EXHIBIT (13)

SOUTH STREET FINANCIAL CORP.

ALBEMARLE, NORTH CAROLINA

2006 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 at December 31, 2006 and 2005                   |  | 13   
|                                                                                  | 
|Statements of income for the years ended December 31, 2006 and 2005               |  | 14   
|                                                                                  | 
|Statements of stockholders equity for the years ended December 31, 2006 and 2005 |  | 15   
|                                                                                  | 
|Statements of cash flows for the years ended December 31, 2006 and 2005           |  | 16-17
|                                                                                  | 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                        |  | 18-45
|                                                                                  | 
|CORPORATE INFORMATION                                                             |  | 46-47

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,  
|                                                    |  | 2006                                     |         | 2005 |   | 2004    |  | 2003 |         | 2002
|                                                    |  | (In Thousands, Except Per Share Amounts)
|Financial Condition Data:                           |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Total assets                                        |  | $                                        | 276,986 |      | $ | 243,233 |  | $    | 215,551 |      | $ | 220,154 |  | $ | 224,798
|Investment securities (1)                           |  |                                          | 44,155  |      |   | 39,063  |  |      | 48,140  |      |   | 58,243  |  |   | 44,564 
|Loans receivable, net (2)                           |  |                                          | 209,953 |      |   | 183,212 |  |      | 152,431 |      |   | 143,344 |  |   | 172,184
|Deposits                                            |  |                                          | 236,111 |      |   | 198,634 |  |      | 186,905 |      |   | 181,120 |  |   | 175,659
|Borrowings                                          |  |                                          | 10,000  |      |   | 15,000  |  |      |        |      |   | 10,000  |  |   | 21,000 
|Stockholders equity                                |  |                                          | 25,388  |      |   | 25,970  |  |      | 25,731  |      |   | 25,647  |  |   | 24,895 
|Book value per share                                |  |                                          | 8.59    |      |   | 8.66    |  |      | 8.44    |      |   | 8.33    |  |   | 8.08   
|                                                    |  |                                          |         |      |  
|Operating Data:                                     |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Interest income                                     |  | $                                        | 15,694  |      | $ | 12,663  |  | $    | 10,531  |      | $ | 11,466  |  | $ | 13,879 
|Interest expense                                    |  |                                          | 8,259   |      |   | 5,271   |  |      | 4,430   |      |   | 5,166   |  |   | 6,969  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Net interest income                                 |  |                                          | 7,435   |      |   | 7,392   |  |      | 6,101   |      |   | 6,300   |  |   | 6,910  
|Provision for loan losses                           |  |                                          | 120     |      |   | 120     |  |      | 90      |      |   | 120     |  |   | 100    
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Net interest income after provision for loan losses |  |                                          | 7,315   |      |   | 7,272   |  |      | 6,011   |      |   | 6,180   |  |   | 6,810  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Non-interest income                                 |  |                                          | 895     |      |   | 856     |  |      | 789     |      |   | 819     |  |   | 522    
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Non-interest expense:                               |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Compensation and employee                           |  |                                          | 4,212   |      |   | 3,843   |  |      | 3,445   |      |   | 3,534   |  |   | 3,372  
|Other                                               |  |                                          | 2,021   |      |   | 1,893   |  |      | 1,640   |      |   | 1,546   |  |   | 1,449  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Total non-interest expense                          |  |                                          | 6,233   |      |   | 5,736   |  |      | 5,085   |      |   | 5,080   |  |   | 4,821  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Income before income taxes                          |  |                                          | 1,977   |      |   | 2,392   |  |      | 1,715   |      |   | 1,919   |  |   | 2,511  
|Income tax expense                                  |  |                                          | 700     |      |   | 812     |  |      | 626     |      |   | 675     |  |   | 849    
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        
|Net income                                          |  | $                                        | 1,277   |      | $ | 1,580   |  | $    | 1,089   |      | $ | 1,244   |  | $ | 1,662  
|                                                    |  |                                          |         |      |   |         |  |      |         |      |   |         |  |   |        



1



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

SELECTED CONSOLIDATED FINANCIAL DATA



|                                                                             |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|---------------------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                             |  | At or for the Years Ended December 31,   |       
|                                                                             |  | 2006                                     |        |   | 2005 |   |        | 2004 |  |   | 2003   |   |  | 2002 |       
|                                                                             |  | (In Thousands, Except Per Share Amounts) |       
|Selected Other Data:                                                         |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Basic earnings per share                                                     |  | $                                        | .44    |   |      | $ | .54    |      |  | $ | .37    |   |  | $    | 0.43   |   |  | $ | 0.58   |  
|Diluted earnings per share                                                   |  |                                          | .44    |   |      |   | .54    |      |  |   | .37    |   |  |      | 0.43   |   |  |   | 0.58   |  
|Dividends per share                                                          |  |                                          | .40    |   |      |   | .40    |      |  |   | .40    |   |  |      | 0.40   |   |  |   | 0.40   |  
|Dividend payout ratio(6)                                                     |  |                                          | 95.24  | % |      |   | 74.49  | %    |  |   | 108.11 | % |  |      | 95.24  | % |  |   | 68.97  | %
|Return on average assets                                                     |  |                                          | .47    | % |      |   | .70    | %    |  |   | .51    | % |  |      | 0.56   | % |  |   | 0.77   | %
|Return on average equity                                                     |  |                                          | 4.66   | % |      |   | 6.13   | %    |  |   | 4.25   | % |  |      | 4.92   | % |  |   | 6.85   | %
|Average equity to average assets                                             |  |                                          | 10.02  | % |      |   | 11.48  | %    |  |   | 12.04  | % |  |      | 11.43  | % |  |   | 11.22  | %
|Stockholders equity to end-of- period assets                                |  |                                          | 9.17   | % |      |   | 10.68  | %    |  |   | 11.94  | % |  |      | 11.65  | % |  |   | 11.07  | %
|Interest rate spread for period(3)                                           |  |                                          | 3.01   | % |      |   | 3.42   | %    |  |   | 2.99   | % |  |      | 2.84   | % |  |   | 2.95   | %
|Average interest-earning assets to average interest-bearing liabilities      |  |                                          | 103.57 | % |      |   | 106.11 | %    |  |   | 107.18 | % |  |      | 107.95 | % |  |   | 110.78 | %
|Net interest margin(4)                                                       |  |                                          | 3.13   | % |      |   | 3.58   | %    |  |   | 3.09   | % |  |      | 3.04   | % |  |   | 3.31   | %
|Non-performing assets to total assets at period end(5)                       |  |                                          | .48    | % |      |   | .46    | %    |  |   | .22    | % |  |      | 0.65   | % |  |   | 0.58   | %
|Non-performing loans to total loans at period end                            |  |                                          | .63    | % |      |   | .48    | %    |  |   | .32    | % |  |      | 0.99   | % |  |   | 0.74   | %
|Allowance for loan losses to non- performing loans at period end             |  |                                          | 58.69  | % |      |   | 33.99  | %    |  |   | 83.80  | % |  |      | 78.08  | % |  |   | 40.42  | %
|Allowance for loan losses at period end as a percent of total gross loans    |  |                                          | .37    | % |      |   | .37    | %    |  |   | 0.37   | % |  |      | 0.30   | % |  |   | 0.30   | %
|Net interest income, after provision for loan losses to non-interest expense |  |                                          | 117.36 |   |      |   | 126.77 | %    |  |   | 118.21 | % |  |      | 121.65 | % |  |   | 141.25 | %
|Non-interest expense to average assets                                       |  |                                          | 2.40   | % |      |   | 2.55   | %    |  |   | 2.38   | % |  |      | 2.30   | % |  |   | 2.23   | %
|Deposit accounts                                                             |  |                                          | 11,492 |   |      |   | 11,213 |      |  |   | 10,982 |   |  |      | 11,421 |   |  |   | 11,041 |  
|Loan accounts                                                                |  |                                          | 3,321  |   |      |   | 3,212  |      |  |   | 2,911  |   |  |      | 2,869  |   |  |   | 3,252  |  
|Number of full service banking offices                                       |  |                                          | 3      |   |      |   | 3      |      |  |   | 2      |   |  |      | 2      |   |  |   | 2      |  

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|(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



2006 Report to Shareholders:



3



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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 South Street Financial Corp.
(the Company). Home Savings Bank of Albemarle, SSB (the Bank, Home Savings or Home), and South Street Development Corporation (SSDC) which owns 100% of Park Ridge Associates, LLC (Park Ridge) for the years ended December 31. 2006
and 2005. 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 2005, 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.

The Company is a one bank holding company for the Bank 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 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.

The Bank has one wholly owned subsidiary, SSDC, an
investment company that owns 100% of Park Ridge which owns 25.6 acres of prime real estate located within the city limits of Albemarle, North Carolina. developed the property into a premier residential subdivision. As of December 2006, Park Ridge
has 30 lots to be sold.



4



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENTS DISCUSSION AND ANALYSIS



Recent Developments

On March 22, 2007, the Company filed amendments to its Articles of Incorporation. The first amendment authorized the creation of 500,000 shares of a new Series A Preferred stock (Preferred Stock). The second amendment converted all
shares of common stock held by record shareholders of less than 750 shares of common stock into shares of the Series A Preferred stock on a one-for-one basis (the Conversion). The creation of the Preferred Stock and the Conversion became effective
at 11:59 p.m. Easter Time on March 22, 2007 (the Effective Date). For a period of thirty days following the Effective Date, those shareholders holding share of Preferred Stock as a result of the Conversion will be entitled to sell such shares
to the Company as $10.00 a share. The Conversion did not change the shares of any shareholder who owns 750 or more shares of common stock as of the Effective Date (or who holds any number of common stock shares in their brokers name). Those
shareholders owning 750 or more shares of Company common stock on the Effective Date, as well as any shareholder owning shares of common stock in street name, continued to own common shares after the Conversion.

The primary purpose of the Conversion was to reduce the number of owners of common stock and de-register the Company as a reporting company under the Securities and
Exchange Act of 1934, as amended (the Exchange Act). De-registration as an Exchange Act reporting company will significantly reduce the Companys on-going and anticipated financial, personnel, and administrative costs related to reporting and
compliance with the Sarbanes-Oxley Act of 2002, and the rules and regulations promulgated by the SEC in response to the Act.

The Companys
shareholders approve the Conversion at a special meeting held on March 20, 2007.

Comparison of Financial Condition at December 31, 2006 and
2005

During 2006, the Companys total assets increased by $33.8 million, or 13.9%, from $243.2 million at December 31, 2005 to $277.0 million
at December 31, 2006. This increase in our total assets resulted primarily from increases in our loan portfolio and in our liquid assets, net of a decrease in our Federal Home Loan Bank Stock. Our loan portfolio increased from $183.2 million at
December 31, 2005 to $210.0 million at the end of 2006, an increase of $26.7 million. Additionally during the year we sold $170,000 worth of FHLB stock. Our liquid assets, consisting of cash and cash equivalents and investment securities,
increased from $38.4 million at December 31, 2005 to $43.9 million at the end of 2006, an increase of $5.5 million.

Also during 2006, deposits from
our customers increased by $37.5 million to $236.1 million at December 31, 2006 compared with $198.6 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 provided funds to reduce borrowings, which consist solely of advances from the Federal Home Loan Bank, from $15.0 million at the beginning of the year to $10.0
million at December 31, 2006, a decrease of $5.0 million and additional provided funds for the aforementioned loan portfolio.

Stockholders
equity decreased by $582,000 during 2006. This net decrease was the result of several factors. Items which increased stockholders equity were: net income of $1.3 million, amortization of ESOP compensation expense of $326,000, and amortization
of the return of capital dividends paid on unvested ESOP shares of $107,000. These increases were offset by the following items which decreased stockholders equity: Unrealized gains on available for sale investment securities of $193,000,
unrealized loss effected by the adoption of SFAS No. 158 of $808,000, the payment of quarterly cash dividends totaling $1.2 million, or $.40 per share, and the repurchase of company stock in the amount of $426,000.



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, 2006 and 2005

Net Income

The Company earned net income of $1.3 million or $.44 per
share for 2006, as compared with net income of $1.6 million or $.54 per share in 2005. This decrease of $303,000 or $.10 per share is principally attributable to the increase in our compensation and benefits expense during 2006, 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 non-interest-bearing liabilities and capital.

Net interest income increased $43,000 for the year ended December 31, 2006 over the amount earned in 2005. During 2006 our level of average interest earning assets increased from $209.6 million in 2005 to $237.4
million, and the average rate we earned on those assets increased 57 basis points from 6.04% in 2005 to 6.61% in 2006. The combined effect of these increases resulted in the increase in our interest income of $3.0 million. This increase in our
interest income, however, was somewhat negated by the increase in our interest expense during 2006. While our average interest-bearing liabilities increased from $198.4 million in 2005 to $229.2 million in 2006, 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 94 basis points from 2.66% in 2005 to 3.60% in 2006.

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 Ended December 31, 2006 vs. 2005 |       |   | Year Ended December 31, 2005 vs. 2004 |  
|                                            |  | Increase (Decrease) Due To            |       |   | Increase (Decrease) Due To            |  
|                                            |  | Volume                                |       |   | Rate                                  |   |       | Total |  |   | Volume |   |  | Rate |       | Total | 
|                                            |  | (Dollars in thousands)                |      
|Interest income:                            |  |                                       |       |   |                                       |   |       |       |  |   |        |   |  |      |       |       |  |   |       |  |   |       |  
|Interest-bearing deposits                   |  | $                                     | (46   | ) |                                       | $ | 319   |       |  | $ | 273    |   |  | $    | (164  | )     |  | $ | 130   |  | $ | (34   | )
|Investments                                 |  |                                       | (14   | ) |                                       |   | (1    | )     |  |   | (15    | ) |  |      | 100   |       |  |   | 135   |  |   | 235   |  
|Loans receivable, net                       |  |                                       | 2,050 |   |                                       |   | 723   |       |  |   | 2,773  |   |  |      | 1,183 |       |  |   | 748   |  |   | 1,931 |  
|                                            |  |                                       |       |   |                                       |   |       |       |  |   |        |   |  |      |       |       |  |   |       |  |   |       |  
|Total interest income                       |  |                                       | 1,990 |   |                                       |   | 1,041 |       |  |   | 3,031  |   |  |      | 1,119 |       |  |   | 1,013 |  |   | 2,132 |  
|                                            |  |                                       |       |   |                                       |   |       |       |  |   |        |   |  |      |       |       |  |   |       |  |   |       |  
|Interest expense:                           |  |                                       |       |   |                                       |   |       |       |  |   |        |   |  |      |       |       |  |   |       |  |   |       |  
|Deposits:                                   |  |                                       |       |   |                                       |   |       |       |  |   |        |   |  |      |       |       |  |   |       |  |   |       |  
|Passbook savings                            |  |                                       | (33   | ) |                                       |   | 267   |       |  |   | 234    |   |  |      | (5    | )     |  |   | 77    |  |   | 72    |  
|NOW and money market                        |  |                                       | 22    |   |                                       |   | 55    |       |  |   | 77     |   |  |      | 11    |       |  |   | 2     |  |   | 13    |  
|Certificates of deposit                     |  |                                       | 837   |   |                                       |   | 1,530 |       |  |   | 2,367  |   |  |      | 136   |       |  |   | 370   |  |   | 506   |  
|Borrowings                                  |  |                                       | 254   |   |                                       |   | 56    |       |  |   | 310    |   |  |      | 94    |       |  |   | 156   |  |   | 250   |  
|                                            |  |                                       |       |   |                                       |   |       |       |  |   |        |   |  |      |       |       |  |   |       |  |   |       |  
|Total interest expense                      |  |                                       | 1,080 |   |                                       |   | 1,908 |       |  |   | 2,988  |   |  |      | 236   |       |  |   | 605   |  |   | 841   |  
|                                            |  |                                       |       |   |                                       |   |       |       |  |   |        |   |  |      |       |       |  |   |       |  |   |       |  
|Net interest income and increase (decrease) |  | $                                     | 910   |   |                                       | $ | (867  | )     |  | $ | 43     |   |  | $    | 883   |       |  | $ | 408   |  | $ | 1,291 |  
|                                            |  |                                       |       |   |                                       |   |       |       |  |   |        |   |  |      |       |       |  |   |       |  |   |       |  

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, 2006, 2005 and 2004, respectively.



|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|-------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---------------------------- | - | ----------- | ---------------------------- | ---- | ---------------------- |  | - | -------- | - | ----------- | - | ------ | -------------- | ---- | - | -------- | - | ----------- | - |  | - | ------ |  | ---- | -
|                                                                                 |  | Year Ended December 31, 2006 |         |   | Year Ended December 31, 2005 |   |             | Year Ended December 31, 2004 |     
|                                                                                 |  | AverageBalance               |         |   | Interest                     |   | AverageRate |                              |      | AverageBalance         |  |   | Interest |   | AverageRate |   |        | AverageBalance |      |   | Interest |   | AverageRate |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      | (Dollars in thousands) |  |   |          |   |             |   |        |                |     
|Interest earning assets:                                                         |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Interest-bearing deposits(1)                                                     |  | $                            | 10,228  |   |                              | $ | 559         |                              | 5.47 | %                      |  | $ | 11,377   |   |             | $ | 286    |                | 2.51 | % |          | $ | 24,748      |   |  | $ | 320    |  | 1.29 | %
|Investments(2)                                                                   |  |                              | 29,780  |   |                              |   | 1,035       |                              | 3.48 | %                      |  |   | 30,181   |   |             |   | 1,050  |                | 3.48 | % |          |   | 26,764      |   |  |   | 815    |  | 3.04 | %
|Loans receivable, net(5)                                                         |  |                              | 197,369 |   |                              |   | 14,100      |                              | 7.14 | %                      |  |   | 168,089  |   |             |   | 11,327 |                | 6.74 | % |          |   | 146,048     |   |  |   | 9,396  |  | 6.43 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Total interest-earning assets                                                    |  |                              | 237,377 |   |                              |   | 15,694      |                              | 6.61 | %                      |  |   | 209,647  |   |             |   | 12,663 |                | 6.04 | % |          |   | 197,561     |   |  |   | 10,531 |  | 5.33 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Non interest-earning assets                                                      |  |                              | 21,948  |   |                              |   |             |                              |      |                        |  |   | 18,520   |   |             |   |        |                |      |   |          |   | 16,128      |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Total assets                                                                     |  | $                            | 259,325 |   |                              |   |             |                              |      |                        |  | $ | 228,167  |   |             |   |        |                |      |   |          | $ | 213,688     |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Interest-bearing liabilities:                                                    |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Deposits:                                                                        |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Passbook savings                                                                 |  | $                            | 29,551  |   |                              |   | 734         |                              | 2.50 | %                      |  | $ | 31,149   |   |             |   | 504    |                | 1.62 | % |          | $ | 32,039      |   |  |   | 432    |  | 1.34 | %
|NOW and money market                                                             |  |                              | 27,225  |   |                              |   | 186         |                              | .67  | %                      |  |   | 23,285   |   |             |   | 105    |                | .45  | % |          |   | 20,227      |   |  |   | 92     |  | .45  | %
|Certificates of deposit                                                          |  |                              | 159,566 |   |                              |   | 6,759       |                              | 4.24 | %                      |  |   | 137,074  |   |             |   | 4,392  |                | 3.20 | % |          |   | 131,275     |   |  |   | 3,886  |  | 2.96 | %
|Borrowings                                                                       |  |                              | 12,846  |   |                              |   | 580         |                              | 4.52 | %                      |  |   | 6,846    |   |             |   | 270    |                | 3.94 | % |          |   | 769         |   |  |   | 20     |  | 2.60 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Total interest-bearing liabilities                                               |  |                              | 229,188 |   |                              |   | 8,259       |                              | 3.60 | %                      |  |   | 198,354  |   |             |   | 5,271  |                | 2.66 | % |          |   | 184,310     |   |  |   | 4,430  |  | 2.40 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Non-interest-bearing liabilities                                                 |  |                              | 4,143   |   |                              |   |             |                              |      |                        |  |   | 3,995    |   |             |   |        |                |      |   |          |   | 3,656       |   |  |   |        |  |      |  
|Stockholders equity                                                             |  |                              | 25,994  |   |                              |   |             |                              |      |                        |  |   | 25,818   |   |             |   |        |                |      |   |          |   | 25,722      |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Total liabilities and stockholders equity                                       |  | $                            | 259,325 |   |                              |   |             |                              |      |                        |  | $ | 228,167  |   |             |   |        |                |      |   |          | $ | 213,688     |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Net interest income and interest rate spread(3)                                  |  |                              |         |   |                              | $ | 7,435       |                              | 3.01 | %                      |  |   |          |   |             | $ | 7,392  |                | 3.38 | % |          |   |             |   |  | $ | 6,101  |  | 2.93 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Net yield on average interest-earning assets(4)                                  |  |                              |         |   |                              |   |             |                              | 3.13 | %                      |  |   |          |   |             |   |        |                | 3.53 | % |          |   |             |   |  |   |        |  | 3.08 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                              | 103.57  | % |                              |   |             |                              |      |                        |  |   | 106.11   | % |             |   |        |                |      |   |          |   | 107.18      | % |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                        |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  

---

|(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 2006 and 2005. Also during 2006, our loan charge-offs decreased from $21,000 in 2005 to $12,000. 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, increased from $883,000 at December 31, 2005 to $1.2 million at December 31, 2006.
The Company has adopted policies that it believes provide for prudent and adequate levels of loan loss allowances. At December 31, 2006, the allowance for loan losses amounted to $782,000, which management believes is adequate to absorb losses
inherent in its loan portfolio. The level of allowance for loan losses only increased by $108,000 during the year due to the $12,000 write-off mentioned above.

Noninterest Income

Non-interest income increased $39,000 during the year from $856,000 during 2005 to $895,000 in 2006. 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 2006.

Noninterest Expense

Our compensation and benefits expense increased $369,000 in 2006 compared to 2005. This increase
resulted from an increase of the Companys 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
professional fees of $92,000. This increase resulted from an increase in legal expenses of $54,000 associated with delisting the company on the NASDAQ Global Market.

Income Taxes

The provision for income taxes, as a percentage of income before income taxes, was 35.4% and 34.0% for
the years ended December 31, 2006 and 2005, 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 2006 and 2005. 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 the banks liquidity management is to ensure the availability of sufficient cash flows to meet all of its financial commitments. Liquidity
management addresses The Bank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 the Bank 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, 2006 cash inflow was provided by the
proceeds from maturities, calls and principal repayments on securities of $10.9 million, cash provided by operating activities of $1.7 million and an increase in deposits of $37.5 million. Significant cash outflows during 2006 included purchases of
investment securities of $9.0 million, net loan originations of $26.9 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 48% of the Banks
certificates of deposit outstanding at December 31, 2006 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. The Bank 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, The Bank must meet
certain liquidity requirements, which are established by the Administrator of the North Carolina Commissioner of Banks. The Banks liquidity ratio at December 31, 2006, 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, The Bank believes that it will have sufficient funds available to meet anticipated future loan commitments, unexpected deposit withdrawals, or other cash
requirements.



9



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

MANAGEMENTS DISCUSSION AND ANALYSIS



Asset/Liability Management

The Bank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 the Bank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, The Bank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. The Bank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 the
Bank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 the Banks net interest income. At December 31, 2006, The Bank had a
one-year sensitivity gap of negative 36.40%. 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, The Bank 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 the Bank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 51.48%.

The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 2006, 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 the Bank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, 2006   |        
|                                                                                     |  | 1 Year orLess          |         |    | More Than1 Year to 5 Years |   |          | More Than5 Years |  |   | Total   |  
|                                                                                     |  | (Dollars in thousands) |        
|INTEREST-EARNING ASSETS:                                                             |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|Interest-bearing deposits                                                            |  | $                      | 15,216  |    |                            | $ |         |                  |  | $ |        |   |  | $ | 15,216  |  
|Federal funds sold                                                                   |  |                        | 2,359   |    |                            |   |         |                  |  |   |        |   |  |   | 2,359   |  
|Securities held to maturity                                                          |  |                        |        |    |                            |   | 32       |                  |  |   | 4,458   |   |  |   | 4,490   |  
|Securities available for sale                                                        |  |                        | 10,926  |    |                            |   | 8,986    |                  |  |   | 1,248   |   |  |   | 21,160  |  
|Federal Home Loan Bank stock, at cost                                                |  |                        |        |    |                            |   |         |                  |  |   | 930     |   |  |   | 930     |  
|Loans, net                                                                           |  |                        | 53,079  |    |                            |   | 36,097   |                  |  |   | 120,777 |   |  |   | 209,953 |  
|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|Total interest-earning assets                                                        |  | $                      | 81,580  |    |                            | $ | 45,115   |                  |  | $ | 127,413 |   |  | $ | 254,108 |  
|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|INTEREST-BEARING LIABILITIES:                                                        |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|Passbook savings                                                                     |  | $                      | 27,776  |    |                            | $ |         |                  |  | $ |        |   |  | $ | 27,776  |  
|NOW accounts                                                                         |  |                        | 21,858  |    |                            |   |         |                  |  |   |        |   |  |   | 21,858  |  
|Money market                                                                         |  |                        | 9,944   |    |                            |   |         |                  |  |   |        |   |  |   | 9,944   |  
|Certificates of deposit                                                              |  |                        | 114,497 |    |                            |   | 62,036   |                  |  |   |         |   |  |   | 176,533 |  
|Borrowings                                                                           |  |                        |        |    |                            |   | 10,000   |                  |  |   |        |   |  |   | 10,000  |  
|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|                                                                                     |  | $                      | 174,075 |    |                            | $ | 72,036   |                  |  | $ |        |   |  | $ | 246,111 |  
|                                                                                     |  |                        |         |    |                            |   |          |                  |  |   |         |   |  |   |         |  
|INTEREST SENSITIVITY GAP                                                             |  | $                      | (92,495 | )  |                            | $ | (26,921  | )                |  | $ | 127,413 |   |  | $ | 7,997   |  
|                                                                                     |  |                        |         |   
|CUMULATIVE INTEREST SENSITIVITY GAP                                                  |  | $                      | (92,495 | )  |                            | $ | (119,416 | )                |  | $ | 7,997   |   |  | $ | 7,997   |  
|                                                                                     |  |                        |         |   
|CUMULATIVE INTEREST SENSITIVITY GAP AS A PERCENTAGE OF TOTAL INTEREST-EARNING ASSETS |  |                        | (36.40  | )% |                            |   | (46.99   | )%               |  |   | 3.15    | % |  |   | 3.15    | %
|                                                                                     |  |                        |         |   
|CUMULATIVE RATIO OF INTEREST-SENSITIVE ASSETS TO INTEREST-SENSITIVE LIABILITIES      |  |                        | 46.86   | %  |                            |   | 51.48    | %                |  |   | 103.25  | % |  |   | 103.25  | %

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 as of December 31, 2006 and 2005, 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 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
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, 2006 and 2005 and the results of their operations and their cash flows for
the years in the three year period ended December 31, 2006 then ended in conformity with accounting principles generally accepted in the United States of America.

LOGO

Charlotte, North Carolina

April 6, 2007



12



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31, 2006 and 2005



|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                                                     |  | 2006                   |         |   | 2005 |  
|                                                                                                                                                     |  | (Dollars in thousands) |        
|ASSETS                                                                                                                                               |  |                        |         |   |      |   |         |  
|Cash and cash equivalents:                                                                                                                           |  |                        |         |   |      |   |         |  
|Non-interest-bearing deposits                                                                                                                        |  | $                      | 5,164   |   |      | $ | 5,692   |  
|Interest-bearing deposits                                                                                                                            |  |                        | 15,216  |   |      |   | 6,245   |  
|Federal funds sold                                                                                                                                   |  |                        | 2,359   |   |      |   | 2,363   |  
|Securities held to maturity, fair value December 31, 2006, $4,362; December 31, 2005, $5,119                                                         |  |                        | 4,490   |   |      |   | 5,254   |  
|Securities available for sale                                                                                                                        |  |                        | 21,160  |   |      |   | 24,101  |  
|Federal Home Loan Bank stock                                                                                                                         |  |                        | 930     |   |      |   | 1,100   |  
|                                                                                                                                                     |  |                       
|Loans receivable                                                                                                                                     |  |                        | 210,735 |   |      |   | 183,886 |  
|Allowance for loan losses                                                                                                                            |  |                        | (782    | ) |      |   | (674    | )
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Net loans                                                                                                                                            |  |                        | 209,953 |   |      |   | 183,212 |  
|                                                                                                                                                     |  |                       
|Real estate held for investment                                                                                                                      |  |                        | 653     |   |      |   | 653     |  
|Foreclosed real estate                                                                                                                               |  |                        | 119     |   |      |   | 229     |  
|Premises and equipment, net                                                                                                                          |  |                        | 5,923   |   |      |   | 4,608   |  
|Bank owned life insurance                                                                                                                            |  |                        | 7,916   |   |      |   | 7,573   |  
|Prepaid expenses and other assets                                                                                                                    |  |                        | 3,103   |   |      |   | 2,203   |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Total assets                                                                                                                                         |  | $                      | 276,986 |   |      | $ | 243,233 |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|                                                                                                                                                     |  |                       
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                 |  |                        |         |   |      |   |         |  
|Liabilities:                                                                                                                                         |  |                        |         |   |      |   |         |  
|Deposits                                                                                                                                             |  | $                      | 236,111 |   |      | $ | 198,634 |  
|Borrowings:                                                                                                                                          |  |                        |         |   |      |   |         |  
|Short term                                                                                                                                           |  |                        | 5,000   |   |      |   | 10,000  |  
|Long term                                                                                                                                            |  |                        | 5,000   |   |      |   | 5,000   |  
|Accrued expenses and other liabilities                                                                                                               |  |                        | 5,487   |   |      |   | 3,629   |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Total liabilities                                                                                                                                    |  |                        | 251,598 |   |      |   | 217,263 |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|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 2,954,696 shares at December 31, 2006 and
2,999,594 December 31, 2005, Respectively |  |                        | 5,915   |   |      |   | 6,428   |  
|Unearned compensation                                                                                                                                |  |                        | (52     | ) |      |   | (159    | )
|Unearned ESOP                                                                                                                                        |  |                        | (208    | ) |      |   | (534    | )
|Retained earnings, substantially restricted                                                                                                          |  |                        | 20,596  |   |      |   | 20,483  |  
|Accumulated other comprehensive income (loss)                                                                                                        |  |                        | (863    | ) |      |   | (248    | )
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Total stockholders equity                                                                                                                           |  |                        | 25,388  |   |      |   | 25,970  |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  
|Total liabilities and stockholders equity                                                                                                           |  | $                      | 276,986 |   |      | $ | 243,233 |  
|                                                                                                                                                     |  |                        |         |   |      |   |         |  

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, 2006 and 2005



|                                                              |  |                                               |           |      |   |          
|------------------------------------------------------------- |  | --------------------------------------------- | --------- | ---- | - | ---------
|                                                              |  | 2006                                          |           | 2005
|                                                              |  | (Dollars in thousands, except per share data)
|INTEREST INCOME                                               |  |                                               |           |      |   |          
|Loans, including fees                                         |  | $                                             | 14,100    |      | $ | 11,327   
|Investment securities                                         |  |                                               | 1,035     |      |   | 1,050    
|Other interest and dividends                                  |  |                                               | 559       |      |   | 286      
|                                                              |  |                                               |           |      |   |          
|TOTAL INTEREST INCOME                                         |  |                                               | 15,694    |      |   | 12,663   
|                                                              |  |                                               |           |      |   |          
|INTEREST EXPENSE                                              |  |                                               |           |      |   |          
|Deposits                                                      |  |                                               | 7,679     |      |   | 5,001    
|Borrowings                                                    |  |                                               | 580       |      |   | 270      
|                                                              |  |                                               |           |      |   |          
|TOTAL INTEREST EXPENSE                                        |  |                                               | 8,259     |      |   | 5,271    
|                                                              |  |                                               |           |      |   |          
|NET INTEREST INCOME                                           |  |                                               | 7,435     |      |   | 7,392    
|                                                              |  |                                              
|PROVISION FOR LOAN LOSSES                                     |  |                                               | 120       |      |   | 120      
|                                                              |  |                                               |           |      |   |          
|NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES           |  |                                               | 7,315     |      |   | 7,272    
|                                                              |  |                                               |           |      |   |          
|NON-INTEREST INCOME                                           |  |                                               |           |      |   |          
|Service charges on deposit accounts                           |  |                                               | 458       |      |   | 429      
|Income from bank owned life insurance                         |  |                                               | 343       |      |   | 328      
|Other                                                         |  |                                               | 94        |      |   | 99       
|                                                              |  |                                               |           |      |   |          
|TOTAL NON-INTEREST INCOME                                     |  |                                               | 895       |      |   | 856      
|                                                              |  |                                               |           |      |   |          
|NON-INTEREST EXPENSES                                         |  |                                               |           |      |   |          
|Compensation and benefits                                     |  |                                               | 4,212     |      |   | 3,843    
|Net occupancy and equipment                                   |  |                                               | 564       |      |   | 517      
|Data processing                                               |  |                                               | 367       |      |   | 370      
|Professional fees                                             |  |                                               | 240       |      |   | 148      
|Other                                                         |  |                                               | 850       |      |   | 858      
|                                                              |  |                                               |           |      |   |          
|TOTAL NON-INTEREST EXPENSES                                   |  |                                               | 6,233     |      |   | 5,736    
|                                                              |  |                                               |           |      |   |          
|INCOME BEFORE INCOME TAXES                                    |  |                                               | 1,977     |      |   | 2,392    
|                                                              |  |                                              
|INCOME TAXES                                                  |  |                                               | 700       |      |   | 812      
|                                                              |  |                                               |           |      |   |          
|NET INCOME                                                    |  | $                                             | 1,277     |      | $ | 1,580    
|                                                              |  |                                               |           |      |   |          
|BASIC AND DILUTED NET INCOME PER COMMON SHARE                 |  | $                                             | 0.44      |      | $ | 0.54     
|                                                              |  |                                               |           |      |   |          
|DIVIDENDS PER SHARE                                           |  | $                                             | 0.40      |      | $ | 0.40     
|                                                              |  |                                               |           |      |   |          
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, BASIC AND DILUTED |  |                                               | 2,916,628 |      |   | 2,943,307
|                                                              |  |                                               |           |      |   |          

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, 2006 and 2005



|                                                                                         |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|---------------------------------------------------------------------------------------- |  | ---------------------- |  | ----------- | ----- | - | -------------------- | - | ---- | ------------ |  | - | --------------------------------------- | - |  | ------------------------------------------ | ------ | - | ------------------------ | - | ---- | - |  | - | ------ | -
|                                                                                         |  | Shares ofCommonStock   |  | CommonStock |       |   | UnearnedCompensation |   |      | UnearnedESOP |  |   | RetainedEarningsSubstantiallyRestricted |   |  | AccumulatedOtherComprehensiveIncome (loss) |        |   | TotalStockholdersEquity |  
|                                                                                         |  | (Dollars in thousands) | 
|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 |  
|Amortization of ESOP compensation                                                        |  |                        |  |             | (87   | ) |                      |   |     |              |  |   | 326                                     |   |  |                                            |       |   |                          |   |     |   |  |   | 239    |  
|Purchases and retirement of 44,898 shares of common                                      |  | 44,898                 |  |             | (426  | ) |                      |   |     |              |  |   |                                        |   |  |                                            |       |   |                          |   |     |   |  |   | (426   | )
|Cash dividends (.40 per share)                                                           |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            | (1,164 | ) |                          |   |     |   |  |   | (1,164 | )
|Comprehensive income:                                                                    |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Net income                                                                               |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            | 1,277  |   |                          |   |     |   |  |   | 1,277  |  
|Net change in unrealized loss on securities available for sale, net of taxes of $123,000 |  |                       |  |             |      |   |                      |   |     |              |  |   |                                        |   |  |                                            |       |   |                          |   | 193  |   |  |   | 193    |  
|                                                                                         |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Total comprehensive Income                                                               |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   | 1,470  |  
|                                                                                         |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Adoption of SFAS No. 158, Net of taxes of $507,000                                       |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   | (808 | ) |  |   | (808   | )
|Amortization of return of capital dividend                                               |  |                       |  |             |      |   |                      |   | 107  |              |  |   |                                        |   |  |                                            |       |   |                          |   |     |   |  |   | 107    |  
|                                                                                         |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  
|Balance at December 31, 2006                                                             |  | 2,954,696              |  | $           | 5,915 |   |                      | $ | (52  | )            |  | $ | (208                                    | ) |  | $                                          | 20,596 |   |                          | $ | (863 | ) |  | $ | 25,388 |  
|                                                                                         |  |                        |  |             |       |   |                      |   |      |              |  |   |                                         |   |  |                                            |        |   |                          |   |      |   |  |   |        |  

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, 2006 and 2005



|                                                                                        |  |                        |         |   |      |   |         |  
|--------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                        |  | 2006                   |         |   | 2005 |  
|                                                                                        |  | (Dollars in thousands) |        
|Cash Flows from Operating Activities:                                                   |  |                        |         |   |      |   |         |  
|Net income                                                                              |  | $                      | 1,277   |   |      | $ | 1,580   |  
|Adjustments to reconcile net income to net cash provided by operating activities:       |  |                        |         |   |      |   |         |  
|Net accretion of premiums and discounts on securities                                   |  |                        | 60      |   |      |   | 60      |  
|Amortization of deferred loan fees                                                      |  |                        | (23     | ) |      |   | (28     | )
|Depreciation expense                                                                    |  |                        | 209     |   |      |   | 194     |  
|Provision for loan losses                                                               |  |                        | 120     |   |      |   | 120     |  
|Loss on disposal of equipment                                                           |  |                        |        |   |      |   | 4       |  
|Income from Bank-owned life insurance                                                   |  |                        | (343    | ) |      |   | (328    | )
|Amortization of ESOP compensation                                                       |  |                        | 346     |   |      |   | 430     |  
|Change in assets and liabilities:                                                       |  |                        |         |   |      |   |         |  
|Increase in other assets                                                                |  |                        | (521    | ) |      |   | (708    | )
|Increase in accrued expenses and other liabilities                                      |  |                        | 551     |   |      |   | 714     |  
|                                                                                        |  |                        |         |   |      |   |         |  
|Net cash provided by operating activities                                               |  |                        | 1,676   |   |      |   | 2,038   |  
|                                                                                        |  |                        |         |   |      |   |         |  
|Cash Flows from Investing Activities:                                                   |  |                        |         |   |      |   |         |  
|Purchase of securities available for sale                                               |  |                        | (6,998  | ) |      |   | (6,018  | )
|Proceeds from maturities of securities available for sale                               |  |                        | 10,218  |   |      |   | 395     |  
|Proceeds from maturities, calls and principal repayments of securities held to maturity |  |                        | 740     |   |      |   | 1,166   |  
|Loan originations and principal payments on loans, net                                  |  |                        | (26,843 | ) |      |   | (31,102 | )
|Purchase of property and equipment                                                      |  |                        | (1,524  | ) |      |   | (2,204  | )
|Proceeds from sale of foreclosed assets                                                 |  |                        | 115     |   |      |   | 57      |  
|Purchase of FHLB Stock                                                                  |  |                        |        |   |      |   | (674    | )
|Redemption of FHLB stock                                                                |  |                        | 170     |   |      |   | 8       |  
|                                                                                        |  |                        |         |   |      |   |         |  
|Net cash used in investing activities                                                   |  |                        | (24,122 | ) |      |   | (38,372 | )
|                                                                                        |  |                        |         |   |      |   |         |  

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, 2006 and 2005 (Continued)



|                                                                         |  |                        |        |   |      |   |         |  
|------------------------------------------------------------------------ |  | ---------------------- | ------ | - | ---- | - | ------- | -
|                                                                         |  | 2006                   |        |   | 2005 |  
|                                                                         |  | (Dollars in thousands) |       
|Cash Flows from Financing Activities:                                    |  |                        |        |   |      |   |         |  
|Net increase in deposits                                                 |  | $                      | 37,477 |   |      | $ | 11,729  |  
|Payment of dividends                                                     |  |                        | (1,167 | ) |      |   | (1,173  | )
|Purchases and retirement of common stock                                 |  |                        | (425   | ) |      |   | (468    | )
|Advances from FHLB                                                       |  |                        |       |   |      |   | 15,000  |  
|Repayments of FHLB advances                                              |  |                        | (5,000 | ) |      |   |        |  
|                                                                         |  |                        |        |   |      |   |         |  
|Net cash provided by financing activities                                |  |                        | 30,885 |   |      |   | 25,088  |  
|                                                                         |  |                        |        |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                     |  |                        | 8,439  |   |      |   | (11,246 | )
|CASH AND CASH EQUIVALENTS, BEGINNING                                     |  |                        | 14,300 |   |      |   | 25,546  |  
|                                                                         |  |                        |        |   |      |   |         |  
|CASH AND CASH EQUIVALENTS, ENDING                                        |  | $                      | 22,739 |   |      | $ | 14,300  |  
|                                                                         |  |                        |        |   |      |   |         |  
|Supplemental Disclosures of Cash Flow Information:                       |  |                        |        |   |      |   |         |  
|Cash payments for:                                                       |  | $                      | 8,192  |   |      | $ | 5,271   |  
|Interest                                                                 |  |                        |        |   |      |   |         |  
|Income taxes                                                             |  |                        | 850    |   |      |   | 881     |  
|                                                                         |  |                       
|Supplemental Disclosures of Noncash Transactions:                        |  |                        |        |   |      |   |         |  
|Change in unrealized losses on available for sale securities, net of tax |  |                        | 193    |   |      |   | (130    | )
|Change in dividends accrued                                              |  |                        | (4     | ) |      |   | (5      | )
|Loans issued to finance sale of OREO                                     |  |                        | 34     |   |      |   |        |  

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 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.

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, 2006.

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



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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)

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 20 to 31.5 years for buildings, leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter, 5 to 10 years for furniture,
fixtures and equipment and 3 to 5 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 $7.9 million and $7.6 million at December 31, 2006 and 2005, respectively. The increase in the cash surrender value is included in non-interest income in the consolidated statements of operations and amounted to
$343,000 and $328,000 for the years ended December 31, 2006 and 2005, respectively.

Stock compensation plans

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment,  (SFAS No. 123R) which was issued
by the FASB in December 2004. SFAS No. 123R revises SFAS No. 123 Accounting for stock Based Compensation, and supersedes APB No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and its related
interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in
exchange for the award (presumptively the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award on the grant-date fair value of the award. SFAS No. 123R also amends SFAS
No. 95 Statement of Cash Flows, to require that excess tax benefits be reported as financing cash flows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period amounts have not been
restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.

Prior to the adoption of SFAS No. 123R, the Bank used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation
expense for options granted with exercise prices equal to the fair market value of the Companys common stock on the date of grant. All granted options were fully vested by December 31, 2001 and accordingly, the adoption of SFAS
No. 123(R) has not had a material effect on our consolidated financial statements.



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)

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.

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 42,899 and 76,646 in 2006 and
2005, respectively, while there were no unallocated shares under the management recognition plan in 2006 or 2005. The Company had no dilutive potential common shares outstanding during 2006 and 2005. The weighted average number of shares outstanding
at December 31, 2006 and 2005 was 2,916,628 and 2,943,307, 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.



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)

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.

Reclassifications

Certain amounts
in the 2005 financial statements have been reclassified to conform to the 2006 presentation. The reclassifications had no effect on net income or stockholders equity as previously reported.

Recent accounting pronouncements

In September 2006, the FASB
issued Statement of Financial Accounting Standards No. 157,Fair Value Measurements (SFAS No. 157). SFAS No. 157 enhances existing guidance for measuring assets and liabilities using fair value. Prior to the
issuance of SFAS No. 157, guidance for applying fair value was incorporated in several accounting pronouncements. SFAS No. 157 provides a single definition of fair value, together with a framework for measuring it, and requires additional
disclosure about the use of fair value to measure assets and liabilities. SFAS No. 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest
priority being quoted prices in active markets. Under SFAS No. 157, fair value measurements are disclosed by level within that hierarchy. While SFAS No. 157 does not add any new fair value measurements, it does change current practice.
Changes to practice include: (1) a requirement for an entity to include its own credit standing in the measurement of its liabilities; (2) a modification of the transaction price presumption; (3) a prohibition on the use of block
discounts when valuing large blocks of securities for broker-dealers and investment companies; and (4) a requirement to adjust the value of restricted stock for the effect of the restriction even if the restriction lapses within one year. SFAS
No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has not determined the impact of adopting SFAS No. 157 on its
consolidated financial statements.



23



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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)

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158,Employers Accounting for Defined Benefit Pension and Other
Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R) (SFAS No. 158). SFAS No. 158 requires an employer to: (a) Recognize in its statement of financial position an asset for a
plans overfunded status or a liability for a plans underfunded status; (b) measure a plans assets and its obligations that determine its funded status as of the end of the employers fiscal year (with limited exceptions);
and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income of a business entity and in changes in net assets of a
not-for-profit organization. The requirement by SFAS No. 158 to recognize the funded status of a benefit plan and the disclosure requirements of SFAS No. 158 became effective for the Company as of the end of the fiscal year ending
December 31, 2006. See Footnote 5 for further information. The requirement to measure plan assets and benefit obligations as of the date of the employers fiscal year-end statement of financial position is effective for fiscal years ending
after December 15, 2008

In September 2006, the SEC staff issued SAB No. 108,Considering the Effects of Prior Year Misstatements
When Quantifying Misstatements in the Current Year Financial Statements (SAB No. 108). SAB No. 108 addresses the diversity in practice by registrants when quantifying the effect of an error on the financial
statements. SAB No. 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements and is effective for annual periods ending after November 15, 2006. The Company
adopted the provisions of SAB No. 108 effective December 31, 2006, and the adoption did not have a material impact on the Companys financial results.

In June 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes (FIN 48), an interpretation of FASB Statement No. 109,Accounting for Income
Taxes . FIN 48 addresses the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. In addition, FIN 48 expands the disclosure
requirements concerning unrecognized tax benefits as well as any significant changes that may occur in the next twelve months associated with such unrecognized tax benefits. FIN 48 will be effective for the beginning of the Companys 2007
fiscal year, with adoption treated as a cumulative-effect-type adjustment to retained earnings as of the beginning of 2007. The Company does not anticipate recording any material adjustment as a result of adopting this Interpretation.

In September 2006, the Emerging Issues Task Force (EITF) issued EITF Issue 06-4,Accounting for Deferred Compensation and Postretirement Benefit Aspects of
Endorsement Split-Dollar Life Insurance Arrangements (EITF Issue 06-4). EITF Issue 06-4 requires that for endorsement split-dollar insurance arrangements that provide a benefit to an employee that extends to postretirement periods,
an employer should recognize a liability for future benefits in accordance with FASB Statement No. 106 or Accounting Principles Board (APB) Opinion No. 12 based on the substantive agreement of the employee. If the employee has effectively
agreed to maintain a life insurance policy during postretirement periods, the costs of the life insurance policy during the postretirement periods should be accrued in accordance with either FASB Statement No. 106 or APB Opinion No. 12.
EITF Issue 06-4 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact of EITF Issue 06-4 on its financial statements.

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



24



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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:



|                                                  |  |                        |        |                        |   |                        |  |   |                        |   |  |   |       
|------------------------------------------------- |  | ---------------------- | ------ | ---------------------- | - | ---------------------- |  | - | ---------------------- | - |  | - | ------
|                                                  |  | 2006                  
|                                                  |  | Amortized Cost         |        | Gross Unrealized Gains |   | GrossUnrealized Losses |  |   | Estimated Market Value
|                                                  |  | (Dollars in thousands)
|Securities available for sale:                    |  |                        |        |                        |   |                        |  |   |                        |   |  |   |       
|U.S. Government and federal agencies obligations  |  | $                      | 19,999 |                        | $ |                       |  | $ | (87                    | ) |  | $ | 19,912
|Mortgage-backed securities                        |  |                        | 616    |                        |   | 3                      |  |   | (7                     | ) |  |   | 612   
|Nexity Financial Corp Stock                       |  |                        | 300    |                        |   |                        |  |   |                        |   |  |   | 300   
|Bankers Bank Stock                                |  |                        | 336    |                        |   |                       |  |   |                       |   |  |   | 336   
|                                                  |  |                        |        |                        |   |                        |  |   |                        |   |  |   |       
|                                                  |  | $                      | 21,251 |                        | $ | 3                      |  | $ | (94                    | ) |  | $ | 21,160
|                                                  |  |                        |        |                        |   |                        |  |   |                        |   |  |   |       
|Securities held to maturity:                      |  |                        |        |                        |   |                        |  |   |                        |   |  |   |       
|Mortgage-backed securities and related securities |  | $                      | 4,490  |                        | $ | 12                     |  | $ | (140                   | ) |  | $ | 4,362 
|                                                  |  |                        |        |                        |   |                        |  |   |                        |   |  |   |       



|                                                  |  |                        |        |                        |   |                         |  |   |                        |   |  |   |       
|------------------------------------------------- |  | ---------------------- | ------ | ---------------------- | - | ----------------------- |  | - | ---------------------- | - |  | - | ------
|                                                  |  | 2005                  
|                                                  |  | Amortized Cost         |        | Gross Unrealized Gains |   | Gross Unrealized Losses |  |   | Estimated Market Value
|                                                  |  | (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 
|                                                  |  |                        |        |                        |   |                         |  |   |                        |   |  |   |       

The amortized cost and fair values of securities as of December 31, 2006 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.



|                                    |  |                        |        |            |   |       
|----------------------------------- |  | ---------------------- | ------ | ---------- | - | ------
|                                    |  | Amortized Cost         |        | Fair Value
|                                    |  | (Dollars in thousands)
|Securities available for sale:      |  |                        |        |            |   |       
|Due within 1 year                   |  | $                      | 11,000 |            | $ | 10,926
|Due after one but within five years |  |                        | 8,999  |            |   | 8,986 
|Due after five but within ten years |  |                        | 357    |            |   | 360   
|Due after ten years                 |  |                        | 259    |            |   | 252   
|Equity securities                   |  |                        | 636    |            |   | 636   
|                                    |  |                        |        |            |   |       
|                                    |  | $                      | 21,251 |            | $ | 21,160
|                                    |  |                        |        |            |   |       



25



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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                   |  | $                      |      |           | $ |     
|Due after one but within five years |  |                        | 32    |           |   | 32   
|Due after five but within ten years |  |                        | 23    |           |   | 25   
|Due after ten years                 |  |                        | 4,435 |           |   | 4,305
|                                    |  |                        |       |           |   |      
|                                    |  | $                      | 4,490 |           | $ | 4,362
|                                    |  |                        |       |           |   |      

There were no sales of securities in 2006 or 2005.

The Company had pledged securities with an amortized cost of $12.0 million and $11.0 million at December 31, 2006 and 2005, 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, 2006:



|                                                  |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|------------------------------------------------- |  | ---------------------- | ------ | -------------------------- | - | ---------------------------- |  | ------------- | --- | ----- | - | ----- |  | - | ------
|                                                  |  | 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  |  | $                      | 10,926 |                            | $ | 8,986                        |  | $             |    |       | $ |      |  | $ | 19,912
|Mortgage-backed securities                        |  |                        |       |                            |   |                             |  |               | 360 |       |   | 252   |  |   | 612   
|Equity securities                                 |  |                        | 636    |                            |   |                             |  |               |    |       |   |      |  |   | 636   
|Securities held to maturity:                      |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|Mortgage-backed securities and related securities |  |                        |       |                            |   | 32                           |  |               | 23  |       |   | 4,435 |  |   | 4,490 
|Other investments:                                |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|Interest-earning deposits                         |  |                        | 15,216 |                            |   |                             |  |               |    |       |   |      |  |   | 15,216
|Federal funds sold                                |  |                        | 2,359  |                            |   |                             |  |               |    |       |   |      |  |   | 2,359 
|Federal Home Loan Bank stock                      |  |                        |       |                            |   |                             |  |               |    |       |   | 930   |  |   | 930   
|                                                  |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       
|                                                  |  | $                      | 29,137 |                            | $ | 9,018                        |  | $             | 383 |       | $ | 5,617 |  | $ | 44,155
|                                                  |  |                        |        |                            |   |                              |  |               |     |       |   |       |  |   |       



26



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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, 2006:



|                                                  |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|------------------------------------------------- |  | ----------------------- | - |  | -------------------------- | - |  | ---------------------------- | - |  | ------------- | - |  | ----- | -
|                                                  |  | 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 |  | 3.21                    | % |  | 5.25                       | % |  |                             |   |  |              |   |  | 4.13  | %
|Mortgage-backed securities                        |  |                        |   |  |                           |   |  | 5.78                         | % |  | 6.50          | % |  | 6.08  | %
|Equity securities                                 |  |                        |   |  |                           |   |  |                             |   |  | 1.50          | % |  | 1.50  | %
|Securities held to maturity:                      |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|Mortgage-backed securities and related securities |  |                        |   |  | 8.79                       | % |  | 8.92                         | % |  | 5.05          | % |  | 5.09  | %
|Other investments:                                |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|Interest-earning deposits                         |  | 5.36                    | % |  |                           |   |  |                             |   |  |              |   |  | 5.36  | %
|Federal funds sold                                |  | 5.13                    | % |  |                           |   |  |                             |   |  |              |   |  | 5.13  | %
|Federal Home Loan Bank stock                      |  |                        |   |  |                           |   |  |                             |   |  | 5.90          | % |  | 5.90  | %
|                                                  |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  
|                                                  |  | 4.22                    | % |  | 5.26                       | % |  | 6.13                         | % |  | 4.81          | % |  | 4.59  | %
|                                                  |  |                         |   |  |                            |   |  |                              |   |  |               |   |  |       |  

---

|(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, 2006 and 2005. This unrealized loss on investment securities is a result of volatility in the market during 2006 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 and our ability to hold these investments
to maturity.



|                                                         |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|-------------------------------------------------------- |  | ---------------------- | ------ | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                                         |  | 2006                  
|                                                         |  | 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                   |  | $                      | 10,926 |                   | $ | 75        |  | $                | 8,986  |           | $ | 12               |  | $ | 19,912 |  | $ | 87 
|Mortgage-backed securities                               |  |                        |       |                   |   |          |  |                  | 252    |           |   | 7                |  |   | 252    |  |   | 7  
|                                                         |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities available for sale |  |                        | 10,926 |                   |   | 75        |  |                  | 9,238  |           |   | 19               |  |   | 20,164 |  |   | 94 
|                                                         |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Held to maturity:                                        |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Mortgage-backed securities                               |  |                        |       |                   |   |          |  |                  | 3,997  |           |   | 140              |  |   | 3,997  |  |   | 140
|                                                         |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities                    |  | $                      | 10,926 |                   | $ | 75        |  | $                | 13,235 |           | $ | 159              |  | $ | 24,161 |  | $ | 234
|                                                         |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    



27



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 2. Securities (Continued)



|                                                         |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|-------------------------------------------------------- |  | ---------------------- | ----- | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                                         |  | 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
|                                                         |  |                        |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    

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 $930,000,
$300,000 and $336,000, respectively at December 31, 2006 and $1.1 million, $300,000 and $336,000, respectively 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, 2006      |         |   | December 31, 2005 |       
|                                |  | Amount                 |         |   | % ofTotal         |        |   | Amount |   |         | % ofTotal | 
|                                |  | (Dollars in thousands) |        
|Real estate loans:              |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Residential 1-4 family          |  | $                      | 118,691 |   |                   | 55.32  | % |        | $ | 109,697 |           |  | 58.26  | %
|Home equity                     |  |                        | 17,312  |   |                   | 8.07   | % |        |   | 17,403  |           |  | 9.24   | %
|Residential multi-family        |  |                        | 2,112   |   |                   | 0.98   | % |        |   | 1,895   |           |  | 1.01   | %
|Nonresidential real estate      |  |                        | 36,287  |   |                   | 16.91  | % |        |   | 29,344  |           |  | 15.59  | %
|Residential construction        |  |                        | 9,208   |   |                   | 4.29   | % |        |   | 10,226  |           |  | 5.43   | %
|Land                            |  |                        | 15,169  |   |                   | 7.07   | % |        |   | 8,214   |           |  | 4.36   | %
|Line of credit                  |  |                        | 236     |   |                   | .11    | % |        |   | 357     |           |  | 0.19   | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Total real estate loans         |  |                        | 199,015 |   |                   | 92.75  | % |        |   | 177,136 |           |  | 94.08  | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Commercial/consumer loans:      |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Commercial                      |  |                        | 12,546  |   |                   | 5.85   | % |        |   | 8,584   |           |  | 4.55   | %
|Share and other                 |  |                        | 2,823   |   |                   | 1.32   | % |        |   | 2,439   |           |  | 1.30   | %
|Credit reserve                  |  |                        | 163     |   |                   | 0.08   | % |        |   | 125     |           |  | 0.07   | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Total commercial/consumer loans |  |                        | 15,532  |   |                   | 7.25   | % |        |   | 11,148  |           |  | 5.92   | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Subtotal                        |  |                        | 214,547 |   |                   | 100.00 | % |        |   | 188,284 |           |  | 100.00 | %
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Allowance for loan losses       |  |                        | (782    | ) |                   |        |   |        |   | (674    | )         |  |        |  
|Net deferred loan fees          |  |                        | (169    | ) |                   |        |   |        |   | (192    | )         |  |        |  
|Loans in process                |  |                        | (3,643  | ) |                   |        |   |        |   | (4,206  | )         |  |        |  
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  
|Total                           |  | $                      | 209,953 |   |                   |        |   |        | $ | 183,212 |           |  |        |  
|                                |  |                        |         |   |                   |        |   |        |   |         |           |  |        |  



28



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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, 2006. 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, 2006   |       
|                          |  | 1 Year or Less         |        |   | More than 1 Year to 5 Years |   | Greater Than 5 Years |  | Total |        
|                          |  | (Dollars in thousands) |       
|Residential 1-4 family    |  | $                      | 8,630  |   |                             | $ | 3,645                |  | $     | 102,773 |  | $ | 115,048 |  
|All other loans           |  |                        | 45,401 |   |                             |   | 32,452               |  |       | 18,003  |  |   | 95,856  |  
|Net deferred loan fees    |  |                        | (169   | ) |                             |   |                     |  |       |        |  |   | (169    | )
|Allowance for loan losses |  |                        | (782   | ) |                             |   |                     |  |       |        |  |   | (782    | )
|                          |  |                        |        |   |                             |   |                      |  |       |         |  |   |         |  
|Totals                    |  | $                      | 53,080 |   |                             | $ | 36,097               |  | $     | 120,776 |  | $ | 209,953 |  
|                          |  |                        |        |   |                             |   |                      |  |       |         |  |   |         |  

The following table sets forth the dollar amount at December 31, 2006 of all loans maturing or repricing on
or after December 31, 2007 which have fixed or adjustable interest rates.



|                       |  |                        |         |                  |   |       
|---------------------- |  | ---------------------- | ------- | ---------------- | - | ------
|                       |  | FixedRates             |         | Adjustable Rates
|                       |  | (Dollars in thousands)
|Residential 1-4 family |  | $                      | 96,247  |                  | $ | 10,171
|All other loans        |  |                        | 40,775  |                  |   | 9,680 
|                       |  |                        |         |                  |   |       
|                       |  | $                      | 137,022 |                  | $ | 19,851
|                       |  |                        |         |                  |   |       

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



|                                                             |  |                         |       |   |      |   |       |  
|------------------------------------------------------------ |  | ----------------------- | ----- | - | ---- | - | ----- | -
|                                                             |  | Year Ended December 31, |      
|                                                             |  | 2006                    |       |   | 2005 |  
|                                                             |  | (Dollars in thousands)  |      
|Balance, beginning of year                                   |  | $                       | 674   |   |      | $ | 575   |  
|Provision for loan losses                                    |  |                         | 120   |   |      |   | 120   |  
|Net charge-offs:                                             |  |                         |       |   |      |   |       |  
|Consumer                                                     |  |                         | 1     |   |      |   | 6     |  
|Commercial                                                   |  |                         | 11    |   |      |   | 15    |  
|                                                             |  |                         |       |   |      |   |       |  
|Balance, end of year                                         |  | $                       | 782   |   |      | $ | 674   |  
|                                                             |  |                         |       |   |      |   |       |  
|Net charge-offs as a percent of average loans                |  |                         | 0.01  | % |      |   | 0.01  | %
|Allowance at period end as a percent of nonperforming loans  |  |                         | 64.45 | % |      |   | 76.33 | %
|Allowance at period end as a percent of nonperforming assets |  |                         | 64.45 | % |      |   | 60.61 | %
|Allowance at period end as a percent of total gross loans    |  |                         | 0.36  | % |      |   | 0.36  | %



29



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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, 2006      |     |                                      | December 31, 2005 |  
|                                 |  | Amount ofAllowance     |     | Percent ofAllowanceto TotalAllowance |                   |   | Percent ofLoans toTotal Loans |        |   | Amount ofAllowance |   | Percent ofAllowanceto TotalAllowance |  |        | Percent ofLoans toTotal Loans | 
|                                 |  | (Dollars in thousands) |    
|Real estate loans:               |  |                        |     |                                      |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Residential 1-4 family           |  | $                      | 225 |                                      | 28.77             | % |                               | 55.32  | % |                    | $ | 200                                  |  | 29.68  | %                             |  | 58.26  | %
|Home equity                      |  |                        | 18  |                                      | 2.30              | % |                               | 8.07   | % |                    |   | 17                                   |  | 2.52   | %                             |  | 9.24   | %
|Residential multi-family         |  |                        | 3   |                                      | 0.38              | % |                               | 0.98   | % |                    |   | 2                                    |  | 0.30   | %                             |  | 1.01   | %
|Nonresidential real estate       |  |                        | 34  |                                      | 4.35              | % |                               | 16.91  | % |                    |   | 30                                   |  | 4.45   | %                             |  | 15.59  | %
|Residential construction         |  |                        | 15  |                                      | 1.92              | % |                               | 4.29   | % |                    |   | 13                                   |  | 1.93   | %                             |  | 5.43   | %
|Land                             |  |                        | 8   |                                      | 1.02              | % |                               | 7.07   | % |                    |   | 5                                    |  | 0.74   | %                             |  | 4.36   | %
|Line of credit                   |  |                        | 5   |                                      | 0.64              | % |                               | 0.11   | % |                    |   | 5                                    |  | 0.74   | %                             |  | 0.19   | %
|                                 |  |                        |     |                                      |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Total real estate loans          |  |                        | 308 |                                      | 39.38             | % |                               | 92.75  | % |                    |   | 272                                  |  | 40.36  | %                             |  | 94.08  | %
|                                 |  |                        |     |                                      |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Commercial/consumer loans:       |  |                        |     |                                      |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Commercial loans                 |  |                        | 220 |                                      | 28.13             | % |                               | 5.85   | % |                    |   | 175                                  |  | 25.97  | %                             |  | 4.56   | %
|Share and other                  |  |                        | 25  |                                      | 3.20              | % |                               | 1.32   | % |                    |   | 17                                   |  | 2.52   | %                             |  | 1.30   | %
|Credit reserve                   |  |                        | 15  |                                      | 1.92              | % |                               | 0.08   | % |                    |   | 10                                   |  | 1.48   | %                             |  | 0.06   | %
|                                 |  |                        |     |                                      |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Total commercial/ consumer loans |  |                        | 260 |                                      | 33.25             | % |                               | 7.25   | % |                    |   | 202                                  |  | 29.97  | %                             |  | 5.92   | %
|                                 |  |                        |     |                                      |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Unallocated                      |  |                        | 214 |                                      | 27.37             | % |                               |        |   |                    |   | 200                                  |  | 29.67  | %                             |  |        |  
|                                 |  |                        |     |                                      |                   |   |                               |        |   |                    |   |                                      |  |        |                               |  |        |  
|Total                            |  | $                      | 782 |                                      | 100.00            | % |                               | 100.00 | % |                    | $ | 674                                  |  | 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 $1,213,000 and $883,000 and had related allowance for loan losses of $114,000 and
$152,000 at December 31, 2006 and 2005, respectively. The amount of interest recognized on impaired loans during the portion of the year that they were impaired was not material in 2006 or 2005.

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



|                                          |  |                         |       |   |      |   |       |  
|----------------------------------------- |  | ----------------------- | ----- | - | ---- | - | ----- | -
|                                          |  | Year Ended December 31, |      
|                                          |  | 2006                    |       |   | 2005 |  
|                                          |  | (Dollars in thousands)  |      
|Nonaccrual loans                          |  | $                       | 1,213 |   |      | $ | 883   |  
|Foreclosed real estate                    |  |                         | 119   |   |      |   | 229   |  
|                                          |  |                         |       |   |      |   |       |  
|Total non-performing assets               |  | $                       | 1,332 |   |      | $ | 1,112 |  
|                                          |  |                         |       |   |      |   |       |  
|Non-performing loans to total gross loans |  |                         | 0.63  | % |      |   | 0.48  | %
|                                          |  |                         |       |   |      |   |       |  



30



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 3. Loans Receivable (Continued)



|                                      |  |                         |         |   |      |   |         |  
|------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                      |  | Year Ended December 31, |        
|                                      |  | 2006                    |         |   | 2005 |  
|                                      |  | (Dollars in thousands)  |        
|Non-performing assets to total assets |  |                         | 0.48    | % |      |   | 0.46    | %
|                                      |  |                         |         |   |      |   |         |  
|Total assets                          |  | $                       | 276,986 |   |      | $ | 243,233 |  
|                                      |  |                         |         |   |      |   |         |  
|Total gross loans                     |  | $                       | 210,735 |   |      | $ | 183,886 |  
|                                      |  |                         |         |   |      |   |         |  

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, |       
|                   |  | 2006                    |        |   | 2005 |  
|                   |  | (Dollars in thousands)  |       
|Balance, beginning |  | $                       | 8,755  |   |      | $ | 6,148 |  
|Originations       |  |                         | 11,202 |   |      |   | 3,285 |  
|Payments received  |  |                         | (7,879 | ) |      |   | (678  | )
|                   |  |                         |        |   |      |   |       |  
|Balance, ending    |  | $                       | 12,078 |   |      | $ | 8,755 |  
|                   |  |                         |        |   |      |   |       |  

Note 4. Premises and Equipment

Premises and equipment consist of the following:



|                              |  |                         |        |   |      |   |        |  
|----------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | -
|                              |  | Year Ended December 31, |       
|                              |  | 2006                    |        |   | 2005 |  
|                              |  | (Dollars in thousands)  |       
|Land                          |  | $                       | 1,598  |   |      | $ | 1,597  |  
|Buildings and improvements    |  |                         | 5,165  |   |      |   | 3,664  |  
|Furniture and equipment       |  |                         | 1,259  |   |      |   | 1,246  |  
|                              |  |                         |        |   |      |   |        |  
|                              |  |                         | 8,022  |   |      |   | 6,507  |  
|Less accumulated depreciation |  |                         | (2,099 | ) |      |   | (1,899 | )
|                              |  |                         |        |   |      |   |        |  
|                              |  | $                       | 5,923  |   |      | $ | 4,608  |  
|                              |  |                         |        |   |      |   |        |  

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 $257,000 and $237,000 for the years ended December 31, 2006 and 2005, respectively, and is included in compensation and benefits in the accompanying consolidated
statements of income.



31



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 5. Employee Pension Plan (Continued)

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



|                                     |  |                         |        |   |      |   |        |  
|------------------------------------ |  | ----------------------- | ------ | - | ---- | - | ------ | -
|                                     |  | Year Ended December 31, |       
|                                     |  | 2006                    |        |   | 2005 |  
|                                     |  | (Dollars in thousands)  |       
|Change in benefit obligation:        |  |                         |        |   |      |   |        |  
|Benefit obligation, beginning        |  | $                       | 3,230  |   |      | $ | 2,717  |  
|Service cost                         |  |                         | 147    |   |      |   | 124    |  
|Interest cost                        |  |                         | 203    |   |      |   | 176    |  
|Actuarial (gain) loss                |  |                         | 28     |   |      |   | 213    |  
|Benefits paid                        |  |                         | (214   | ) |      |   |       |  
|                                     |  |                         |        |   |      |   |        |  
|Benefit obligation, ending           |  |                         | 3,394  |   |      |   | 3,230  |  
|                                     |  |                         |        |   |      |   |        |  
|Change in plan assets:               |  |                         |        |   |      |   |        |  
|Fair value of plan assets, beginning |  |                         | 1,881  |   |      |   | 1,514  |  
|Actual return on plan assets         |  |                         | 157    |   |      |   | 138    |  
|Employer contribution                |  |                         | 258    |   |      |   | 229    |  
|Benefits paid                        |  |                         | (214   | ) |      |   |       |  
|                                     |  |                         |        |   |      |   |        |  
|Fair value of plan assets, ending    |  |                         | 2,082  |   |      |   | 1,881  |  
|                                     |  |                         |        |   |      |   |        |  
|Funded status at end of year         |  |                         | (1,311 | ) |      |   | (1,349 | )
|Unrecognized net actuarial loss      |  |                         |       |   |      |   | 1,217  |  
|Unrecognized prior service cost      |  |                         |       |   |      |   | 135    |  
|                                     |  |                         |        |   |      |   |        |  
|Pension Asset (Liability)            |  | $                       | (1,311 | ) |      | $ | 3      |  
|                                     |  |                         |        |   |      |   |        |  

Amounts recognized in the statement of financial position consist of:



|                                 |  |                        |        |   |      |   |  
|-------------------------------- |  | ---------------------- | ------ | - | ---- | - | -
|                                 |  | 2006                   |        |   | 2005
|                                 |  | (Dollars in thousands)
|Pension asset                    |  | $                      |       |   |      | $ | 3
|Accrued benefit liability        |  |                        | (1,311 | ) |      |   | 
|Deferred tax asset               |  |                        | 507    |   |      |   | 
|Accumulated comprehensive income |  |                        | 808    |   |      |   | 
|                                 |  |                        |        |   |      |   |  
|Net amount recognized            |  | $                      | 4      |   |      | $ | 3
|                                 |  |                        |        |   |      |   |  

The Company adopted SFAS 158 on its effective date of December 31, 2006. The following table summarizes the
effect on retirement benefit-related amounts reported in the consolidated statements of condition.



|                                     |  |                                                    |   |             |   |       |               |  |   |      
|------------------------------------ |  | -------------------------------------------------- | - | ----------- | - | ----- | ------------- |  | - | -----
|                                     |  | Effect of Adopting Statement 158 December 31, 2006
|                                     |  | (dollars in thousands)                            
|                                     |  | BeforeAdoption                                     |   | Adjustments |   |       | AfterAdoption
|Other Assets                         |  |                                                    |   |             |   |       |               |  |   |      
|Prepaid pension cost                 |  | $                                                  | 4 |             | $ | (4    | )             |  | $ |     
|Deferred tax asset                   |  |                                                    |  |             |   | 507   |               |  |   | 507  
|Other Liabilities                    |  |                                                    |  |             |   | 1,311 |               |  |   | 1,311
|Benefit liability                    |  |                                                    |   |             |   |       |               |  |   |      
|Stockholders Equity                 |  | $                                                  |  |             | $ | 808   |               |  | $ | 808  
|Accumulated other comprehensive loss |  |                                                    |   |             |   |       |               |  |   |      



32



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 5. Employee Pension Plan (Continued)

At December 31, 2006 and 2005, the assumptions used to determine the benefit obligation are as follows:



|                               |  |                         |   |  |      |  
|------------------------------ |  | ----------------------- | - |  | ---- | -
|                               |  | Year Ended December 31, |  
|                               |  | 2006                    |   |  | 2005 |  
|Discount rate                  |  | 7.0                     | % |  | 7.0  | %
|Expected return on plan assets |  | 7.5                     | % |  | 7.5  | %
|Rate of compensation increase  |  | 3.5                     | % |  | 3.5  | %

The components of net periodic pension cost are as follows:



|                                   |  |                         |      |   |      |   |      |  
|---------------------------------- |  | ----------------------- | ---- | - | ---- | - | ---- | -
|                                   |  | Year Ended December 31, |     
|                                   |  | 2006                    |      |   | 2005 |  
|                                   |  | (Dollars in thousands)  |     
|Service cost                       |  | $                       | 146  |   |      | $ | 124  |  
|Interest cost                      |  |                         | 203  |   |      |   | 176  |  
|Expected return on plan assets     |  |                         | (155 | ) |      |   | (126 | )
|Amortization of prior service cost |  |                         | 34   |   |      |   | 34   |  
|Recognized net actuarial loss      |  |                         | 29   |   |      |   | 29   |  
|                                   |  |                         |      |   |      |   |      |  
|Net periodic benefit cost          |  | $                       | 257  |   |      | $ | 237  |  
|                                   |  |                         |      |   |      |   |      |  

Determination of Expected Long-Term Rate of Return

The assumed expected return on assets considers the current level of expected returns on risk-free investments (primarily government bonds), the historical level of risk
premium associated with the other asset classes in the portfolio and the expectation for future returns of each asset class. The expected return of each asset class is weighted based on the target allocation to develop the expected long-term rate of
return on assets. This resulted in the selection of the 7.5% rate used for 2006.

The Companys pension plan weighted average asset allocations at
December 31, 2006 and 2005.



|                          |  |        |   |  |        |  
|------------------------- |  | ------ | - |  | ------ | -
|Asset Category            |  | 2006   |   |  | 2005   |  
|Cash and cash equivalents |  | 100.00 | % |  | 100.00 | %

Investment Policy and Strategy

Target allocations are established based on periodic evaluation of risk/reward under various economic scenarios and with varying asset class allocations. The near-term and long-term impact on obligations and asset
values are projected and evaluated for funding and financial implications. Actual allocation and investment performance is reviewed quarterly.

The minimum
required contribution for 2006 was $258,000. The maximum required contribution for the 2007 plan year is $324,000.



33



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 5. Employee Pension Plan (Continued)

The Companys projected benefit payments:



|          |  |   |          
|--------- |  | - | ---------
|2007      |  | $ |         
|2008      |  |   | 9,506    
|2009      |  |   | 16,926   
|2010      |  |   | 60,303   
|2011      |  |   | 59,753   
|2012-2016 |  |   | 1,144,795
|          |  |   |          
|Total     |  | $ | 1,291,283
|          |  |   |          

Note 6. Deposits

Deposits are summarized as follows:



|                        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  
|----------------------- |  | ---------------------- | ------- | ----------- | ----------------- | - | ------------ | ------ | - | ------ | - | ----------- |  | ---- | ------------ |  | ------ | -
|                        |  | December 31, 2006      |         |             | December 31, 2005 |  
|                        |  | Amount                 |         | AverageRate |                   |   | % ofDeposits |        |   | Amount |   | AverageRate |  |      | % ofDeposits | 
|                        |  | (Dollars in thousands) |        
|Demand accounts:        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  
|Passbook savings        |  | $                      | 27,776  |             | 2.71              | % |              | 11.76  | % |        | $ | 29,141      |  | 1.73 | %            |  | 14.67  | %
|NOW accounts            |  |                        | 21,858  |             | 0.25              | % |              | 9.23   | % |        |   | 19,666      |  | 0.14 | %            |  | 9.90   | %
|Money market            |  |                        | 9,944   |             | 3.20              | % |              | 4.21   | % |        |   | 6,430       |  | 1.19 | %            |  | 3.24   | %
|                        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  
|Total demand deposits   |  |                        | 59,578  |             | 1.89              | % |              | 25.23  | % |        |   | 55,237      |  | 1.10 | %            |  | 27.81  | %
|Certificates of deposit |  |                        | 176,533 |             | 4.73              | % |              | 74.77  | % |        |   | 143,397     |  | 3.06 | %            |  | 72.19  | %
|                        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  
|Total deposits          |  | $                      | 236,111 |             | 4.15              | % |              | 100.00 | % |        | $ | 198,634     |  | 2.52 | %            |  | 100.00 | %
|                        |  |                        |         |             |                   |   |              |        |   |        |   |             |  |      |              |  |        |  

At December 31, 2006, the scheduled maturities of certificates of deposit are as follows:



|                         |  |                        |        
|------------------------ |  | ---------------------- | -------
|Year Ending December 31, |  | Amount                
|                         |  | (Dollars in thousands)
|2007                     |  | $                      | 114,413
|2008                     |  |                        | 36,764 
|2009                     |  |                        | 7,738  
|2010                     |  |                        | 17,494 
|2011                     |  |                        | 124    
|                         |  |                        |        
|                         |  | $                      | 176,533
|                         |  |                        |        

The aggregate amount of jumbo certificates of deposit with a minimum denomination of $100,000 was approximately
$66.4 and $57.3 million at December 31, 2006 and 2005, respectively.



34



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 6. Deposits (Continued)

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



|                                |  |                        |       
|------------------------------- |  | ---------------------- | ------
|                                |  | December 31, 2006     
|                                |  | (Dollars in thousands)
|Maturity period:                |  |                        |       
|Within 3 months or less         |  | $                      | 17,837
|Over 3 months through 6 months  |  |                        | 15,682
|Over 6 months through 12 months |  |                        | 14,155
|Over 12 months                  |  |                        | 18,737
|                                |  |                        |       
|                                |  | $                      | 66,411
|                                |  |                        |       

Interest expense on deposits is summarized as follows:



|                        |  |                         |       |      |   |      
|----------------------- |  | ----------------------- | ----- | ---- | - | -----
|                        |  | Year Ended December 31,
|                        |  | 2006                    |       | 2005
|                        |  | (Dollars in thousands) 
|Passbook savings        |  | $                       | 734   |      | $ | 504  
|NOW and money market    |  |                         | 186   |      |   | 105  
|Certificates of deposit |  |                         | 6,759 |      |   | 4,392
|                        |  |                         |       |      |   |      
|                        |  | $                       | 7,679 |      | $ | 5,001
|                        |  |                         |       |      |   |      

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, 2006 and 2005:



|                                       |  |              |  |        |            |   |      |   |            |      |  |      |        
|-------------------------------------- |  | ------------ |  | ------ | ---------- | - | ---- | - | ---------- | ---- |  | ---- | -------
|                                       |  |              |  | Amount |            |   |      |  
|Maturity                               |  | Call Feature |  | 2006   |            |   | 2005 |   |            | 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  |   |      |   | 5,000,000  |      |  | 4.66 | % Fixed
|Due on September 2, 2008               |  | None         |  |        | 5,000,000  |   |      |   |           |      |  | 5.22 | % Fixed
|                                       |  |              |  |        |            |   |      |   |            |      |  |      |        
|Total FHLB borrowings                  |  |              |  | $      | 10,000,000 |   |      | $ | 15,000,000 |      |  |      |        
|                                       |  |              |  |        |            |   |      |   |            |      |  |      |        
|Total weighted average rate            |  |              |  |        | 4.94       | % |      |   | 4.29       | %    |  |      |        
|                                       |  |              |  |        |            |   |      |   |            |      |  |      |        
|Maximum amount outstanding during year |  |              |  | $      | 20,000,000 |   |      | $ | 18,000,000 |      |  |      |        
|                                       |  |              |  |        |            |   |      |   |            |      |  |      |        

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, 2006 was approximately $121 million. This agreement with the FHLB provides for a line of credit up to 15% of the Companys assets.



35



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



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:



|     |  |   |       
|---- |  | - | ------
|2007 |  | $ | 18,000
|2008 |  |   | 4,500 
|     |  |   |       
|     |  | $ | 22,500
|     |  |   |       

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 $2,568,000 and $2,373,000 at December 31, 2006 and 2005, respectively. The total expense for the deferred
compensation agreements and supplemental income agreements amounted to $275,000 and $125,000 for the years ended December 31, 2006 and 2005, 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 1997 and expire in 2007. Options granted to
non-employee directors vested immediately on the date of grant. All options were fully vested as of December 31, 2001.



36



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 10. Management Recognition Plan and Stock Option Plan (Continued)

A summary of the Companys option plans as of and for the years ended December 31, 2006 and 2005 is as follows:

|                                  |  |                                 |  |                     |   |                     |                               |       |                    |            |   |                                |   |      
|--------------------------------- |  | ------------------------------- |  | ------------------- | - | ------------------- | ----------------------------- | ----- | ------------------ | ---------- | - | ------------------------------ | - | -----
|                                  |  |                                 |  | Outstanding Options |   | Exercisable Options
|                                  |  | SharesAvailablefor FutureGrants |  | Number Outstanding  |   |                     | WeightedAverageExercise Price |       | Number Outstanding |            |   | WeightedAverage Exercise Price
|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
|Options granted/vesting           |  |                                |  |                    |   |                     |                               |      |                    |           |   |                                |   |     
|Options exercised                 |  |                                |  |                    |   |                     |                               |      |                    |           |   |                                |   |     
|Options forfeited                 |  |                                |  |                    |   |                     |                               |      |                    |           |   |                                |   |     
|                                  |  |                                 |  |                     |   |                     |                               |       |                    |            |   |                                |   |      
|At December 31, 2006              |  |                                |  | 449,650             |   |                     | $                             | 12.00 |                    | 449,650    |   |                                | $ | 12.00
|                                  |  |                                 |  |                     |   |                     |                               |       |                    |            |   |                                |   |      
|Aggregate intrinsic value         |  |                                 |  | (1,205,062          | ) |                     |                               |       |                    | (1,205,062 | ) |                                |   |      
|Weighted average contractual term |  |                                 |  | .75                 |   |                     |                               |       |                    | .75        |   |                                |   |      

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.

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, 2006, retained earnings contain certain historical additions to bad debt reserves for income tax purposes of approximately $2.9 million, 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 $1.1 million as of December 31, 2006.



37



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 11. Income Tax Matters (Continued)

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,
|                                                        |  | 2006                    |       | 2005
|                                                        |  | (Dollars in thousands) 
|Deferred tax assets:                                    |  |                         |       |      |   |      
|Deferred compensation and supplemental income           |  | $                       | 990   |      | $ | 915  
|Allowance for loan losses                               |  |                         | 301   |      |   | 260  
|Investment in LLC                                       |  |                         | 67    |      |   | 67   
|Unrealized loss on securities available for sale        |  |                         | 35    |      |   | 158  
|Net unrealized loss related to adoption of SFAS No. 158 |  |                         | 507   |      |   |     
|Other                                                   |  |                         | 49    |      |   | 52   
|                                                        |  |                         |       |      |   |      
|Total deferred tax assets                               |  |                         | 1,949 |      |   | 1,452
|                                                        |  |                         |       |      |   |      
|Deferred tax liabilities:                               |  |                         |       |      |   |      
|Net deferred loan fees and costs                        |  |                         | 227   |      |   | 219  
|Federal Home Loan Bank dividends                        |  |                         | 38    |      |   | 64   
|Prepaid expenses                                        |  |                         | 28    |      |   | 18   
|Premises and equipment                                  |  |                         | 71    |      |   | 77   
|Other                                                   |  |                         | 5     |      |   | 5    
|                                                        |  |                         |       |      |   |      
|Total deferred tax liabilities                          |  |                         | 369   |      |   | 383  
|                                                        |  |                         |       |      |   |      
|Net deferred tax assets                                 |  | $                       | 1,580 |      | $ | 1,069
|                                                        |  |                         |       |      |   |      

The Company has no valuation allowance at December 31, 2006 or 2005 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, |     
|                                 |  | 2006                    |      |   | 2005 |  
|                                 |  | (Dollars in thousands)  |     
|Current tax expense              |  | $                       | 827  |   |      | $ | 878 |  
|Deferred tax provision (benefit) |  |                         | (127 | ) |      |   | (66 | )
|                                 |  |                         |      |   |      |   |     |  
|                                 |  | $                       | 700  |   |      | $ | 812 |  
|                                 |  |                         |      |   |      |   |     |  



38



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 11. Income Tax Matters (Continued)

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, |    
|                                            |  | 2006                    |     |   | 2005 |  
|                                            |  | (Dollars in thousands)  |    
|Expense computed at statutory rate of 34%   |  | $                       | 672 |   |      | $ | 813 |  
|Effect of state income taxes                |  |                         | 28  |   |      |   | 59  |  
|Nontaxable increase in cash surrender value |  |                         | (8  | ) |      |   | (55 | )
|Nondeductible ESOP expenses                 |  |                         | 7   |   |      |   | 8   |  
|Other, net                                  |  |                         | 1   |   |      |   | (13 | )
|                                            |  |                         |     |   |      |   |     |  
|                                            |  | $                       | 700 |   |      | $ | 812 |  
|                                            |  |                         |     |   |      |   |     |  

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, 2006 and 2005, the Bank paid $1.19 and
$1.2 million, respectively, in dividends to the Company.

The Company paid cash dividends totaling $.40 per share during each of the years ended
December 31, 2006 and 2005, respectively.

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.



39



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 12. Stockholders Equity (Continued)

As of December 31, 2006, 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, 2006 and 2005, as presented in the following table.



|                       |  |                        |        |       |                            |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|---------------------- |  | ---------------------- | ------ | ----- | -------------------------- | - | ------ | --------------------------------------------------------------------- | ------ |  | --- | ------ |  | ------ |  | ---- | -
|                       |  | Actual                 |        |       | Minimum CapitalRequirement |   |        | Minimum To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                       |  | Amount                 |        | Ratio |                            |   | Amount |                                                                       | Ratio  |  |     | Amount |  | Ratio  | 
|                       |  | (Dollars in Thousands) |       
|December 31, 2006:     |  |                        |        |       |                            |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Total Capital to Risk  |  |                        |        |       |                            |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Weighted Assets:       |  |                        |        |       |                            |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Consolidated           |  | $                      | 27,034 |       | 14.98                      | % |        | $                                                                     | 14,433 |  | 8.0 | %      |  | N/A    |  | N/A  |  
|Bank                   |  |                        | 23,881 |       | 13.03                      | % |        |                                                                       | 14,667 |  | 8.0 | %      |  | 18,334 |  | 10.0 | %
|Tier 1 Capital to Risk |  |                        |        |       |                            |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Weighted Assets:       |  |                        |        |       |                            |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Consolidated           |  | $                      | 26,252 |       | 14.55                      | % |        | $                                                                     | 7,217  |  | 4.0 | %      |  | N/A    |  | N/A  |  
|Bank                   |  |                        | 23,099 |       | 12.60                      | % |        |                                                                       | 7,334  |  | 4.0 | %      |  | 11,001 |  | 6.0  | %
|Tier 1 Capital to      |  |                        |        |       |                            |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Average Assets:        |  |                        |        |       |                            |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|Consolidated           |  | $                      | 26,252 |       | 12.29                      | % |        | $                                                                     | 6,408  |  | 3.0 | %      |  | N/A    |  | N/A  |  
|Bank                   |  |                        | 23,099 |       | 8.64                       | % |        |                                                                       | 8,022  |  | 3.0 | %      |  | 13,370 |  | 5.0  | %



|                       |  |                        |        |       |                           |   |        |                                                                       |        |  |     |        |  |        |  |      |  
|---------------------- |  | ---------------------- | ------ | ----- | ------------------------- | - | ------ | --------------------------------------------------------------------- | ------ |  | --- | ------ |  | ------ |  | ---- | -
|                       |  | 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                     | % |        |                                                                       | 12,791 |  | 8.0 | %      |  | 23,494 |  | 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                     | % |        |                                                                       | 6,396  |  | 4.0 | %      |  | 14,096 |  | 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                      | % |        |                                                                       | 7,048  |  | 3.0 | %      |  | 11,746 |  | 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.



40



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 13. Employee Stock Ownership Plan (Continued)

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, 2006, the outstanding balance of the unallocated shares is $208,000, 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, 2006 and 2005,
$107,000 and $128,000, respectively, was amortized as compensation expense.

Net expenses of $239,000 and $302,000 have been recorded during the years
ended December 31, 2006 and 2005, 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, 2006,
410,205 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, 2006, based on a fair value of the ESOP shares released or committed to be released is approximately $3.7 million. The fair value of the unallocated shares is $218,000 at
December 31, 2006. 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.



41



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 14. Off Balance-Sheet Risk (Continued)

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, 2006 is as follows:

Financial instruments whose contract amounts represent credit risk:



|                                          |  |   |       
|----------------------------------------- |  | - | ------
|Commitments to extend credit              |  | $ | 7,148 
|Undisbursed lines of credit               |  |   | 16,235
|Undisbursed portion of construction loans |  |   | 3,395 

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.

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:



42



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 15. Fair Value of Financial Instruments (Continued)

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

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.

Bank owned life insurance (BOLI)

The carrying amount for BOLI approximates its fair value.

Accrued Interest

The carrying amount is a reasonable estimate of 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.



43



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SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 15. Fair Value of Financial Instruments (Continued)

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, 2006 and 2005:



|                                                 |  |                        |         |                     |   |                |  |                      |         |  |   |        
|------------------------------------------------ |  | ---------------------- | ------- | ------------------- | - | -------------- |  | -------------------- | ------- |  | - | -------
|                                                 |  | 2006                   |         | 2005               
|                                                 |  | Carryingamount         |         | Estimatedfair value |   | Carryingamount |  | Estimated fair value
|                                                 |  | (Dollars in thousands)
|Financial assets:                                |  |                        |         |                     |   |                |  |                      |         |  |   |        
|Cash and due from banks                          |  | $                      | 5,164   |                     | $ | 5,164          |  | $                    | 5,692   |  | $ | 5,692  
|Interest-bearing deposits and federal funds sold |  |                        | 17,575  |                     |   | 17,575         |  |                      | 8,608   |  |   | 8,608  
|Held to maturity investments                     |  |                        | 4,490   |                     |   | 4,362          |  |                      | 5,254   |  |   | 5,119  
|Available for sale investments                   |  |                        | 21,160  |                     |   | 21,160         |  |                      | 24,101  |  |   | 24,101 
|Loans, net                                       |  |                        | 209,953 |                     |   | 209,465        |  |                      | 183,212 |  |   | 183,829
|Federal Home Loan Bank stock                     |  |                        | 930     |                     |   | 930            |  |                      | 1,100   |  |   | 1,100  
|Bank owned life insurance                        |  |                        | 7,916   |                     |   | 7,916          |  |                      | 7,573   |  |   | 7,573  
|Accrued Interest receivable                      |  |                        | 1,317   |                     |   | 1,317          |  |                      | 1,010   |  |   | 1,010  
|                                                 |  |                        |         |                    
|Financial liabilities:                           |  |                        |         |                     |   |                |  |                      |         |  |   |        
|Deposits                                         |  |                        | 236,111 |                     |   | 235,788        |  |                      | 198,634 |  |   | 197,007
|Borrowings                                       |  |                        | 10,000  |                     |   | 10,007         |  |                      | 15,000  |  |   | 15,000 
|Accrued interest payable                         |  |                        | 110     |                     |   | 110            |  |                      | 56      |  |   | 56     

Note 16. Parent Company Financial Data

Condensed Balance Sheets



|                                      |  |                        |        |      |   |       
|------------------------------------- |  | ---------------------- | ------ | ---- | - | ------
|                                      |  | December 31,          
|                                      |  | 2006                   |        | 2005
|                                      |  | (Dollars in thousands)
|Assets:                               |  |                        |        |      |   |       
|Cash                                  |  | $                      | 1      |      | $ | 4     
|Federal funds sold                    |  |                        | 1,297  |      |   | 1,310 
|Securities available for sale         |  |                        | 2,298  |      |   | 2,267 
|Accrued interest receivable           |  |                        | 16     |      |   | 17    
|Other assets                          |  |                        | 2      |      |   | 6     
|Investment in Home Savings Bank       |  |                        | 23,236 |      |   | 22,808
|                                      |  |                        |        |      |   |       
|                                      |  | $                      | 25,850 |      | $ | 26,412
|                                      |  |                        |        |      |   |       
|Liabilities and Stockholders Equity: |  |                        |        |      |   |       
|Liabilities:                          |  |                        |        |      |   |       
|Other liabilities                     |  | $                      | 462    |      | $ | 442   
|                                      |  |                        |        |      |   |       
|Stockholders Equity:                 |  |                        | 25,388 |      |   | 25,970
|                                      |  |                        |        |      |   |       
|                                      |  | $                      | 25,850 |      | $ | 26,412
|                                      |  |                        |        |      |   |       



44



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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 Income



|                                        |  |                          |       |   |      |   |       |  
|--------------------------------------- |  | ------------------------ | ----- | - | ---- | - | ----- | -
|                                        |  | Years Ended December 31, |      
|                                        |  | 2006                     |       |   | 2005 |  
|                                        |  | (Dollars in thousands)   |      
|Interest income                         |  | $                        | 142   |   |      | $ | 169   |  
|Equity in earnings of Home Savings Bank |  |                          | 1,207 |   |      |   | 1,489 |  
|Other expense                           |  |                          | (40   | ) |      |   | (42   | )
|Income taxes                            |  |                          | (32   | ) |      |   | (36   | )
|                                        |  |                          |       |   |      |   |       |  
|Net income                              |  | $                        | 1,277 |   |      | $ | 1,580 |  
|                                        |  |                          |       |   |      |   |       |  

Condensed Statements of Cash Flows



|                                                                                            |  |                          |        |   |      |   |        |  
|------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                            |  | Years Ended December 31, |       
|                                                                                            |  | 2006                     |        |   | 2005 |  
|                                                                                            |  | (Dollars in thousands)   |       
|Cash Flows from Operating Activities:                                                       |  |                          |        |   |      |   |        |  
|Net income                                                                                  |  | $                        | 1,277  |   |      | $ | 1,580  |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                          |        |   |      |   |        |  
|Equity in earnings of Home Savings Bank                                                     |  |                          | (1,207 | ) |      |   | (1,489 | )
|Upstream dividend from Home Savings Bank                                                    |  |                          | 1,186  |   |      |   | 1,173  |  
|Decrease in accrued interest receivable and other assets                                    |  |                          | 5      |   |      |   | 10     |  
|Increase in accrued expenses and other liabilities                                          |  |                          | 21     |   |      |   | (35    | )
|                                                                                            |  |                          |        |   |      |   |        |  
|Net cash provided by operating activities                                                   |  |                          | 1,282  |   |      |   | 1,239  |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Cash Flows from Investing Activities:                                                       |  |                          |        |   |      |   |        |  
|Principal payment received on note receivable from ESOP                                     |  |                          | 326    |   |      |   | 398    |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Net cash provided by investing activities                                                   |  |                          | 326    |   |      |   | 398    |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Cash Flows from Financing Activities:                                                       |  |                          |        |   |      |   |        |  
|Retirement of stock purchased                                                               |  |                          | (425   | ) |      |   | (468   | )
|Payment of dividends                                                                        |  |                          | (1,167 | ) |      |   | (1,173 | )
|                                                                                            |  |                          |        |   |      |   |        |  
|Net cash used in financing activities                                                       |  |                          | (1,592 | ) |      |   | (1,641 | )
|                                                                                            |  |                          |        |   |      |   |        |  
|Net decrease in cash and cash equivalents                                                   |  |                          | (16    | ) |      |   | (4     | )
|                                                                                            |  |                         
|Cash and cash equivalents:                                                                  |  |                          |        |   |      |   |        |  
|Beginning                                                                                   |  |                          | 1,314  |   |      |   | 1,318  |  
|                                                                                            |  |                          |        |   |      |   |        |  
|Ending                                                                                      |  | $                        | 1,298  |   |      | $ | 1,314  |  
|                                                                                            |  |                          |        |   |      |   |        |  



45



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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 Board |  | Owner and President        
|of Home Savings Bank                 |  | 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                                                |  | INDEPENDENT AUDITORS                                                          |  | SPECIAL LEGAL COUNSEL                                                                                         
|Registrar and Transfer Company 10 Commerce
Drive Cranford, NJ 07016 |  | Dixon Hughes PLLC 6525 Morrison Boulevard, Suite
516 Charlotte, NC 28211-3563 |  | Brooks, Pierce, McLendon,Humphrey & Leonard, LLP2000 Renaissance
Plaza230 North Elm StreetGreensboro, 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 2007 annual meeting of stockholders of South Street Financial Corp. will be held at 4 p.m. on May 21, 2007 at the Companys corporate office at 155 West
South Street, Albemarle, NC.



---

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

COMMON STOCK INFORMATION

The Companys common stock is listed on the NASDAQ Global Market
under the symbol SSFC and began trading on October 3, 1996. At December 31, 2006, there were approximately 558 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  
|2006:          |  |           |      |             |   |       |  |   |     
|First Quarter  |  | $         | 0.10 |             | $ | 10.00 |  | $ | 8.42
|Second Quarter |  |           | 0.10 |             |   | 9.71  |  |   | 8.81
|Third Quarter  |  |           | 0.10 |             |   | 9.49  |  |   | 8.50
|Fourth Quarter |  |           | 0.10 |             |   | 9.52  |  |   | 8.38
|               |  |           |     
|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



47