’** | ** ** | **Total   Comprehensive** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|-----------------------------------------|------------|--------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                                            | ** ** | **Shares****(1)** | ** ** | **Amount (1)**          | ** ** | **Capital (1)**                         | ** ** | **Income**   | ** ** | **Deficit**                   | ** ** | **Equity**                | ** ** | **Income** | ** ** |
| Balance at  December 31, 2006                    |       | 4,697,697         |       | $                       | 46,977     |                                    | $          | 29,635,458   |       | $                             | —     |                      | $          | 12,520 |   | $ | 29,694,955 |   |   |   |
|                                                  |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
| Net income                                            |       | —            |       | —                  |       | —                                  |       | —       |       | 208,372                       |       | 208,372                   |       | $ | 208,372 |   |
|                                                  |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
| Other  comprehensive income:                          |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
|                                                  |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
| Unrealized  losses on securities, net of income taxes |       | —            |       | —                  |       | —                                  |       | —       |       | —                        |       | —                    |       | — |   |
|                                                  |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
| Total  comprehensive income                           |       |              |       |                    |       |                                    |       |         |       |                          |       | $                         | 208,372    |   |
|                                                  |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
| Stock option compensation                             |       | —            |       | —                  |       | 8,763                                   |       | —       |       | —                        |       | 8,763                     |       |   |   |
|                                                  |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
| Cash paid for  fractional shares                      |       | —            |       | —                  |       | (5,701                                  | )          | —       |       | —                        |       | (5,701                    | )          |   |   |
|                                                  |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
| Stock options exercised                               |       | 1,000             |       | 10                      |       | 6,390                                   |       | —       |       | —                        |       | 6,400                     |       |   |   |
|                                                  |       |              |       |                    |       |                                    |       |         |       |                          |       |                      |       |   |   |
| Balance at March 31, 2007                        |       | 4,698,697         |       | $                       | 46,987     |                                    | $          | 29,644,910   |       | $                             | —     |                      | $          | 220,892 |   | $ | 29,912,789 |   |   |   |

 

----

(1)  Adjusted for 5-for-4 stock split effective January 16,2007.

 

The accompanying notes are an integral part ofthe consolidated financial statements.

 

4

----

 

**CommunitySouth FinancialCorporation**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Three Months   ended** | ** ** | **Three Months  ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**       | ** ** | **March 31,**      | ** ** |
| ** **                                                                         | ** ** | **2008**                 | ** ** | **2007**                | ** ** |
| **Operating  activities**                                                          |       |                     |       |                    |       |
| Net income                                                                         |       | $                        | 341,491    |                    | $          | 208,372 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                     |       |                    |       |
| Provision for  loan losses                                                         |       | 125,000                  |       | 362,000                 |       |
| Stock option  compensation                                                         |       | 17,893                   |       | 8,763                   |       |
| Appreciation of  bank-owned life insurance                                         |       | (55,512                  | )          | (55,512                 | )          |
| Depreciation                                                                       |       | 181,214                  |       | 131,047                 |       |
| Deferred income  tax benefit                                                       |       | (29,400                  | )          | —                  |       |
| Increase  (decrease) in accrued interest receivable                                |       | 331,576                  |       | (18,402                 | )          |
| Increase in  accrued interest payable                                              |       | 1,488,615                |       | 390,284                 |       |
| Decrease in  accrued expenses                                                      |       | (172,892                 | )          | (63,434                 | )          |
| Decrease  (increase) in other assets                                               |       | (34,223                  | )          | 104,186                 |       |
| Increase  (decrease) in other liabilities                                          |       | 8,094                    |       | (10,712                 | )          |
| Loss on disposal  of property and equipment                                        |       | —                   |       | 709                     |       |
| ** **                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| Net cash  provided by operating activities                                         |       | 2,201,856                |       | 1,057,301               |       |
| ** **                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| **Investing  activities**                                                          |       |                     |       |                    |       |
| Net increase in loans outstanding                                                  |       | (7,110,833               | )          | (27,012,268             | )          |
| Purchases of investment securities                                                 |       | (29,202,242              | )          | —                  |       |
| Purchases of FHLB stock                                                            |       | (458,400                 | )          | —                  |       |
| Purchase of property and equipment                                                 |       | (79,102                  | )          | (276,806                | )          |
|                                                                               |       |                     |       |                    |       |
| Net cash used in  investing activities                                             |       | (36,850,577              | )          | (27,289,074             | )          |
| ** **                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| **Financing  activities**                                                          | ** ** | ** **               | ** ** | ** **              | ** ** |
| Net increase (decrease) in deposit accounts                                        |       | (17,291,968              | )          | 35,664,565              |       |
| Advances from FHLB                                                                 |       | 5,000,000                |       | —                  |       |
| Increase in repurchase agreements                                                  |       | 15,000,000               |       | —                  |       |
| Cash paid for fractional shares                                                    |       | —                   |       | (5,701                  | )          |
| Stock options exercised                                                            |       | —                   |       | 6,400                   |       |
| ** **                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| Net cash  provided by financing activities                                         |       | 2,708,032                |       | 35,665,264              |       |
| ** **                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| Net increase (decrease) in cash and cash equivalents                               |       | (31,940,689              | )          | 9,433,491               |       |
| ** **                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                 |       | 40,151,681               |       | 21,041,070              |       |
| ** **                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                       |       | $                        | 8,210,992  |                    | $          | 30,474,561 |   |
|                                                                               |       |                     |       |                    |       |
| **SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION**                               |       |                     |       |                    |       |
| Cash paid for:                                                                     |       |                     |       |                    |       |
| Interest                                                                           |       | $                        | 2,164,523  |                    | $          | 2,374,279 |   |
| Income taxes                                                                       |       | $                        | 212,500    |                    | $          | 1,197 |   |
|                                                                               |       |                     |       |                    |       |
| **Schedule of non-cash transactions**                                              |       |                     |       |                    |       |
| Unrealized gains  on investment securities, net of income taxes                    |       | $                        | 85,808     |                    | $          | — |   |

 

The accompanying notes are an integral part ofthe consolidated financial statements.

 

5

----

 

**Notes toUnaudited Consolidated Financial Statements**

 

**NOTE 1 – NATURE OF BUSINESS AND BASIS OFPRESENTATION**

 

**Business Activity and Organization –**CommunitySouthFinancial Corporation (the “Company”) is a South Carolina corporation organizedfor the purpose of owning and controlling all of the capital stock ofCommunitySouth Bank and Trust (the “Bank”). The Bank is a state chartered bank organized under the laws of SouthCarolina.  From inception on March 20,2004 through January 18, 2005, the Company engaged in organizational andpre-opening activities necessary to obtain regulatory approvals and to prepareits subsidiary, the Bank, to commence business as a financial institution.  The Company received approval from theFederal Deposit Insurance Corporation (“FDIC”), the Federal Reserve Board (“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 businessof accepting deposits insured by the FDIC, and providing commercial, consumerand mortgage loans to the general public.

 

The Company sold 4,681,069 shares of common stock at $6.40 per share inan initial public offering that was completed on February 15, 2005 (asadjusted for all stock splits).  Theoffering raised $29,430,810, net of offering costs.  The directors and officers of the Companypurchased 659,531 shares at $6.40 per share for a total of $4,221,000.

 

**Basis of Presentation –**Theaccompanying financial statements have been prepared in accordance withgenerally accepted accounting principles in the United States of America and togeneral practices in the banking industry for interim financial information andwith the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.  Operating results for the three month periodended March 31, 2008 is not necessarily indicative of the results that maybe expected for the year ending December 31, 2008.  For further information, refer to the auditedconsolidated financial statements and footnotes dated December 31, 2007included in the Company’s Form 10-KSB for the year ended December 31,2007 as filed with the Securities and Exchange Commission.

 

**NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

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

 

**Management’s Estimates**– The preparation of consolidated financial statements in conformity withgenerally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of income and expenses during the reportingperiod.  Actual results could differ fromthose estimates.

 

**DisclosureRegarding Segments** – The Company reports as one operatingsegment, as management reviews the results of operations of the Company as asingle enterprise.

 

**Cash andCash Equivalents**– For purposes of reporting cash flows, cashand cash equivalents include cash on hand, amounts due from banks, short-terminterest bearing deposits and federal funds sold.  Cash and cash equivalents have an originalmaturity of three months or less.

 

**Concentrations of Credit Risk**– Financial instruments, which potentially subject the Company toconcentrations 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 variouspersonal and commercial purposes primarily in the upstate region of SouthCarolina.  The Company’s loan portfoliois not concentrated in loans to any single borrower or to a relatively smallnumber of borrowers.  Additionally,management is not aware of any concentrations of loans to classes of borrowersor industries that would be similarly affected by economic conditions.

 

6

----

 

In addition to monitoring potential concentrations of loans toparticular borrowers or groups of borrowers, industries and geographic regions,management monitors exposure to credit risk that could arise from potentialconcentrations of lending products and practices such as loans that subjectborrowers to substantial payment increases (e.g. principal deferral periods, loanswith initial interest-only periods, etc), and loans with high loan-to-valueratios.  Additionally, there are industrypractices that could subject the Company to increased credit risk shouldeconomic conditions change over the course of a loan’s life.  For example, the Company makes variable rateloans and fixed rate principal-amortizing loans with maturities prior to theloan being fully paid (i.e. balloon payment loans).  These loans are underwritten and monitored tomanage the associated risks.  Managementhas determined that there is no concentration of credit risk associated withits lending policies or practices.

 

The Company’s investment portfolio consists of both marketable andnon-marketable equity securities. Management believes credit risk associated with the equity securities isnot significant. The Company places its deposits and correspondent accountswith and sells its federal funds to high quality institutions.  Management believes credit risk associatedwith correspondent accounts is not significant.

 

**Investment Securities** – The Company accounts for investment securities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”).  The statement requires investments in equity and debt securities to be classified into three categories:

 

1.               *Available for sale securities*: These aresecurities that are not classified as either held to maturity or as tradingsecurities.  These securities are reported at fair market value. Unrealized gains and losses are reported, net of income taxes, as separatecomponents of shareholders’ equity (accumulated other comprehensive income).

 

2.               *Held to maturity securities*: These areinvestment securities that the Company has the ability and intent to hold untilmaturity.  These securities are stated at cost, adjusted for amortizationof premiums and the accretion of discounts.

 

3.               *Trading securities*: These are securitiesthat are bought and held principally for the purpose of selling in the nearfuture.  Trading securities are reported at fair market value, and relatedunrealized gains and losses are recognized in the income statement.  TheCompany has no trading securities.

 

Gains or losses on dispositions of investment securities are based onthe differences between the net proceeds and the adjusted carrying amount ofthe securities sold, using the specific identification method.  Premiums and discounts are amortized or accrued into interest income by amethod that approximates a level yield.

 

**Other Investments –**CommunitySouthBank and Trust, as a member institution, is required to own stock investmentsin the FHLB.  Investment in the FHLB is acondition of borrowing from the FHLB, and the stock is pledged to collateralizesuch borrowings.  No ready market existsfor the stock and it has no quoted market value.  However, redemption of these stocks hashistorically been at par value.  Thedividend 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 loanlosses and net deferred loan origination fees. Interest income is computed using the simple interest method and isrecorded in the period earned. Loan origination fees collected and certain loanorigination costs are deferred and the net amount is accreted as income using amethod that approximates the level yield method over the life of the relatedloans.

 

In accordance with SFAS No. 114, “Accounting by Creditors forImpairment of a Loan,” (“SFAS 114”), loans are considered to be impaired when,in management’s judgment and based on current information, the full collectionof principal and interest becomes doubtful. A loan is also considered impaired if its terms are modified in atroubled debt restructuring.  Impairedloans are placed in non-performing status, and future payments are applied toprincipal until such time as collection of the obligation is no longerdoubtful. Interest accrual resumes only when loans return to performingstatus.  To return to performing status,loans must be fully current, and continued timely payments must be a reasonableexpectation.  Loans are generally placedon non-accrual status when principal or interest becomes ninety days past due,or when payment in full is not anticipated.  When a loan is placed onnon-accrual status, interest accrued but not received is generally reversedagainst interest income.  Cash receipts on non-accrual loans are notrecorded as interest income, but are used to reduce principal.

 

7

----

 

The Company identifies impaired loans through its normal internal loanreview process.  Loans on the Company’spotential problem loan list are considered potentially impaired loans.  These loans are evaluated in determiningwhether all outstanding principal and interest are expected to becollected.  Loans are not consideredimpaired if a minimal payment delay occurs and all amounts due, includingaccrued interest at the contractual interest rate for the period of delay, areexpected to be collected.  Management hasdetermined that the Company had $102,584 and $35,172 in impaired loans at March 31,2008 and December 31, 2007, respectively.

 

**Allowancefor Loan Losses** – The allowance for loan losses isestablished as losses are estimated to have occurred through a provision forloan losses charged to earnings.  Loanlosses are charged against the allowance when management believes theuncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are creditedto the allowance.

 

The allowance for loan losses is evaluated on a regular basis bymanagement and is based upon management’s periodic review of the collectabilityof the loans in light of historical experiences, the nature and volume of theloan portfolio, adverse situations that may affect the borrower’s ability torepay, estimated value of any underlying collateral and prevailing economicconditions.  This evaluation isinherently subjective as it requires estimates that are susceptible tosignificant revision as more information becomes available.

 

The allowance consists of specific, general and unallocatedcomponents.  The specific componentrelates to loans that are classified as either doubtful, substandard or specialmention.  For such loans that are alsoclassified as impaired, an allowance is established when the discounted cashflows (or collateral value or observable market price) of the impaired loan islower than the carrying value of the loan. The general component coversnon-classified loans and is based on historical loss experience adjusted forqualitative factors.  An unallocatedcomponent is maintained to cover uncertainties that could affect management’sestimate of probable losses.  Theunallocated component of the allowance reflects the margin of imprecisioninherent in the underlying assumptions used in the methodologies for estimatingspecific and general losses in the portfolio.

 

A loan is considered impaired when, based on current information andevents, it is probable that the Company will be unable to collect the scheduledpayments of principal or interest when due according to the contractual termsof the loan agreement.  Factors consideredby management in determining impairment include payment status, collateralvalue, and the probability of collecting scheduled principal and interestpayments due.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record and the amount ofthe shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loanbasis for commercial and construction loans by either the present value ofexpected future cash flows discounted at the loan’s effective interest rate,the loan’s obtainable market price, or the fair value of the collateral if theloan is collateral dependent.

 

Large groups of smaller balance homogeneous loans are collectivelyevaluated for impairment.  Accordingly,the Company does not separately identify individual consumer and residentialloans for impairment disclosures, unless such loans are the subject of arestructuring agreement.

 

**Bank-Owned Life Insurance** – The Company has purchased lifeinsurance policies on certain key employees. These policies are recorded in other assets at their net cash surrendervalue, or the amount that can be realized. Income from these policies and changes in the net cash surrender valueare recorded in non-interest income.

 

**Advertising–** Advertising, promotional, and other business developmentcosts generally are expensed as incurred. External costs incurred in producing media advertising are expensed thefirst time the advertising takes place. External costs relating to direct mailing costs are expensed in theperiod in which the direct mailings are sent.

 

**Property and Equipment**– Premises, furniture and equipment are stated at cost, less accumulateddepreciation.  Depreciation expense iscomputed using the straight-line method, based on the estimated useful livesfor furniture and equipment of 5 to 10 years. Leasehold improvements are amortized over the life of the lease.  Maintenance and repairs are charged tocurrent expense.  The costs of majorrenewals and improvements are capitalized.

 

**Residential Loan Origination Fees** – The Company offers residential loanorigination services to its customers in its immediate market area.  The loans are offered on terms and pricesoffered by the Company’s correspondents and are closed in the name of thecorrespondents.  The Company receivesfees for services it provides in conjunction with the origination services itprovides.  The fees are recognized at thetime the loans are closed by the Company’s correspondent.

 

8

----

 

**Income Taxes** – The consolidated financial statements have been prepared on the accrual basis.  When income and expenses are recognized in different periods for financial reporting purposes versus for the purposes of computing income taxes currently payable, deferred taxes are provided on such temporary differences.  The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”).

 

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) to clarify the accounting and disclosure for uncertainty in tax positions, as defined.  FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes.  The Company implemented the provisions of FIN 48 as of January 1, 2007, and has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions.  The Company believes that its income tax filing positions taken or expected to be taken in an its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flow.  Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN 48.  In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.

 

Under SFAS 109 and FIN 48, deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns.  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.  Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled.  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 carry-forwards.

 

**Earnings Per Share** – Basicearnings per share represents the net income allocated to shareholders dividedby the weighted-average number of common shares outstanding during theperiod.  Diluted earnings per sharereflect the impact of additional common shares that would have been outstandingif dilutive potential common shares had been issued.  Potential common shares that may be issued bythe Company relate to both outstanding warrants and stock options, and aredetermined using the treasury stock method.

 

**Stock–based Compensation** – On January 1,2006, the Company adopted the fair value recognition provisions of theFinancial Accounting Standards Board’s (“FASB”) SFAS No. 123(R), “Share-BasedPayment”, which is a revision of SFAS No. 123, “Accounting for Stock-BasedCompensation”, to account for compensation costs under its stock optionplans.  The Company previously utilizedthe intrinsic value method under Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees (as amended)” (“APB 25”).  Under the intrinsic value method prescribedby APB 25, no compensation costs were recognized for the Company’s stockoptions because the option exercise price in its plans equaled the market priceon the date of grant.  Prior to January 1,2006, the Company only disclosed the pro forma effects on net income andearnings per share as if the fair value recognition provisions of SFAS No. 123(R) hadbeen utilized.

 

# **In adopting SFAS No. 123(R), the Company electedto use the modified prospective method to account for the transition from theintrinsic value method to the fair value recognition method.  Under the modified prospective method,compensation cost is recognized from the adoption date forward for all newstock options granted and for any outstanding unvested awards as if the fairvalue method had been applied to those awards as of the date of grant.**

# ** **

**Off-Balance Sheet FinancialInstruments** – In the ordinary course of business, the Companyenters into off-balance sheet financial instruments consisting of commitmentsto extend credit and letters of credit. These financial instruments are recorded in the financial statementswhen they become payable by the customer.

 

**Recently Issued Accounting Standards –**Thefollowing is a summary of recent authoritative pronouncements that could impactthe accounting, reporting, and / or disclosure of financial information by theCompany.

 

Effective January 1, 2008, the Company adopted SFAS No. 157, “FairValue Measurements” (“SFAS 157”) which provides a framework for measuring anddisclosing fair value under generally accepted accounting principles.  SFAS 157 requires disclosures about the fairvalue of assets and liabilities recognized in the balance sheet in periods subsequentto initial recognition, whether the measurements are made on a recurring basis(for example, available-for-sale investment securities) or on a non-recurringbasis (for example, impaired loans).

 

9

----

 

SFAS 157 defines fair value as the exchange price that would bereceived for an asset or paid to transfer a liability (an exit price) in theprincipal or most advantageous market for the asset or liability in an orderlytransaction between market participants on the measurement date.  SFAS 157 also establishes a fair valuehierarchy which requires an entity to maximize the use of observable inputs andminimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputsthat may be used to measure fair value:

 
| Level 1 |   | Quoted prices in active  markets for identical assets or liabilities. Level 1 assets and liabilities  include debt and equity securities and derivative contracts that are traded  in an active exchange market, as well as U.S. Treasury, other U.S. Government  and agency mortgage-backed debt securities that are highly liquid and are  actively traded in over-the-counter markets.                                                                                                                                                                                                                                                                                                                                                         |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| Level 2 |   | Observable inputs other  than Level 1 prices such as quoted prices for similar assets or liabilities;  quoted prices in markets that are not active; or other inputs that are  observable or can be corroborated by observable market data for substantially  the full term of the assets or liabilities. Level 2 assets and liabilities  include debt securities with quoted prices that are traded less frequently  than exchange-traded instruments and derivative contracts whose value is  determined using a pricing model with inputs that are observable in the  market or can be derived principally from or corroborated by observable  market data. This category generally includes certain derivative contracts  and impaired loans. |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| Level 3 |   | Unobservable inputs  that are supported by little or no market activity and that are significant  to the fair value of the assets or liabilities. Level 3 assets and  liabilities include financial instruments whose value is determined using  pricing models, discounted cash flow methodologies, or similar techniques, as  well as instruments for which the determination of fair value requires  significant management judgment or estimation. For example, this category  generally includes certain private equity investments, retained residual  interests in securitizations, residential mortgage servicing rights, and  highly-structured or long-term derivative contracts.                                                       |

 

Available-for-sale investment securities (approximately $54.2 millionat March 31, 2008) are the only assets whose fair values are measured on arecurring basis using Level 1 inputs (active market quotes).

 

The Company has no liabilities carried at fair value or measured atfair value on a non-recurring basis.

 

The Company is predominantly an asset-based lender with real estateserving as collateral on a substantial majority of loans.  Loans which are deemed to be impaired areprimarily valued on a non-recurring basis at the fair values of the underlyingreal estate collateral.  When practical,such fair values are obtained using independent appraisals, which the Companyconsiders to be level 2 inputs.   Theaggregate carrying amount of impaired loans at March 31, 2008 was$102,584.

 

FASB Staff Position No. FAS 157-2 delays the implementation ofSFAS 157 until the first quarter of 2009 with respect to goodwill, otherintangible assets, real estate and other assets acquired through foreclosureand other non-financial assets measured at fair value on a non-recurring basis.

 

The Company has no assets or liabilities whose fair values are measuredusing level 3 inputs.

 

Other accounting standards that have been issued or proposed by theFASB or other standards-setting bodies are not expected to have a materialimpact on the Company’s financial position, results of operations or cashflows.

 

**Risks and Uncertainties** – In thenormal course of its business, the Company encounters two significant types ofrisk: economic and regulatory.  There arethree main components of economic risk: interest rate risk, credit risk and market risk.  The Company is subject to interest rate riskto the degree that its interest-bearing liabilities mature or reprice atdifferent speeds, or on different bases, than its interest-earning assets.  Credit risk is the risk of default on theCompany’s loan portfolio that results from the borrower’s inability orunwillingness to make contractually required payments.  Market risk reflects changes in the value ofcollateral underlying loans receivable and the valuation of real estate held bythe Company.

 

The Company is subject to the regulations of various governmentalagencies.  These regulations can and dochange significantly from period to period. The Company also undergoes periodic examinations by the regulatoryagencies, which may subject it to further changes with respect to assetvaluations, amounts of required loss allowances and operating restrictions fromthe regulators’ judgments based on information available to them at the time oftheir examination.

 

**Reclassifications** -Certain captions and amounts in the prior financial statements werereclassified to conform with the 2008 presentation.  Such reclassifications had no effect onpreviously reported net income or shareholders’ equity.

 

10

----

 

**NOTE 3 – INVESTMENT SECURITIES**

 

# **The amortized costs and fairvalues of investment securities are as follows:**

 
| ** **                                   | ** ** | **Amortized** | ** **     | **Gross Unrealized** | ** ** | **Fair**    | ** ** |
|----------------------------------------------|------------|---------------|----------------|---------------------------|------------|-------------|------------|
| **As of March 31, 2008** | ** ** | **Cost**      | ** **     | **Gains**                 | ** ** | **Losses**  | ** ** | **Value** | ** ** |
| **Available  for sale**                      |       |          |           |                      |       |        |       |   |   |
| Government  sponsored enterprises            |       | $             | 28,488,579     |                      | $          | 257,454     |       | $ | — |   | $ | 28,746,033 |   |
| Mortgage-backed                              |       | 25,216,420    |           | 246,953                   |       | 127,349     |       | 25,336,024 |   |
| Marketable  securities                       |       | 100,000       |           | —                    |       | —      |       | 100,000 |   |
| Total available  for sale                    | ** ** | **$**         | **53,804,999** | ** **                | **$**      | **504,407** | ** ** | **$** | **127,349** | ** ** | **$** | **54,182,057** | ** ** |

 

**NOTE 4 – LEASES**

 

The Company leases branch locations in Spartanburg,Mauldin, Anderson, Greer and Greenville as well as the loan operations centerin Easley. The initial lease terms range from three to ten years with variousrenewal options. The minimum future rental payments under non-cancelableoperating leases having remaining terms in excess of one year, for each of thenext five years and in the aggregate are:

 
| 2008                                  |       | $         | 259,695       |       |
|---------------------------------------|------------|-----------|---------------|------------|
| 2009                                  |       | 353,771   |          |
| 2010                                  |       | 332,364   |          |
| 2011                                  |       | 331,862   |          |
| 2012                                  |       | 345,471   |          |
| Thereafter                            |       | 1,288,756 |          |
| Total minimum  future rental payments | ** ** | **$**     | **2,911,919** | ** ** |

 

Theloan operations center in Easley is leased from a partnership in which aCompany director has a partnership interest.

 

**NOTE 5 – RELATED PARTY TRANSACTIONS**

 

Certain parties (principally certain directors and executive officersof 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 thesame terms, including interest rates and collateral, as those prevailing at thetime for comparable transactions with unrelated persons and do not involve morethan the normal risk of collectability.

 

### **NOTE 6 –COMMITMENTS AND CONTINGENCIES**

### ** **

The Company is subject to claims and lawsuits which arise primarily inthe ordinary course of business. Management is not aware of any legal proceedings which would have amaterial adverse effect on the financial position or operating results of theCompany.

 

**NOTE 7 – STOCK-BASED COMPENSATION**

 

Upon completion of the offering, the Company agreed to issue warrantsto the organizing directors for the purchase of one share of common stock at$6.40 per share for every two shares purchased in the stock offering, up to amaximum of 15,625 warrants per director. The warrants were fully vested 120days after January 18, 2005 and will expire on January 18, 2015.  Warrants held by directors of the Companywill expire 90 days after the director ceases to be a director or officer ofthe Company (365 days if due to death or disability). The Company issued atotal of 171,404 warrants.  In addition,the Company has adopted a stock option plan. As of March 31, 2008 the Company has 764,968 outstanding options toemployees and directors. On January 16, 2006 the Company adopted aresolution that terminated the “evergreen” provision of the Company 2005 StockIncentive Plan. As a result, the number of shares of common stock issuableunder the plan shall not be further increased in connection with any futureshare issuances by the Company. The exercise price of each option is equal tothe market price of the Company’s stock on the date of grant. The maximum termis ten years, and they typically vest in no greater than five years. Whennecessary, the Company may purchase shares on the open market to satisfy shareoption exercises. During the ensuing year, the Company is expected to acquireno shares.

 

The table set forth below summarizes stock option activity for theCompany’s stock compensation plans for the quarter ended March 31, 2008 asadjusted for all stock splits.

 

11

----

 
| ** **                                 | ** ** | **Stock Options** | ** ** | **Warrants**  | ** ** |
|--------------------------------------------|------------|------------------------|------------|---------------|------------|
| ** **                                 | ** ** | ** **             | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                 | ** ** | ** **             | ** ** | **Average**   | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                 | ** ** | ** **             | ** ** | **Exercise**  | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                 | ** ** | **Number**             | ** ** | **Price**     | ** ** | **Number** | ** ** | **Price** | ** ** |
| **Outstanding  at December 31, 2007** |       | 761,493                |       | $             | 7.17       |   | 171,404 |   | $ | 6.40 |   |
| Granted                                    |       | 7,350                  |       | 9.25          |       | — |   | — |   |
| Forfeited                                  |       | 3,875                  |       | 15.23         |       | — |   | — |   |
| Exercised                                  |       | —                 |       | —        |       | — |   | — |   |
| **Outstanding  at March 31, 2008**    | ** ** | **764,968**            | ** ** | **7.15**      | ** ** | **171,404** | ** ** | **6.40** | ** ** |
|                                            |            |                        |            |               |            |  |  |  |  |  |  |

 

The table set forth below summarizes non-vested stockoptions as of March 31, 2008.

 
| ** **                                 | ** ** | ** ** | ** ** | **Fair**  | ** ** |
|--------------------------------------------|------------|------------|------------|-----------|------------|
| ** **                                 | ** ** | **Number** | ** ** | **Value** | ** ** |
| **Outstanding  at December 31, 2007** |       | 42,273     |       | $         | 6.79       |   |
| Granted                                    |       | 7,350      |       | 4.16      |       |
| Vested                                     |       | 2,274      |       | 6.65      |       |
| Forfeited                                  |       | —     |       | —    |       |
| **Outstanding  at March 31, 2008**    | ** ** | **47,349** | ** ** | **6.38**  | ** ** |
|                                            |            |            |            |           |            |  |

 

As of March 31, 2008, there was $288,152 in total unrecognizedcompensation cost related to non-vested share-based compensation arrangements,which is expected to be recognized over a weighted average period of 47 months.As of December 31, 2007, there was $255,917 in total unrecognizedcompensation cost related to non-vested share-based compensation arrangements,which is expected to be recognized over a weighted average period of 49 months.

 

The fair value of each option granted is estimated on the grant dateusing the Black-Scholes option-pricing model with the following assumptions for2008 and 2007:  dividend yield of 0%,expected term of 10 years, risk-free interest rate of 5.0%, expected life of 10years, and expected volatility of 20%.

 

The following table summarizes information about stockoptions outstanding under the Company’s plans at March 31, 2008 and December 31,2007.

 
| **March 31, 2008**     | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|----------------------------------|------------|-----------------|------------|-----------------|------------|
| Number of  options               |       | 764,968         |       | 717,619         |       |
| Weighted average  remaining life |       | 7.12 years      |       | 7.00 years      |       |
| Weighted average  exercise price |       | $               | 7.15       |            | $          | 6.69 |   |
| High exercise  price             |       | $               | 16.80      |            | $          | 16.80 |   |
| Low exercise  price              |       | $               | 6.40       |            | $          | 6.40 |   |

 
| **December 31, 2007**  | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|----------------------------------|------------|-----------------|------------|-----------------|------------|
| Number of  options               |       | 761,493         |       | 719,220         |       |
| Weighted average  remaining life |       | 7.35 years      |       | 7.25 years      |       |
| Weighted average  exercise price |       | $               | 7.17       |            | $          | 6.71 |   |
| High exercise  price             |       | $               | 16.80      |            | $          | 16.80 |   |
| Low exercise  price              |       | $               | 6.40       |            | $          | 6.40 |   |

 

There were no options exercised during the quarter and thus no cash wasreceived related to this type of transaction. The intrinsic value of optionsexercised during 2008 and 2007 was $0 and $2,880, respectively.

 

At March 31, 2008, all of the 171,404 warrants were exercisableand had an average remaining life of 6.80 years. At December 31, 2007, allof the 171,404 warrants were exercisable and had an average remaining life of7.05 years.

 

12

----

 

**Item 2.  Management’sDiscussion and Analysis or Plan of Operation.**

 

*The following discussion reviews our results ofoperations and assesses our financial condition.  You should read the following discussion andanalysis in conjunction with the accompanying consolidated financialstatements.  The commentary should beread in conjunction with the discussion of forward-looking statements, thefinancial statements, and the related notes and the other statisticalinformation included in this report.*

 

**DISCUSSION OF FORWARD-LOOKINGSTATEMENTS**

 

This report contains “forward-lookingstatements” relating to, without limitation, future economic performance, plansand objectives of management for future operations, and projections of revenuesand other financial items that are based on the beliefs of management, as wellas 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 toidentify forward-looking statements.  Ouractual results may differ materially from the results discussed in theforward-looking statements, and our operating performance each quarter issubject to various risks and uncertainties that include, without limitation,those described under the heading “Risk Factors” in our Annual Report on Form 10-KSBfor the year ended December 31, 2007 as filed with the Securities andExchange Commission and the following:

 

·      our rapid growth to date andshort operating history;

 

·      the opening of additionalfull-service branches and the resulting pressure this could cause on ourmanagement team;

 

·      significantincreases in competitive pressure in the banking and financial servicesindustries;

 

·      changesin the interest rate environment which could reduce anticipated or actualmargins;

 

·      changesin political conditions or the legislative or regulatory environment;

 

·      generaleconomic conditions, either nationally or regionally and especially in ourprimary service area, becoming less favorable than expected resulting in, amongother things, a deterioration in credit quality;

 

·      changesoccurring in business conditions and inflation;

 

·      changesin technology;

 

·      changesin deposits flows;

 

·      changesin monetary and tax policies;

 

·      thelack of seasoning of our loan portfolio, especially given our rapid loangrowth;

 

·      theamount of our real estate based loans, and the weakness in the commercial realestate market;

 

·      thelevel of allowance for loan losses;

 

·      therate of delinquencies and amounts of charge-offs;

 

·      adversechanges in asset quality and resulting credit risk-related losses and expenses;

 

·      lossof consumer confidence and economic disruptions resulting from terroristactivities;

 

·      changesin the securities markets; and

 

·      otherrisks and uncertainties detailed from time to time in our filings with theSecurities and Exchange Commission.

 

All forward-looking statements in this report are based on informationavailable to us as of the date of this report. We undertake no obligation to publicly update or otherwise revise anyforward-looking statements, whether as a result of new information, futureevents, or otherwise.

 

# **Overview**

# ** **

CommunitySouth Financial Corporation is a bank holding companyheadquartered in Easley, South Carolina. Our subsidiary, CommunitySouth Bank and Trust, opened for business on January 18,2005.  In addition to the main office inEasley, the Bank has five branch locations in the upstate region of SouthCarolina.  We opened our Mauldin branchin the fourth quarter of 2005, our Spartanburg branch in the first quarter of2006, our Anderson branch in the third quarter of 2006, our Greer branch in thefourth quarter of 2006 and our Greenville branch in the third quarter of2007.  We anticipate continued branchexpansion in the Upstate region as opportunities arise.  The Bank provides banking services todomestic markets, principally in the Upstate of South Carolina.  The deposits of the Bank are insured by theFederal Deposit Insurance Corporation. All share and per share information in this report has been adjusted forthe 5-for-4 stock splits effected in the form of a stock dividend paid on January 16,2007 and January 16, 2006 to shareholders of record as of December 15,2006 and December 15, 2005, respectively.

 

13

----

 

Like mostcommunity banks, we derive most of our income from interest we receive on ourloans and investments.  Our primarysource of funds for making these loans and investments is our deposits, onwhich we pay interest.  Consequently, oneof the key measures of our success is our amount of net interest income, or thedifference between the income on our interest-earning assets, such as loans andinvestments, and the expense on our interest-bearing liabilities, such asdeposits.  Another key measure is thespread between the yield we earn on these interest-earning assets and the ratewe pay on our interest-bearing liabilities.

 

Of course, thereare risks inherent in all loans, so we maintain an allowance for loan losses toabsorb probable losses on existing loans that may become uncollectible.  We establish and maintain this allowance bycharging a provision for loan losses against our operating earnings.  In the following section we have included adetailed discussion of this process.

 

In addition toearning interest on our loans and investments, we earn income through fees andother expenses we charge to our customers. We describe the various components of this non-interest income, as wellas our non-interest expense, in the following discussion.

 

**Results of Operations**

 

*Three Months ended March 31, 2008 and 2007*

 

*Overview*

 

Our net income was $341,491 for the three months ended March 31,2008 as compared to $208,372 for the three months ended March 31,2007.  Since we began operations in thefirst quarter of 2005, we have experienced significant growth, which has led toa substantial increase in revenues and expenses.  Due to our growth, we have now attained alevel of earning assets that supports our costs and we are currently operatingprofitably. For the three months ended March 31, 2008, we realized$6,277,956 in interest income, of which $731,109 was from investment activitiesand $5,546,847 was from loan activities. For the three months ended March 31, 2007, we realized $4,914,809in interest income, of which $310,156 was from investment activities and$4,604,653 was from loan activities.  Thesubstantial increase in our interest income is primarily a result of ourcontinued loan growth during our third year of operation.  We anticipate the growth in loans willcontinue to drive the growth in assets and the growth in interest income,although the rate of our loan growth has slowed in the past quarter, primarilyas a result of the downturn in the economy and the real estate market.  The primary source of funding for our loan portfoliois deposits that are acquired both locally and via the national brokeredcertificate market.  We incurred interestexpense of $3,653,138 and $2,764,563 for the three months ended March 31,2008 and March 31, 2007, respectively. This increase in our interest expense was a result of increased levelsof interest bearing deposits. We have experienced a decline in our net interestmargin to 2.81% from 3.44% for the quarters ended March 31, 2008 and 2007,respectively. The decline was due to the competitive pressure on commercialloan pricing as well as deposit pricing.

 

*Provision for Loan Losses*

 

Our provision for loan losses for the three months ended March 31,2008 was $125,000 compared to $362,000 for the comparable prior year period.The $237,000 decrease was the result of reduced loan production in 2008compared to the same period in 2007. The increase in gross loans outstandingwas $6.7 million for the first quarter of 2008 as compared to an increase of$26.7 million for the first quarter of 2007.

 

*Non-interest Income*

 

We had non-interest income of $340,775 and $344,683 for the threemonths ended March 31, 2008 and 2007, respectively.  Mortgage origination fee income for the threemonths ended March 31, 2008 was $162,895. We had $245,736 in mortgage origination fee income in the first quarterof 2007.  The decrease was the result ofthe overall decline in the demand for home mortgages due to the currenteconomic conditions.  Further, changes instate and federal laws regarding the oversight of mortgage brokers and lenderscould increase our costs of operations and affect our mortgage originationvolume which could negatively impact our non-interest income in the future.

 

14

----

 

*Non-interest Expense*

 

We incurred non-interest expense of $2,316,002 during the three monthsended March 31, 2008.  Included inthe expense was $1,234,585 of salaries and employee benefits, $190,782 of dataprocessing expense, $78,104 of professional fees expense, $11,163 ofadvertising expense, $27,784 of expense related to office supplies, $36,058 oftelephone expense and $52,500 of assessments related to FDIC.  The non-interest expense incurred in thethree months ended March 31, 2007 was $1,789,335.  Included in the expense was $993,220 ofsalaries and employee benefits, $120,860 of data processing expense, $42,221 ofprofessional fee expense, $30,869 of advertising expense, $52,182 of expenserelated to office supplies, $39,472 of telephone expense and $8,392 ofassessments related to FDIC.

 

For the three months ended March 31, 2008, we incurred other fixedasset expenses of $181,214 in depreciation and $47,624 in equipment maintenanceand rental.  For the three months ended March 31,2007, we incurred other fixed asset expenses of $131,047 in depreciation and$30,273 in equipment maintenance and rental. We incurred $162,534 and $131,899 in occupancy expense related to all ofour office locations for the three months ended March 31, 2008 and 2007,respectively.

 

The increase in non-interest expense is the result of the addition of anew branch and personnel over the past year as well as expense related tocustomer growth at the existing branches.

 

**Assets and Liabilities**

 

*General*

 

At March 31, 2008, total assets increased 1.18%to $382.3 million as compared to $377.9 million at December 31, 2007.  Gross loans increased $6.7 million, or 2.22%,during the first three months of 2008. As described below, federal funds sold decreased to $2.5 million at March 31,2008 compared to $33.7 million at December 31, 2007.  Cash and cash equivalents decreased $31.9million, or 79.55%, since December 31, 2007.  As described below, deposits decreased $17.3million, or 5.28%, during the first three months of 2008.  At March 31, 2008, shareholders’ equitywas $31.9 million.

 

*Investment Securities*

 

Investments available for sale increased by $29.3 million, or 118.09%,since December 31, 2007 due to the purchase of and the appreciationrelated to government agency bonds and mortgaged-backed securities.  Since December 31, 2007 the rationalefor the general change of investing in federal funds to investing in securitiesavailable for sale was to take advantage of higher earning rates and longerterms on the Bank’s investable funds.

 

*Other Investments*

 

Other investments increased by $458,400 since December 31, 2007due to the purchase of additional FHLB stock. All of the FHLB stock is used to collateralize advances with the FHLB.

 

*Loans*

 

Since loans typically provide higher interest yields than other typesof interest earning assets, we allocate the majority of our earning assets toour loan portfolio.  Gross loansincreased by $6.7 million, or 2.22%, during the first three months of2008.  Loan demand has slowed during thefirst quarter of 2008 due to general economic conditions and the real estatemarket.  We expect this trend to continueduring the next quarter.

 

Balances within major loan categories are as follows:

 
| **(dollar amounts in thousands)** | ** ** | **March 31, 2008** | ** **  | **December 31, 2007** | ** ** |
|--------------------------------------------------|------------|------------------------------|-------------|---------------------------------|------------|
| Real estate -  construction                      |       | $                            | 129,653     |                            | $          | 124,016 |   |
| Real estate -  mortgage                          |       | 150,383                      |        | 149,370                         |       |
| Commercial and  industrial                       |       | 26,463                       |        | 26,095                          |       |
| Consumer and  other                              |       | 3,171                        |        | 3,453                           |       |
| Total loans,  gross                              |       | 309,670                      |        | 302,934                         |       |
| Less allowance  for loan losses                  |       | (4,289                       | )           | (4,214                          | )          |
| Total loans, net                                 | ** ** | **$**                        | **305,381** | ** **                      | **$**      | **298,720** | ** ** |

 

15

----

 

We 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 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 place a delinquent loan in non-accrual status when the loan becomes 90 days or more past due.  When we place a loan in non-accrual status, we reverse all interest which has been accrued on the loan but remains unpaid and we deduct this interest from earnings as a reduction of reported interest income.  We do not accrue any additional interest on the loan balance until we conclude the collection of both principal and interest is reasonably certain.  At March 31, 2008, there were $102,584 in loans that were non-accruing and $1,580,127 in loans that were 30 days past due.  At December 31, 2007, there were $35,172 in loans that were non-accruing and $724,741 in loans that were 30 days past due.

 

*Potential ProblemLoans*

 

Potential problem loans are loans that are not included in impaired loans (non-accrual loans or loans past due 90 days or more and still accruing), but about which management has become aware of information about possible credit problems of the borrowers that causes doubt about their ability to comply with current repayment terms.  At March 31, 2008 and December 31, 2007, the Company had identified $3,194,993 and $1,625,150, respectively, of potential problem loans through its internal review procedures.  The results of this internal review process are considered in determining management’s assessment of the adequacy of the allowance for loan losses.

 

*Provision andAllowance for Loan Losses*

 

The Company has developed policies and procedures for evaluating theoverall quality of its credit portfolio and the timely identification ofpotential problem loans.  On a quarterlybasis, the Company’s Board of Directors reviews and approves the appropriatelevel for the Company’s allowance for loan losses based upon management’srecommendations, the results of the internal monitoring and reporting system,and an analysis of economic conditions in its market.

 

Additions to the allowance for loan losses, which are expensed throughthe provision for loan losses on the Company’s income statement, are madeperiodically to maintain the allowance at an appropriate level based onmanagement’s analysis of the estimated losses inherent in the loanportfolio.  Loan losses and recoveriesare charged or credited directly to the allowance.  The amount of the provision is a function ofthe level of loans outstanding, the level of non-performing loans, historicalloan loss experience, the amount of loan losses actually charged against thereserve during a given period, and current and anticipated economic conditions.

 

The Company’s allowance for loan losses is based upon judgments andassumptions about risk elements in the portfolio, future economic conditions,and other factors affecting borrowers. The process includes identification and analysis of loss potential invarious portfolio segments utilizing a credit risk grading process and specificreviews and evaluations of significant problem credits.  However, there is no precise method of estimatingcredit losses, since any estimate of loan losses is necessarily subjective andthe accuracy depends on the outcome of future events.  In addition, due to our rapid growth over thepast several years and our limited operating history, a large portion of theloans in our loan portfolio was originated recently.  In general, loans do not begin to show signsof credit deterioration or default until they have been outstanding for someperiod of time, a process referred to as seasoning.  As a result, a portfolio of more mature loanswill usually behave more predictably than a newer portfolio.  Because our loan portfolio is relatively new,the current level of delinquencies and defaults may not be representative ofthe level that will prevail when the portfolio becomes more seasoned, which maybe higher than current levels.  Ifcharge-offs in future periods increase, we may be required to increase ourprovision for loan losses, which would decrease our net income and possibly ourcapital.

 

Based on present information and an ongoing evaluation, managementconsiders the allowance for loan losses to be adequate to meet presently knownand inherent losses in the loan portfolio. Management’s judgment about the adequacy of the allowance is based upona number of assumptions about future events which it believes to be reasonablebut which may or may not be accurate. Thus, there can be no assurance that charge-offs in future periods willnot exceed the allowance for loan losses or that additional increases in theallowance for loan losses will not be required. The Company does not allocate the allowance for loan losses to specificcategories of loans but evaluates the adequacy on an overall portfolio basisutilizing a risk grading system.

 

16

----

 

*Deposits*

 

Our primary source of funds for loans and investments is ourdeposits.  We have chosen to obtain aportion of our certificates of deposits from areas outside of our market, whichare brokered deposits. The deposits obtained outside of our market areagenerally have rates comparable to those being offered for certificates ofdeposits in our local market.  As of March 31,2008, total deposits had decreased by $17.3 million, or 5.28%, from December 31,2007.  The largest percentage decreasewas in savings, which decreased $4.6 million, or 18.87%, from December 31,2007 to March 31, 2008.  This wasprimarily the result of a run-off of money market accounts that had beenestablished as temporary holding accounts for IRS section 1031 exchangetransactions.  The decline in depositswas also affected by certain Bank deposit pricing methods that resulted in adecline in certificates and allowed us to shift a portion of our funding toFHLB advances and repurchase agreements, which together increased $20 millionsince December 31, 2007.  Weanticipate that future deposit growth will be positive and will be sufficientto fund our anticipated loan growth.

 

Balances within the major deposit categories are asfollows:

 
| **(dollar amounts in thousands)** | ** ** | **March 31, 2008** | ** **  | **December 31, 2007** | ** ** |
|--------------------------------------------------|------------|------------------------------|-------------|---------------------------------|------------|
| Non-interest  bearing demand                     |       | $                            | 22,409      |                            | $          | 24,464 |   |
| Interest bearing  demand                         |       | 16,926                       |        | 13,721                          |       |
| Savings                                          |       | 19,986                       |        | 24,634                          |       |
| Time deposits  less than $100,000                |       | 56,406                       |        | 59,528                          |       |
| Time deposits of  $100,000 or over               |       | 46,446                       |        | 47,118                          |       |
| Brokered  deposits                               |       | 148,199                      |        | 158,199                         |       |
| Total deposits                                   | ** ** | **$**                        | **310,372** | ** **                      | **$**      | **327,664** | ** ** |

 

*Advances from FHLB*

 

Advances from FHLB are a source of funding that theBank uses depending on the current level of deposits and the availability of collateralto secure FHLB borrowings.  At March 31,2008, the Bank had received advances of $5.0 million from FHLB.

 

*Repurchase Agreements*

 

At March 31, 2008, the Bank had sold $30.0million of securities under agreements to repurchase with brokers with a weightedaverage rate of 2.58% and an average maturity of 79 months.  The maximum amount outstanding at anymonth-end was $30.0 million.  Theseagreements were secured with approximately $34.6 million of investmentsecurities.

 

**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 March 31, 2008, we had lines of credit with unrelated banks totaling $15.5 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, cash equivalents and securities available for sale-to-total assets ratio, which was at 16.3% at March 31, 2008.

 

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 $37.8 million was available as of March 31, 2008.  Advances under this credit facility are subject to qualifying collateral.

 

17

----

 

**Impactof Off-Balance Sheet Instruments**

 

Through the operations of our Bank, we have made contractualcommitments to extend credit in the ordinary course of our businessactivities.  These commitments arelegally binding agreements to lend money to our customers at predeterminedinterest rates for a specified period of time. At March 31, 2008, we had issued commitments to extend credit of$51.1 million through various types of lending arrangements.  We evaluate each customer’s credit worthinesson a case-by-case basis.  The amount ofcollateral obtained, if deemed necessary by us upon extension of credit, isbased 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 thesecommitments by subjecting them to normal underwriting and risk managementprocesses.  The following tablesummarizes our off-balance-sheet financial instruments whose contract amountsrepresent credit risk:

 
| **(dollar amounts in thousands)** | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
|                                             |       |                         |       |                            |       |
| Commitments to  extend credit                    |       | $                            | 47,314,931 |                            | $          | 49,342,960 |   |
|                                             |       |                         |       |                            |       |
| Standby letters  of credit                       |       | $                            | 3,826,890  |                            | $          | 3,176,854 |   |

 

**Capital Resources**

 

Total shareholders’ equity increased from $31.5 million at December 31,2007 to $31.9 million at March 31, 2008. The increase is principally due to the net income for the period of$341,491.

 

The FRB and bankregulatory agencies require bank holding companies and financial institutionsto maintain capital at adequate levels based on a percentage of assets andoff-balance sheet exposures, adjusted for risk weights ranging from 0% to100%.  FRB guidelines contain anexemption from the capital requirements for “small bank holding companies,”which in 2006 were amended to cover most bank holding companies with less than$500 million in total assets that do not have a material amount of debt orequity securities outstanding registered with the SEC.  Although our class of common stock isregistered under Section 12 of the Securities Exchange Act, we believethat because our stock is not listed on any exchange or otherwise activelytraded, the Federal Reserve Board will interpret its new guidelines to meanthat we qualify as a small bank holding company.  Nevertheless, our Bank remains subject tothese capital requirements.  Failure tomeet minimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on the Bank’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities and certain off-balance sheet items as calculated under regulatoryaccounting practices.  The Bank’s capitalamounts and classifications are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.  Regardless, our Bank is “well capitalized”under these minimum capital requirements as set per bank regulatory agencies.

 

Under the capitaladequacy guidelines, regulatory capital is classified into two tiers.  These guidelines require an institution tomaintain a certain level of Tier 1 and Tier 2 capital to risk-weightedassets.  Tier 1 capital consists ofcommon shareholders’ equity, excluding the unrealized gain or loss onsecurities available for sale, minus certain intangible assets.  In determining the amount of risk-weightedassets, all assets, including certain off-balance sheet assets, are multipliedby a risk-weight factor of 0% to 100% based on the risks believed to beinherent in the type of asset.  Tier 2capital consists of Tier 1 capital plus the general reserve for loan losses,subject to certain limitations.  We arealso required to maintain capital at a minimum level based on total averageassets, which is known as the Tier 1 leverage ratio.

 

The Bank is also required to maintain capital at a minimum level basedon quarterly average assets, which is known as the leverage ratio.  Only the strongest banks are allowed tomaintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratiosat least 1% to 2% above the minimum.

 

18

----

 

The Bank exceeded the regulatory capital requirements at March 31,2008 and December 31, 2007 as set forth in the following table.

 
| ** **                                | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **Amount**                   | ** ** | **Ratio**                       | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
|                                      |       |                         |       |                            |       |   |   |   |   |
| Tier 1 capital  (to risk-weighted assets) |       | $                            | 31,484,000 |                            | 9.11       | % | $ | 30,102,000 |   | 8.92 | % |
| Total capital  (to risk-weighted assets)  |       | 35,773,000                   |       | 10.35                           |       | 34,316,000 |   | 10.17 |   |
| Tier 1 capital  (to average assets)       |       | 31,484,000                   |       | 8.20                            |       | 30,102,000 |   | 8.26 |   |
|                                           |            |                              |            |                                 |            |  |  |  |  |  |  |

 

**Critical Accounting Policies**

 

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

 

Certain accounting policies involve significant judgments andassumptions by us that have a material impact on the carrying value of certainassets and liabilities.  We considerthese accounting policies to be critical accounting policies.  The judgment and assumptions we use are basedon historical experience and other factors, which we believe to be reasonableunder the circumstances.  Because of thenature of the judgment and assumptions we make, actual results could differfrom these judgments and estimates that could have a material impact on thecarrying 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 flows, 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. Quantitative and Qualitative DisclosuresAbout Market Risk.**

 

Not applicable.

 

**Item 4. Controls and Procedures.**

 

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of ourdisclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that our currentdisclosure controls and procedures are effective as of March 31,2008.  There have been no significantchanges in our internal controls over financial reporting during the fiscalquarter ended March 31, 2008 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

The design of any systemof controls and procedures is based in part upon certain assumptions about thelikelihood of future events.  There canbe no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions, regardless of how remote.

 

**Part II - Other Information**

 

**Item 1. Legal Proceedings.**

 

Not Applicable.

 

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

 

Not applicable.

 

19

----

 

**Item 3. Defaults Upon SeniorSecurities.**

 

Not applicable.

 

**Item 4. Submission of Mattersto Vote of Security Holders.**

 

Not applicable.

 

**Item 5. Other Information.**

 

Not applicable.

 

**Item 6. Exhibits.**

 

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

 

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

 

32            Section 1350Certifications.

 

20

----

 

# **SIGNATURES**

# ** **

In accordance with the requirements of the Securities Exchange Act of1934, the Registrant caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
| Date: May 15, 2008 | By:                                          | /s/ C. Allan Ducker, III |
|-------------------------|----------------------------------------------|-------------------------------|
|                    | C. Allan Ducker, III                    |
|                    | Chief Executive Officer                      |
|                    | (Principal Executive Officer)                |
|                    |                                         |
| Date: May 15, 2008 | By:                                          | /s/ John W. Hobbs             |
|                    | John W. Hobbs                                |
|                    | Chief Financial Officer                      |
|                    | (Principal Financial and Accounting Officer) |

 

21

----

 

**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** **                                                                  |
|-------------|------------|-----------------------------------------------------------------------------|
| **Number**  |       | **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

----