EXHIBIT (13)

SOUTH STREET FINANCIAL CORP.

ALBEMARLE, NORTH CAROLINA

2005 ANNUAL REPORT



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

TABLE OF CONTENTS



|                                                                                 |  |      
|-------------------------------------------------------------------------------- |  | -----
|SELECTED CONSOLIDATED FINANCIAL DATA                                             |  | 1-2  
|                                                                                 | 
|REPORT TO STOCKHOLDERS                                                           |  | 3    
|                                                                                 | 
|MANAGEMENTS DISCUSSION AND ANALYSIS                                             |  | 4-11 
|                                                                                 | 
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                          |  | 12   
|                                                                                 | 
|CONSOLIDATED FINANCIAL STATEMENTS                                                |  |      
|                                                                                 | 
|Statements of financial condition atDecember 31, 2005 and 2004                   |  | 13   
|                                                                                 | 
|Statements of income for the years endedDecember 31, 2005 and 2004               |  | 14   
|                                                                                 | 
|Statements of stockholders equity for the years endedDecember 31, 2005 and 2004 |  | 15   
|                                                                                 | 
|Statements of cash flows for the years endedDecember 31, 2005 and 2004           |  | 16-17
|                                                                                 | 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                       |  | 18-44
|                                                                                 | 
|CORPORATE INFORMATION                                                            |  | 45-46

This Annual Report to Stockholders contains certain forward-looking statements consisting of estimates with
respect to the financial condition, results of operations and other business of South Street Financial Corp. that are subject to various factors which could cause actual results to differ materially from those estimates. Factors that could influence
the estimates include changes in the national, regional and local market conditions, a slowing economy, layoffs, legislative and regulatory conditions, and an adverse interest rate environment.



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

SELECTED CONSOLIDATED FINANCIAL DATA



|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|--------------------------------------------------- |  | ---------------------------------------- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                                    |  | At or for the Years Ended December 31,  
|                                                    |  | 2005                                     |         | 2004 |   | 2003    |  | 2002 |         | 2001
|                                                    |  | (In Thousands, Except Per Share Amounts)
|Financial Condition Data:                           |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Total assets                                        |  | $                                        | 243,233 |      | $ | 215,551 |  | $    | 220,154 |      | $ | 224,798 |  | $ | 212,368
|Investment securities(1)                            |  |                                          | 39,063  |      |   | 48,140  |  |      | 58,243  |      |   | 44,564  |  |   | 31,510 
|Loans receivable, net(2)                            |  |                                          | 183,212 |      |   | 152,431 |  |      | 143,344 |      |   | 172,184 |  |   | 173,132
|Deposits                                            |  |                                          | 198,634 |      |   | 186,905 |  |      | 181,120 |      |   | 175,659 |  |   | 167,590
|Borrowings                                          |  |                                          | 15,000  |      |   |        |  |      | 10,000  |      |   | 21,000  |  |   | 17,000 
|Stockholders equity                                |  |                                          | 25,970  |      |   | 25,731  |  |      | 25,647  |      |   | 24,895  |  |   | 23,889 
|Book value per share                                |  |                                          | 8.66    |      |   | 8.44    |  |      | 8.33    |      |   | 8.08    |  |   | 7.68   
|                                                    |  |                                          |         |      |  
|Operating Data:                                     |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Interest income                                     |  | $                                        | 12,663  |      | $ | 10,531  |  | $    | 11,466  |      | $ | 13,879  |  | $ | 14,659 
|Interest expense                                    |  |                                          | 5,271   |      |   | 4,430   |  |      | 5,166   |      |   | 6,969   |  |   | 8,945  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Net interest income                                 |  |                                          | 7,392   |      |   | 6,101   |  |      | 6,300   |      |   | 6,910   |  |   | 5,714  
|Provision for loan losses                           |  |                                          | 120     |      |   | 90      |  |      | 120     |      |   | 100     |  |   |       
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Net interest income after provision for loan losses |  |                                          | 7,272   |      |   | 6,011   |  |      | 6,180   |      |   | 6,810   |  |   | 5,714  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Non-interest income                                 |  |                                          | 856     |      |   | 789     |  |      | 819     |      |   | 522     |  |   | 357    
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Non-interest expense:                               |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Compensation and employee                           |  |                                          | 3,843   |      |   | 3,445   |  |      | 3,534   |      |   | 3,372   |  |   | 3,111  
|Other                                               |  |                                          | 1,893   |      |   | 1,640   |  |      | 1,546   |      |   | 1,449   |  |   | 1,462  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Total non-interest expense                          |  |                                          | 5,736   |      |   | 5,085   |  |      | 5,080   |      |   | 4,821   |  |   | 4,573  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Income before income taxes                          |  |                                          | 2,392   |      |   | 1,715   |  |      | 1,919   |      |   | 2,511   |  |   | 1,498  
|Income tax expense                                  |  |                                          | 812     |      |   | 626     |  |      | 675     |      |   | 849     |  |   | 525    
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Net income                                          |  | $                                        | 1,580   |      | $ | 1,089   |  | $    | 1,244   |      | $ | 1,662   |  | $ | 973    
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        



1



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

SELECTED CONSOLIDATED FINANCIAL DATA



|                                                                             |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|---------------------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                             |  | At or for the Years Ended December 31,   |       
|                                                                             |  | 2005                                     |        |   | 2004 |   |        | 2003 |  |   | 2002   |   |  | 2001 |       
|                                                                             |  | (In Thousands, Except Per Share Amounts) |       
|Selected Other Data:                                                         |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Basic earnings per share                                                     |  | $                                        | .54    |   |      | $ | .37    |      |  | $ | 0.43   |   |  | $    | 0.58   |   |  | $ | 0.35   |  
|Diluted earnings per share                                                   |  |                                          | .54    |   |      |   | .37    |      |  |   | 0.43   |   |  |      | 0.58   |   |  |   | 0.35   |  
|Dividends per share                                                          |  |                                          | .40    |   |      |   | .40    |      |  |   | 0.40   |   |  |      | 0.40   |   |  |   | 0.40   |  
|Dividend payout ratio(6)                                                     |  |                                          | 74.49  | % |      |   | 108.11 | %    |  |   | 95.24  | % |  |      | 68.97  | % |  |   | 114.29 | %
|Return on average assets                                                     |  |                                          | .70    | % |      |   | .51    | %    |  |   | 0.56   | % |  |      | 0.77   | % |  |   | 0.47   | %
|Return on average equity                                                     |  |                                          | 6.13   | % |      |   | 4.25   | %    |  |   | 4.92   | % |  |      | 6.85   | % |  |   | 4.22   | %
|Average equity to average assets                                             |  |                                          | 11.48  | % |      |   | 12.04  | %    |  |   | 11.43  | % |  |      | 11.22  | % |  |   | 11.24  | %
|Stockholders equity to end-of-period assets                                 |  |                                          | 10.68  | % |      |   | 11.94  | %    |  |   | 11.65  | % |  |      | 11.07  | % |  |   | 11.25  | %
|Interest rate spread for period(3)                                           |  |                                          | 3.42   | % |      |   | 2.99   | %    |  |   | 2.84   | % |  |      | 2.95   | % |  |   | 2.34   | %
|Average interest-earning assets to average interest-bearing liabilities      |  |                                          | 106.11 | % |      |   | 107.18 | %    |  |   | 107.95 | % |  |      | 110.78 | % |  |   | 110.92 | %
|Net interest margin(4)                                                       |  |                                          | 3.58   | % |      |   | 3.09   | %    |  |   | 3.04   | % |  |      | 3.31   | % |  |   | 2.83   | %
|Non-performing assets to total assets at period end(5)                       |  |                                          | .36    | % |      |   | .22    | %    |  |   | 0.65   | % |  |      | 0.58   | % |  |   | 0.36   | %
|Non-performing loans to total loans at period end                            |  |                                          | .35    | % |      |   | .32    | %    |  |   | 0.99   | % |  |      | 0.74   | % |  |   | 0.43   | %
|Allowance for loan losses to non-performing loans at period end              |  |                                          | 104.73 | % |      |   | 83.80  | %    |  |   | 78.08  | % |  |      | 40.42  | % |  |   | 57.16  | %
|Allowance for loan losses at period end as a percent of total gross loans    |  |                                          | .37    | % |      |   | 0.37   | %    |  |   | 0.30   | % |  |      | 0.30   | % |  |   | 0.24   | %
|Net interest income, after provision for loan losses to non-interest expense |  |                                          | 126.77 | % |      |   | 118.21 | %    |  |   | 121.65 | % |  |      | 141.25 | % |  |   | 120.49 | %
|Non-interest expense to average assets                                       |  |                                          | 2.55   | % |      |   | 2.38   | %    |  |   | 2.30   | % |  |      | 2.23   | % |  |   | 2.23   | %
|Deposit accounts                                                             |  |                                          | 11,213 |   |      |   | 10,982 |      |  |   | 11,421 |   |  |      | 11,041 |   |  |   | 12,366 |  
|Loan accounts                                                                |  |                                          | 3,212  |   |      |   | 2,911  |      |  |   | 2,869  |   |  |      | 3,252  |   |  |   | 3,348  |  
|Number of full service banking offices                                       |  |                                          | 3      |   |      |   | 2      |      |  |   | 2      |   |  |      | 2      |   |  |   | 2      |  

---

|(1) | Includes interest-bearing deposits, federal funds
sold, Federal Home Loan Bank stock, and investment securities.
|--- | ----------------------------------------------------------------------------------------------------------------

|(2) | Loans receivable, net, represents gross loans less
net deferred loan fees and allowance for loan losses.
|--- | --------------------------------------------------------------------------------------------------------

|(3) | The interest rate spread represents the difference
between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | The net interest margin represents net interest
income as a percent of average interest-earning assets.
|--- | -------------------------------------------------------------------------------------------------------

|(5) | Nonperforming assets include mortgage loans and
consumer loans 90 days or more delinquent and real estate acquired in the settlement of loans.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------

|(6) | The dividend payout ratio represents dividends per
share as a percent of basic earnings per share.
|--- | --------------------------------------------------------------------------------------------------



2



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South Street Financial Corp. and Subsidiary

Report to Stockholders

Dear Stockholders:



3



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS

The following discussion and analysis is intended to assist readers in
understanding the results of operations in 2005 and 2004 and changes in financial position at December 31, 2005. This discussion and analysis is intended to complement and should be read in conjunction with the audited consolidated financial
statements of the Company and related notes appearing elsewhere in this annual report to stockholders.

Description of Business

South Street Financial Corp. (the Company) was incorporated under laws of the State of North Carolina for the purpose of becoming the bank holding company of Home Savings
Bank of Albemarle, Inc., SSB (the Bank, Home Savings or Home) in connection with the Banks conversion from a state chartered mutual savings bank to a state chartered stock savings bank (the Conversion), pursuant to its Plan of Conversion. A
subscription and community offering of the Companys shares closed on October 2, 1996, at which time the Company acquired all of the shares of the Bank and commenced operations.

In accordance with the Plan of Conversion, the Company issued 4,496,500 shares of common stock at the price of $10 per share which resulted in proceeds of $43,645,000,
net of conversion costs. The Company transferred $19,558,000 of the net proceeds to Home Savings for the purchase of all of the capital stock of the Bank.

The Company has no operations and conducts no business of its own other than owning Home Savings, investing its portion of the net proceeds received in the conversion, and lending funds to the Employee Stock Ownership Plan (the ESOP) which
was formed in connection with the Conversion. The principal business of the Bank is accepting deposits from the general public and using those deposits and other sources of funds to make loans secured by real estate and other forms of collateral
located in the Banks primary market area of Stanly County, North Carolina.

Home Savings results of operations depend primarily on its net
interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. The Banks operations are also affected by noninterest income, such as miscellaneous income from
loans, customer deposit account service charges, and other sources of revenue. The Banks principal operating expenses, aside from interest expense, consist of compensation and associated benefits, federal deposit insurance premiums, occupancy
costs, and other general and administrative expenses.

During 1998, the Bank formed a wholly owned subsidiary, South Street Development Corporation (SSDC)
with a $1.8 million cash investment. SSDC then invested $10,000 for a 50% interest in Park Ridge Associates, LLC (Park Ridge). The other 50% interest in Park Ridge was owned by an outside individual until 2000, when SSDC purchased the remaining
interest and Park Ridge became a 100% subsidiary of SSDC. In June 1998, Park Ridge acquired 25.6 acres of prime real estate located within the city limits of Albemarle, North Carolina. The joint venture was created to acquire and develop the
property into a premier residential subdivision. As of December 2005, 16 of the 30 lots to be sold had been committed to buyers.



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS

The following discussion and analysis contains the consolidated financial
results for the Company, Home Savings, SSDC for the years ended December 31, 2005 and 2004. Because the Company has no operations and conducts no business other than as described above and SSDC and Park Ridge assets are primarily real estate
held for investment and their operations have not significantly impacted the consolidated financial statements for the years ended December 31, 2005 and 2004, the discussion contained in this Managements Discussion and Analysis concerns
primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and the Bank and its subsidiaries are collectively referred to herein as the Company unless
otherwise noted.

Comparison of Financial Condition at December 31, 2005 and 2004

During 2005, the Companys total assets increased by $27.7 million, or 12.8%, from $215.6 million at December 31, 2004 to $243.2 million at December 31, 2005. This increase in our total assets resulted
primarily from increases in our loan portfolio and Federal Home Bank Stock net of a decrease in our liquid assets. Our loan portfolio increased from $152.4 million at December 31, 2004 to $183.2 million at the end of 2005, an increase of $30.8
million. Additionally during the year we purchased $666,000 worth of FHLB stock. Our liquid assets, consisting of cash and cash equivalents and investment securities, decreased from $50.7 million at December 31, 2004 to $43.7 million at the end
of 2005, a decrease of $7.0 million.

Also during 2005, deposits from our customers increased by $11.7 million to $198.6 million at December 31, 2005
compared with $186.9 with million at the beginning of the year, with most of the increase occurring in certificates of deposit, which cost the Company significantly more than do demand accounts. The liquidity provided from these additional deposits,
combined with the increase in borrowings, which consist solely of advances from the Federal Home Loan Bank, from no outstanding balance at the beginning of the year to $15.0 million at December 31, 2005, an increase of $15.0 million or 100%,
provided funds for the aforementioned loan portfolio.

Stockholders equity increased by $239,000 during 2005. This net increase was the result of
several factors. Items which increased stockholders equity were: net income of $1.6 million, amortization of compensation expense of $399,000, and amortization of the return of capital dividends paid on unvested ESOP shares of $128,000. These
increases were offset by the following items which decreased stockholders equity: Unrealized losses on available for sale investment securities of $129,000, the payment of quarterly cash dividends totaling $1.2 million, or $.40 per share, and
the repurchase of company stock in the amount of $468,000.



5



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS

Comparison of Operating Results for the Years Ended December 31, 2005
and 2004

Net Income

The Company earned net income
of $1.6 million or $.54 per share for 2005, as compared with net income of $1.1 million or $.37 per share in 2004. This increase of $500,000 or $.17 per share is principally attributable to the increase in our net interest income during 2005, which
is analyzed further in the discussion that follows.

Net Interest Income

Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loan and investment
securities, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning
assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average
interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities and capital.

Net interest income increased to $7.4 million for the year ended December 31, 2005, compared to the $6.1 million earned in 2004, an increase of $1.3 million, as the
increase in our interest income surpassed the increase in our interest expense. During 2005 our level of average interest earning assets increased from $197.5 million in 2004 to $206.5 million, and the average rate we earned on those assets
increased 80 basis points from 5.33% in 2004 to 6.13% in 2005. The combined effect of these increases resulted in the increase in our interest income of $2.1million. This increase in our interest income, however, was somewhat negated by the increase
in our interest expense during 2005. While our average interest-bearing liabilities increased from $184.3 million in 2004 to $194.4 million in 2005, it is important to note that much of this increase occurred in our advances from the FHLB and the
increase in our certificates of deposits, which have rates significantly higher than our other types of interest-bearing liabilities. Additionally, the average rate we paid for our interest-bearing liabilities during the year increased 31 basis
points from 2.40% in 2004 to 2.71% in 2005.

The following table analyzes the dollar amount of changes in interest income and interest expense for major
components of interest-earning assets and interest-bearing liabilities. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior periods rate); (ii) changes attributable to rate
(changes in rate multiplied by the prior periods volume); and (iii) mixed changes (changes in volume multiplied by changes in rate), with any rate/volume variances allocated based on their absolute values.



6



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS



|                                            |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  
|------------------------------------------- |  | ------------------------------------ | ----- | - | ------------------------------------- | - | ----- |  | - | ------ | - |  | ---- | ---- | - | ----- | - | ---- | - |  | - | ------ | -
|                                            |  | Year EndedDecember 31, 2005 vs. 2004 |       |   | Year Ended December 31, 2004 vs. 2003 |  
|                                            |  | Increase (Decrease) Due To           |       |   | Increase                              |  
|                                            |  | Volume                               |       |   | Rate                                  |   | Total |  |   | Volume |   |  | Rate |      |   | Total |  
|                                            |  | (Dollars in thousands)               |      
|Interest income:                            |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  
|Interest-bearing deposits                   |  | $                                    | (164  | ) |                                       | $ | 130   |  | $ | (34    | ) |  | $    | (133 | ) |       | $ | 14   |   |  | $ | (119   | )
|Investments                                 |  |                                      | 100   |   |                                       |   | 135   |  |   | 235    |   |  |      | 357  |   |       |   | 66   |   |  |   | 423    |  
|Loans receivable, net                       |  |                                      | 1,183 |   |                                       |   | 748   |  |   | 1,931  |   |  |      | (760 | ) |       |   | (479 | ) |  |   | (1,239 | )
|                                            |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  
|Total interest income                       |  |                                      | 1,119 |   |                                       |   | 1,013 |  |   | 2,132  |   |  |      | (536 | ) |       |   | (399 | ) |  |   | (935   | )
|                                            |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  
|Interest expense:                           |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  
|Deposits:                                   |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  
|Passbook savings                            |  |                                      | (5    | ) |                                       |   | 77    |  |   | 72     |   |  |      | 13   |   |       |   | (69  | ) |  |   | (56    | )
|NOW and money market                        |  |                                      | 11    |   |                                       |   | 2     |  |   | 13     |   |  |      | 1    |   |       |   | (47  | ) |  |   | (46    | )
|Certificates of deposit                     |  |                                      | 136   |   |                                       |   | 370   |  |   | 506    |   |  |      | 140  |   |       |   | (424 | ) |  |   | (284   | )
|Borrowings                                  |  |                                      | 94    |   |                                       |   | 156   |  |   | 250    |   |  |      | (346 | ) |       |   | (4   | ) |  |   | (350   | )
|                                            |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  
|Total interest expense                      |  |                                      | 236   |   |                                       |   | 605   |  |   | 841    |   |  |      | (192 | ) |       |   | (544 | ) |  |   | (736   | )
|                                            |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  
|Net interest income and increase (decrease) |  | $                                    | 883   |   |                                       | $ | 408   |  | $ | 1,291  |   |  | $    | (344 | ) |       | $ | 145  |   |  | $ | (199   | )
|                                            |  |                                      |       |   |                                       |   |       |  |   |        |   |  |      |      |   |       |   |      |   |  |   |        |  

The following table provides additional information concerning the Companys yields on interest-earning
assets and cost of funds on interest-bearing liabilities for the years ended December 31, 2005, 2004 and 2003, respectively.



|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|-------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---------------------------- | - | ----------- | ---------------------------- | ---- | -------------- |  | - | -------- | - | ----------- | - | ------ | ------- | ---- | - | --------------- | - | ----------- | - |  | - | ------ |  | ---- | -
|                                                                                 |  | Year Ended December 31, 2005 |         |   | Year Ended December 31, 2004 |   |             | Year Ended December 31, 2003 |     
|                                                                                 |  | AverageBalance               |         |   | Interest                     |   | AverageRate |                              |      | AverageBalance |  |   | Interest |   | AverageRate |   |        | Balance |      |   | AverageInterest |   | AverageRate |  
|                                                                                 |  | (Dollars in thousands)       |        
|Interest earning assets:                                                         |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Interest-bearing deposits(1)                                                     |  | $                            | 12,017  |   |                              | $ | 286         |                              | 2.38 | %              |  | $ | 24,748   |   |             | $ | 320    |         | 1.29 | % |                 | $ | 35,177      |   |  | $ | 439    |  | 1.25 | %
|Investments(2)                                                                   |  |                              | 30,065  |   |                              |   | 1,050       |                              | 3.49 | %              |  |   | 26,764   |   |             |   | 815    |         | 3.04 | % |                 |   | 14,382      |   |  |   | 392    |  | 2.73 | %
|Loans receivable, net(5)                                                         |  |                              | 164,452 |   |                              |   | 11,327      |                              | 6.89 | %              |  |   | 146,048  |   |             |   | 9,396  |         | 6.43 | % |                 |   | 157,584     |   |  |   | 10,635 |  | 6.75 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Total interest-earning assets                                                    |  |                              | 206,534 |   |                              |   | 12,663      |                              | 6.13 | %              |  |   | 197,561  |   |             |   | 10,531 |         | 5.33 | % |                 |   | 207,143     |   |  |   | 11,466 |  | 5.54 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Non interest-earning assets                                                      |  |                              | 17,959  |   |                              |   |             |                              |      |                |  |   | 16,128   |   |             |   |        |         |      |   |                 |   | 14,092      |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Total assets                                                                     |  | $                            | 224,493 |   |                              |   |             |                              |      |                |  | $ | 213,688  |   |             |   |        |         |      |   |                 | $ | 221,235     |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Interest-bearing liabilities:                                                    |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Deposits:                                                                        |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Passbook savings                                                                 |  | $                            | 31,685  |   |                              |   | 504         |                              | 1.59 | %              |  | $ | 32,039   |   |             |   | 432    |         | 1.34 | % |                 | $ | 31,148      |   |  |   | 488    |  | 1.57 | %
|NOW and money market                                                             |  |                              | 22,687  |   |                              |   | 105         |                              | .46  | %              |  |   | 20,227   |   |             |   | 92     |         | .45  | % |                 |   | 20,013      |   |  |   | 138    |  | 0.69 | %
|Certificates of deposit                                                          |  |                              | 135,867 |   |                              |   | 4,392       |                              | 3.23 | %              |  |   | 131,275  |   |             |   | 3,886  |         | 2.96 | % |                 |   | 126,797     |   |  |   | 4,170  |  | 3.29 | %
|Borrowings                                                                       |  |                              | 4,400   |   |                              |   | 270         |                              | 6.14 | %              |  |   | 769      |   |             |   | 20     |         | 2.60 | % |                 |   | 13,923      |   |  |   | 370    |  | 2.66 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Total interest-bearing liabilities                                               |  |                              | 194,439 |   |                              |   | 5,271       |                              | 2.71 | %              |  |   | 184,310  |   |             |   | 4,430  |         | 2.40 | % |                 |   | 191,881     |   |  |   | 5,166  |  | 2.69 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Non-interest-bearing liabilities                                                 |  |                              | 4,080   |   |                              |   |             |                              |      |                |  |   | 3,656    |   |             |   |        |         |      |   |                 |   | 4,072       |   |  |   |        |  |      |  
|Stockholders equity                                                             |  |                              | 25,774  |   |                              |   |             |                              |      |                |  |   | 25,722   |   |             |   |        |         |      |   |                 |   | 25,282      |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Total liabilities and stockholders equity                                       |  | $                            | 224,493 |   |                              |   |             |                              |      |                |  | $ | 213,688  |   |             |   |        |         |      |   |                 | $ | 221,235     |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Net interest income and interest rate spread(3)                                  |  |                              |         |   |                              | $ | 7,392       |                              | 3.42 | %              |  |   |          |   |             | $ | 6,101  |         | 2.93 | % |                 |   |             |   |  | $ | 6,300  |  | 2.85 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Net yield on average interest-earning assets(4)                                  |  |                              |         |   |                              |   |             |                              | 3.58 | %              |  |   |          |   |             |   |        |         | 3.08 | % |                 |   |             |   |  |   |        |  | 3.04 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                              | 106.11  | % |                              |   |             |                              |      |                |  |   | 107.18   | % |             |   |        |         |      |   |                 |   | 107.95      | % |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |         |      |   |                 |   |             |   |  |   |        |  |      |  

---

|(1) | Includes interest-bearing deposits and federal funds
sold.
|--- | ----------------------------------------------------------

|(2) | Includes investment securities and FHLB common
stock.
|--- | -----------------------------------------------------

|(3) | Interest rate spread represents the difference
between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Net yield on interest-earning assets represents net
interest income divided by average interest-earning assets.
|--- | ---------------------------------------------------------------------------------------------------------------

|(5) | Loans placed on nonperforming status have been
included in the computation of average balances.
|--- | -----------------------------------------------------------------------------------------------



7



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS

Provision for Loan Losses and Asset Quality

The provision for loan losses was $120,000 during 2005 compared to $90,000 in 2004. Also during 2005, our loan charge-offs decreased from $85,000 in 2004 to $21,000. The
allowance for loan losses is maintained at a level deemed adequate to absorb probable losses inherent in the loan portfolio and results from managements consideration of such factors as the financial condition of the borrower, past and
expected loss experience, and other factors management feels deserve recognition in establishing an appropriate reserve. Although management attempts to maintain the allowance at a level deemed adequate, future additions to the allowance may be
necessary based upon changes in market conditions. In addition, various regulatory agencies periodically review our allowance for loan losses. These agencies may require us to make adjustments based upon their judgments about information available
to them at the time of their examination.

The level of our non-performing loans, which consists of nonaccrual loans, decreased from $1.3 million at
December 31, 2004 to $883,000 at December 31, 2005. The Company has adopted policies that it believes provide for prudent and adequate levels of loan loss allowances. At December 31, 2005, the allowance for loan losses amounted to
$674,000, which management believes is adequate to absorb losses inherent in its loan portfolio. The level of allowance for loan losses only increased by $99,000 during the year due to the $21,000 write-off mentioned above.

Noninterest Income

Non-interest income increased $67,000 during the
year from $789,000 during 2004 to $856,000 in 2005. This increase resulted primarily from the increase in service charges on deposit accounts, which resulted from the aforementioned increase in our demand deposit accounts in 2005.

Noninterest Expense

Our compensation and benefits expense increased
$398,000 in 2005 compared to 2004. This increase resulted from an increase of the Company staff during the year along with the annual increase in wages and an increase health insurance for the year. In addition to the increase in compensation
and benefits expense is an increase in net occupancy expense of $173,000. This increase resulted from an increase in depreciation expense of $56,000 and the increase of expenses associated with opening the new Oakboro branch in 2005 amounting to
$76,000.

Income Taxes

The provision for income taxes,
as a percentage of income before income taxes, was 34.0% and 36.5% for the years ended December 31, 2005 and 2004, respectively.



8



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS

Capital Resources and Liquidity

The Company paid regular quarterly cash dividends of $.40 per share in the aggregate during 2005 and 2004. Although the Company anticipates that it will continue to
declare cash dividends on a regular basis, the Board of Directors will continue to review its policy on the payment of dividends on an ongoing basis, and such payments will be subject to future earnings, cash flows, capital needs and regulatory
restrictions.

The objective of Homes liquidity management is to ensure the availability of sufficient cash flows to meet all of its financial
commitments. Liquidity management addresses Homes ability to meet deposit withdrawals either on demand or at contractual maturity, to repay borrowings, if any, as they mature and to originate new loans and make investments as opportunities
arise.

Significant liquidity sources for Home are cash provided by net loan repayments, new customer deposits, operating activities, and the sale or
maturity of investment securities. Cash flows from investing activities typically are dependent on the level of loan demand and the amount of new deposits that the Company is able to generate. During the year ended December 31, 2005 cash inflow
was provided by the proceeds from maturities, calls and principal repayments on securities of $1.2 million, cash provided by operating activities of $2.0 million and an increase in deposits of $11.7 million. Significant cash outflows during 2005
included purchases of investment securities of $6.0 million, net loan originations of $31.1 million, and dividend payments of $1.2 million.

Levels of
deposit accounts are impacted primarily by overall market rates and the pricing policies that Home sets to attract or maintain its deposits, which are affected by Homes demand for loans and its other liquidity needs. Approximately 65% of
Homes certificates of deposit outstanding at December 31, 2005 are scheduled to mature within the next year. Management believes that substantially all of these deposits will be renewed and intends to price such deposits at competitive
rates in order to ensure that these deposits are renewed. Home does not hold brokered deposits or significant levels of public deposits which are less likely to renew if a higher rate of interest can be obtained elsewhere. Liquidity levels and
Homes operations would be significantly hindered should a sizable portion of these deposits not be renewed.

Cash provided by operating and financing
activities has historically been used by the Company to make new loans to its customers. Excess cash will be used in the future to make new loans as demand warrants and to maintain the Companys liquid investment portfolios by offsetting
maturities, which are timed to provide needed cash flows to meet anticipated short term liquidity requirements.

As a state chartered savings bank, Home
must meet certain liquidity requirements, which are established by the Administrator of the North Carolina Savings Institutions Division. Homes liquidity ratio at December 31, 2005, as computed under such regulations, was in excess of
such requirements. Given its excess liquidity and its ability to borrow from the FHLB of Atlanta, Home believes that it will have sufficient funds available to meet anticipated future loan commitments, unexpected deposit withdrawals, or other cash
requirements.



9



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS

Asset/Liability Management

Homes asset/liability management, or interest rate risk management, is focused primarily on evaluating and managing Homes net interest income given various
risk criteria. Factors beyond Homes control, such as the effects of changes in market interest rates and competition, may also have an impact on the management of interest rate risk.

In the absence of other factors, Homes overall yield on interest-earning assets will increase as will its cost of funds on its interest-bearing liabilities when
market rates increase over an extended period of time. Inversely, Homes yields and cost of funds will decrease when market rates decline. Home is able to manage these swings to some extent by attempting to control the maturity or rate
adjustments of its interest-earning assets and interest-bearing liabilities over given periods of time. Homes gap is typically described as the difference between the amounts of such assets and liabilities that reprice within a period of time.
In a declining interest rate environment, a negative gap, or a situation where Homes interest-bearing liabilities subject to repricing exceed the level of interest-earning assets that will mature or reprice, will have a favorable impact on
Homes net interest income. At December 31, 2005, Home had a one-year sensitivity gap of negative 38.91%. Conversely, an increase in general market rates over a sustained period of time will tend to affect Homes net interest income
adversely.

In order to minimize the potential effects of adverse material and prolonged increases or decreases in market interest rates on the
Companys operations, management has implemented an asset/liability program designed to stabilize the Companys interest rate gap. The program emphasizes the investment of excess cash in short or intermediate term interest-earning assets,
the solicitation of transaction deposit accounts which are less sensitive to changes in interest rates and can be repriced rapidly, and to a lesser extent, the origination of adjustable rate mortgage loans.

In addition to shortening the average repricing period of its assets, Home has sought to lengthen the average maturity of its liabilities by adopting a tiered pricing
program for its certificates of deposit, which provides higher rates of interest on its longer term certificates in order to encourage depositors to invest in certificates with longer maturities.

Although Homes asset/liability management program has generally helped to decrease the exposure of its earnings to interest rate increases, Home continues to have
a negative gap position which will be adversely impacted during prolonged periods of rising interest rates and positively affected during prolonged periods of interest rate declines. The Companys interest-earning assets less interest-bearing
liabilities maturing or repricing within five years as a percentage of total interest-earning assets was a negative 47.69%.

The following table sets forth
the amount of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2005, which are projected to reprice or mature in each of the future time periods shown. The computations were made without using assumptions for
loan prepayments or deposit decline. Except as stated below, the amounts of assets and liabilities shown that reprice or mature within a given period were determined in accordance with contractual terms of the assets or liabilities. In making the
computations, all adjustable rate loans were considered to be due at the end of the next upcoming adjustment period. Fixed rate loans are reflected at their contractual maturities with consideration given to scheduled payments. Marketable equity
securities and savings accounts with no stated maturities are subject to immediate repricing and availability and have been classified in the earliest category. FHLB of Atlanta stock must be maintained at certain regulatory levels and is classified
in the more than ten category. The interest rate sensitivity of Homes assets and liabilities illustrated in the following table would vary substantially if different assumptions were used or if actual experience differs from that indicated by
such assumptions.



10



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS



|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------ |  | ---------------------- | ------- | -- | -------------------------- | - | -------- | ---------------- |  | - | ------- | - |  | - | ------- | -
|                                                                                     |  | At December 31, 2005   |        
|                                                                                     |  | 1 Year or Less         |         |    | More Than1 Year to 5 Years |   |          | More Than5 Years |  |   | Total   |  
|                                                                                     |  | (Dollars in thousands) |        
|INTEREST-EARNING ASSETS:                                                             |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|Interest-bearing deposits                                                            |  | $                      | 6,245   |    |                            | $ |         |                  |  | $ |        |   |  | $ | 6,245   |  
|Federal funds sold                                                                   |  |                        | 2,363   |    |                            |   |         |                  |  |   |        |   |  |   | 2,363   |  
|Securities held to maturity                                                          |  |                        | 1       |    |                            |   | 60       |                  |  |   | 5,193   |   |  |   | 5,254   |  
|Securities available for sale                                                        |  |                        | 11,831  |    |                            |   | 10,793   |                  |  |   | 1,477   |   |  |   | 24,101  |  
|Federal Home Loan Bank stock, at cost                                                |  |                        |        |    |                            |   |         |                  |  |   | 1,100   |   |  |   | 1,100   |  
|Loans, net                                                                           |  |                        | 52,118  |    |                            |   | 24,211   |                  |  |   | 106,883 |   |  |   | 183,212 |  
|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|Total interest-earning assets                                                        |  | $                      | 72,558  |    |                            | $ | 35,064   |                  |  | $ | 114,653 |   |  | $ | 222,275 |  
|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|INTEREST-BEARING LIABILITIES:                                                        |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|Passbook savings                                                                     |  | $                      | 29,141  |    |                            | $ |         |                  |  | $ |        |   |  | $ | 29,141  |  
|NOW accounts                                                                         |  |                        | 19,666  |    |                            |   |         |                  |  |   |        |   |  |   | 19,666  |  
|Money market                                                                         |  |                        | 6,429   |    |                            |   |         |                  |  |   |        |   |  |   | 6,429   |  
|Certificates of deposit                                                              |  |                        | 93,808  |    |                            |   | 49,590   |                  |  |   |        |   |  |   | 143,398 |  
|Borrowings                                                                           |  |                        | 10,000  |    |                            |   | 5,000    |                  |  |   |        |   |  |   | 15,000  |  
|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|                                                                                     |  | $                      | 159,044 |    |                            | $ | 54,590   |                  |  | $ |        |   |  | $ | 213,634 |  
|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|INTEREST SENSITIVITY GAP                                                             |  | $                      | (86,486 | )  |                            | $ | (19,526  | )                |  | $ | 114,653 |   |  | $ | 8,641   |  
|CUMULATIVE INTEREST SENSITIVITY GAP                                                  |  | $                      | (86,486 | )  |                            | $ | (106,012 | )                |  | $ | 8,641   |   |  | $ | 8,641   |  
|CUMULATIVE INTEREST SENSITIVITY GAP AS A PERCENTAGE OF TOTAL INTEREST-EARNING ASSETS |  |                        | (38.91  | )% |                            |   | (47.69   | )%               |  |   | 3.89    | % |  |   |         | %
|CUMULATIVE RATIO OF INTEREST-SENSITIVE ASSETS TO INTEREST-SENSITIVE LIABILITIES      |  |                        | 45.62   | %  |                            |   | 50.38    | %                |  |   | 104.04  | % |  |   | 104.04  | %

Critical Accounting Policy

The Companys most significant critical accounting policy is the determination of its allowance for loan losses. A critical accounting policy is one that both is very important to the portrayal of the
Companys financial condition and results, and requires managements most difficult, subjective or complex judgments. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of
matters that are inherently uncertain.

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

The Company has various financial instruments (outstanding commitments) with off-balance sheet risk that are issued in the normal course of business to meet the financial
needs of its customers. See Note 14 to the consolidated financial statements for more information regarding these commitments and contingent liabilities.

Recent Accounting Pronouncements

See Note 1 to the accompanying financial statements for a full description of recent accounting
pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.



11



---

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors

South Street Financial Corp.

Albemarle, North Carolina

We have audited the accompanying consolidated statements of financial condition of South Street Financial Corp. and subsidiary (the Company) as of
December 31, 2005 and 2004 and the related consolidated statements of income, stockholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management.
Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of South Street Financial Corp. and subsidiary as of December 31, 2005 and 2004 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.

LOGO

Charlotte, North Carolina

March 30, 2006



12



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31, 2005 and 2004



|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                                                     |  | 2005                   |         |   | 2004 |  
|                                                                                                                                                     |  | (Dollars in thousands) |        
|ASSETS                                                                                                                                               |  |                        |         |   |      |   |         |  
|Cash and cash equivalents:                                                                                                                           |  |                        |         |   |      |   |         |  
|Non-interest-bearing deposits                                                                                                                        |  | $                      | 5,692   |   |      | $ | 3,010   |  
|Interest-bearing deposits                                                                                                                            |  |                        | 6,245   |   |      |   | 20,166  |  
|Federal funds sold                                                                                                                                   |  |                        | 2,363   |   |      |   | 2,370   |  
|Securities held to maturity, fair value December 31, 2005, $5,119; December 31, 2005, $6,440                                                         |  |                        | 5,254   |   |      |   | 6,479   |  
|Securities available for sale                                                                                                                        |  |                        | 24,101  |   |      |   | 18,691  |  
|Federal Home Loan Bank stock                                                                                                                         |  |                        | 1,100   |   |      |   | 434     |  
|Loans receivable                                                                                                                                     |  |                        | 183,886 |   |      |   | 153,006 |  
|Allowance for loan losses                                                                                                                            |  |                        | (674    | ) |      |   | (575    | )
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Net loans                                                                                                                                            |  |                        | 183,212 |   |      |   | 152,431 |  
|                                                                                                                                                     |  |                       
|Real estate held for investment                                                                                                                      |  |                        | 653     |   |      |   | 653     |  
|Foreclosed real estate                                                                                                                               |  |                        | 229     |   |      |   | 57      |  
|Premises and equipment, net                                                                                                                          |  |                        | 4,608   |   |      |   | 2,602   |  
|Bank owned life insurance                                                                                                                            |  |                        | 7,573   |   |      |   | 7,245   |  
|Prepaid expenses and other assets                                                                                                                    |  |                        | 2,203   |   |      |   | 1,413   |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Total assets                                                                                                                                         |  | $                      | 243,233 |   |      | $ | 215,551 |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                 |  |                        |         |   |      |   |         |  
|Liabilities:                                                                                                                                         |  |                        |         |   |      |   |         |  
|Deposits                                                                                                                                             |  | $                      | 198,634 |   |      | $ | 186,905 |  
|Borrowings                                                                                                                                           |  |                        | 15,000  |   |      |   |        |  
|Accrued expenses and other liabilities                                                                                                               |  |                        | 3,629   |   |      |   | 2,915   |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Total liabilities                                                                                                                                    |  |                        | 217,263 |   |      |   | 189,820 |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Commitments (Note 14)                                                                                                                                |  |                        |         |   |      |   |         |  
|Stockholders Equity:                                                                                                                                |  |                        |         |   |      |   |         |  
|Preferred stock, no par value; authorized 5,000,000 shares; none issued                                                                              |  |                        |        |   |      |   |        |  
|Common stock, no par value, authorized 20,000,000 shares; issued 2,999,594 shares at December 31, 2005 and
3,047,886 December 31, 2004, respectively |  |                        | 6,428   |   |      |   | 6,993   |  
|Unearned compensation                                                                                                                                |  |                        | (159    | ) |      |   | (287    | )
|Unearned ESOP                                                                                                                                        |  |                        | (534    | ) |      |   | (933    | )
|Retained earnings, substantially restricted                                                                                                          |  |                        | 20,483  |   |      |   | 20,076  |  
|Accumulated other comprehensive income (loss)                                                                                                        |  |                        | (248    | ) |      |   | (118    | )
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Total stockholders equity                                                                                                                           |  |                        | 25,970  |   |      |   | 25,731  |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Total liabilities and stockholders equity                                                                                                           |  | $                      | 243,233 |   |      | $ | 215,551 |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  

See Notes to Consolidated Financial Statements.



13



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31, 2005 and 2004



|                                                              |  |                                               |           |      |   |          
|------------------------------------------------------------- |  | --------------------------------------------- | --------- | ---- | - | ---------
|                                                              |  | 2005                                          |           | 2004
|                                                              |  | (Dollars in thousands, except per share data)
|INTEREST INCOME                                               |  |                                               |           |      |   |          
|Loans, including fees                                         |  | $                                             | 11,327    |      | $ | 9,396    
|Investment securities                                         |  |                                               | 977       |      |   | 715      
|Other interest and dividends                                  |  |                                               | 359       |      |   | 420      
|                                                              |  |                                               |           |      |   |          
|TOTAL INTEREST INCOME                                         |  |                                               | 12,663    |      |   | 10,531   
|                                                              |  |                                               |           |      |   |          
|INTEREST EXPENSE                                              |  |                                               |           |      |   |          
|Deposits                                                      |  |                                               | 5,001     |      |   | 4,410    
|Borrowings                                                    |  |                                               | 270       |      |   | 20       
|                                                              |  |                                               |           |      |   |          
|TOTAL INTEREST EXPENSE                                        |  |                                               | 5,271     |      |   | 4,430    
|                                                              |  |                                               |           |      |   |          
|NET INTEREST INCOME                                           |  |                                               | 7,392     |      |   | 6,101    
|PROVISION FOR LOAN LOSSES                                     |  |                                               | 120       |      |   | 90       
|                                                              |  |                                               |           |      |   |          
|NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES           |  |                                               | 7,272     |      |   | 6,011    
|                                                              |  |                                               |           |      |   |          
|NON-INTEREST INCOME                                           |  |                                               |           |      |   |          
|Service charges on deposit accounts                           |  |                                               | 429       |      |   | 376      
|Income from bank owned life insurance                         |  |                                               | 328       |      |   | 327      
|Other                                                         |  |                                               | 99        |      |   | 86       
|                                                              |  |                                               |           |      |   |          
|TOTAL NON-INTEREST INCOME                                     |  |                                               | 856       |      |   | 789      
|                                                              |  |                                               |           |      |   |          
|NON-INTEREST EXPENSES                                         |  |                                               |           |      |   |          
|Compensation and benefits                                     |  |                                               | 3,843     |      |   | 3,445    
|Net occupancy and equipment                                   |  |                                               | 517       |      |   | 344      
|Data processing                                               |  |                                               | 370       |      |   | 372      
|Professional fees                                             |  |                                               | 148       |      |   | 118      
|Other                                                         |  |                                               | 858       |      |   | 806      
|                                                              |  |                                               |           |      |   |          
|TOTAL NON-INTEREST EXPENSES                                   |  |                                               | 5,736     |      |   | 5,085    
|                                                              |  |                                               |           |      |   |          
|INCOME BEFORE INCOME TAXES                                    |  |                                               | 2,392     |      |   | 1,715    
|INCOME TAXES                                                  |  |                                               | 812       |      |   | 626      
|                                                              |  |                                               |           |      |   |          
|NET INCOME                                                    |  | $                                             | 1,580     |      | $ | 1,089    
|                                                              |  |                                               |           |      |   |          
|BASIC AND DILUTED NET INCOME PER COMMON SHARE                 |  | $                                             | 0.54      |      | $ | 0.37     
|                                                              |  |                                               |           |      |   |          
|DIVIDENDS PER SHARE                                           |  | $                                             | 0.40      |      | $ | 0.40     
|                                                              |  |                                               |           |      |   |          
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, BASIC AND DILUTED |  |                                               | 2,943,307 |      |   | 2,965,289
|                                                              |  |                                               |           |      |   |          

See Notes to Consolidated Financial Statements.



14



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

Years Ended December 31, 2005 and 2004



|                                                                                        |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|--------------------------------------------------------------------------------------- |  | ---------------------- |  | ----------- | ----- | - | -------------------- | - | ---- | ------------ |  | - | --------------------------------------- | - |  | ------------------------------------------ | ------ | - | ------------------------ | - | ---- | - |  | - | ------ | -
|                                                                                        |  | Shares ofCommonStock   |  | CommonStock |       |   | UnearnedCompensation |   |      | UnearnedESOP |  |   | RetainedEarningsSubstantiallyRestricted |   |  | AccumulatedOtherComprehensiveIncome (loss) |        |   | TotalStockholdersEquity |  
|                                                                                        |  | (Dollars in thousands) | 
|Balance at December 31, 2003                                                            |  | 3,079,867              |  | $           | 7,488 |   |                      | $ | (674 | )            |  | $ | (1,362                                  | ) |  | $                                          | 20,160 |   |                          | $ | 35   |   |  | $ | 25,647 |  
|Amortization of ESOP compensation                                                       |  |                       |  |             | (174  | ) |                      |   |     |              |  |   | 429                                     |   |  |                                            |       |   |                          |   |     |   |  |   | 255    |  
|Purchases and retirement of 31,981 shares of common                                     |  | 31,981                 |  |             | (321  | ) |                      |   |     |              |  |   |                                        |   |  |                                            |       |   |                          |   |     |   |  |   | (321   | )
|Cash dividends (.40 per share)                                                          |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            | (1,173 | ) |                          |   |     |   |  |   | (1,173 | )
|Comprehensive income:                                                                   |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Net income                                                                              |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            | 1,089  |   |                          |   |     |   |  |   | 1,089  |  
|Net change in unrealized loss on securities available for sale, net of taxes of $98,000 |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            |       |   |                          |   | (153 | ) |  |   | (153   | )
|                                                                                        |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Total comprehensive income                                                              |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   | 936    |  
|                                                                                        |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Amortization of return of capital dividend                                              |  |                       |  |             |      |   |                      |   | 387  |              |  |   |                                        |   |  |                                            |       |   |                          |   |     |   |  |   | 387    |  
|                                                                                        |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Balance at December 31, 2004                                                            |  | 3,047,886              |  |             | 6,993 |   |                      |   | (287 | )            |  |   | (933                                    | ) |  |                                            | 20,076 |   |                          |   | (118 | ) |  |   | 25,731 |  
|Amortization of ESOP compensation                                                       |  |                       |  |             | (97   | ) |                      |   |     |              |  |   | 399                                     |   |  |                                            |       |   |                          |   |     |   |  |   | 302    |  
|Purchases and retirement of 48,292 shares of common                                     |  | 48,292                 |  |             | (468  | ) |                      |   |     |              |  |   |                                        |   |  |                                            |       |   |                          |   |     |   |  |   | (468   | )
|Cash dividends (.40 per share)                                                          |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            | (1,173 | ) |                          |   |     |   |  |   | (1,173 | )
|Comprehensive income:                                                                   |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Net income                                                                              |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            | 1,580  |   |                          |   |     |   |  |   | 1,580  |  
|Net change in unrealized loss on securities available for sale, net of taxes of $82,000 |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            |       |   |                          |   | (130 | ) |  |   | (130   | )
|                                                                                        |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Total comprehensive income                                                              |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   | 1,450  |  
|                                                                                        |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Amortization of return of capital dividend                                              |  |                       |  |             |      |   |                      |   | 128  |              |  |   |                                        |   |  |                                            |       |   |                          |   |     |   |  |   | 128    |  
|                                                                                        |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Balance at December 31, 2005                                                            |  | 2,999,594              |  | $           | 6,428 |   |                      | $ | (159 | )            |  | $ | (534                                    | ) |  | $                                          | 20,483 |   |                          | $ | (248 | ) |  | $ | 25,970 |  
|                                                                                        |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  

See Notes to Consolidated Financial Statements.



15



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2005 and 2004



|                                                                                        |  |                        |         |   |      |   |         |  
|--------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                        |  | 2005                   |         |   | 2004 |  
|                                                                                        |  | (Dollars in thousands) |        
|Cash Flows from Operating Activities:                                                   |  |                        |         |   |      |   |         |  
|Net income                                                                              |  | $                      | 1,580   |   |      | $ | 1,089   |  
|Adjustments to reconcile net income to net cash provided by operating activities:       |  |                        |         |   |      |   |         |  
|Net accretion of premiums and discounts on securities                                   |  |                        | 60      |   |      |   | 157     |  
|Amortization of deferred loan fees                                                      |  |                        | (28     | ) |      |   | (369    | )
|Depreciation expense                                                                    |  |                        | 194     |   |      |   | 138     |  
|Provision for loan losses                                                               |  |                        | 120     |   |      |   | 90      |  
|Loss on disposal of equipment                                                           |  |                        | 4       |   |      |   |        |  
|Provision for losses on foreclosed real estate                                          |  |                        |        |   |      |   | 78      |  
|Loss on sale of foreclosed real estate                                                  |  |                        |        |   |      |   | (10     | )
|Income from Bank-owned life insurance                                                   |  |                        | (328    | ) |      |   | (327    | )
|Amortization of unearned compensation                                                   |  |                        | 128     |   |      |   | 387     |  
|Amortization of ESOP compensation                                                       |  |                        | 302     |   |      |   | 255     |  
|(Increase) decrease in prepaid expenses and other assets                                |  |                        | (708    | ) |      |   | 604     |  
|Increase (decrease) in accrued expenses and other liabilities                           |  |                        | 714     |   |      |   | (475    | )
|                                                                                        |  |                        |         |   |      |   |         |  
|Net cash provided by operating activities                                               |  |                        | 2,038   |   |      |   | 1,617   |  
|                                                                                        |  |                        |         |   |      |   |         |  
|Cash Flows from Investing Activities:                                                   |  |                        |         |   |      |   |         |  
|Purchase of securities available for sale                                               |  |                        | (6,018  | ) |      |   | (17,000 | )
|Proceeds from maturities of securities available for sale                               |  |                        | 395     |   |      |   | 10,359  |  
|Proceeds from maturities, calls and principal repayments of securities held to maturity |  |                        | 1,166   |   |      |   | 1,257   |  
|Loan originations and principal payments on loans, net                                  |  |                        | (31,102 | ) |      |   | (8,363  | )
|Purchase of office properties and equipment                                             |  |                        | (2,204  | ) |      |   | (156    | )
|Proceeds from sale of foreclosed assets                                                 |  |                        | 57      |   |      |   | 198     |  
|Purchase of FHLB Stock                                                                  |  |                        | (674    | ) |      |   |        |  
|Redemption of FHLB stock                                                                |  |                        | 8       |   |      |   | 1,058   |  
|                                                                                        |  |                        |         |   |      |   |         |  
|Net cash used in investing activities                                                   |  |                        | (38,372 | ) |      |   | (12,647 | )
|                                                                                        |  |                        |         |   |      |   |         |  

See Notes to Consolidated Financial Statements.



16



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2005 and 2004 (Continued)



|                                                                         |  |                        |         |   |      |   |         |  
|------------------------------------------------------------------------ |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                         |  | 2005                   |         |   | 2004 |  
|                                                                         |  | (Dollars in thousands) |        
|Cash Flows from Financing Activities:                                    |  |                        |         |   |      |   |         |  
|Net increase in deposits                                                 |  | $                      | 11,729  |   |      | $ | 5,785   |  
|Payment of dividends                                                     |  |                        | (1,173  | ) |      |   | (1,170  | )
|Purchases and retirement of common stock                                 |  |                        | (468    | ) |      |   | (321    | )
|Borrowings from FHLB                                                     |  |                        | 15,000  |   |      |   |        |  
|Repayments on borrowings                                                 |  |                        |        |   |      |   | (10,000 | )
|Payment on life insurance policies                                       |  |                        |        |   |      |   | (220    | )
|                                                                         |  |                        |         |   |      |   |         |  
|Net cash (used in) provided by financing activities                      |  |                        | 25,088  |   |      |   | (5,926  | )
|                                                                         |  |                        |         |   |      |   |         |  
|Net decrease in cash and cash equivalents                                |  |                        | (11,246 | ) |      |   | (16,956 | )
|Cash and cash equivalents:                                               |  |                        |         |   |      |   |         |  
|Beginning                                                                |  |                        | 25,546  |   |      |   | 42,502  |  
|                                                                         |  |                        |         |   |      |   |         |  
|Ending                                                                   |  | $                      | 14,300  |   |      | $ | 25,546  |  
|                                                                         |  |                        |         |   |      |   |         |  
|Supplemental Disclosures of Cash Flow Information:                       |  |                        |         |   |      |   |         |  
|Cash payments for:                                                       |  |                        |         |   |      |   |         |  
|Interest                                                                 |  | $                      | 5,271   |   |      | $ | 4,453   |  
|Income taxes                                                             |  |                        | 881     |   |      |   | 190     |  
|Supplemental Disclosures of Noncash Transactions:                        |  |                        |         |   |      |   |         |  
|Change in unrealized losses on available for sale securities, net of tax |  |                        | (130    | ) |      |   | (153    | )
|Change in dividends accrued                                              |  |                        | (5      | ) |      |   | 3       |  
|Loans issued to finance sale of OREO                                     |  |                        |        |   |      |   | 367     |  

See Notes to Consolidated Financial Statements.



17



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Nature of Business and Summary of Significant Accounting Policies

Organization

South Street Financial Corp., a North Carolina
corporation, (the Company) is a bank holding company registered with the Board of Governors of the Federal Reserve System (the Federal Reserve) under the Bank Holding Company Act of 1956, as amended (the BHCA) and the savings bank holding company
laws of North Carolina. The Company serves as a holding company for Home Savings Bank of Albemarle, Inc., SSB (Home Savings or the Bank). The Companys activities consist of managing its investment portfolio, holding the indebtedness
outstanding from the Banks Employee Stock Ownership Plan (the ESOP) and owning the Bank. The Companys principal sources of income are earnings on its investments and interest payments received from the ESOP with respect to the ESOP loan.
In addition, the Company will receive any dividends that are declared and paid by the Bank on its capital stock.

Nature of business

Home Savings is primarily engaged in the business of obtaining savings deposits and originating single-family residential loans within its primary
lending area of Stanly County, North Carolina. The Banks underwriting polices require such loans to be made with a loan-to-value ratio of at least 80% based upon appraised values unless private mortgage insurance is obtained. These loans are
secured by the underlying properties. The Banks primary regulators are the Federal Deposit Insurance Company (FDIC) and the Administrator of the North Carolina Savings Institutions Division (the NC Administrator). The Banks deposits are
insured by the Savings Association Insurance Fund (SAIF) of the FDIC.

During 1998, the Bank formed a wholly owned subsidiary, South Street Development
Corporation (SSDC) with a $1.8 million cash investment. SSDC then invested $10,000 for a 50% interest in Park Ridge Associates, LLC (Park Ridge). The other 50% interest in Park Ridge was purchased by SSDC in 2000.

The following is a description of the significant accounting policies used in the preparation of the accompanying consolidated financial statements:

Principles of consolidation

The consolidated financial
statements include the accounts of South Street Financial Corp. and its wholly owned subsidiary, Home Savings Bank of Albemarle, Inc., SSB, the Banks wholly owned subsidiary, South Street Development Corporation, and SSDCs wholly owned
subsidiary, Park Ridge Associates, LLC. All significant intercompany transactions and balances have been eliminated in consolidation.

Use of
estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses.

Cash and cash equivalents

For the purpose of presentation in
the statement of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet captions Non-interest-bearing deposits, Interest-bearing deposits, and Federal funds sold.



18



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Nature of Business and Summary of Significant Accounting Policies (Continued)

Investment securities

The Company has investments in debt and
equity securities, which consist primarily of obligations of the U.S. Government and federal agencies, mortgage-backed securities and common stock. Management classifies all securities as trading, available for sale, or held to maturity on the date
of purchase and the appropriateness of such classification is reassessed at each statement of financial condition date. Since the Company does not buy investment securities in anticipation of short-term fluctuations in market prices, none of the
investment securities are classified as trading in accordance with Statement of Financial Accounting Standards (SFAS) No. 115. All securities have been classified as either available for sale or held to maturity. Declines in the
fair value of individual securities classified as either available for sale or held to maturity below their amortized cost that are determined to be other than temporary, result in write-downs of the individual securities to their fair value with
the resulting write-downs included in current earnings as realized losses.

Securities available for sale

Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Any
decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Companys assets and liabilities, liquidity needs, regulatory
capital considerations, and other similar factors. Securities available for sale are carried at fair value. Premiums and discounts are amortized using the interest method over the securities contractual lives. Unrealized gains or losses are
reported as increases or decreases in other comprehensive income, net of the related deferred tax effect. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in income.

Securities held to maturity

Securities classified as held to
maturity are those securities the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for
amortization of premium and accretion of discount, computed by the interest method over their contractual lives. Based on the Companys financial position and liquidity, management believes the Company has the ability to hold these securities
to maturity.

Stock in Federal Home Loan Bank of Atlanta

As a requirement for membership, the Company invests in stock of the Federal Home Loan Bank of Atlanta (FHLB). This investment is carried at cost. Due to the redemption provisions of the FHLB, the Company estimated that fair
value equals cost and that this investment was not impaired at December 31, 2005.

Loans receivable

Loans receivable are stated at unpaid principal balances, less the allowance for loan losses, the undisbursed portion of construction loans, and net deferred loan
origination fees. The Companys loan portfolio consists principally of mortgage loans collateralized by first trust deeds on single family residences, other residential property, commercial property and land.



19



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Nature of Business and Summary of Significant Accounting Policies (Continued)

Allowance for loan losses

The allowance for loan losses is
increased by charges to income and decreased by charge-offs (net of recoveries). The allowance is an amount that management believes will be adequate to absorb probable losses inherent in the loan portfolio. Managements periodic evaluation of
the adequacy of the allowance is based on the Companys past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers ability to pay, the estimated value of any underlying
collateral, and current economic conditions. The loan portfolio is further analyzed by each loan type and delinquency status to determine the risk category for each loan that is used in calculating the allowance for loan losses. Loans delinquent
greater than 90 days are evaluated individually for loss exposure, while other loans are evaluated aggregately by type. Allocated and unallocated portions are determined in the same manner. While management uses the best information to make
evaluations, future adjustments may be necessary if economic or other conditions differ substantially from the assumptions used. In addition, regulatory examiners may require the Company to recognize changes to the allowance for loan losses based on
their judgments about information available to them at the time of their examination.

Impaired loans

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest
payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking
into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal
and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected 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 the loan is collateral dependent.

Interest income

The Company recognizes interest income on loans using the interest method over the contractual life of the loan. The Company continues to accrue interest on loans,
including loans delinquent 90 days or more, when the collection of interest is not in doubt. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. Interest income is
subsequently recognized only to the extent cash payments are received. The interest on these loans is accounted for on the cash-basis or cost-recovery method until qualifying for return to accrual. Loans are returned to accrual status when all the
principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Loan origination fees and related
costs

Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income
using the interest method over the contractual life of the loans, adjusted for actual prepayments.

Foreclosed real estate

Foreclosed real estate is initially recorded at estimated fair value at the date of foreclosure, establishing a new cost basis. Based on periodic evaluations by
management, the carrying values are reduced where they exceed fair value minus estimated costs to sell. Costs relating to the development and improvement of the property are capitalized, while holding costs of the property are charged to expense in
the period incurred.



20



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Nature of Business and Summary of Significant Accounting Policies (Continued)

Real estate held for investment

Real estate held for
investment is stated at the lower of cost or market value.

Premises and equipment

Company premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of
the assets. Estimated useful lives are up to 50 years for buildings, 5 to 10 years for furniture, fixtures and equipment and 3 years for computers and related equipment. Repairs and maintenance costs are charged to operations as incurred and
additions and improvements to premises and equipment are capitalized. Upon sale or retirement, the cost and related accumulated depreciation are removed from the accounts and any gains or losses are reflected in current operations.

Bank owned life insurance

In 2003, the Company purchased
additional life insurance on certain of its officers and directors. The cash surrender value of these policies was approximately $7,573,000 and $7,245,000 at December 31, 2005 and 2004, respectively. The increase in the cash surrender value is
included in non-interest income in the consolidated statements of operations and amounted to $328,000 and $327,000 for the years ended December 31, 2005 and 2004, respectively.

Stock compensation plans

SFAS No. 123, Accounting for Stock-Based Compensation, encourages all
entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the
vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees,whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the
Companys stock option plans have no intrinsic value at the grant date and, under Opinion No. 25, no compensation cost is recognized for them. The Company has elected to continue with the accounting methodology in Opinion No. 25. All
granted options were fully vested by December 31, 2001.

Other benefit plans

The Company provides a noncontributory pension plan covering substantially all of the Companys employees who are eligible as to age and length of service. The
Companys funding policy is to make the maximum annual contribution that is deductible for income tax purposes.

The Company has deferred
compensation, supplemental income and retirement plan agreements for the benefit of certain officers of the Company and members of the Board of Directors. The plans are funded through life insurance policies held by the Company, and the liabilities
are being accrued over the service periods of employees and directors. The Company also has an ESOP which covers substantially all of its employees. Contributions to the plan are based upon the amortization requirements of the ESOPs debt to
the Company, subject to compensation limitations, and are expensed in accordance with the AICPAs Statement of Position 93-6, Employers Accounting for Employee Stock Ownership Plans.



21



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Nature of Business and Summary of Significant Accounting Policies (Continued)

Income taxes

Deferred taxes are provided on an asset and
liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are
the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Earnings per share

SFAS No. 128 requires the presentation of earnings per share by all entities that
have common stock or potential common stock, such as options, warrants and convertible securities, outstanding that trade in a public market. Those entities that have only common stock outstanding are required to present basic earnings per-share
amounts. Basic per-share amounts are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator). All other entities are required to present basic and diluted per-share amounts.
Diluted per-share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce the loss or increase the income per common share from continuing operations. For both computations, the
weighted average number of shares of common stock purchased by the Companys employee stock ownership and management recognition plans, and which have not been allocated to participant accounts, are not assumed to be outstanding. The weighted
average number of shares of common stock not allocated to participant accounts under the employee stock ownership plan was 76,646 and 105,679 in 2005 and 2004, respectively, while there were no unallocated shares under the management recognition
plan in 2005 or 2004. The Company had no dilutive potential common shares outstanding during 2005 and 2004. The weighted average number of shares outstanding at December 31, 2005 and 2004 was 2,943,307 and 2,965,289, respectively.

Comprehensive income

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

Fair value of financial instruments

The estimated fair values required under SFAS No. 107, Disclosures About Fair Value of
Financial Instruments, have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates
presented for the fair value of the Companys financial instruments are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions or estimation methodologies may
have a material effect on the estimated fair market value amounts.

The fair value estimates presented are based on pertinent information available to
management as of the dates presented. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial
statements since these dates and, therefore, current estimates of fair value may differ significantly from the amounts presented in these consolidated financial statements.



22



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Nature of Business and Summary of Significant Accounting Policies (Continued)

Reclassifications

Certain amounts in the 2004 financial
statements have been reclassified to conform to the 2005 presentation. The reclassifications had no effect on net income or stockholders equity as previously reported.

Recent accounting pronouncements

On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin
No. 105, Application of Accounting Principles to Loan Commitments (SAB 105). SAB 105 clarifies existing accounting practices relating to the valuation of issued loan commitments, including interest rate lock commitments
(IRLC), subject to SFAS No. 149 and Derivative Implementation Group Issue C13, Scope Exceptions: When a Loan Commitment is included in the Scope of Statement 133. Furthermore, SAB 105 disallows the inclusion of the values of
a servicing component and other internally developed intangible assets in the initial and subsequent IRLC valuation. The provisions of SAB 105 were effective for loan commitments entered into after March 31, 2004. The adoption of SAB 105 did
not have a material impact on the consolidated financial statements.

In March 2004, the Emerging Issues Task Force (EITF) released EITF Issue
03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. The Issue provides guidance for determining whether an investment is other-than-temporarily impaired and requires certain disclosures with
respect to these investments. The recognition and measurement guidance for other-than-temporary impairment has been delayed by the issuance of FASB Staff Position EITF 03-1-1 on September 30, 2004. The adoption of Issue 03-1 did not result in
any other-than-temporary impairment.

In December 2003, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP)
03-3, Accounting for Loans or Certain Debt Securities Acquired in a Transfer. The SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investors initial investment in
loans or debt securities acquired in a transfer if those differences relate to a deterioration of credit quality. The SOP also prohibits companies from carrying over or creating a valuation allowance in the initial accounting for loans
acquired that meet the scope criteria of the SOP. The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The adoption of this SOP is not expected to have a material impact on the Companys financial
position or results of operations.

In December 2004, the FASB issued SFAS No. 123(R), Accounting for Stock-Based Compensation (SFAS No. 123(R)).
SFAS No. 123(R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions. SFAS No. 123(R) requires that the fair value of such equity instruments be recognized as an expense in the historical financial statements as services are performed. Prior to SFAS
No. 123(R), only certain pro forma disclosures of fair value were required. The provisions of this Statement are effective for the first reporting period that begins after December 15, 2005. Accordingly, we will adopt SFAS No. 123(R)
commencing with the quarter ending March 31, 2006. Since all options granted were fully vested on December 31, 2001 there would be no cost of employee stock option compensation in our consolidated financial statements for the years ended
December 31, 2005 and 2004. Accordingly, the adoption of SFAS No. 123(R) is not expected to have a material effect on our consolidated financial statements.



23



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 2. Securities

Amortized cost and fair values of securities are summarized as follows:



|                                                  |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|------------------------------------------------- |  | ---------------------- | ------ | -------------------- | - | --------------------- |  | - | -------------------- | - |  | - | ------
|                                                  |  | 2005                  
|                                                  |  | AmortizedCost          |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedMarketValue
|                                                  |  | (Dollars in thousands)
|Securities available for sale:                    |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|U.S. Government and federal agencies obligations  |  | $                      | 22,997 |                      | $ |                      |  | $ | (372                 | ) |  | $ | 22,625
|Mortgage-backed securities                        |  |                        | 874    |                      |   | 9                     |  |   | (43                  | ) |  |   | 840   
|Equity securities                                 |  |                        | 636    |                      |   |                      |  |   |                     |   |  |   | 636   
|                                                  |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|                                                  |  | $                      | 24,507 |                      | $ | 9                     |  | $ | (415                 | ) |  | $ | 24,101
|                                                  |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|Securities held to maturity:                      |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|Mortgage-backed securities and related securities |  | $                      | 5,254  |                      | $ | 17                    |  | $ | (152                 | ) |  | $ | 5,119 
|                                                  |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|                                                  | 
|                                                  |  | 2004                  
|                                                  |  | AmortizedCost          |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedMarketValue
|                                                  |  | (Dollars in thousands)
|Securities available for sale:                    |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|U.S. Government and federal agencies obligations  |  | $                      | 17,000 |                      | $ |                      |  | $ | (178                 | ) |  | $ | 16,822
|Mortgage-backed securities                        |  |                        | 1,285  |                      |   | 40                    |  |   | (56                  | ) |  |   | 1,269 
|Equity securities                                 |  |                        | 600    |                      |   |                      |  |   |                     |   |  |   | 600   
|                                                  |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|                                                  |  | $                      | 18,885 |                      | $ | 40                    |  | $ | (234                 | ) |  | $ | 18,691
|                                                  |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|Securities held to maturity:                      |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       
|Mortgage-backed securities and related securities |  | $                      | 6,479  |                      | $ | 57                    |  | $ | (96                  | ) |  | $ | 6,440 
|                                                  |  |                        |        |                      |   |                       |  |   |                      |   |  |   |       

The amortized cost and fair values of securities as of December 31, 2005 by contractual maturity are shown
below. Actual maturities may differ from contractual maturities for mortgage-backed securities because the mortgages underlying the securities may be called or repaid without any penalties.



|                                    |  |                        |        |           |   |       
|----------------------------------- |  | ---------------------- | ------ | --------- | - | ------
|                                    |  | AmortizedCost          |        | FairValue
|                                    |  | (Dollars in thousands)
|Securities available for sale:      |  |                        |        |           |   |       
|Due within 1 year                   |  | $                      | 11,997 |           | $ | 11,832
|Due after one but within five years |  |                        | 11,000 |           |   | 10,792
|Due after five but within ten years |  |                        | 483    |           |   | 493   
|Due after ten years                 |  |                        | 391    |           |   | 348   
|Equity securities                   |  |                        | 636    |           |   | 636   
|                                    |  |                        |        |           |   |       
|                                    |  | $                      | 24,507 |           | $ | 24,101
|                                    |  |                        |        |           |   |       



24



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 2. Securities (Continued)



|                                    |  |                        |       |           |   |      
|----------------------------------- |  | ---------------------- | ----- | --------- | - | -----
|                                    |  | AmortizedCost          |       | FairValue
|                                    |  | (Dollars in thousands)
|Securities held to maturity:        |  |                        |       |           |   |      
|Due within 1 year                   |  | $                      | 1     |           | $ | 1    
|Due after one but within five years |  |                        | 60    |           |   | 62   
|Due after five but within ten years |  |                        | 4     |           |   | 4    
|Due after ten years                 |  |                        | 5,189 |           |   | 5,052
|                                    |  |                        |       |           |   |      
|                                    |  | $                      | 5,254 |           | $ | 5,119
|                                    |  |                        |       |           |   |      

There were no sales of securities in 2005 or 2004.

The Company had pledged securities with an amortized cost of $11.0 million and $12.0 million at December 31, 2005 and 2004, respectively, as collateral for public deposits and treasury and tax loan accounts.

The following table sets forth certain information regarding the carrying value and contractual maturities of the Companys investment portfolio at
December 31, 2005:



|                                                  |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|------------------------------------------------- |  | ---------------------- | ------ | -------------------------- | - | ---------------------------- |  | ------------- | --- | ----- | - | ----- |  | - | ------
|                                                  |  | Carrying Value        
|                                                  |  | 1 Year                 |        | After 1Year Through5 Years |   | After 5Years Through10 Years |  | After10 Years |     | Total
|                                                  |  | (Dollars in thousands)
|Securities available for sale:                    |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|U.S. Government and federal agencies obligations  |  | $                      | 11,832 |                            | $ | 10,793                       |  | $             |    |       | $ |      |  | $ | 22,625
|Mortgage-backed securities                        |  |                        |        |                            |   |                              |  |               | 493 |       |   | 347   |  |   | 840   
|Equity securities                                 |  |                        | 636    |                            |   |                             |  |               |    |       |   |      |  |   | 636   
|Securities held to maturity:                      |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|Mortgage-backed securities and related securities |  |                        | 1      |                            |   | 60                           |  |               | 4   |       |   | 5,189 |  |   | 5,254 
|Other investments:                                |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|Interest-earning deposits                         |  |                        | 6,245  |                            |   |                             |  |               |    |       |   |      |  |   | 6,245 
|Federal funds sold                                |  |                        | 2,363  |                            |   |                             |  |               |    |       |   |      |  |   | 2,363 
|Federal Home Loan Bank stock                      |  |                        |       |                            |   |                             |  |               |    |       |   | 1,100 |  |   | 1,100 
|                                                  |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|                                                  |  | $                      | 21,077 |                            | $ | 10,853                       |  | $             | 497 |       | $ | 6,636 |  | $ | 39,063
|                                                  |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       



25



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 2. Securities (Continued)

The following table sets forth the weighted average yield by maturity of the Companys investment portfolio at December 31, 2005:



|                                                  |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|------------------------------------------------- |  | ----------------------- | - |  | -------------------------- | - |  | ---------------------------- | - |  | ------------- | - |  | ----- | -
|                                                  |  | Weighted Average Yields |  
|                                                  |  | 1 Year                  |   |  | After 1Year Through5 Years |   |  | After 5Years Through10 Years |   |  | After10 Years |   |  | Total |  
|Securities available for sale: (1)                |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|U. S. Government and federal agencies obligations |  | 2.73                    | % |  | 3.21                       | % |  | 0.00                         | % |  | 0.00          | % |  | 2.96  | %
|Mortgage-backed securities                        |  | 0.00                    | % |  | 0.00                       | % |  | 5.78                         | % |  | 6.50          | % |  | 6.10  | %
|Equity securities                                 |  | 0.00                    | % |  | 0.00                       | % |  | 0.00                         | % |  | 1.35          | % |  | 1.35  | %
|Securities held to maturity:                      |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|Mortgage-backed securities and related securities |  | 7.50                    | % |  | 8.72                       | % |  | 8.00                         | % |  | 5.10          | % |  | 5.14  | %
|Other investments:                                |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|Interest-earning deposits                         |  | 4.18                    | % |  | 0.00                       | % |  | 0.00                         | % |  | 0.00          | % |  | 4.18  | %
|Federal funds sold                                |  | 3.06                    | % |  | 0.00                       | % |  | 0.00                         | % |  | 0.00          | % |  | 3.06  | %
|Federal Home Loan Bank stock                      |  | 0.00                    | % |  | 0.00                       | % |  | 0.00                         | % |  | 2.70          | % |  | 2.70  | %
|                                                  |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|                                                  |  | 3.21                    | % |  | 3.24                       | % |  | 5.79                         | % |  | 4.40          | % |  | 3.48  | %
|                                                  |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  

---

|(1) | Average yields based on amortized cost.
|--- | ---------------------------------------

The following
tables show investments gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005 and 2004. This
unrealized loss on investment securities is a result of volatility in the market during 2005 and relates to several mortgage backed securities as well as several federal agencies. The unrealized loss on this investment security is considered by
management to be temporary given the credit rating on the investment security and the short duration of the unrealized loss.



|                                                         |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|-------------------------------------------------------- |  | ---------------------- | ----- | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                                         |  | 2005                  
|                                                         |  | Less Than 12 Months    |       | 12 Months or More |   | Total    
|                                                         |  | Fairvalue              |       | Unrealizedlosses  |   | Fairvalue |  | Unrealizedlosses |        | Fairvalue |   | Unrealizedlosses
|                                                         |  | (Amounts in thousands)
|Securities available for sale:                           |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|U.S. Governmental and Federal agencies                   |  | $                      | 5,929 |                   | $ | 68        |  | $                | 16,696 |           | $ | 304              |  | $ | 22,625 |  | $ | 372
|Mortgage-backed securities                               |  |                        |      |                   |   |          |  |                  | 347    |           |   | 43               |  |   | 347    |  |   | 43 
|                                                         |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities available for sale |  |                        | 5,929 |                   |   | 68        |  |                  | 17,043 |           |   | 347              |  |   | 22,972 |  |   | 415
|                                                         |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Held to maturity:                                        |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Mortgage-backed securities                               |  |                        | 2,194 |                   |   | 55        |  |                  | 2,647  |           |   | 97               |  |   | 4,841  |  |   | 152
|                                                         |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities                    |  | $                      | 8,123 |                   | $ | 123       |  | $                | 19,690 |           | $ | 444              |  | $ | 27,813 |  | $ | 567
|                                                         |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    



26



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 2. Securities (Continued)



|                                                         |  |                        |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|-------------------------------------------------------- |  | ---------------------- | ------ | ----------------- | - | --------- |  | ---------------- | --- | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                                         |  | 2004                  
|                                                         |  | Less Than 12 Months    |        | 12 Months or More |   | Total    
|                                                         |  | Fairvalue              |        | Unrealizedlosses  |   | Fairvalue |  | Unrealizedlosses |     | Fairvalue |   | Unrealizedlosses
|                                                         |  | (Amounts in thousands)
|Securities available for sale:                           |  |                        |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|U.S. Governmental and Federal agencies                   |  | $                      | 16,822 |                   | $ | 178       |  | $                |    |           | $ |                 |  | $ | 16,822 |  | $ | 178
|Mortgage-backed securities                               |  |                        | 353    |                   |   | 1         |  |                  | 213 |           |   | 55               |  |   | 566    |  |   | 56 
|                                                         |  |                        |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities available for sale |  |                        | 17,175 |                   |   | 179       |  |                  | 213 |           |   | 55               |  |   | 17,388 |  |   | 234
|                                                         |  |                        |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|Held to maturity:                                        |  |                        |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|Mortgage-backed securities                               |  |                        | 2,679  |                   |   | 5         |  |                  | 610 |           |   | 91               |  |   | 3,289  |  |   | 96 
|                                                         |  |                        |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities                    |  | $                      | 19,854 |                   | $ | 184       |  | $                | 823 |           | $ | 146              |  | $ | 20,677 |  | $ | 330
|                                                         |  |                        |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    

Investments in Equity Securities Carried at Cost

The aggregate cost of the Companys cost method investments, consisting of securities in Federal Home Loan Bank, Nexity Bank and Bankers Bank amounted to $1,100,000,
$300,000 and $300,000, respectively and totaled $1,700,000 at December 31, 2005. The Company estimated that the fair value equaled or exceeded the cost of these investments (that is, the investments were not impaired). The investment in Federal
Home Loan Bank stock is not reflected in investment securities; the investment is carried as a separate line item in the financial statements.

Note 3.
Loans Receivable

Loans receivable are summarized below:



|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|------------------------------- |  | ---------------------- | ------- | - | ----------------- | ------ | - | ------ | - | ------- | --------- |  | ------ | -
|                                |  | December 31, 2005      |         |   | December 31, 2004 |       
|                                |  | Amount                 |         |   | % ofTotal         |        |   | Amount |   |         | % ofTotal | 
|                                |  | (Dollars in thousands) |        
|Real estate loans:              |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Residential 1-4 family          |  | $                      | 109,697 |   |                   | 58.26  | % |        | $ | 86,429  |           |  | 61.36  | %
|Home equity                     |  |                        | 17,403  |   |                   | 9.24   | % |        |   | 14,660  |           |  | 9.35   | %
|Residential multi-family        |  |                        | 1,895   |   |                   | 1.01   | % |        |   | 1,944   |           |  | 1.24   | %
|Nonresidential real estate      |  |                        | 29,344  |   |                   | 15.59  | % |        |   | 24,221  |           |  | 15.44  | %
|Residential construction        |  |                        | 10,226  |   |                   | 5.43   | % |        |   | 8,387   |           |  | 5.35   | %
|Land                            |  |                        | 8,214   |   |                   | 4.36   | % |        |   | 3,708   |           |  | 2.36   | %
|Line of credit                  |  |                        | 357     |   |                   | .19    | % |        |   | 549     |           |  | 0.35   | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Total real estate loans         |  |                        | 177,136 |   |                   | 94.08  | % |        |   | 139,898 |           |  | 95.46  | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Commercial/consumer loans:      |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Commercial                      |  |                        | 8,584   |   |                   | 4.55   | % |        |   | 14,635  |           |  | 3.07   | %
|Share and other                 |  |                        | 2,439   |   |                   | 1.30   | % |        |   | 2,212   |           |  | 1.41   | %
|Credit reserve                  |  |                        | 125     |   |                   | .07    | % |        |   | 90      |           |  | 0.06   | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Total commercial/consumer loans |  |                        | 11,148  |   |                   | 5.92   | % |        |   | 16,937  |           |  | 4.54   | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Subtotal                        |  |                        | 188,284 |   |                   | 100.00 | % |        |   | 156,835 |           |  | 100.00 | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Allowance for loan losses       |  |                        | (674    | ) |                   |        |   |        |   | (575    | )         |  |        |  
|Net deferred loan fees          |  |                        | (192    | ) |                   |        |   |        |   | (220    | )         |  |        |  
|Loans in process                |  |                        | (4,206  | ) |                   |        |   |        |   | (3,609  | )         |  |        |  
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Total                           |  | $                      | 183,212 |   |                   |        |   |        | $ | 152,431 |           |  |        |  
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  



27



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 3. Loans Receivable (Continued)

The following table sets forth the time to contractual maturity of the Companys loan portfolio at December 31, 2005. Demand loans, loans having no stated maturity and overdrafts are reported as due in one
year or less. The table does not include prepayments. Amounts in the table are net of loans in process, unamortized loan fees, and the allowance for loan losses.



|                          |  |                        |        |   |                           |   |                     |  |       |         |  |   |         |  
|------------------------- |  | ---------------------- | ------ | - | ------------------------- | - | ------------------- |  | ----- | ------- |  | - | ------- | -
|                          |  | At December 31, 2005   |       
|                          |  | 1 Year or Less         |        |   | More than1 Year to5 Years |   | GreaterThan 5 Years |  | Total |        
|                          |  | (Dollars in thousands) |       
|Residential 1-4 family    |  | $                      | 9,455  |   |                           | $ | 6,831               |  | $     | 89,204  |  | $ | 105,490 |  
|All other loans           |  |                        | 43,529 |   |                           |   | 17,380              |  |       | 17,679  |  |   | 78,588  |  
|Net deferred loan fees    |  |                        | (192   | ) |                           |   |                    |  |       |        |  |   | (192    | )
|Allowance for loan losses |  |                        | (674   | ) |                           |   |                    |  |       |        |  |   | (674    | )
|                          |  |                        |        |   |                           |   |                     |  |       |         |  |   |         |  
|Totals                    |  | $                      | 52,118 |   |                           | $ | 24,211              |  | $     | 106,883 |  | $ | 183,212 |  
|                          |  |                        |        |   |                           |   |                     |  |       |         |  |   |         |  

The following table sets forth the dollar amount at December 31, 2005 of all loans maturing or repricing on
or after December 31, 2006 which have fixed or adjustable interest rates.



|                       |  |                        |         |                 |   |       
|---------------------- |  | ---------------------- | ------- | --------------- | - | ------
|                       |  | Fixed Rates            |         | AdjustableRates
|                       |  | (Dollars in thousands)
|Residential 1-4 family |  | $                      | 87,110  |                 | $ | 8,925 
|All other loans        |  |                        | 20,526  |                 |   | 14,533
|                       |  |                        |         |                 |   |       
|                       |  | $                      | 107,636 |                 | $ | 23,458
|                       |  |                        |         |                 |   |       

The following is an analysis of the allowance for loan losses:



|                                                             |  |                         |       |   |      |   |       |  
|------------------------------------------------------------ |  | ----------------------- | ----- | - | ---- | - | ----- | -
|                                                             |  | Year Ended December 31, |      
|                                                             |  | 2005                    |       |   | 2004 |  
|                                                             |  | (Dollars in thousands)  |      
|Balance, beginning of year                                   |  | $                       | 575   |   |      | $ | 570   |  
|Provision for loan losses                                    |  |                         | 120   |   |      |   | 90    |  
|Net charge-offs:                                             |  |                         |       |   |      |   |       |  
|Consumer                                                     |  |                         | 6     |   |      |   |      |  
|Commercial                                                   |  |                         | 15    |   |      |   | 85    |  
|                                                             |  |                         |       |   |      |   |       |  
|Balance, end of year                                         |  | $                       | 674   |   |      | $ | 575   |  
|                                                             |  |                         |       |   |      |   |       |  
|Net charge-offs as a percent of average loans                |  |                         | 0.01  | % |      |   | 0.06  | %
|Allowance at period end as a percent of nonperforming loans  |  |                         | 76.33 | % |      |   | 42.94 | %
|Allowance at period end as a percent of nonperforming assets |  |                         | 60.61 | % |      |   | 41.19 | %
|Allowance at period end as a percent of total gross loans    |  |                         | 0.36  | % |      |   | 0.37  | %



28



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 3. Loans Receivable (Continued)

The allocation of the allowance for loan losses applicable to each category of loans is as follows:



|                                 |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|-------------------------------- |  | ---------------------- | --- | ------------------------------------- | ----------------- | - | ----------------------------- | ------ | - | ------------------ | - | ------------------------------------ |  | ------ | ----------------------------- |  | ------ | -
|                                 |  | December 31, 2005      |     |                                       | December 31, 2004 |  
|                                 |  | Amount ofAllowance     |     | Percent ofAllowance to TotalAllowance |                   |   | Percent ofLoans toTotal Loans |        |   | Amount ofAllowance |   | Percent ofAllowanceto TotalAllowance |  |        | Percent ofLoans toTotal Loans | 
|                                 |  | (Dollars in thousands) |    
|Real estate loans:               |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Residential 1-4 family           |  | $                      | 200 |                                       | 29.68             | % |                               | 58.26  | % |                    | $ | 200                                  |  | 34.78  | %                             |  | 61.36  | %
|Home equity                      |  |                        | 17  |                                       | 2.52              | % |                               | 9.24   | % |                    |   | 15                                   |  | 2.61   | %                             |  | 9.35   | %
|Residential multi-family         |  |                        | 2   |                                       | 0.30              | % |                               | 1.01   | % |                    |   | 2                                    |  | 0.35   | %                             |  | 1.24   | %
|Nonresidential real estate       |  |                        | 30  |                                       | 4.45              | % |                               | 15.59  | % |                    |   | 20                                   |  | 3.48   | %                             |  | 15.44  | %
|Residential construction         |  |                        | 13  |                                       | 1.93              | % |                               | 5.43   | % |                    |   | 7                                    |  | 1.22   | %                             |  | 5.35   | %
|Land                             |  |                        | 5   |                                       | 0.74              | % |                               | 4.36   | % |                    |   | 5                                    |  | 0.87   | %                             |  | 2.36   | %
|Line of credit                   |  |                        | 5   |                                       | 0.74              | % |                               | 0.19   | % |                    |   | 5                                    |  | 0.87   | %                             |  | 0.35   | %
|                                 |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Total real estate loans          |  |                        | 272 |                                       | 40.36             | % |                               | 94.08  | % |                    |   | 254                                  |  | 44.17  | %                             |  | 95.46  | %
|                                 |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Commercial/consumer loans:       |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Commercial loans                 |  |                        | 175 |                                       | 25.97             | % |                               | 4.56   | % |                    |   | 130                                  |  | 22.61  | %                             |  | 3.07   | %
|Share and other                  |  |                        | 17  |                                       | 2.52              | % |                               | 1.30   | % |                    |   | 15                                   |  | 2.61   | %                             |  | 1.41   | %
|Credit reserve                   |  |                        | 10  |                                       | 1.48              | % |                               | 0.06   | % |                    |   | 10                                   |  | 1.74   | %                             |  | 0.06   | %
|                                 |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Total commercial/ consumer loans |  |                        | 202 |                                       | 29.97             | % |                               | 5.92   | % |                    |   | 155                                  |  | 26.96  | %                             |  | 4.54   | %
|                                 |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Unallocated                      |  |                        | 200 |                                       | 29.67             | % |                               |        |   |                    |   | 166                                  |  | 28.87  | %                             |  |        |  
|                                 |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Total                            |  | $                      | 674 |                                       | 100.00            | % |                               | 100.00 | % |                    | $ | 575                                  |  | 100.00 | %                             |  | 100.00 | %
|                                 |  |                        |     |                                       |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  

SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,
Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures, requires that the Company establish a specific allowance for impaired loans and disclosure of the Companys method of accounting for interest income on
impaired loans. The Company assesses loans delinquent more than 90 days past due for impairment. Such loans are on nonaccrual status and amounted to approximately $883,000 and $1,339,000 and had related allowance for loan losses of $152,000 and
$104,000 at December 31, 2005 and 2004, respectively. The amount of interest recognized on impaired loans during the portion of the year that they were impaired was not material in 2005 or 2004.



29



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 3. Loans Receivable (Continued)

The following table sets forth information with respect to nonperforming assets identified by the Company, including nonaccrual loans.



|                                          |  |                         |         |   |      |   |         |  
|----------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                          |  | Year Ended December 31, |        
|                                          |  | 2005                    |         |   | 2004 |  
|                                          |  | (Dollars in thousands)  |        
|Nonaccrual loans                          |  | $                       | 883     |   |      | $ | 1,339   |  
|Foreclosed real estate                    |  |                         | 229     |   |      |   | 57      |  
|                                          |  |                         |         |   |      |   |         |  
|Total non-performing assets               |  | $                       | 1,112   |   |      | $ | 1,396   |  
|                                          |  |                         |         |   |      |   |         |  
|Non-performing loans to total gross loans |  |                         | 0.48    | % |      |   | 0.88    | %
|                                          |  |                         |         |   |      |   |         |  
|Non-performing assets to total assets     |  |                         | 0.46    | % |      |   | 0.65    | %
|                                          |  |                         |         |   |      |   |         |  
|Total assets                              |  | $                       | 243,233 |   |      | $ | 215,551 |  
|                                          |  |                         |         |   |      |   |         |  
|Total gross loans                         |  | $                       | 183,886 |   |      | $ | 153,006 |  
|                                          |  |                         |         |   |      |   |         |  

Officers and directors of the Company were indebted to the Company for loans made in the ordinary course of
business. The following is an analysis of the loans to officers and directors:



|                   |  |                         |       |   |      |   |        |  
|------------------ |  | ----------------------- | ----- | - | ---- | - | ------ | -
|                   |  | Year Ended December 31, |      
|                   |  | 2005                    |       |   | 2004 |  
|                   |  | (Dollars in thousands)  |      
|Balance, beginning |  | $                       | 6,148 |   |      | $ | 7,558  |  
|Originations       |  |                         | 3,285 |   |      |   | 52     |  
|Payments received  |  |                         | (678  | ) |      |   | (1,462 | )
|                   |  |                         |       |   |      |   |        |  
|Balance, ending    |  | $                       | 8,755 |   |      | $ | 6,148  |  
|                   |  |                         |       |   |      |   |        |  

Note 4. Premises and Equipment

Premises and equipment consist of the following:



|                              |  |                         |        |   |      |   |        |  
|----------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | -
|                              |  | Year Ended December 31, |       
|                              |  | 2005                    |        |   | 2004 |  
|                              |  | (Dollars in thousands)  |       
|Land                          |  | $                       | 1,597  |   |      | $ | 1,095  |  
|Buildings and improvements    |  |                         | 3,664  |   |      |   | 2,217  |  
|Furniture and equipment       |  |                         | 1,246  |   |      |   | 1,010  |  
|                              |  |                         |        |   |      |   |        |  
|                              |  |                         | 6,507  |   |      |   | 4,322  |  
|Less accumulated depreciation |  |                         | (1,899 | ) |      |   | (1,720 | )
|                              |  |                         |        |   |      |   |        |  
|                              |  | $                       | 4,608  |   |      | $ | 2,602  |  
|                              |  |                         |        |   |      |   |        |  



30



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 5. Employee Pension Plan

The Company has a defined benefit plan covering substantially all employees. The benefits are based on years of service and the employees expected compensation during five consecutive plan years within the last
ten plan years that produce the highest average. Total pension expense was $237,000 and $235,000 for the years ended December 31, 2005 and 2004, respectively, and is included in compensation and benefits in the accompanying consolidated
statements of income.

The following tables set forth the Plans status as of and for the years ended:



|                                     |  |                         |        |   |      |   |        |  
|------------------------------------ |  | ----------------------- | ------ | - | ---- | - | ------ | -
|                                     |  | Year Ended December 31, |       
|                                     |  | 2005                    |        |   | 2004 |  
|                                     |  | (Dollars in thousands)  |       
|Change in benefit obligation:        |  |                         |        |   |      |   |        |  
|Benefit obligation, beginning        |  | $                       | 2,717  |   |      | $ | 2,061  |  
|Service cost                         |  |                         | 124    |   |      |   | 116    |  
|Interest cost                        |  |                         | 176    |   |      |   | 160    |  
|Actuarial (gain) loss                |  |                         | 213    |   |      |   | 462    |  
|Benefits paid                        |  |                         |       |   |      |   | (82    | )
|                                     |  |                         |        |   |      |   |        |  
|Benefit obligation, ending           |  |                         | 3,230  |   |      |   | 2,717  |  
|                                     |  |                         |        |   |      |   |        |  
|Change in plan assets:               |  |                         |        |   |      |   |        |  
|Fair value of plan assets, beginning |  |                         | 1,514  |   |      |   | 1,313  |  
|Actual return on plan assets         |  |                         | 138    |   |      |   | 115    |  
|Employer contribution                |  |                         | 229    |   |      |   | 168    |  
|Benefits paid                        |  |                         |       |   |      |   | (82    | )
|                                     |  |                         |        |   |      |   |        |  
|Fair value of plan assets, ending    |  |                         | 1,881  |   |      |   | 1,514  |  
|                                     |  |                         |        |   |      |   |        |  
|Funded status                        |  |                         | (1,349 | ) |      |   | (1,203 | )
|Unrecognized net actuarial loss      |  |                         | 1,217  |   |      |   | 1,046  |  
|Unrecognized prior service cost      |  |                         | 135    |   |      |   | 168    |  
|                                     |  |                         |        |   |      |   |        |  
|Prepaid pension benefit cost         |  | $                       | 3      |   |      | $ | 11     |  
|                                     |  |                         |        |   |      |   |        |  

At December 31, 2005 and 2004, the assumptions used to determine the benefit obligation are as follows:



|                              |  |                         |   |  |      |  
|----------------------------- |  | ----------------------- | - |  | ---- | -
|                              |  | Year Ended December 31, |  
|                              |  | 2005                    |   |  | 2004 |  
|Discount rate                 |  | 7.0                     | % |  | 6.5  | %
|Rate of compensation increase |  | 3.5                     | % |  | 3.5  | %

The components of net periodic pension cost are as follows:



|                                   |  |                         |      |   |      |   |      |  
|---------------------------------- |  | ----------------------- | ---- | - | ---- | - | ---- | -
|                                   |  | Year Ended December 31, |     
|                                   |  | 2005                    |      |   | 2004 |  
|                                   |  | (Dollars in thousands)  |     
|Service cost                       |  | $                       | 124  |   |      | $ | 116  |  
|Interest cost                      |  |                         | 176  |   |      |   | 160  |  
|Expected return on plan assets     |  |                         | (126 | ) |      |   | (108 | )
|Amortization of prior service cost |  |                         | 34   |   |      |   | 34   |  
|Recognized net actuarial loss      |  |                         | 29   |   |      |   | 33   |  
|                                   |  |                         |      |   |      |   |      |  
|Net periodic benefit cost          |  | $                       | 237  |   |      | $ | 235  |  
|                                   |  |                         |      |   |      |   |      |  



31



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 5. Employee Pension Plan (Continued)

For the years ended December 31, 2005 and 2004 the assumptions used to determine net periodic pension cost are as follows:



|                                       |  |                         |   |  |      |  
|-------------------------------------- |  | ----------------------- | - |  | ---- | -
|                                       |  | Year Ended December 31, |  
|                                       |  | 2005                    |   |  | 2004 |  
|Discount rate                          |  | 7.5                     | % |  | 6.5  | %
|Expected rate of return on plan assets |  | 7.5                     | % |  | 6.5  | %
|Rate of compensation increase          |  | 3.5                     | % |  | 3.5  | %

Determination of Expected Long-Term Rate of Return

The expected long-term rate of return for the Plans assets is based on the expected weighted return of the different asset categories as provide in the Plans
Investment Policy. The investment policy provides for the sponsor to credit a fixed rate of interest on any certificates of deposit with the Bank based on the interest rate (7.5%) used for determining the Banks funding as required under
ERISA. Any equity investments are expected to return 7% to 10% over the long-term. Currently the investment policy provides that 100% of the plans assets are to be invested in fixed income securities, primarily certificates of deposit; and
therefore, the weighted long-term rate of return is expected to be 7.5%

The Companys pension plan weighted average asset allocations at
December 31, 2005 and 2004.



|                          |  |        |   |  |        |  
|------------------------- |  | ------ | - |  | ------ | -
|Asset Category            |  | 2005   |   |  | 2004   |  
|Cash and cash equivalents |  | 100.00 | % |  | 100.00 | %

Investment Policy and Strategy

The investment policy, as established by the Pension Investment Committee, is conservative and provides primarily for the generation of income with the conservation of capital. Although the policy does not currently
provide for any investment in equities, the Pension Investment Committee does review periodically the asset allocation, and may from time to time change the asset allocation between fixed income and equities.

The Bank expects to contribute to the Plan during 2005 approximately $ 229,000.

The Banks projected benefit payments:



|          |  |   |          
|--------- |  | - | ---------
|2006      |  | $ |         
|2007      |  |   |         
|2008      |  |   | 12,306   
|2009      |  |   | 48,241   
|2010      |  |   | 86,136   
|2011-2016 |  |   | 1,001,779
|          |  |   |          
|Total     |  | $ | 1,148,462
|          |  |   |          



32



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 6. Deposits

Deposits are summarized as follows:



|                        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  
|----------------------- |  | ---------------------- | ------- | ----------- | ----------------- | - | ------------ | ------ | - | ------ | - | ----------- |  | ---- | ------------ |  | ------ | -
|                        |  | December 31, 2005      |         |             | December 31, 2004 |  
|                        |  | Amount                 |         | AverageRate |                   |   | % ofDeposits |        |   | Amount |   | AverageRate |  |      | % ofDeposits | 
|                        |  | (Dollars in thousands) |        
|Demand accounts:        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  
|Passbook savings        |  | $                      | 29,141  |             | 1.73              | % |              | 14.67  | % |        | $ | 32,099      |  | 1.34 | %            |  | 17.17  | %
|NOW accounts            |  |                        | 19,666  |             | .14               | % |              | 9.90   | % |        |   | 13,213      |  | 0.19 | %            |  | 7.08   | %
|Money market            |  |                        | 6,430   |             | 1.19              | % |              | 3.24   | % |        |   | 6,688       |  | 0.90 | %            |  | 3.58   | %
|                        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  
|Total demand deposits   |  |                        | 55,237  |             | 1.10              | % |              | 27.81  | % |        |   | 52,020      |  | 0.99 | %            |  | 27.83  | %
|Certificates of deposit |  |                        | 143,397 |             | 3.06              | % |              | 72.19  | % |        |   | 134,905     |  | 2.96 | %            |  | 72.17  | %
|                        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  
|Total deposits          |  | $                      | 198,634 |             | 2.52              | % |              | 100.00 | % |        | $ | 186,905     |  | 2.40 | %            |  | 100.00 | %
|                        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  

At December 31, 2005, the scheduled maturities of certificates of deposit are as follows:



|                         |  |                        |        
|------------------------ |  | ---------------------- | -------
|Year Ending December 31, |  | Amount                
|                         |  | (Dollars in thousands)
|2006                     |  | $                      | 93,848 
|2007                     |  |                        | 25,592 
|2008                     |  |                        | 18,646 
|2009                     |  |                        | 5,054  
|2010                     |  |                        | 257    
|                         |  |                        |        
|                         |  | $                      | 143,397
|                         |  |                        |        

The aggregate amount of jumbo certificates of deposit with a minimum denomination of $100,000 was approximately
$57,308,000 and $48,346,000 at December 31, 2005 and 2004, respectively.

The aggregate amount of certificates of deposit by maturity with a minimum
denomination of $100,000 is as follows:



|                                |  |                        |       
|------------------------------- |  | ---------------------- | ------
|                                |  | December 31, 2005     
|                                |  | (Dollars in thousands)
|Maturity period:                |  |                        |       
|Within 3 months or less         |  | $                      | 8,044 
|Over 3 months through 6 months  |  |                        | 15,383
|Over 6 months through 12 months |  |                        | 15,536
|Over 12 months                  |  |                        | 18,345
|                                |  |                        |       
|                                |  | $                      | 57,308
|                                |  |                        |       



33



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 6. Deposits (Continued)

Interest expense on deposits is summarized as follows:



|                        |  |                         |       |      |   |      
|----------------------- |  | ----------------------- | ----- | ---- | - | -----
|                        |  | Year Ended December 31,
|                        |  | 2005                    |       | 2004
|                        |  | (Dollars in thousands) 
|Passbook savings        |  | $                       | 504   |      | $ | 432  
|NOW and money market    |  |                         | 105   |      |   | 91   
|Certificates of deposit |  |                         | 4,392 |      |   | 3,887
|                        |  |                         |       |      |   |      
|                        |  | $                       | 5,001 |      | $ | 4,410
|                        |  |                         |       |      |   |      

Eligible savings accounts are insured to $100,000 by the SAIF which is administered by the FDIC.

Note 7. Borrowings

Borrowings consisting of advances from the
Federal Home Loan Bank of Atlanta were as follows at December 31, 2005 and 2004:



|                                       |  |              |  |        |            |   |      |   |            |      |  |            
|-------------------------------------- |  | ------------ |  | ------ | ---------- | - | ---- | - | ---------- | ---- |  | -----------
|                                       |  |              |  | Amount |            |   |     
|Maturity                               |  | Call Feature |  | 2005   |            |   | 2004 |   |            | Rate
|Due on May 25, 2006                    |  | None         |  | $      | 5,000,000  |   |      |   |           |      |  | 3.85% Fixed
|Due on August 30, 2006                 |  | None         |  |        | 5,000,000  |   |      |   |           |      |  | 4.35% Fixed
|Due on February 20, 2007               |  | None         |  |        | 5,000,000  |   |      |   |           |      |  | 4.66% Fixed
|                                       |  |              |  |        |            |   |      |   |            |      |  |            
|Total FHLB borrowings                  |  |              |  | $      | 15,000,000 |   |      | $ |           |      |  |            
|                                       |  |              |  |        |            |   |      |   |            |      |  |            
|Total weighted average rate            |  |              |  |        | 4.29       | % |      |   | 2.45       | %    |  |            
|                                       |  |              |  |        |            |   |      |   |            |      |  |            
|Maximum amount outstanding during year |  |              |  | $      | 18,000,000 |   |      | $ | 10,000,000 |      |  |            
|                                       |  |              |  |        |            |   |      |   |            |      |  |            

Pursuant to a collateral agreement with the FHLB, advances are collateralized by all the Companys FHLB stock
and qualifying first mortgage loans. The balance of qualifying first mortgage loans as of December 31, 2005 was approximately $109 million. This agreement with the FHLB provides for a line of credit up to 15% of the Companys assets.

Note 8 - Leases

The Bank leases its Oakboro office
building located at 117 North Main Street. The lease term is for three years ending March 31, 2008 with renewal options through 2011. Future rentals under these leases are as follows:



|     |  |   |       
|---- |  | - | ------
|2006 |  | $ | 18,000
|2007 |  |   | 18,000
|2008 |  |   | 4,500 
|     |  |   |       
|     |  | $ | 40,500
|     |  |   |       



34



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 9. Other Benefit Plans

Deferred Compensation Agreements

The Company has entered into deferred compensation agreements providing
retirement and death benefits for seven directors and supplemental income agreements for four executive officers. Vested benefits under these agreements are payable in monthly installments over the remaining life of participants after retirement.
The present value of the liability for the benefits is being accrued over the service life of the underlying agreements, which amounted to $2,373,000 and $2,340,000 at December 31, 2005 and 2004, respectively. The total expense for the deferred
compensation agreements and supplemental income agreements amounted to $125,000 and $92,000 for the years ended December 31, 2005 and 2004, respectively.

Split-Dollar Life Insurance

The Company has entered into Life Insurance Endorsement Method Split Dollar Agreements with certain
officers. Under these agreements, upon death of the officer, the Company first recovers the cash surrender value of the contract and then shares the remaining death benefits from insurance contracts, which are written with different carriers, with
the designated beneficiaries of the officers. The death benefit to the officers beneficiaries is a multiple of base salary at the time of the agreements. The Company, as owner of the policies, retains an interest in the life insurance proceeds
and a 100% interest in the cash surrender value of the policies.

Note 10. Management Recognition Plan and Stock Option Plan

The Companys stockholders approved the Companys Stock Option Plan on October 15, 1997. The Stock Option Plan reserves for issuance up to 449,650 stock
options to certain officers, directors, and employees either in the form of incentive stock options or non-incentive stock options. The exercise price of the stock options may not be less than the fair value of the Companys common stock at
date of grant. All options granted have an exercise price of $12.00 per share. The options granted to employees, which vest at the rate of 25% annually beginning at the date of grant, were all granted in 1998 and expire in 2008. Options granted to
non-employee directors vested immediately on the date of grant. All options were fully vested as of December 31, 2001.

A summary of the
Companys option plans as of and for the years ended December 31, 2005 and 2004 is as follows:



|                        |  |                                 |  |                     |  |                              |       |                   |         |                              |   |      
|----------------------- |  | ------------------------------- |  | ------------------- |  | ---------------------------- | ----- | ----------------- | ------- | ---------------------------- | - | -----
|                        |  |                                 |  | Outstanding Options |  | Exercisable Options         
|                        |  | SharesAvailablefor FutureGrants |  | NumberOutstanding   |  | WeightedAverageExercisePrice |       | NumberOutstanding |         | WeightedAverageExercisePrice
|At December 31, 2003    |  |                                |  | 449,650             |  | $                            | 12.00 |                   | 449,650 |                              | $ | 12.00
|Options granted/vesting |  |                                |  |                    |  |                              |      |                   |        |                              |   |     
|Options exercised       |  |                                |  |                    |  |                              |      |                   |        |                              |   |     
|Options forfeited       |  |                                |  |                    |  |                              |      |                   |        |                              |   |     
|                        |  |                                 |  |                     |  |                              |       |                   |         |                              |   |      
|At December 31, 2004    |  |                                |  | 449,650             |  |                              | 12.00 |                   | 449,650 |                              |   | 12.00
|Options granted/vesting |  |                                |  |                    |  |                              |      |                   |        |                              |   |     
|Options exercised       |  |                                |  |                    |  |                              |      |                   |        |                              |   |     
|Options forfeited       |  |                                |  |                    |  |                              |      |                   |        |                              |   |     
|                        |  |                                 |  |                     |  |                              |       |                   |         |                              |   |      
|At December 31, 2005    |  |                                |  | 449,650             |  | $                            | 12.00 |                   | 449,650 |                              | $ | 12.00
|                        |  |                                 |  |                     |  |                              |       |                   |         |                              |   |      



35



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 11. Income Tax Matters

Under the Internal Revenue Code, the Company is allowed a special bad debt deduction related to additions to tax bad debt reserves established for the purposes of absorbing losses. Through 1996, the provisions of the
Code permitted the Company to deduct from taxable income an allowance for bad debts based on 8% of taxable income before such deduction or actual loss experience. Legislation passed in 1996 eliminated the percentage of taxable income method as an
option for computing bad debt deductions in all future years. The Company is still permitted to take deductions for bad debts, but is required to compute such deductions using an experience method.

The Company must also recapture over a six year period its tax bad debt reserves which accumulated from 1987 through 1996 and amount to approximately $1,023,000. The tax
associated with the recaptured reserve is approximately $350,000. The recapture was scheduled to begin with the Companys 1997 year but was delayed two years because the Company originated a required minimum level of mortgage loans over this
period. Deferred income taxes have been previously established for the taxes associated with the recaptured reserves, and the ultimate payment of the taxes will not result in a charge to earnings. The Company recaptured the remaining amount of this
reserve by December 31, 2004.

Deferred taxes have been provided for certain increases in the Companys tax bad debt reserves subsequent to 1987
which are in excess of recorded book loan loss allowances. At December 31, 2005, retained earnings contain certain historical additions to bad debt reserves for income tax purposes of approximately $2,870,000, the balance at September 30,
1987, for which no deferred taxes have been provided because the Company does not intend to use these reserves for purposes other than to absorb loan losses. If amounts which qualified as bad debt deductions are used for purposes other than to
absorb losses or adjustments arising from the carryback of net operating losses, income taxes may be imposed at the then existing rates. The unrecorded deferred income tax liability on the above amount was approximately $1,125,000 as of
December 31, 2005.

The tax effects of temporary differences that gave rise to significant portions of the net deferred tax asset (classified as other
assets in the statements of financial condition) are as follows:

Deferred income taxes consist of the following:



|                                                 |  |                         |       |      |   |      
|------------------------------------------------ |  | ----------------------- | ----- | ---- | - | -----
|                                                 |  | Year Ended December 31,
|                                                 |  | 2005                    |       | 2004
|                                                 |  | (Dollars in thousands) 
|Deferred tax assets:                             |  |                         |       |      |   |      
|Deferred compensation and supplemental income    |  | $                       | 915   |      | $ | 898  
|Allowance for loan losses                        |  |                         | 260   |      |   | 222  
|Capital loss carryover                           |  |                         |      |      |   | 54   
|Investment in LLC                                |  |                         | 67    |      |   | 67   
|Unrealized loss on securities available for sale |  |                         | 158   |      |   | 76   
|Other                                            |  |                         | 52    |      |   | 13   
|                                                 |  |                         |       |      |   |      
|Total deferred tax assets                        |  |                         | 1,452 |      |   | 1,330
|                                                 |  |                         |       |      |   |      
|Deferred tax liabilities:                        |  |                         |       |      |   |      
|Net deferred loan fees and costs                 |  |                         | 219   |      |   | 226  
|Federal Home Loan Bank dividends                 |  |                         | 64    |      |   | 64   
|Prepaid expenses                                 |  |                         | 18    |      |   | 21   
|Premises and equipment                           |  |                         | 77    |      |   | 94   
|Other                                            |  |                         | 5     |      |   | 4    
|                                                 |  |                         |       |      |   |      
|Total deferred tax liabilities                   |  |                         | 383   |      |   | 409  
|                                                 |  |                         |       |      |   |      
|Net deferred tax assets                          |  | $                       | 1,069 |      | $ | 921  
|                                                 |  |                         |       |      |   |      



36



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 11. Income Tax Matters (Continued)

The Company has no valuation allowance at December 31, 2005 or 2004 because management has determined that it is more likely than not that the results of future operations will generate sufficient taxable income
to realize the deferred tax assets.

Allocation of income tax expense between current and deferred portions is as follows:



|                                 |  |                         |     |   |      |   |      |  
|-------------------------------- |  | ----------------------- | --- | - | ---- | - | ---- | -
|                                 |  | Year Ended December 31, |    
|                                 |  | 2005                    |     |   | 2004 |  
|                                 |  | (Dollars in thousands)  |    
|Current tax expense              |  | $                       | 878 |   |      | $ | 953  |  
|Deferred tax provision (benefit) |  |                         | (66 | ) |      |   | (327 | )
|                                 |  |                         |     |   |      |   |      |  
|                                 |  | $                       | 812 |   |      | $ | 626  |  
|                                 |  |                         |     |   |      |   |      |  

The difference between the provision for income taxes and the amounts applied by applying the statutory federal
income tax rate of 34% to income before income taxes is summarized below:



|                                            |  |                         |     |   |      |   |     |  
|------------------------------------------- |  | ----------------------- | --- | - | ---- | - | --- | -
|                                            |  | Year Ended December 31, |    
|                                            |  | 2005                    |     |   | 2004 |  
|                                            |  | (Dollars in thousands)  |    
|Expense computed at statutory rate of 34%   |  | $                       | 813 |   |      | $ | 583 |  
|Effect of state income taxes                |  |                         | 59  |   |      |   | 78  |  
|Nontaxable increase in cash surrender value |  |                         | (55 | ) |      |   | (76 | )
|Nondeductible ESOP expenses                 |  |                         | 8   |   |      |   | 104 |  
|Other, net                                  |  |                         | (13 | ) |      |   | (63 | )
|                                            |  |                         |     |   |      |   |     |  
|                                            |  | $                       | 812 |   |      | $ | 626 |  
|                                            |  |                         |     |   |      |   |     |  

Note 12. Stockholders Equity

Subject to applicable law, the Board of Directors of the Company or Home Savings may each provide for the payment of dividends. Future declarations of cash dividends, if any, by the Company may depend upon dividend
payments by the Bank to the Company. Subject to regulations promulgated by the North Carolina Commissioner of Banks, the Bank will not be permitted to pay dividends on its common stock if its stockholders equity would be reduced below the
amount required for the liquidation account or its capital requirement.

During the years ended December 31, 2005 and 2004, the Bank paid $1,213,370
and $1,231,866, respectively, in dividends to the Company.

The Company paid cash dividends totaling $.40 per share during each of the years ended
December 31, 2005 and 2004, respectively.



37



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 12. Stockholders Equity (Continued)

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly
additional discretionaryactions by regulators that, if undertaken, could have a direct material effect on the Companys and the Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative regulatory accounting practices. The Companys and the Banks capital amounts and classifications are also subject to qualitative
judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

The FDIC requires the Company and the Bank to have a minimum leverage ratio of Tier I Capital (principally consisting of retained earnings and any future common stockholders equity, less any intangible assets) to all assets of at
least 3%, provided that it receives the highest rating during the examination process. For institutions that receive less than the highest rating, the Tier I capital requirement is 1% to 2% above the stated minimum. The FDIC also requires the
Company and the Bank to have a ratio of total capital to risk-weighted assets of 8%, of which at least 4% must be in the form of Tier I capital.

As of
December 31, 2005, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management
believes have changed the Banks category. The Company and the Bank complied with all of the capital requirements at December 31, 2005 and 2004, as presented in the following table.



|                                        |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |       |  |      |  
|--------------------------------------- |  | ---------------------- | ------ | ----- | ------------------------- | - | ------ | --------------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- |  | ---- | -
|                                        |  | Actual                 |        |       | MinimumCapitalRequirement |   |        | Minimum To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                                        |  | Amount                 |        | Ratio |                           |   | Amount |                                                                       | Ratio  |  |     | Amount |  | Ratio | 
|                                        |  | (Dollars in Thousands) |       
|December 31, 2005:                      |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |       |  |      |  
|Total Capital to Risk Weighted Assets:  |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |       |  |      |  
|Consolidated                            |  | $                      | 26,892 |       | 16.83                     | % |        | $                                                                     | 12,786 |  | 8.0 | %      |  | N/A   |  | N/A  |  
|Bank                                    |  |                        | 23,615 |       | 14.77                     | % |        |                                                                       | 12,786 |  | 8.0 | %      |  |       |  | 10.0 | %
|Tier 1 Capital to Risk Weighted Assets: |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |       |  |      |  
|Consolidated                            |  | $                      | 26,218 |       | 16.40                     | % |        | $                                                                     | 6,393  |  | 4.0 | %      |  | N/A   |  | N/A  |  
|Bank                                    |  |                        | 22,941 |       | 14.35                     | % |        |                                                                       | 6,393  |  | 4.0 | %      |  |       |  | 6.0  | %
|Tier 1 Capital to Average Assets:       |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |       |  |      |  
|Consolidated                            |  | $                      | 26,218 |       | 11.06                     | % |        | $                                                                     | 7,112  |  | 3.0 | %      |  | N/A   |  | N/A  |  
|Bank                                    |  |                        | 22,941 |       | 9.76                      | % |        |                                                                       | 7,112  |  | 3.0 | %      |  |       |  | 5.0  | %



38



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 12. Stockholders Equity (Continued)



|                                        |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|--------------------------------------- |  | ---------------------- | ------ | ----- | ------------------------- | - | ------ | --------------------------------------------------------------------- | ------ |  | --- | ------ |  | ------ |  | ---- | -
|                                        |  | Actual                 |        |       | MinimumCapitalRequirement |   |        | Minimum To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                                        |  | Amount                 |        | Ratio |                           |   | Amount |                                                                       | Ratio  |  |     | Amount |  | Ratio  | 
|                                        |  | (Dollars in Thousands) |       
|December 31, 2004:                      |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Total Capital to Risk Weighted Assets:  |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Consolidated                            |  | $                      | 26,423 |       | 20.00                     | % |        | $                                                                     | 10,571 |  | 8.0 | %      |  | N/A    |  | N/A  |  
|Bank                                    |  |                        | 23,264 |       | 17.60                     | % |        |                                                                       | 10,571 |  | 8.0 | %      |  | 13,213 |  | 10.0 | %
|Tier 1 Capital to Risk Weighted Assets: |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Consolidated                            |  | $                      | 25,849 |       | 19.56                     | % |        | $                                                                     | 5,285  |  | 4.0 | %      |  | N/A    |  | N/A  |  
|Bank                                    |  |                        | 22,690 |       | 17.17                     | % |        |                                                                       | 5,285  |  | 4.0 | %      |  | 7,928  |  | 6.0  | %
|Tier 1 Capital to Average Assets:       |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Consolidated                            |  | $                      | 25,849 |       | 11.98                     | % |        | $                                                                     | 6,472  |  | 3.0 | %      |  | N/A    |  | N/A  |  
|Bank                                    |  |                        | 22,690 |       | 10.70                     | % |        |                                                                       | 6,472  |  | 3.0 | %      |  | 10,787 |  | 5.0  | %

Note 13. Employee Stock Ownership Plan

The Company has established an ESOP to benefit all qualified employees. The ESOP purchased 359,720 shares of common stock in the open market subsequent to the Conversion with proceeds received from a loan from the
Company. The ESOP purchased 168,448 additional shares with proceeds received from the return of capital dividend paid by the Company in 1998.

The
Companys note receivable is to be repaid based upon 15 annual installments of principal and interest on September 30 of each year through September 30, 2011. Interest is based upon prime which will be adjusted and paid annually. The
note may be prepaid without penalty. The unallocated shares of stock held by the ESOP are pledged as collateral for the debt. The ESOP is funded by contributions made by the Company in amounts sufficient to retire the debt. At December 31,
2005, the outstanding balance of the unaudited shares is $534,000, and is presented as a reduction of stockholders equity.

Shares are released as
the debt is repaid and dividends from the common stock held by the ESOP are allocated among participants on the basis of compensation in the year of allocation. Benefits become 100% vested after five years of credited service. Forfeitures of
nonvested benefits will be reallocated among remaining participating employees in the same proportion as contributions.

Dividends on unallocated shares
may be used by the ESOP to repay the debt to the Company and are not reported as dividends but as additional compensation expense in the financial statements. Dividends on allocated or committed to be allocated shares may also be used to repay the
debt to the Company and are reported as dividends in the financial statements. Special return of capital dividends paid on 331,742 unallocated ESOP shares totaled $1,990,000 on September 30, 1998 and are being amortized as compensation expense
in subsequent periods as ESOP shares are released to the participants. During the years ended December 31, 2005 and 2004, $128,000 and $387,000, respectively, was amortized as compensation expense.



39



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 13. Employee Stock Ownership Plan (Continued)

Net expenses of $302,000 and $255,000 have been recorded during the years ended December 31, 2005 and 2004, respectively, in connection with the ESOP. The expenses
represent the difference between the fair value of the shares which have been released or committed to be released to participants and the cost of these shares to the ESOP has been debited to common stock in accordance with the provisions of AICPA
Statement of Position 93-6.

At December 31, 2005, 378,196 shares held by the ESOP have been released or committed to be released to the plans
participants for purposes of computing earnings per share.

The ESOP has a put option which requires the Company to repurchase its common stock from
participants in the ESOP who are eligible to receive benefits under the terms of the plan and elect to receive cash in exchange for their common stock. The potential commitment for the put option at December 31, 2005, based on a fair value of
the ESOP shares released or committed to be released is approximately $3,593,000. The fair value of the unallocated shares is $529,000 at December 31, 2005. This commitment will fluctuate based on the fair value of the shares.

Note 14. Off Balance-Sheet Risk

The Company is a party to financial
instruments with off-balance sheet credit risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. Those instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The
Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of
the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Company, upon extension of credit is based on managements credit evaluation of the borrower. Collateral obtained varies but may include real estate, stocks, bonds, and certificates of deposit.

A summary of the contract amounts (in thousands) of the Companys exposure to off-balance sheet credit risk as of December 31, 2005 is as
follows:

Financial instruments whose contract amounts represent credit risk:



|                                          |  |   |       
|----------------------------------------- |  | - | ------
|Commitments to extend credit              |  | $ | 10,175
|Undisbursed lines of credit               |  |   | 13,710
|Undisbursed portion of construction loans |  |   | 4,206 

The Company entered into an employment agreement with one executive officer to provide for his continued
employment. The agreement provides for an initial term of three years and can be extended an additional year annually.



40



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 14. Off Balance-Sheet Risk (Continued)

In the normal course of its operations, the Company from time to time is party to various legal proceedings. Based upon information currently available, and after consultation with its legal counsel, management
believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the Companys business, financial position or results of operations.

Note 15. Fair Value of Financial Instruments

Financial instruments for which fair value disclosures are required
include cash and due from banks, interest-bearing deposits, federal funds sold, investment securities, loans, Federal Home Loan bank stock, bank owned life insurance, deposit accounts and advances from the Federal Home Loan Bank. Fair value
estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the
Companys entire holdings of a particular financial instrument. Because no active market readily exists for a portion of the Companys financial instruments, fair value estimates are based on judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be
determined with precision. Changes in assumptions could significantly affect the estimates.

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

Cash and Due from Banks, Interest-bearing
Deposits and Federal Funds Sold

The carrying amounts for cash and due from banks, interest-bearing deposits and federal funds sold
approximate fair value because of the short maturities of those instruments.

Investment Securities

Fair values for investment securities held to maturity and available for sale are based on quoted market prices, where available. If quoted market prices
are not available, fair values are based on quoted market prices of comparable instruments.

Loans

For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by
similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.

Federal Home Loan Bank Stock

The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.



41



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 15. Fair Value of Financial Instruments (Continued)

Bank owned life insurance (BOLI)

The carrying
amount for BOLI approximates its fair value.

Deposits

The fair value of demand deposits is the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting expected future cash flows using the rates currently offered for
instruments of similar remaining maturities.

Borrowings

The fair value of advances from the Federal Home Loan Bank is based upon the discounted value of expected future cash flows when using current rates at which borrowings of similar maturity could be obtained.

Financial Instruments with Off-Balance Sheet Risk

With regard to financial instruments with off-balance sheet risk discussed in Note 14, it is not practicable to estimate the fair value of future financing commitments. The large majority of commitments to extend
credit and standby letters of credit are at variable rates and/or have relatively short terms to maturity. Therefore, the fair value for these financial instruments is considered to be immaterial.

The carrying amounts and estimated fair values of the Companys financial instruments, none of which are held for trading purposes, are as follows at
December 31, 2005 and 2004:



|                                                 |  |                        |         |                     |   |                |  |                     |         |  |   |        
|------------------------------------------------ |  | ---------------------- | ------- | ------------------- | - | -------------- |  | ------------------- | ------- |  | - | -------
|                                                 |  | 2005                   |         | 2004               
|                                                 |  | Carryingamount         |         | Estimatedfair value |   | Carryingamount |  | Estimatedfair value
|                                                 |  | (Dollars in thousands)
|Financial assets:                                |  |                        |         |                     |   |                |  |                     |         |  |   |        
|Cash and due from banks                          |  | $                      | 5,692   |                     | $ | 5,692          |  | $                   | 3,010   |  | $ | 3,010  
|Interest-bearing deposits and federal funds sold |  |                        | 8,608   |                     |   | 8,608          |  |                     | 22,566  |  |   | 22,566 
|Held to maturity investments                     |  |                        | 5,254   |                     |   | 5,119          |  |                     | 6,479   |  |   | 6,440  
|Available for sale investments                   |  |                        | 24,101  |                     |   | 24,101         |  |                     | 18,691  |  |   | 18,691 
|Loans, net                                       |  |                        | 183,212 |                     |   | 183,829        |  |                     | 152,431 |  |   | 153,424
|Federal Home Loan Bank stock                     |  |                        | 1,100   |                     |   | 1,100          |  |                     | 434     |  |   | 434    
|Bank owned life insurance                        |  |                        | 7,573   |                     |   | 7,573          |  |                     | 7,245   |  |   | 7,245  
|                                                 |  |                        |         |                    
|Financial liabilities:                           |  |                        |         |                     |   |                |  |                     |         |  |   |        
|Deposits                                         |  |                        | 198,634 |                     |   | 197,007        |  |                     | 186,905 |  |   | 187,794
|Borrowings                                       |  |                        | 15,000  |                     |   | 15,000         |  |                     |        |  |   |       



42



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 16. Parent Company Financial Data



|                                              |  |                          |        |   |      |   |        |  
|--------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|Condensed Balance Sheets                      | 
|                                              | 
|                                              |  | December 31,             |       
|                                              |  | 2005                     |        |   | 2004 |  
|                                              |  | (Dollars in thousands)   |       
|Assets:                                       |  |                          |        |   |      |   |        |  
|Cash                                          |  | $                        | 4      |   |      | $ | 2      |  
|Federal funds sold                            |  |                          | 1,310  |   |      |   | 1,316  |  
|Securities available for sale                 |  |                          | 2,267  |   |      |   | 2,278  |  
|Accrued interest receivable                   |  |                          | 17     |   |      |   | 23     |  
|Other assets                                  |  |                          | 6      |   |      |   | 10     |  
|Investment in Home Savings Bank               |  |                          | 22,808 |   |      |   | 22,585 |  
|                                              |  |                          |        |   |      |   |        |  
|                                              |  | $                        | 26,412 |   |      | $ | 26,214 |  
|                                              |  |                          |        |   |      |   |        |  
|Liabilities and Stockholders Equity:         |  |                          |        |   |      |   |        |  
|Liabilities:                                  |  |                          |        |   |      |   |        |  
|Other liabilities                             |  | $                        | 442    |   |      | $ | 483    |  
|                                              |  |                          |        |   |      |   |        |  
|Stockholders Equity:                         |  |                          |        |   |      |   |        |  
|Common stock                                  |  |                          | 6,428  |   |      |   | 6,993  |  
|Unearned compensation                         |  |                          | (159   | ) |      |   | (287   | )
|Unearned ESOP                                 |  |                          | (534   | ) |      |   | (933   | )
|Retained earnings                             |  |                          | 20,483 |   |      |   | 20,076 |  
|Accumulated other comprehensive income (loss) |  |                          | (248   | ) |      |   | (118   | )
|                                              |  |                          |        |   |      |   |        |  
|                                              |  |                          | 25,970 |   |      |   | 25,731 |  
|                                              |  |                          |        |   |      |   |        |  
|                                              |  | $                        | 26,412 |   |      | $ | 26,214 |  
|                                              |  |                          |        |   |      |   |        |  
|                                             
|Condensed Statements of Income                | 
|                                              | 
|                                              |  | Years Ended December 31, |       
|                                              |  | 2005                     |        |   | 2004 |  
|                                              |  | (Dollars in thousands)   |       
|Interest income                               |  | $                        | 169    |   |      | $ | 166    |  
|Equity in earnings of Home Savings Bank       |  |                          | 1,489  |   |      |   | 1,009  |  
|Other expense                                 |  |                          | (42    | ) |      |   | (36    | )
|Income taxes                                  |  |                          | (36    | ) |      |   | (50    | )
|                                              |  |                          |        |   |      |   |        |  
|Net income                                    |  | $                        | 1,580  |   |      | $ | 1,089  |  
|                                              |  |                          |        |   |      |   |        |  



43



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 16. Parent Company Financial Data (Continued)

Condensed Statements of Cash Flows



|                                                                                            |  |                          |        |   |      |   |        |  
|------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                            |  | Years Ended December 31, |       
|                                                                                            |  | 2005                     |        |   | 2004 |  
|                                                                                            |  | (Dollars in thousands)   |       
|Cash Flows from Operating Activities:                                                       |  |                          |        |   |      |   |        |  
|Net income                                                                                  |  | $                        | 1,580  |   |      | $ | 1,089  |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                          |        |   |      |   |        |  
|Equity in earnings of Home Savings Bank                                                     |  |                          | (1,489 | ) |      |   | (1,009 | )
|Upstream dividend from Home Savings Bank                                                    |  |                          | 1,213  |   |      |   | 1,232  |  
|Decrease in accrued interest receivable and other assets                                    |  |                          | 10     |   |      |   | 10     |  
|Increase in accrued expenses and other liabilities                                          |  |                          | (35    | ) |      |   | 57     |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Net cash provided by operating activities                                                   |  |                          | 1,279  |   |      |   | 1,379  |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Cash Flows from Investing Activities:                                                       |  |                          |        |   |      |   |        |  
|Purchase of securities available for sale                                                   |  |                          |       |   |      |   | (2,000 | )
|Principal payment received on note receivable from ESOP                                     |  |                          | 398    |   |      |   | 429    |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Net cash (used in) provided by investing activities                                         |  |                          | 398    |   |      |   | (1,571 | )
|                                                                                            |  |                          |        |   |      |   |        |  
|Cash Flows from Financing Activities:                                                       |  |                          |        |   |      |   |        |  
|Retirement of stock purchased                                                               |  |                          | (468   | ) |      |   | (321   | )
|Payment of dividends                                                                        |  |                          | (1,213 | ) |      |   | (1,224 | )
|                                                                                            |  |                          |        |   |      |   |        |  
|Net cash used in financing activities                                                       |  |                          | (1,681 | ) |      |   | (1,545 | )
|                                                                                            |  |                          |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                        |  |                          | (4     | ) |      |   | (1,737 | )
|                                                                                            |  |                         
|Cash and cash equivalents:                                                                  |  |                          |        |   |      |   |        |  
|Beginning                                                                                   |  |                          | 1,318  |   |      |   | 3,055  |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Ending                                                                                      |  | $                        | 1,314  |   |      | $ | 1,318  |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Supplemental Disclosures of Cash Flow Information:                                          |  |                          |        |   |      |   |        |  
|Cash payments for:                                                                          |  |                          |        |   |      |   |        |  
|Income taxes                                                                                |  | $                        | 41     |   |      | $ | 24     |  
|Supplemental Disclosures of Noncash Transactions:                                           |  |                          |        |   |      |   |        |  
|Investing and Financing:                                                                    |  |                          |        |   |      |   |        |  
|Change in unrealized losses on available for sale securities, net of taxes                  |  |                          | (130   | ) |      |   | (153   | )
|Change in dividends accrued                                                                 |  |                          | (5     | ) |      |   | 3      |  



44



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

CORPORATE INFORMATION



|                                                         |  |                                                
|-------------------------------------------------------- |  | -----------------------------------------------
|OFFICERS OF THE COMPANY                                 
|                                                         | 
|R. Ronald Swanner                                        |  | Cris D. Turner                                 
|President, CEO and Chairman of Board                     |  | Vice-President                                 
|                                                         | 
|David L. Smith                                           |  | Christopher F. Cranford                        
|Secretary                                                |  | CFO and Treasurer                              
|                                                         | 
|Melody M Goins                                           |  | Janice M. Smith                                
|Vice-President                                           |  | Assistant Secretary                            
|                                                        
|DIRECTORS OF THE HOLDING COMPANY AND BANK               
|                                                         | 
|R. Ronald Swanner                                        |  | Douglas D. Stokes                              
|President, CEO and Chairman of Boardof Home Savings Bank |  | Owner and President Stokes Construction Company
|                                                         | 
|Joel A. Huneycutt                                        |  | Caldwell A. Holbrook, Jr.                      
|President,                                               |  | Owner of Gus Holbrook                          
|Locust Lumber Company                                    |  | General Contractor                             
|                                                         | 
|Greg E. Underwood                                        |  | J. Banks Garrison, Jr.                         
|Certified Public Accountant                              |  | President of South Central                     
|Private Practice                                         |  | Oil Company                                    



|                                                                                         |  |                                                                                                    |  |                                                                                                                                         
|---------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------
|STOCK TRANSFER AGENT Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 |  | INDEPENDENT AUDITORS Dixon Hughes PLLC 6525 Morrison Boulevard, Suite 516 Charlotte, NC 28211-3563 |  | SPECIAL LEGAL COUNSEL Brooks, Pierce, McLendon, Humphrey & Leonard, LLP 2000 Renaissance Plaza 230 North Elm Street Greensboro, NC 27420
|                                                                                         |  |                                                                                                   
|                                                                                         |  | CORPORATE OFFICE 155 West South Street P.O. Box 489 Albemarle, NC 28002-0489                       |  |                                                                                                                                         

FORM 10-KSB

A copy of Form 10-KSB as filed with the Securities and Exchange Commission will be furnished without charge to the Companys stockholders upon written request to South Street Financial Corp., 155 West South Street, P.O. Box 489,
Albemarle, NC 28002.

ANNUAL MEETING

The 2006
annual meeting of stockholders of South Street Financial Corp. will be held at 4 p.m. on May 22, 2006 at the Companys corporate office at 155 West South Street, Albemarle, NC.



45



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

COMMON STOCK INFORMATION

The Companys common stock is listed on the NASDAQ National
Market under the symbol SSFC and began trading on October 3, 1996. At December 31, 2005, there were approximately 572 shareholders of record, not including the number of persons or entities where stock is held in nominee or street name
through various brokerage firms or banks. The following table reflects the stock trading and dividend payment frequency of the Company.



|               |  |           |      |             |   |       |  |   |     
|-------------- |  | --------- | ---- | ----------- | - | ----- |  | - | ----
|               |  | Dividends |      | Stock Price
|               |  | Regular   |      | High        |   | Low  
|2005:          |  |           |      |             |   |       |  |   |     
|First Quarter  |  | $         | 0.10 |             | $ | 10.24 |  | $ | 9.30
|Second Quarter |  |           | 0.10 |             |   | 10.00 |  |   | 9.41
|Third Quarter  |  |           | 0.10 |             |   | 10.00 |  |   | 9.25
|Fourth Quarter |  |           | 0.10 |             |   | 10.00 |  |   | 9.00
|               |  |           |     
|2004:          |  |           |      |             |   |       |  |   |     
|First Quarter  |  | $         | 0.10 |             | $ | 10.80 |  | $ | 9.85
|Second Quarter |  |           | 0.10 |             |   | 10.50 |  |   | 9.13
|Third Quarter  |  |           | 0.10 |             |   | 10.80 |  |   | 9.40
|Fourth Quarter |  |           | 0.10 |             |   | 10.23 |  |   | 9.05



46