EXHIBIT 13

                       CORNERSTONE BANCORP AND SUBSIDIARY
                            Portions of Registrant's
                              2005 Annual Report to
                            Shareholders Incorporated
                       by Reference into 2005 Form 10-KSB












<PAGE>


                                    CONTENTS



Forward Looking statements ................................................   1
Website Preferences .......................................................   1
Management's Discussion and Analysis of
  Financial Condition and Results of Operations ...........................   2
Report of Independent Registered Public Accounting Firm ...................  20
Consolidated Balance Sheets ...............................................  21
Consolidated Statements of Income .........................................  22
Consolidated Statements of Shareholders' Equity
  and Comprehensive Income (Loss) .........................................  23
Consolidated Statements of Cash Flows .....................................  24
Notes to Consolidated Financial Statements ................................  25


<PAGE>


FORWARD LOOKING STATEMENTS

         Statements  included in this report which are not  historical in nature
are intended to be, and are hereby  identified as "forward  looking  statements"
for  purposes  of the safe  harbor  provided  by Section  21E of the  Securities
Exchange Act of 1934, as amended. Words such as "estimate", "project", "intend",
"expect",  "believe",  "anticipate",  "plan", and similar  expressions  identify
forward-looking  statements.  The Company  cautions readers that forward looking
statements  including  without  limitation,  those relating to the Company's new
offices, future business prospects,  revenues,  working capital, adequacy of the
allowance for loan losses, liquidity, capital needs, interest costs, and income,
are subject to certain risks and  uncertainties  that could cause actual results
to differ from those indicated in the forward looking statements, due to several
important factors herein  identified,  among others, and other risks and factors
identified from time to time in the Company's  reports filed with the Securities
and Exchange Commission.

         These  forward-looking  statements  are based on current  expectations,
estimates  and  projections  about  our  industry,   management's  beliefs,  and
assumptions made by management.  Such information includes,  without limitation,
discussions  as to estimates,  expectations,  beliefs,  plans,  strategies,  and
objectives concerning the Company's future financial and operating  performance.
These  statements  are not guarantees of future  performance  and are subject to
risks, uncertainties and assumptions that are difficult to predict, particularly
in light of the fact that the Company is a  relatively  new company with limited
operating  history.  Therefore,  actual results may differ materially from those
expressed  or  forecasted  in such  forward-looking  statements.  The  risks and
uncertainties include, but are not limited to:

     o    The Company's growth and ability to maintain growth;
     o    governmental  monetary and fiscal policies, as well as legislative and
          regulatory changes;
     o    the effect of interest  rate changes on our level and  composition  of
          deposits,  loan  demand  and the  value  of our  loan  collateral  and
          securities;
     o    the effects of competition from other financial institutions operating
          in the Company's  market areas and elsewhere,  including  institutions
          operating locally, regionally, nationally and internationally;
     o    failure of our customers to repay loans;
     o    failure of assumptions  underlying the  establishment of the allowance
          for loan losses, including the value of collateral securing loans; and
     o    loss of consumer  confidence and economic  disruptions  resulting from
          terrorist activities.

         The Company  undertakes no obligation to publicly  update or revise any
forward-looking  statements,  whether  as a result  of new  information,  future
events or otherwise.  In light of these risks,  uncertainties,  and assumptions,
the forward-looking events discussed in this report might not occur.

WEBSITE REFERENCES

         References  to the  Bank's  website  included  in, or  incorporated  by
reference  into,  this report are for  information  purposes  only,  and are not
intended to incorporate our website by reference into this report.


                                       1
<PAGE>

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

         Cornerstone Bancorp,  (the "Company") is a bank holding company and has
no  operations  other than those  carried  on by its  wholly  owned  subsidiary,
Cornerstone National Bank (the "Bank"). The Bank commenced business on September
15,  1999.  It conducts a general  banking  business  from three  offices in the
Easley area of Pickens County,  in the Berea area of Greenville  County,  and in
the  Powdersville  area of Anderson  County,  South Carolina.  The  Powdersville
office was opened during 2005. The Bank  established a wholly owned  subsidiary,
Crescent Financial Services, Inc. ("Crescent") in 2004.

         The following  information  describes  various financial aspects of the
Bank's  business.  This  information  should  be read in  conjunction  with  the
consolidated financial statements of the Company, which appear elsewhere in this
document,  and the Company's Form 10-KSB, filed with the Securities and Exchange
Commission.

Services of the Bank

Deposits

         The Bank offers the full range of deposit services typically  available
in most banks and savings and loan  associations,  including  checking accounts,
NOW accounts,  retirement accounts (including  Individual  Retirement Accounts),
and savings and other time deposits of various  types,  ranging from daily money
market accounts to longer-term certificates of deposit. The transaction accounts
and  time  certificates  are  tailored  to the  principal  market  area at rates
competitive  with those offered in the area. All deposit accounts are insured by
the Federal  Deposit  Insurance  Corporation  ("FDIC") up to the maximum  amount
permitted by law. The Bank solicits these accounts from individuals, businesses,
associations and organizations,  and government  authorities.  Although the Bank
intends to be competitive in its efforts to attract  deposit  accounts,  it does
not  aggressively  seek jumbo  certificates of deposit  (certificates in amounts
greater than $100,000).

Lending Activities

         The Bank  offers a range of  lending  services,  including,  commercial
loans,  consumer  loans,  and real estate  mortgage  loans. To address the risks
inherent in making  loans,  management  maintains an  allowance  for loan losses
based on, among other things,  an evaluation of the Bank's loan loss experience,
management's  experience at other financial institutions in the market area, the
amount  of  and  trends  in  past  due  and  nonperforming  loans,  current  and
anticipated economic changes and the values of loan collateral.  Based upon such
factors,  management makes various  assumptions and judgments about the ultimate
collectibility  of the loan  portfolio  and provides an allowance  for potential
loan losses based upon a  percentage  of the  outstanding  balances and specific
loans.  However,  because  there are  certain  risks  that  cannot be  precisely
quantified,  management's  judgment of the allowance is necessarily  approximate
and imprecise.  The adequacy and methodology of the allowance for loan losses is
also subject to regulatory examination.

Real Estate Loans

         One of the primary  components  of the Bank's loan  portfolio  is loans
secured by first or second  mortgages on residential and commercial real estate.
These loans generally consist of short to mid-term commercial real estate loans,
construction and development  loans and residential real estate loans (including
home  equity  and  second  mortgage  loans).  Interest  rates  may be  fixed  or
adjustable and the Bank frequently charges an origination fee. The Bank seeks to
manage credit risk in the commercial real estate portfolio by emphasizing  loans
on  owner-occupied  office and retail buildings where the  loan-to-value  ratio,
established by  independent  appraisals,  does not exceed 80%. In addition,  the
Bank  generally  requires  personal  guarantees of the  principal  owners of the
property.  The  loan-to-value  ratio for first and second mortgage loans and for
construction  loans  generally  does not  exceed  80%.  In an effort to  control
interest rate risk, long term residential  mortgages are underwritten and funded
by, and closed in the name of, third party investors.

         The principal  economic risk associated with all loans,  including real
estate loans, is the creditworthiness of the Bank's borrowers.  The ability of a
borrower to repay a real estate loan depends upon a number of economic  factors,


                                       2
<PAGE>

including employment levels and fluctuations in the value of real estate. In the
case of a real estate  construction  loan, there is generally no income from the
underlying property during the construction period, and the developer's personal
obligations under the loan are typically  limited.  In the case of a real estate
purchase  loan,  the  borrower may be unable to repay the loan at the end of the
loan  term and thus may be  forced to  refinance  the loan at a higher  interest
rate,  or,  in  certain  cases,  the  borrower  may  default  as a result of its
inability to refinance the loan.  In either case,  the risk of nonpayment by the
borrower is increased. Each of these factors increases the risk of nonpayment by
the borrower.

         The Bank also  faces  additional  credit  risks to the  extent  that it
engages in making  adjustable  rate mortgage loans  ("ARMs").  In the case of an
ARM, as interest rates increase, the borrower's required payments increase, thus
increasing  the  potential  for default.  The  marketability  of all real estate
loans,  including  ARMs, is also generally  affected by the prevailing  level of
interest rates.

Commercial Loans

         The Bank  makes  loans for  commercial  purposes  in  various  lines of
business.  Commercial loans include both secured and unsecured loans for working
capital  (including  inventory and  receivables),  loans for business  expansion
(including acquisition of real estate and improvements), and loans for purchases
of equipment and  machinery.  Equipment  loans are typically  made for a term of
five  years or less at  either  fixed or  variable  rates,  with the loan  fully
amortized over the term and secured by the financed  equipment.  Working capital
loans  typically  have terms not exceeding  one year and are usually  secured by
accounts  receivable,  inventory or personal guarantees of the principals of the
business.  Commercial loans vary greatly  depending upon the  circumstances  and
loan terms are  structured  on a  case-by-case  basis to better  serve  customer
needs.

         The risks  associated  with  commercial  loans vary with many  economic
factors,  including the economy in the Bank's market areas. The well-established
banks in the Bank's market areas make  proportionately  more loans to medium- to
large-sized  businesses than the Bank makes. Many of the Bank's commercial loans
are made to small- to medium-sized businesses, which are typically smaller, have
shorter operating histories,  and less sophisticated record keeping systems than
larger  entities.  As a  result,  these  smaller  entities  may be less  able to
withstand  adverse  competitive,  economic and financial  conditions than larger
borrowers. In addition, because payments on loans secured by commercial property
generally  depend to a large degree on the results of operations  and management
of the properties,  repayment of such loans may be subject,  to a greater extent
than  other  loans,  to  adverse  conditions  in the real  estate  market or the
economy.

Consumer Loans

         The Bank  makes a variety  of loans to  individuals  for  personal  and
household purposes,  including secured and unsecured installment and term loans,
home equity loans and lines of credit and unsecured  revolving  lines of credit.
The secured  installment and term loans to consumers  generally consist of loans
to  purchase  automobiles,   boats,  recreational  vehicles,  mobile  homes  and
household  furnishings,  with the  collateral  for each loan being the purchased
property.  The  underwriting  criteria for home equity loans and lines of credit
are generally the same as applied by the Bank when making a first mortgage loan,
as described above, and home equity lines of credit typically expire 15 years or
less after origination, unless renewed or extended.

         Consumer  loans  generally  involve  more credit risks than other loans
because of the type and nature of the  underlying  collateral  or because of the
absence  of any  collateral.  Consumer  loan  repayments  are  dependent  on the
borrower's  continuing  financial  stability  and  are  likely  to be  adversely
affected by job loss,  divorce and  illness.  Furthermore,  the  application  of
various  federal and state laws,  including  federal  and state  bankruptcy  and
insolvency  laws,  may limit the amount  which can be recovered on such loans in
the case of default. In most cases, any repossessed  collateral will not provide
an adequate  source of repayment of the outstanding  loan balance.  Although the
underwriting  process for consumer  loans  includes a comparison of the value of
the security,  if any, to the proposed loan amount,  the Bank cannot predict the
extent to which the  borrower's  ability to pay, and the value of the  security,
will be affected by prevailing economic and other conditions.

                                       3
<PAGE>

Other Services

         The  Bank  participates  in a  regional  network  of  automated  teller
machines  that may be used by Bank  customers  in major  cities  throughout  the
Southeast. The Bank offers both VISA and MasterCard brands of bankcards together
with  related  lines of credit.  The lines of credit  may be used for  overdraft
protection as well as pre-authorized credit for personal purchases and expenses.
The Bank also provides  travelers  checks,  direct deposit of payroll and social
security  checks,  and  automatic  drafts  for  various  accounts,  but does not
currently provide  international or trust banking  services,  other than foreign
currency  exchange  through a  correspondent  bank.  The Bank offers an Internet
banking    product    accessible    via   the   Bank's    custom    website   at
www.cornerstonenationalbank.com.  The interactive  banking  product  includes an
electronic bill payment service that allows  customers to make scheduled  and/or
recurring bill payments electronically. Credit cards are underwritten and funded
by a third party  provider.  The Bank also offers  merchant  and other  business
related  services to its commercial  customers.  The Bank also has a residential
mortgage  loan  department  with a highly  experienced  staff  qualified to make
virtually any type of residential mortgage loan.

Critical Accounting Policies

         The Company has adopted various accounting  policies,  which govern the
application of accounting  principles generally accepted in the United States of
America  in  the  preparation  of  the  Company's  financial   statements.   The
significant accounting policies of the Company are described in the notes to the
consolidated financial statements.

         Certain   accounting   policies  involve   significant   judgments  and
assumptions by management, which have a material impact on the carrying value of
certain assets and liabilities. Management considers such accounting policies to
be  critical  accounting  policies.   The  judgments  and  assumptions  used  by
management  are based on  historical  experience  and other  factors,  which are
believed to be reasonable under the circumstances.  Because of the nature of the
judgments and assumptions  made by management,  actual results could differ from
these  judgments  and  estimates,  which  could  have a  material  impact on the
carrying  values of assets and  liabilities and the results of operations of the
Company.

         The  Company  believes  the  allowance  for loan  losses is a  critical
accounting  policy that  requires the most  significant  judgments and estimates
used in  preparation  of its  consolidated  financial  statements.  Refer to the
sections "Allowance for Loan Losses", "Potential Problem Loans", Impaired Loans"
and Note 1 to the consolidated  financial  statements for a detailed description
of the Company's estimation process and methodology related to the allowance for
loan losses.

Earnings Performance

         The Company  earned  $1,061,265  in 2005 or $.89 per basic common share
and $.86 per diluted  common share compared to $664,057 or $.57 per basic common
share and $.56 per diluted  common  share for the year ended  December 31, 2004.
This  compares to $356,048  or $.30 per basic and diluted  common  share for the
year ended December 31, 2003. The Company's earnings have consistently  improved
due to the Bank's growth.  The Company had net interest  income (the  difference
between interest earned on interest earning assets and interest paid on interest
bearing  liabilities) of $4.1 million,  $3.2 million, and $2.6 million for 2005,
2004, and 2003,  respectively.  The Company also had other noninterest income of
$1.0 million, $719,275, and $616,994 in 2005, 2004, and 2003, respectively.  The
Company  provided  $140,347,  $197,010,  and $173,574 to the  allowance for loan
losses in 2005, 2004, and 2003,  respectively,  and had other operating expenses
of $3.3 million in 2005,  $2.7 million in 2004, and $2.5 million in 2003.  Total
noninterest expenses (including  personnel costs) include $212,488  specifically
related to opening of the Bank's third full service branch in July 2005.

Net Interest Income

         Net  interest  income is the  amount  of  interest  earned on  interest
earning assets (loans,  investment securities,  time deposits in other banks and
federal funds sold),  less the interest  expenses  incurred on interest  bearing
liabilities (interest bearing deposits and borrowed money), and is the principal
source of the Bank's  earnings.  Net interest income is affected by the level of



                                       4
<PAGE>

interest  rates,  volume and mix of  interest  earning  assets and the  relative
funding of these  assets.  Due to the fact that the Bank's  and  therefore,  the
Company's,  assets are largely monetary in nature,  material changes in interest
rates can have a material impact on the Bank's net interest income.  The Company
and the  Bank  monitor  the  Bank's  assets  and  liabilities  and the  interest
sensitivity  of these assets and  liabilities  using  various  tools,  including
models which attempt to calculate  the impact on the Bank's net interest  margin
as interest rates change.  However, these models, as well as the tables included
here,  employ  assumptions  about  the  Bank's  interest  sensitive  assets  and
liabilities which may or may not prove to be accurate. Such assumptions include,
but are not limited to,  repayment  patterns of borrowers,  calls of securities,
and  unscheduled  redemptions  of  certificates  of  deposit.  The tables on the
following pages include  historical  analyses of yields earned and rates paid on
interest sensitive assets and liabilities,  the effects of changes in the volume
and relative mix of interest  sensitive  assets and  liabilities,  the effect of
changes in interest  rates,  and the ratio of assets and  liabilities  repricing
over specific  time  horizons.  While the  Company's  and the Bank's  management
cannot  predict  the timing and extent of changes in  interest  rates,  they can
attempt to manage the Bank's interest rate  sensitivity to enable the Company to
react to protect the Company's  earnings stream throughout various interest rate
cycles.

         For the years ended  December 31, 2005,  2004,  and 2003,  net interest
income was $4.1 million,  $3.2  million,  and $2.6  million,  respectively.  The
consistent  increases were primarily  attributable to increases in the volume of
loans (see  "Rate/Volume  Analysis  of Net  Interest  Income"  below).  In 2005,
increases  in  rates  also  had  a  significant   impact  on  interest   income,
particularly  in interest  income from loans.  Total  average  interest  earning
assets increased to $94.5 million in 2005 compared to $81.3 million in 2004. The
average  yield on interest  earning  assets  increased 103 basis points to 6.61%
compared to 5.58% in 2004.  The average  cost of  interest  bearing  liabilities
increased 76 basis points from 1.83% in 2004 to 2.59% in 2005.  These  increases
are a result  of the Board of  Governors  of the  Federal  Reserve  System  (the
"Federal  Reserve's")  tightening  of monetary  policy in 2005 and the impact on
short-term  interest  rates.  The net yield on average  interest  earning assets
increased in 2005 to 4.35% from 3.99% in 2004.  The interest rate spread in 2005
was 4.02% compared to 3.75% in 2004.


                                       5
<PAGE>


         The table,  "Average Balances,  Yields and Rates",  provides a detailed
analysis of the effective yields and rates on the categories of interest earning
assets and  interest  bearing  liabilities  for the  Company for the years ended
December 31, 2005 and 2004.

                       Average Balances, Yields and Rates
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                            Year Ended December 31, 2005      Year Ended December 31, 2004
                                                            ----------------------------      ----------------------------
                                                                        Interest                             Interest
                                                           Average       Income/    Yields/     Average       Income/    Yields/
                                                         Balances(1)     Expense    Rates(2)  Balances(1)     Expense   Rates(2)
                                                         -----------     -------    --------  -----------     -------   --------
Assets
<S>                                                         <C>            <C>        <C>         <C>           <C>        <C>
Securities ............................................     $ 12,313       $  464     3.77%       $12,752       $  494     3.87%
Federal Funds Sold ....................................        4,495          149     3.31%         3,389           48     1.42%
Loans (3), (4) ........................................       77,654        5,631     7.25%        65,128        3,990     6.13%
                                                            --------       ------     -----       -------       ------     -----
       Totalinterestearningassets .....................       94,462        6,244     6.61%        81,269        4,532     5.58%
Cash and due from banks ...............................        2,104                                2,016
Allowance for loan losses .............................        (969)                                 (816)
Premises and equipment ................................        4,312                                3,510
Cash surrender value of life insurance policies .......        1,543                                1,434
Other assets ..........................................          842                                  548
                                                            --------                              -------
       Totalassets ....................................     $102,294                              $87,961
                                                            ========                              =======

Liabilities and shareholders' equity
Interest bearing liabilities
     Interestbearingtransactionaccounts ...............     $ 13,510          140     1.04%       $11,833          120     1.01%
     Savingsandmoneymarket ............................       11,689          137     1.17%        15,829          161     1.02%
     Timedeposits .....................................       49,939        1,668     3.34%        34,556          895     2.59%
                                                            --------       ------                 -------       ------

       Totalinterestbearingdeposits ...................       75,138        1,945     2.59%        62,218        1,176     1.89%
Federal Funds purchased and
    customer repurchase agreements ....................        3,605           54     1.50%         5,886           68     1.15%
FHLB advances .........................................        3,928          140     3.56%         2,509           47     1.87%
                                                            --------       ------                 -------       ------
       Total interest bearing liabilities .............       82,671        2,139     2.59%        70,613        1,291     1.83%
                                                                           ------                               ------
Noninterest bearing demand deposits and other
    liabilities .......................................        9,573                                8,931
Shareholders' equity ..................................       10,050                                8,417
                                                            --------                              -------
       Totalliabilitiesandshareholders'equity .........     $102,294                              $87,961
                                                            ========                              =======
Interest rate spread (5) ..............................                                4.02%                               3.75%
Net interest income and net yield on earning assets(6)                     $4,105      4.35%                    $3,241     3.99%
                                                                           ======                               ======
Interest free funds supporting earning assets (7) .....     $ 11,791                              $10,656
</TABLE>
(1)  Average balances calculated based on a daily basis.
(2)  Calculated  based on the number of days in the year that each type of asset
     or liability was in existence. Yield calculated on a pre-tax basis.
(3)  Nonaccruing  loans are included in the average loan  balances and income on
     such loans is recognized on a cash basis.
(4)  Interest  income on loans  includes  loan fee  income  as well as  interest
     income. The amount of loan fees included is not considered material.
(5)  Total yield on interest earning assets less the rate paid on total interest
     bearing liabilities.
(6)  Net interest income divided by total interest earning assets.
(7)  Total interest earning assets less total interest bearing liabilities.



                                       6
<PAGE>

Rate/Volume Analysis of Net Interest Income

         As  indicated  in the caption  "Net  Interest  Income",  the Bank's net
income is largely  dependent on net interest income.  The table below calculates
the  relative  impact on net  interest  income  caused by changes in the average
balances  (volume) of interest  sensitive  assets and liabilities and the impact
caused by changes in interest  rates  earned or paid.  Each table  compares  two
years as  indicated  below.  The effect of a change in average  balance has been
determined  by applying  the average  rate in the earlier  year to the change in
average balance in the later year, as compared with the earlier year. The effect
of a change in the average  rate has been  determined  by  applying  the average
balance in the earlier year to the change in the average rate in the later year,
as compared with the earlier year. In 2005,  increases in interest rates had the
greatest  overall impact on net interest  income.  In 2004 and in years prior to
2004, the Bank has been in a high-growth  stage,  and average balance  increases
(volume) have had the greatest magnitude of impact on net interest income.  This
trend  continued  in 2005,  but did not have a greater  impact  on net  interest
income than the increases in interest rates.

                  Year Ended December 31, 2005 compared to 2004

<TABLE>
<CAPTION>
                                                                                    Increase (Decrease) Due to
                                                                                    --------------------------
                                                                                      (Dollars in Thousands)
                                                                       Volume            Rate        Volume/ Rate(1)        Change
                                                                       ------            ----        ---------------        ------
Interest earned on:
<S>                                                                   <C>               <C>               <C>               <C>
     Securities (2) ........................................          $   (17)          $   (13)          $     -           $   (30)
     Federal Funds sold ....................................               16                64                21               101
     Loans .................................................              768               732               141             1,641
                                                                      -------           -------           -------           -------
         Total interest income .............................              767               783               162             1,712

Interest paid on:
     Deposits ..............................................              373               286               109               768
     Federal Funds purchased and customer
        repurchase agreements ..............................              (26)               21                (8)              (13)
     FHLB advances .........................................               27                42                24                93
                                                                      -------           -------           -------           -------
         Total interest expense ............................              374               349               125               848
                                                                      -------           -------           -------           -------
Change in Net Interest Income ..............................          $   393           $   434           $    37           $   864
                                                                      =======           =======           =======           =======
</TABLE>

                  Year Ended December 31, 2004 compared to 2003

<TABLE>
<CAPTION>
                                                                                      Increase (Decrease) Due to
                                                                                      --------------------------
                                                                                         (Dollars in Thousands)
                                                                       Volume            Rate          Volume/ Rate(1)        Change
                                                                       ------            ----          ---------------        ------
Interest earned on:
<S>                                                                   <C>               <C>               <C>               <C>
     Securities (2) ........................................          $   (87)          $    (6)          $     1           $   (92)
     Federal Funds sold ....................................              (11)               12                (3)               (2)
     Loans .................................................            1,017              (145)              (47)              825
                                                                      -------           -------           -------           -------
         Total interest income .............................              919              (139)              (49)              731

Interest paid on:
     Deposits ..............................................              180              (117)              (17)               46
     Federal Funds purchased and customer
        repurchase agreements ..............................               10                (5)               (1)                4
     FHLB advances .........................................               37                 -                 8                45
                                                                      -------           -------           -------           -------
         Total interest expense ............................              227              (122)              (10)               95
                                                                      -------           -------           -------           -------
Change in Net Interest Income ..............................          $   692           $   (17)          $   (39)          $   636
                                                                      =======           =======           =======           =======
</TABLE>
(1)  Volume/Rate  is calculated as the difference  between the average  balances
     for the periods  multiplied by the difference between the average rates for
     the periods.
(2)  Income calculated on a pre-tax basis.


                                       7
<PAGE>

Interest Rate Sensitivity

         Interest  rate  sensitivity  measures  the timing and  magnitude of the
repricing  of  assets  compared  with the  repricing  of  liabilities  and is an
important  part of  asset/liability  management.  The objective of interest rate
sensitivity  management is to generate stable growth in net interest income, and
to  control  the risks  associated  with  interest  rate  movements.  Management
constantly  reviews  interest rate risk exposure and the expected  interest rate
environment so that  adjustments in interest rate  sensitivity  can be made in a
timely manner.

         On a cumulative  basis,  rate sensitive  assets exceeded rate sensitive
liabilities, resulting in an asset sensitive position at the end of 2005 of $3.8
million,  for a cumulative  gap ratio of 1.06  calculated  at the one-year  time
horizon.  When interest  sensitive  liabilities exceed interest sensitive assets
for a specific repricing "horizon", a negative interest sensitivity gap results.
The gap is positive when interest  sensitive  assets exceed  interest  sensitive
liabilities,  as was the case at the end of 2005 with  respect  to the  one-year
time horizon.  For a bank with a positive gap,  rising  interest  rates would be
expected to have a positive  effect on net  interest  income and  falling  rates
would be expected to have the opposite effect.

         The table below  reflects the balances of interest  earning  assets and
interest  bearing  liabilities  at the  earlier of their  repricing  or maturity
dates.  Amounts of fixed rate loans are  reflected at the loans' final  maturity
dates.  Variable  rate loans are  reflected at the earlier of their  contractual
maturity  date or the date at which  the  loan  may be  repriced  contractually.
Deposits in other banks and debt securities are reflected at the earlier of each
instrument's  repricing  date for  variable  rate  instruments  or the  ultimate
maturity  date for fixed  rate  instruments.  Overnight  federal  funds sold are
reflected in the earliest  repricing  interval due to the immediately  available
nature  of  these  funds.  Interest  bearing  liabilities  with  no  contractual
maturity, such as interest bearing transaction accounts and savings deposits are
reflected in the earliest  repricing  interval due to  contractual  arrangements
which give  management the  opportunity to vary the rates paid on these deposits
within a thirty-day or shorter period.  However, the Bank is under no obligation
to vary the rates paid on those  deposits  within any given  period.  Fixed rate
time  deposits,  principally  certificates  of deposit,  are  reflected at their
contractual  maturity  dates.  Federal  funds  purchased  are  presented  in the
immediate  repricing  interval  because the  interest  rate paid  adjusts at the
beginning of each month.


                                       8
<PAGE>


                          Interest Sensitivity Analysis

<TABLE>
<CAPTION>
                                                                            December 31, 2005
                                                                            -----------------
                                                            1-3      3-12       1-3       3-5      5-15       > 15
                                              Immediate    Months   Months     Years     Years     Years     Years       Total
                                              ---------    ------   ------     -----     -----     -----     -----       -----
                                                                          (Dollars in Thousands)
Interest earning assets
<S>                                           <C>       <C>        <C>       <C>       <C>       <C>        <C>        <C>
    Securities (1) .........................  $     -   $    700   $ 5,955   $ 3,236   $   989   $ 2,514    $   610    $ 14,004
    Federal funds sold .....................    3,183          -         -         -         -         -          -       3,183
    Loans (2) ..............................   47,614      3,472     7,467    11,832    15,186     1,699         62      87,332
                                              -------   --------   -------   -------   -------   -------    -------     -------
         Totalinterestearningassets ........   50,797      4,172    13,422    15,068    16,175     4,213        672     104,519
                                              -------   --------   -------   -------   -------   -------    -------     -------
Interest bearing deposits
    Interest bearing transaction accounts ..   15,966          -         -         -         -         -          -      15,966
    MMDA's & Savings .......................    9,790          -         -         -         -         -          -       9,790
    Time deposits ..........................        -     18,457    15,617    15,723     5,647         -          -      55,444
    Customer repurchase agreements .........    1,784      1,300         -         -         -         -          -       3,084
    FHLB advances ..........................        -         38     1,613     1,953       302       440          -       4,346
                                              -------   --------   -------   -------   -------   -------    -------     -------
        Totalinterestbearingliabilities ....   27,540     19,795    17,230    17,676     5,949       440          -      88,630
                                              -------   --------   -------   -------   -------   -------    -------     -------
Interest sensitivity gap ...................  $23,257   $(15,623)  $(3,808)  $(2,608)  $10,226   $ 3,773    $   672     $15,889
Cumulative interest sensitivity gap ........  $23,257     $7,634   $ 3,826   $ 1,218   $11,444   $15,217    $15,889
Gap ratio ..................................     1.84        .21       .78       .85      2.72      9.57       1.00        1.18
Cumulative gap ratio .......................     1.84       1.16      1.06      1.01      1.13      1.17       1.18
</TABLE>
(1)  Securities with call features have been included in the period in which the
     security matures.
(2)  There were no nonaccruing loans or unamortized  deferred loan fees, both of
     which would normally be subtracted from loans for purposes of this table.

<TABLE>
<CAPTION>
                                                                            December 31, 2004
                                                         1-3       3-12       1-3       3-5      5-15       > 15
                                           Immediate    Months    Months     Years     Years     Years     Years       Total
                                           ---------    ------    ------     -----     -----     -----     -----       -----
                                                                         (Dollars in Thousands)
Interest earning assets
<S>                                          <C>       <C>        <C>       <C>       <C>        <C>       <C>         <C>
    Securities (1)                           $      -  $ 5,202    $ 1,498   $ 4,706   $     -    $1,283    $   532     $13,221
    Federal funds sold                          4,131        -          -         -         -         -          -       4,131
    Loans (2)                                  46,111    5,620      7,338     7,454     7,505     1,130          -      75,158
                                             --------  -------    -------   -------   -------    ------    -------     -------
        Total interest earning assets          50,242   10,822      8,836    12,160     7,505     2,413        532      92,510
                                             --------  -------    -------   -------   -------    ------    -------     -------
Interest bearing deposits
    Interest bearing transaction accounts      13,416        -          -         -         -         -          -      13,416
    MMDA's & Savings                           19,379        -          -         -         -         -          -      19,379
    Time deposits                               1,101    3,405     12,683    14,997     8,133         -          -      40,319
    Customer repurchase agreements              4,484        -      1,000         -         -         -          -       5,484
    FHLB advances                                   -       11         33     1,633     1,634        89          -       3,400
                                             --------  -------    -------   -------   -------    ------    -------     -------
        Total interest bearing liabilities     38,380    3,416     13,716    16,630     9,767        89          -      81,998
                                             --------  -------    -------   -------   -------    ------    -------     -------
Interest sensitivity gap                     $ 11,862  $ 7,406    $(4,880)  $(4,470)  $(2,262)   $2,324    $   532     $10,512
Cumulative interest sensitivity gap          $ 11,862  $19,268    $14,388   $ 9,918   $ 7,656    $9,980    $10,512
Gap ratio                                        1.31     3.17        .64       .73       .77      1.00       1.00        1.13
Cumulative gap ratio                             1.31     1.46       1.26      1.14      1.09      1.12       1.13
</TABLE>
(1)  Securities with call features have been included in the period in which the
     security becomes callable based on the likelihood that these securities may
     be called.
(2)  There were no nonaccruing loans or unamortized  deferred loan fees, both of
     which would normally be subtracted from loans for purposes of this table.


                                       9
<PAGE>

Provision for Loan Losses

         The  provision  for  loan  losses  is  charged  to  earnings  based  on
management's  continuing review and evaluation of the loan portfolio and general
economic  conditions.  The  following  table  summarizes  the  activity  in  the
allowance for loan losses.

<TABLE>
<CAPTION>
                                                                                              Year ended December 31,
                                                                                              -----------------------
                                                                                     2005               2004               2003
                                                                                     ----               ----               ----
<S>                                                                            <C>                  <C>                  <C>
Allowance for possible loan losses, beginning of year ................         $   919,384          $   727,971          $   553,372
Provision for loan losses ............................................             140,347              197,010              173,574
Charge-offs ..........................................................              (1,436)              (5,597)                   -
Recoveries ...........................................................                   -                    -                1,025
                                                                               -----------          -----------          -----------

Allowance for possible loan losses, end of year ......................         $ 1,058,295          $   919,384          $   727,971
                                                                               ===========          ===========          ===========
</TABLE>

         See "Impaired  Loans" and  "Allowance for Loan Losses" for a discussion
of the  factors  management  considers  in its  review  of the  adequacy  of the
allowance and provision for loan losses.

Other Income

         Other income,  which  consists  primarily of mortgage loan  origination
fees,  service charges on deposit accounts,  and other fee income,  increased by
$291,215 to $1,010,490,  in 2005 from $719,275 in 2004 and $616,994 in 2003. The
increase  in  2005  is  primarily   the  result  of  growth  in  mortgage   loan
originations.  The Bank also increased  fees from deposit  accounts and from the
Bank's overdraft  protection product due to growth. The Bank's newly established
insurance subsidiary contributed income of $7,689 in 2005.

Other Expenses

         Other  expenses,  which  consist  primarily  of salaries  and  employee
benefits,  occupancy,  and data  processing,  totaled $3.3 million in 2005, $2.7
million for 2004, and $2.5 million for 2003. Salaries and employee benefits rose
to $2.0 million in 2005 from $1.5 million in 2004 and $1.4 million in 2003.  The
increases in each year were due to the hiring of additional staff to support the
Bank's growth and annual salary  increases.  Personnel to staff the Bank's third
location were the primary staff  additions in 2005.  Net occupancy  increased to
$512,011 in 2005 over  $438,848 in 2004 and  $426,677 in 2003.  The  increase in
2005 is primarily due to the branch opened in July 2005. Data processing expense
increased  5.5% in 2005 after  decreasing  by 10.6% in 2004 as compared to 2003.
The  increase in 2005 is primarily  due to growth and the decrease  from 2003 to
2004 was the  result  of  renegotiation  of  certain  contractual  arrangements.
Supplies  and  advertising  expenses  as well as other  operating  expenses  all
increased mainly due to expenses  associated with the opening of the new branch.
The Company's  efficiency  ratio,  which is measured as the ratio of noninterest
expense to the sum of net  interest  income  plus other  income  expressed  as a
percentage,  improved in 2005 to 64%  compared to 68% in 2004 and 78% in 2003 as
the Company's noninterest expenses continued to be spread over a larger customer
base.

Income Taxes

         For 2005 the Company  recorded income tax expense of $620,658  compared
to $388,898 in 2004 and  $183,418 in 2003.  The  increases  are due to increased
profitability.  The Bank  accounts for income taxes under  Financial  Accounting
Standards  ("SFAS") No. 109,  "Accounting  for Income  Taxes."  Certain items of
income and expense  (principally  provision for loan losses,  depreciation,  and
pre-opening  expenses)  are  included  in one  reporting  period  for  financial
accounting  purposes and another for income tax purposes.  Refer to the notes to
the Company's  consolidated  financial statements contained elsewhere herein for
more information.


                                       10
<PAGE>

Investment Securities

         Management  assigns securities upon purchase into one of the categories
(trading,  available-for-sale  and held-to-maturity)  designated by Statement of
SFAS No. 115 based on intent,  taking into consideration other factors including
expectations  for  changes  in  market  rates  of  interest,   liquidity  needs,
asset/liability  management strategies,  and capital requirements.  The Bank has
not historically held securities for trading purposes.  As of December 31, 2005,
2004 and 2003, the Bank's investment  portfolio comprised  approximately  12.4%,
13.1%, and 17.8%, respectively, of total assets.

         The following table  summarizes the carrying amounts of securities held
by the Bank at December  31, 2005 and 2004.  Available-for-sale  securities  are
stated at  estimated  fair  value.  Held-to-maturity  securities  are  stated at
amortized  cost.  Federal Reserve Bank of Richmond and Federal Home Loan Bank of
Atlanta stocks have no quoted market value, but have  historically been redeemed
at par value, and are therefore carried at cost.

                   Investment Securities Portfolio Composition

                                                                 December 31,
                                                                 ------------
                                                            2005           2004
                                                            -----          ----
                                                          (Dollars in thousands)
        Available for sale:
           U.S. Government Agencies ................       $ 7,676       $ 7,475
           Mortgage-backed securities ..............           663           880
           Corporate bonds .........................             -           217
           Municipal bonds .........................         1,351           403
                                                           -------       -------
              Total available for sale .............         9,690         8,975

        Held to maturity
           U.S. Government Agencies ................         3,704         3,714

        Federal Reserve Bank of Richmond stock .....           210           210
        Federal Home Loan Bank of Atlanta stock ....           400           322
                                                           -------       -------

        Total ......................................       $14,004       $13,221
                                                           =======       =======


         The  following  table  presents  contractual  maturities  and  weighted
average  yields of  securities  at December  31, 2005 and 2004.  Securities  are
presented at their carrying value  (available for sale securities are carried at
fair value and held to maturity  securities are carried at book value,  which is
equal to their amortized cost.)

                                       11
<PAGE>

              Investment Securities Portfolio Maturities and Yields

<TABLE>
<CAPTION>
                                                                    December 31, 2005            December 31, 2004
                                                                 Amount        Yield(1)        Amount        Yield(1)
                                                                 ------        --------        ------        --------
                                                                 (Dollars in thousands)        (Dollars in thousands)
<S>                                                            <C>               <C>         <C>               <C>
  Available for sale securities:
  U.S. Government Agencies
       Within one year .....................................   $ 3,953           2.90%       $   496           2.68%
       After one through five years ........................     3,223           4.40%         6,979           3.27%
       After five through ten years ........................       500           5.75%             -              -%
  FNMA Mortgage-backed securities (2) ......................       663           3.80%           880           3.66%
  Corporate bonds
       Within one year .....................................         -              -%           217           7.05%
  Municipal bonds maturing in five to ten years ............     1,351           3.53%           403           4.54%

  Held to maturity securities:
  U.S. Government Agencies
       Within one year .....................................     2,703           4.55%             -              -%
       After one through five years ........................     1,002           4.93%         3,714           4.65%

  Other securities
       No stated maturity ..................................       609           5.08%           532           4.64%
                                                               -------                       -------
       Total ...............................................   $14,004           4.00%       $13,221           3.82%
                                                               =======                       =======
</TABLE>
(1)  Yields calculated on a pre-tax basis.
(2)  The FNMA Mortgage-backed securities mature within 10 years on an amortizing
     basis.

         While the  majority of the  Company's  U.S.  Government  agency  bonds,
municipal bonds and U.S. government agency mortgage-backed  securities are in an
unrealized  loss position as of December 31, 2005,  none of these  securities is
expected  to  have a loss of  principal  at  final  maturity.  Furthermore,  the
weighted  average life of the securities  portfolio is less than three years and
the majority of the  securities  with losses have a remaining  life of less than
two years. The Company has the intent and ability to hold these securities until
such time as the value recovers or the securities  mature. The Company believes,
based on industry analyst reports and credit ratings,  that the deterioration in
value is  attributable to changes in market interest rates and not in the credit
quality  of  the  issuers  and  therefore,   these  losses  are  not  considered
other-than-temporary.  The Company's  investments  are obligations of the United
States,  its agencies,  or municipal  securities.  In the opinion of Management,
there is no concentration of credit risk in the investment portfolio.

Loan Portfolio

         Management believes the loan portfolio is adequately diversified. There
are no significant  concentrations of loans to any particular  individuals or in
industries which management believes pose a material risk to the Bank, and there
are no foreign loans.  The Bank does have loans in certain broad categories that
comprise over 25% of Tier 1 Capital  adjusted for the allowance for loan losses.
Those categories are as follows:  real estate rental and leasing,  construction,
retail trade,  professional,  scientific and technical services,  manufacturing,
health care and social assistance, and other services. The Company believes that
the Bank has  appropriate  controls in place to monitor risks that may arise due
to  concentrations  in  the  loan  portfolio.  Loans  made  outside  the  policy
guidelines  may  present  additional  credit  risk to the  Company.  In order to
monitor  these  loans  and the  total  number  and  amount  of loans  made  with
exceptions to loan  policies,  the Bank monitors all loans  approved with policy
exceptions.  Monthly, statistics regarding the number of loans and the amount of
loans with policy exceptions are reported to the Board of Directors.  One of the
policy exceptions  reported is for loans exceeding the regulatory limits on loan
to value  ratios.  As of December 31,  2005,  the Bank has $1.5 million of loans
which exceed regulatory loan to value guidelines, an amount which is well within
the allowable maximum of exceptions to the guidelines.

                                       12
<PAGE>

The  banking  industry  offers  products  that can  increase  credit risk should
economic  conditions  change  over the  course of a loan's  life.  Interest-only
loans,  adjustable rate loans, and loans with  amortization  periods that differ
from the maturity date (i.e.,  balloon  payment  loans) are examples of products
that could  subject the Company to increased  credit risk in periods of changing
economic  conditions.  The Company  evaluates each customer's  credit worthiness
based on current and expected  economic  conditions and underwrites and monitors
each loan for  associated  risks.  Therefore,  Management  does not believe that
these  particular  products  subject the Company to unusual  credit risk.  As of
December 31, 2005, the Bank does not portfolio  residential  mortgage loans with
negative  amortization  features,  long term principal only payment features, or
loan to value ratios in excess of 100%.

         The Bank has a mortgage loan brokerage department that accepts mortgage
applications  for  terms  greater  than  15  years.  Mortgage  applications  are
processed and sent to third parties for underwriting.  Approved loans are funded
by,  and  closed  in the  name  of,  third  parties  and the  Bank  receives  an
origination fee.

         The amount of loans outstanding at December 31, 2005 and 2004 are shown
in the following table according to type of loan: Loan Portfolio Composition

<TABLE>
<CAPTION>
                                                                                          December 31,
                                                                                          ------------
                                                                               2005                            2004
                                                                               ----                            ----
                                                                                      (Dollars in thousands)
                                                                                       % of                          % of
                                                                        Amount        Loans            Amount       Loans
                                                                        ------        -----            ------       -----
<S>                                                                     <C>          <C>              <C>           <C>
        Commercial and industrial ...................................   $19,092       21.9%           $13,355        17.8%
        Real Estate - construction ..................................    21,267       24.4             16,011        21.3
        Real Estate - mortgage
               1-4 family residential ...............................    17,754       20.3             17,211        22.9
               Nonfarm, nonresidential ..............................    25,583       29.3             23,204        30.9
               Multifamily residential ..............................     2,042        2.3              2,517         3.3
        Consumer installment ........................................     1,594        1.8              2,860         3.8
                                                                        -------       ----            -------       -----
               Total Loans ..........................................    87,332       100.0%           75,158       100.0%
                Less allowance for loan losses ......................    (1,058)                         (919)
                                                                        -------                       -------
                   Net Loans ........................................   $86,274                       $74,239
                                                                        =======                       =======
</TABLE>

Maturity Distribution of Loans

         The Bank's loan  portfolio  has a large  component of  adjustable  rate
loans.  As of December 31,  2005,  approximately  $51.5  million or 58.9% of the
Bank's loan portfolio was variable.  The following table sets forth the maturity
distribution  of the Bank's loans,  by type, as of December 31, 2005, as well as
the type of  interest  requirement  on such loans.  For  purposes of this table,
variable  rate loans are  included  in the period of their  final  maturity,  as
opposed to their repricing date.


                                       13
<PAGE>

                                       Maturity Distribution on Loans

<TABLE>
<CAPTION>
                                                                            December 31, 2005
                                                                            -----------------
                                                                             (Dollars in Thousands)
                                                                1 Year       1-5       5 Years
                                                               or Less      Years      or More       Total
                                                               -------      -----      -------       -----
<S>                                                             <C>        <C>           <C>        <C>
Commercial and industrial ..................................    $11,525    $ 6,991       $  576     $19,092
Real Estate-construction ...................................     16,057      4,690          520      21,267
Real Estate-mortgage .......................................      9,207     31,073        5,099      45,379
Consumer installment .......................................        904        627           63       1,594
                                                                -------    -------       ------     -------
      Total ................................................    $37,693    $43,381       $6,258     $87,332
                                                                =======    =======       ======     =======

Predetermined rate, maturity greater than one year .........               $27,018       $1,762     $28,780

Variable rate, maturity greater than one year ..............               $16,363       $4,496     $20,859
</TABLE>

For purposes of the table above,  variable rate loans are included in the period
of maturity, rather than in the period in which they can reprice.

Impaired Loans

         A loan will be considered to be impaired when, in management's judgment
based on  current  information  and  events,  it is  probable  that  the  loan's
principal or interest will not be  collectible  in accordance  with the terms of
the original loan agreement.  Impaired loans, when not material, will be carried
in the balance sheet at a value not to exceed their  observable  market price or
the fair value of the  collateral if the repayment of the loan is expected to be
provided  solely  by the  underlying  collateral.  The  carrying  values  of any
material  impaired loans will be measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate, which is the
contractual  interest rate adjusted for any deferred loan fees or costs, premium
or discount existing at the inception or acquisition of the loan.

         Loans  which  management  identifies  as  impaired  generally  will  be
nonperforming loans. Nonperforming loans include nonaccrual loans or loans which
are 90 days or more delinquent as to principal or interest payments. At December
31,  2005 and 2004,  the Bank had no  nonaccrual  loans or loans 90 days or more
past due and no restructured loans.

         Generally,  the accrual of interest  will be  discontinued  on impaired
loans when  principal  or interest  becomes 90 days past due, or when payment in
full is not anticipated,  and any previously accrued interest on such loans will
be reversed  against  current  income.  Any subsequent  interest  income will be
recognized on a cash basis when received unless  collectibility of a significant
amount of principal is in serious doubt. In such cases, collections are credited
first to the remaining  principal  balance on a cost recovery basis. An impaired
loan will not be returned to accrual  status  unless  principal and interest are
current  and the  borrower  has  demonstrated  the  ability to  continue  making
payments as agreed.

Potential Problem Loans

         Management  identifies and maintains a list of potential problem loans.
These are loans that are not included in  nonaccrual  status,  or loans that are
past due 90 days or more and  still  accruing  interest.  A loan is added to the
potential  problem  list when  management  becomes  aware of  information  about
possible  credit  problems of  borrowers  that causes  serious  doubts as to the
ability of such borrowers to comply with the current loan repayment terms. These
loans are  designated  as such in order to be monitored  more closely than other
credits in the Bank's  portfolio.  There were two loans determined by management
to be  potential  problem  loans at  December  31, 2005  totaling  approximately
$275,000. Management is currently assessing the potential impact on the Bank and
the Company. It is not possible to determine the impact at this time.


                                       14
<PAGE>

Allowance for Loan Losses

         The  allowance  for loan  losses  is  increased  by direct  charges  to
operating expense.  Losses on loans will be charged against the allowance in the
period in which  management  determines  that it is likely  that such loans have
become  uncollectible.  Recoveries  of  previously  charged  off  loans  will be
credited to the  allowance.  In reviewing the adequacy of the allowance for loan
losses at each year end,  management will take into consideration the historical
loan losses experienced by the bank, current economic  conditions  affecting the
borrowers'  ability to repay, the volume of loans, and the trends in delinquent,
nonaccruing,  and any  potential  problem  loans,  and the quality of collateral
securing nonperforming and problem loans. Management considers the allowance for
loan losses to be adequate to cover its estimate of loan losses  inherent in the
loan portfolio as of December 31, 2005.

         In  calculating  the amount  required in the allowance for loan losses,
management  applies a  consistent  methodology  that is updated  quarterly.  The
methodology  utilizes a loan risk grading  system and  detailed  loan reviews to
assess credit risks and the overall  quality of the loan  portfolio.  Also,  the
calculation provides for management's assessment of trends in national and local
economic conditions that might affect the general quality of the loan portfolio.


                         Summary of Loan Loss Experience

<TABLE>
<CAPTION>
                                                                                                        Year Ended December 31,
                                                                                                        -----------------------
                                                                                                      2005                    2004
                                                                                                      ----                    ----
                                                                                                        (Dollars in thousands)

<S>                                                                                                 <C>                   <C>
Total loans outstanding at end of period ...............................................            $ 87,332              $ 75,158
Average amount of loans outstanding ....................................................            $ 77,654              $ 65,128

Balance of allowance for loan losses-beginning .........................................            $    919              $    728
Loans charged-off
      Real estate mortgage .............................................................                   -                     4
      Consumer installment .............................................................                   1                     2
                                                                                                    --------              --------
      Total charge-offs ................................................................                   1                     6
Recoveries of loans previously charged-off .............................................                   -                     -
                                                                                                    --------              --------
Net (charge-offs) recoveries ...........................................................                  (1)                   (6)

Additions to allowance charged to expense ..............................................                 140                   197
                                                                                                    --------              --------


Additions to allowance charged to expense
Balance of allowance for loan losses-ending ............................................            $  1,058              $    919
                                                                                                    ========              ========
Ratios
      Net (charge-offs) recoveries to average loans outstanding ........................             <(.01%)               <(.01%)
      Net (charge-offs) recoveries to loans at end of period ...........................             <(.01%)               <(.01%)
      Allowance for loan losses to average loans .......................................                1.36%                 1.41%
      Allowance for loan losses to loans at end of period ..............................                1.21%                 1.22%
      Net (charge-offs) recoveries to allowance for loan losses ........................                (.10%)                (.60%)
      Net (charge-offs) recoveries to provision for loan losses ........................               (1.02%)               (2.84%)
</TABLE>

         The allowance for loan losses is not restricted to specific  categories
of loans and is available to absorb losses in all  categories.  Each category of
loans is reviewed for  characteristics  that  increase or decrease risk of loss,
such  as  the   availability  and   marketability   of  collateral,   degree  of
susceptibility  to  changes  in  economic  conditions,  etc.,  for  purposes  of
estimating  the  allowance  for loan losses.  (See  "Services of the Bank" for a
discussion of risk characteristics for each loan category.) Individual loans are
graded using an internal grading system that considers  information  specific to
the loan. If warranted,  a specific  allocation may be associated with that loan
for purposes of estimating the adequacy of the allowance for loan losses.


                                       15
<PAGE>

Real Estate Owned

         The  Bank  had  no  real  estate  owned   pursuant  to  foreclosure  or
in-substance  foreclosure  at December 31, 2005.  Real estate owned is initially
recorded at the lower of net loan principal balance or its estimated fair market
value less estimated  selling  costs.  The estimated fair value is determined by
appraisal at the time of acquisition.


Deposits

         The amounts and percentage  composition of deposits held by the Bank as
of December 31, 2005 and 2004 are summarized below:

                               Deposit Composition

<TABLE>
<CAPTION>
                                                                      December 31,
                                                                      ------------
                                                          2005                           2004
                                                          ----                           ----
                                                               (Dollars in thousands)
                                                               % of                            % of
                                                Amount         Deposits         Amount         Deposits
                                                ------         --------         ------         --------

<S>                                            <C>              <C>             <C>             <C>
Noninterest bearing demand .................   $10,452           11.4%          $ 9,405          11.4%
Interest bearing transaction accounts ......    15,966           17.4            13,416          16.3
Savings ....................................     3,545            3.9             4,006           4.9
Money market ...............................     6,244            6.8            15,373          18.6
Time deposits $100,000 and over ............    26,006           28.4            17,012          20.6
Other time deposits ........................    29,439           32.1            23,307          28.2
                                               -------          -----           -------         -----
    Total deposits .........................   $91,652          100.0%          $82,519         100.0%
                                               =======          =====           =======         =====
</TABLE>

         The average  amounts of and average  rate paid on deposits  held by the
Bank for the years ended December 31, 2005 and 2004, are summarized below:

                                Average Deposits

<TABLE>
<CAPTION>
                                                                                  Year ended December 31,
                                                                                  -----------------------
                                                                             2005                        2004
                                                                             ----                        ----
                                                                     Amount         Rate         Amount         Rate
                                                                     ------         ----         ------         ----
                                                                                  (Dollars in thousands)
<S>                                                                    <C>           <C>          <C>            <C>
Noninterest bearing demand .......................................     $ 9,654          -%        $ 8,652           -%
Interest bearing transaction accounts ............................      13,510       1.04%         11,833        1.01%
Savings and money market .........................................      11,689       1.17%         15,829        1.02%
Time deposits ....................................................      49,939       3.34%         34,556        2.59%
                                                                       -------                    -------
      Total average deposits .....................................     $84,792                    $70,870
                                                                       =======                    =======
</TABLE>

         As of December 31, 2005,  the Bank held $ 26.0 million of time deposits
with  balances of $100,000 or more. Of that amount,  $4.9 million  mature within
three months,  $2.3 million  mature over three through six months,  $6.7 million
mature over six through  twelve  months,  and $12.1  million  mature over twelve
months.  $3.5  million of time  deposits  over  $100,000 or more are at floating
rates of interest at December 31, 2005.  The majority of time deposits  $100,000
and over are  acquired  from  customers  within the Bank's  service  area in the
ordinary course of business.  While most of the large time deposits are acquired
from  customers  with  standing  relationships  with  the  Bank,  it is a common
industry  practice  not to consider  these  types of  deposits as core  deposits
because  their  retention  can be  expected  to be heavily  influenced  by rates
offered,   and  therefore  such  deposits  may  have  the   characteristics   of
shorter-term  purchased  funds.  Time  deposits  $100,000  and over  involve the
maintenance  of  an  appropriate   matching  of  maturity   distribution  and  a
diversification of sources to achieve an appropriate level of liquidity.


                                       16
<PAGE>

Customer Repurchase Agreements

         Customer  repurchase  agreements  consist of sweep  accounts and retail
repurchase agreements, and totaled $3.1 million and $5.5 million at December 31,
2005 and 2004, respectively.  U. S. Government securities with an amortized cost
of $5.6 million and $6.5 million  (fair value of $5.5 million and $6.5  million)
were used as collateral for the sweep accounts and retail repurchase agreements,
at December 31, 2005 and 2004, respectively.  The majority of these accounts pay
interest on a floating rate basis.

Liquidity

         Liquidity is the ability to meet current and future obligations through
liquidation  or maturity of existing  assets or the  acquisition  of  additional
liabilities.  Adequate  liquidity  is  necessary  to meet  the  requirements  of
customers for loans and deposit  withdrawals  in the most timely and  economical
manner.  Some liquidity is ensured by maintaining assets that may be immediately
converted  into cash at minimal cost  (amounts due from banks and federal  funds
sold).  However,  the most  manageable  sources of  liquidity  are  composed  of
liabilities, with the primary focus on liquidity management being on the ability
to obtain deposits within the Bank's service area. Core deposits (total deposits
less time deposits  greater than $100,000)  provide a relatively  stable funding
base, and were equal to 57.9% of total assets at December 31, 2005.

         Asset liquidity is provided from several sources, including amounts due
from banks and federal funds sold,  and funds from maturing  loans.  The Company
had over $5.9 million in cash and liquid  assets at December 31, 2005.  The Bank
has $4.4 million  available  through lines of credit with other banks and a line
with the Federal  Home Loan Bank of Atlanta  ("FHLB") as  additional  sources of
liquidity  funding.  The line with the FHLB is equal to 10% of  assets  provided
that adequate  collateral  is available  for pledging.  The line may be used for
short or long term  funding  needs  and may be used on a fixed or  variable-rate
basis.  The lines  with the  other  banks  are for  short-term  use only and are
unsecured.  As of December 31, 2005,  the Bank had $4.3 million at various fixed
rates of interest,  maturing at various  dates  through 2014  borrowed  from the
FHLB. The highest balance at any month end was $6.7 million. The average balance
for 2005 was $3.9 million.  The average rate paid on the borrowings for 2005 was
3.56%.  The weighted average interest rate as of December 31, 2005 was 3.71%. At
December 31, 2005  approximately $6.9 million of additional funds were available
under the FHLB  line.  Management  believes  that the Bank's  overall  liquidity
sources are adequate to meet its operating  needs in the ordinary  course of its
business.

Off-Balance Sheet Risk

         The Company,  through the  operations  of the Bank,  makes  contractual
commitments to extend credit in the ordinary course of its business  activities.
These  commitments are legally binding  agreements to lend money to customers of
the Bank at  predetermined  interest  rates for a specified  period of time.  At
December 31, 2005,  the Bank had issued  commitments  to extend  credit of $17.3
million through  various types of lending  arrangements.  Of these  commitments,
$14.1 million are at variable rates and $11.5 million of the total expire within
one year.  Past  experience  indicates that many of these  commitments to extend
credit will expire  unused and it is unlikely that a large portion would be used
in a short period of time.

         In  addition  to  commitments  to extend  credit,  the Bank also issues
standby  letters of credit which are  assurances to a third party that they will
not  suffer  a loss  if the  Bank's  customer  fails  to  meet  its  contractual
obligation to the third party.  Standby letters of credit totaled  approximately
$545,000 at December  31, 2005.  Past  experience  indicates  that many of these
standby  letters of credit  will  expire  unused.  However,  through its various
sources of liquidity  discussed  above,  the Bank believes that it will have the
necessary resources to meet these obligations should the need arise.

         The  Bank   offers   an   automatic   overdraft   protection   product.
Approximately  $1.1 million of  overdraft  protection  is  available  under this
product as of December 31, 2005.  The Bank expects the majority of this capacity
will not be  utilized.  During  2005  the  average  balance  of  demand  deposit
overdrafts was approximately $19,000.

         Neither the Company nor the Bank is involved in other off-balance sheet
contractual relationships, unconsolidated related entities that have off-balance

                                       17
<PAGE>

sheet  arrangements,  or  transactions  that could result in liquidity  needs or
other commitments or significantly impact earnings. The Company did not maintain
any obligations under non-cancelable  operating lease agreements at December 31,
2005.  The  Company is in the second year of a  five-year  contract  with a data
processing service. The annual costs are approximately $180,000.  Refer to notes
10 and 14 to the Company's  consolidated  financial  statements  for  additional
discussion on commitments and contingencies  and financial  instruments with off
balance sheet risk.

Capital Resources

         At  December  31,  2005,  total   shareholders'   equity  increased  by
approximately  $5.0  million  from $8.8  million at  December  31, 2004 to $13.8
million at December 31,  2005.  Most of the increase was a result of a secondary
offering of common stock by the Company  during  2005,  which  increased  common
stock by $4.1 million as of December 31, 2005. The remainder of the increase was
due to net  income of  $1,061,265,  partially  offset by an  unrealized  loss on
investment  securities and cash paid in lieu of fractional shares as a result of
a stock  dividend  paid in 2005.  The  Company  does not  anticipate  it will be
required  to raise  additional  capital  in 2006 if  growth  occurs in line with
current expectations.

         The Company made capital  expenditures  for bank premises and furniture
and equipment in 2005 totaling  approximately $1.0 million.  There are currently
no plans for large capital  expenditures in 2006, but certain equipment may need
to be replaced from time to time. Such  expenditures  were made, or are expected
to be made, from cash on hand.

         The  Company and the Bank are subject to  regulatory  capital  adequacy
standards.  Under  these  standards,  financial  institutions  are  required  to
maintain certain minimum ratios of capital to  risk-weighted  assets and average
total assets. Under the provisions of the Federal Deposit Insurance  Corporation
Improvements Act of 1991, federal financial institution  regulatory  authorities
are  required  to  implement  prescribed  "prompt  corrective  action"  upon the
deterioration  of the capital  position of a bank. If the capital position of an
affected institution were to fall below certain levels,  increasingly  stringent
regulatory  corrective  actions  are  mandated.  The Bank's  regulatory  capital
requirements  and  positions  are  summarized  in  note  18 to the  consolidated
financial  statements.  Because the  Company's  total  assets are less than $150
million,  the  Company's  capital  adequacy was  measured by the Bank's  capital
adequacy,  pursuant to the  guidelines of the Federal  Reserve in effect in 2005
and 2004.

Return on Equity and Assets

         The following  table shows the return on assets (net income  divided by
average total assets),  return on equity (net income divided by average equity),
dividend payout ratio (cash  dividends  declared per share divided by net income
per share),  and equity to assets ratio (average equity divided by average total
assets) for the years ended December 31, 2005 and 2004.

                                                      2005              2004
                                                      ----              ----

Return on assets ...............................     1.02%               .75%
Return on equity ...............................    10.56%              7.89%
Dividend payout ratio ..........................        -%                 -%
Equity to assets ratio (average) ...............     9.66%              9.45%

         The return on assets and equity  improved in 2005 due largely to growth
in the Bank. In the fourth  quarter 2005 the Company  offered  445,000 shares of
common stock in a secondary offering.  The shares were only slightly dilutive to
2005, due to the date of the offering.  However,  the additional  shares will be
dilutive to 2006 results.

         During 2006, the Bank's plan of operation is to attract new deposit and
loan customers,  to increase the ratio of services per customer and increase the
account profitability of the Bank's current customers.  Deposit accounts will be
sought from  individuals and businesses in the Easley,  Berea,  Powdersville and
surrounding  markets.  The Bank  intends  to offer  competitive  rates  for such
accounts  and may seek new  accounts  by  offering  rates  slightly  above those
prevailing  in the  market.  Management  will  continue  to  emphasize  personal
service, accessibility,  and flexibility as reasons for customers to do business
with the Bank.  Personal  contacts by management,  advertising,  and competitive
prices and services will be the Bank's principal marketing tools.

                                       18
<PAGE>

Inflation

         Since the assets and  liabilities  of a bank are primarily  monetary in
nature (payable in fixed,  determinable  amounts),  the performance of a bank is
affected  more by changes in interest  rates than by inflation.  Interest  rates
generally increase as the rate of inflation increases,  but the magnitude of the
change in rates may not be the same.

         While the effect of inflation  on banks is normally not as  significant
as is its influence on those businesses that have large investments in plant and
inventories, it does have an effect. During periods of high inflation, there are
normally  corresponding  increases in the money supply,  and banks will normally
experience  above-average  growth in assets,  loans and  deposits.  Also general
increases  in the  prices  of goods and  services  usually  result in  increased
operating expenses.

Market for Common Equity and Related Stockholder Matters

         Although  the common  stock of the  Company  may be traded from time to
time on an individual  basis,  no  established  trading market has developed and
none is expected to develop in the foreseeable  future.  The common stock is not
listed on any exchange nor is it traded on the NASDAQ  National  Market  System,
nor are there any market makers known to  management.  During the fourth quarter
of 2005, the Company  offered  445,000 shares of its common stock in a secondary
offering.  Prior to December 31, 2005,  the Company sold  approximately  305,000
shares of stock at $13.50 per share.  The  secondary  offering of the  Company's
shares continued through January 15, 2006, and the remaining 140,000 shares were
sold at $13.50 per  share.  As of March 1, 2006,  there were  approximately  662
holders  of  record  of  the  Company's  common  stock,   excluding   individual
participants in security position listings.

         From time to time the Company has issued  stock-based  compensation  to
Directors and certain  executive  officers and  employees of the Bank.  Prior to
December 31, 2005 there were a total of 34,320 options  outstanding that had not
yet vested under the company 2003 Stock Option Plan. In anticipation of adoption
of SFAS No. 123 (R) and to eliminate  the expense to be recorded,  on January 1,
2006, the Company  accelerated the vesting of options  previously  granted under
the 2003 Plan. Notes 1 and 16 of the Company's consolidated financial statements
summarize  the  Company's  stock  option  plans and the  effect of  accelerating
vesting of options granted under the 2003 plan.

         To date the  Company has not paid any cash  dividends,  and to maintain
its  capital,  does not expect to pay cash  dividends  in the near  future.  The
dividend  policy of the  Company is subject  to the  discretion  of the Board of
Directors and depends upon a number of factors,  including  earnings,  financial
conditions,  cash needs and general business  conditions,  as well as applicable
regulatory  considerations.  Because the Company  has no  operations  other than
those of the Bank and only has limited income of its own, the Company would rely
on  dividends  from  the  Bank as its  principal  source  of  cash  to pay  cash
dividends.

         Each national banking  association is required by federal law to obtain
the prior  approval of the OCC for the payment of  dividends if the total of all
dividends  declared  by the  board of  directors  of such  bank in any year will
exceed the total of (i) such bank's net profits (as defined and  interpreted  by
regulation)  for that year plus (ii) the  retained  net  profits (as defined and
interpreted  by  regulation)  for the  preceding  two years,  less any  required
transfers to surplus. In addition,  national banks can only pay dividends to the
extent that retained net profits (including the portion  transferred to surplus)
exceed bad debts (as defined by regulation).

         The  payment  of  dividends  by the  Company  and the  Bank may also be
affected  or limited by other  factors,  such as the  requirements  to  maintain
adequate capital above regulatory guidelines. In addition, if, in the opinion of
the applicable regulatory authority, a bank under its jurisdiction is engaged in
or is about to engage in an unsafe or unsound practice (which,  depending on the
financial  condition of the Bank, could include the payment of dividends),  such
authority may require, after notice and hearing, that such bank cease and desist
from such practice.  The OCC has indicated that paying  dividends that deplete a
national  bank's  capital  base to an  inadequate  level  would be an unsafe and
unsound banking practice.  The Federal Reserve, the OCC and the FDIC have issued
policy  statements,  which provide that bank holding companies and insured banks
should generally only pay cash dividends out of current operating earnings.


                                       19
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Board of Directors
Cornerstone Bancorp and Subsidiary
Easley, South Carolina


           We have  audited  the  accompanying  consolidated  balance  sheets of
Cornerstone  Bancorp and Subsidiary  (the "Company") as of December 31, 2005 and
2004,   and  the  related   consolidated   statements  of  income,   changes  in
shareholders' equity and comprehensive income (loss), and cash flows for each of
the years in the three year period ended December 31, 2005.  These  consolidated
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

           We  conducted  our audits in  accordance  with the  standards  of the
Public Company  Accounting  Oversight  Board (United  States).  Those  standards
require that we plan and perform the audits to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement.
An audit includes  examining,  on a test basis,  evidence supporting the amounts
and disclosures in the consolidated financial statements. An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall consolidated  financial statement
presentation.  We believe  that our audits  provide a  reasonable  basis for our
opinion.

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




                                                          /s/ Elliott Davis, LLC


Greenville, South Carolina
February 3, 2006

                                       20
<PAGE>

                       CORNERSTONE BANCORP AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                                              December 31,
                                                                                                              ------------
                                                                                                       2005                  2004
                                                                                                       ----                  ----
ASSETS

<S>                                                                                              <C>                  <C>
Cash and due from banks ..................................................................       $   2,716,965        $   3,008,847

Federal funds sold .......................................................................           3,183,000            4,130,595

Investment securities
     Available-for-sale ..................................................................           9,689,665            8,975,528
     Held-to-maturity (Fair value $3,707,125 in 2005 and $3,812,437 in 2004) .............           3,704,861            3,713,645
     Other investments ...................................................................             609,800              532,100

Loans, net ...............................................................................          86,273,605           74,238,769
Property and equipment, net ..............................................................           4,577,858            3,778,983
Cash surrender value of life insurance policies ..........................................           1,573,038            1,515,172
Other assets .............................................................................             972,872              738,480
                                                                                                 -------------        -------------
              Total assets ...............................................................       $ 113,301,664        $ 100,632,119
                                                                                                 =============        =============


LIABILITIES AND SHAREHOLDERS' EQUITY

Liabilities
     Deposits
         Noninterest bearing .............................................................       $  10,451,922        $   9,405,079
         Interest bearing ................................................................          81,200,119           73,113,865
                                                                                                 -------------        -------------
         Total deposits ..................................................................          91,652,041           82,518,944
     Customer repurchase agreements ......................................................           3,083,884            5,483,993
     Borrowings from Federal Home Loan Bank of Atlanta ...................................           4,346,505            3,400,000
     Other liabilities ...................................................................             391,249              451,722
                                                                                                 -------------        -------------

         Total liabilities ...............................................................          99,473,679           91,854,659

Commitments and contingencies - Notes 10 and 14

Shareholders' equity
     Preferred stock, 10,000 shares authorized, no shares issued .........................                   -                    -
     Common stock, no par value, 20,000,000 shares authorized, 1,475,743 and
       1,064,656 shares issued at December 31, 2005 and 2004, respectively ...............          13,071,896            8,253,812
     Retained earnings ...................................................................             837,565              543,807
       Accumulated other comprehensive income (loss) .....................................             (81,476)             (20,159)
                                                                                                 -------------        -------------

         Total shareholders' equity ......................................................          13,827,985            8,777,460
                                                                                                 -------------        -------------

         Total liabilities and shareholders' equity ......................................       $ 113,301,664        $ 100,632,119
                                                                                                 =============        =============
</TABLE>

         The  accompanying  notes  are an  integral  part of these  consolidated
financial statements.

                                       21
<PAGE>

                       CORNERSTONE BANCORP AND SUBSIDIARY
                        CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                                                Year ended December 31,
                                                                                                -----------------------
                                                                                        2005              2004               2003
                                                                                        ----              ----               ----
INTEREST INCOME
<S>                                                                                 <C>                <C>                <C>
     Loans and fees on loans ..............................................         $5,631,109         $3,990,474         $3,166,185
     Investment securities ................................................            463,770            493,578            585,729
     Federal funds sold and other interest income .........................            148,694             47,618             49,158
                                                                                    ----------         ----------         ----------

         Total interest income ............................................          6,243,573          4,531,670          3,801,072

INTEREST EXPENSE
     Deposits .............................................................          1,944,612          1,176,198          1,130,605
       Federal funds sold and customer repurchase agreements ..............             53,873             67,348             63,664
     Federal Home Loan Bank advances ......................................            140,456             47,097              2,133
                                                                                    ----------         ----------         ----------

         Total interest expense ...........................................          2,138,941          1,290,643          1,196,402
                                                                                    ----------         ----------         ----------

         Net interest income ..............................................          4,104,632          3,241,027          2,604,670

     Provision for possible loan losses ...................................            140,347            197,010            173,574
                                                                                    ----------         ----------         ----------

         Net interest income after provision for loan losses ..............          3,964,285          3,044,017          2,431,096

NONINTEREST INCOME
     Mortgage loan origination fees .......................................            501,352            289,962            366,433
     Service fees on deposit accounts .....................................            408,561            383,125            223,303
     Gains on sale of security ............................................                  -              5,230                  -
     Other ................................................................            100,577             40,958             27,258
                                                                                    ----------         ----------         ----------

         Total noninterest income .........................................          1,010,490            719,275            616,994
                                                                                    ----------         ----------         ----------

NONINTEREST EXPENSES
     Salaries and benefits ................................................          1,953,315          1,520,890          1,430,947
     Advertising ..........................................................             74,517             54,332             34,241
     Supplies .............................................................             99,805             65,402             85,012
     Data processing ......................................................            150,336            142,523            159,404
     Occupancy and equipment ..............................................            512,011            438,848            426,677
     Professional fees ....................................................            110,645             95,790             79,184
     Directors fees .......................................................             69,175             58,100             50,050
     Deposit charge-offs ..................................................             24,383             65,999              9,421
     Other operating ......................................................            298,665            268,453            233,688
                                                                                    ----------         ----------         ----------

         Total noninterest expenses .......................................          3,292,852          2,710,337          2,508,624
                                                                                    ----------         ----------         ----------

         Income before income taxes .......................................          1,681,923          1,052,955            539,466

     Income tax provision .................................................            620,658            388,898            183,418
                                                                                    ----------         ----------         ----------

         Net income .......................................................         $1,061,265         $  664,057         $  356,048
                                                                                    ==========         ==========         ==========

EARNINGS PER COMMON SHARE
     Basic ................................................................         $      .89         $      .57         $      .30
     Diluted ..............................................................         $      .86         $      .56         $      .30

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
     Basic ................................................................          1,196,250          1,170,938          1,170,938
     Diluted ..............................................................          1,236,740          1,194,879          1,189,289

</TABLE>

         The  accompanying  notes  are an  integral  part of these  consolidated
financial statements.

                                       22
<PAGE>

                       CORNERSTONE BANCORP AND SUBSIDIARY
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                         AND COMPREHENSIVE INCOME (LOSS)

<TABLE>
<CAPTION>
                                                                                                         Accumulated
                                                                Common stock              Retained          other           Total
                                                                ------------              earnings     comprehensive   shareholders'
                                                             Shares        Amount         (deficit)     income (loss)      equity
                                                             ------        ------         ---------     -------------      ------
<S>                                                        <C>         <C>             <C>             <C>             <C>
Balance, December 31, 2002 ..........................        879,994   $  7,984,925    $   (205,734)   $     80,946    $  7,860,137
                                                                                                                       ------------
   Net income .......................................              -              -         356,048               -         356,048
   Other comprehensive income, net
     of income taxes:
   Unrealized loss on investment
        securities ..................................              -              -               -         (49,216)        (49,216)
                                                                                                                       ------------
   Comprehensive income .............................                                                                       306,832
   Stock dividend (10%), net of cash
     in lieu of fractional shares ...................         87,974           (317)              -               -            (317)
                                                           ---------   ------------    ------------    ------------    ------------

Balance, December 31, 2003 ..........................        967,968      7,984,608         150,314          31,730       8,166,652
                                                                                                                       ------------
Net income ..........................................              -              -         664,057               -         664,057
   Other comprehensive income, net of income taxes:
   Unrealized loss on investment
        securities ..................................              -              -               -         (51,889)        (51,889)
                                                                                                                       ------------
   Comprehensive income .............................                                                                       612,168
   Stock dividend (10%), net of
     cash in lieu of fractional shares ..............         96,688        269,204        (270,564)              -          (1,360)
                                                           ---------   ------------    ------------    ------------    ------------

 Balance, December 31, 2004 .........................      1,064,656      8,253,812         543,807         (20,159)      8,777,460
                                                                                                                       ------------
Net income ..........................................              -              -       1,061,265               -       1,061,265
   Other comprehensive income, net of income taxes:
   Unrealized loss on investment
        securities ..................................              -              -               -         (61,317)        (61,317)
                                                                                                                       ------------
   Comprehensive income .............................                                                                       999,948
   Stock dividend (10%), net of
     cash in lieu of fractional
     shares .........................................        106,282        764,937        (767,507)              -          (2,570)

   Issuance of shares in secondary offering,
     net of offering expenses of $61,721 ............        304,805      4,053,147               -               -       4,053,147
                                                           ---------   ------------    ------------    ------------    ------------

Balance, December 31, 2005 ..........................      1,475,743   $ 13,071,896    $    837,565    $    (81,476)   $ 13,827,985
                                                           =========   ============    ============    ============    ============
</TABLE>













         The  accompanying  notes  are an  integral  part of these  consolidated
financial statements


                                       23
<PAGE>

                       CORNERSTONE BANCORP AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                                Year ended December 31,
                                                                                                -----------------------
                                                                                      2005               2004               2003
                                                                                      ----               ----               ----
Operating Activities
<S>                                                                              <C>                <C>                <C>
     Net income ...........................................................      $  1,061,265       $    664,057       $    356,048
     Adjustments to reconcile net income to net cash provided by
        operating activities
         Depreciation and net amortization ................................           258,796            233,714            281,036
         Deferred income tax benefit ......................................            (9,743)           (72,500)           (39,200)
         Provision for possible loan losses ...............................           140,347            197,010            173,574
         (Gain) loss on sale of property and equipment ....................                 -             (1,255)             2,191
         Gain on sale of securities .......................................                 -             (5,230)                 -
         (Increase) decrease in other assets ..............................          (282,515)           (34,709)            72,422
         Increase (decrease) in other liabilities .........................           (66,593)            36,302            191,565
                                                                                 ------------       ------------       ------------

             Net cash provided by operating activities ....................         1,101,557          1,017,389          1,037,636
                                                                                 ------------       ------------       ------------

Investing Activities
     Decrease (increase) in federal funds sold ............................           947,595           (972,087)        (2,153,508)
     Proceeds from maturities and principal paydowns of
        investment securities .............................................         1,644,197          6,972,660         11,381,446
     Proceeds from sales of securities ....................................                 -            708,422                  -
     Purchase of investment securities ....................................        (2,458,873)        (5,872,451)        (7,501,000)
     Purchase of Federal Home Loan Bank of Atlanta stock, net .............           (77,700)           (72,100)          (280,000)
     Purchase of life insurance policies ..................................                 -           (421,183)        (1,088,338)
     Increase in loans, net ...............................................       (12,175,183)       (15,754,645)       (17,707,978)
     Proceeds from sale of property and equipment .........................                 -              8,299              2,500
     Purchase of property and equipment ...................................        (1,041,253)          (523,780)           (87,660)
                                                                                 ------------       ------------       ------------


             Net cash used for investing activities .......................       (13,161,217)       (15,926,865)       (17,434,538)
                                                                                 ------------       ------------       ------------

Financing Activities
     Net increase in deposits .............................................         9,133,097         17,232,725         11,578,697
     Net increase (decrease) in customer repurchase agreements ............        (2,400,109)          (288,199)           789,471
     Borrowings from Federal Home Loan Bank of Atlanta ....................         4,045,000          3,400,000          5,000,000
     Repayments to Federal Home Loan Bank of Atlanta ......................        (3,060,787)        (5,000,000)                 -
       Proceeds from sale of common stock, net ............................         4,053,147                  -                  -
     Cash paid in lieu of fractional shares ...............................            (2,570)            (1,360)              (317)
                                                                                 ------------       ------------       ------------

             Net cash provided by financing activities ....................        11,767,778         15,343,166         17,367,851
                                                                                 ------------       ------------       ------------

              Net increase (decrease) in cash and cash
                equivalents ...............................................          (291,882)           433,690            970,949

Cash and due from banks, beginning of year ................................         3,008,847          2,575,157          1,604,208
                                                                                 ------------       ------------       ------------

Cash and due from banks, end of year ......................................      $  2,176,965       $  3,008,847       $  2,575,157
                                                                                 ============       ============       ============

Cash paid for:
     Interest .............................................................      $  2,128,897       $  1,246,900       $  1,193,619
                                                                                 ============       ============       ============
     Income taxes .........................................................      $    835,000       $    388,991       $     42,679
                                                                                 ============       ============       ============
</TABLE>

         The  accompanying  notes  are an  integral  part of these  consolidated
financial statements

                                       24
<PAGE>

                       CORNERSTONE BANCORP AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES

         Cornerstone Bancorp, (the "Company") was incorporated under the laws of
the State of South  Carolina  for the  purpose of  operating  as a bank  holding
company  for  Cornerstone  National  Bank (the  "Bank").  The  Company  obtained
regulatory  approval  to acquire  the Bank and opened the Bank for  business  on
September 15, 1999,  with a total  capitalization  of $6.0 million.  To increase
capital  available for growth,  the Company offered 445,000 shares of its common
stock  pursuant to a prospectus  dated October 4, 2005. As of December 31, 2005,
304,805  shares had been sold.  Subsequent  to December 31,  2005,  by extension
through  January  15,  2006,  the  remaining  140,195  shares  were  sold.  Upon
completion, the offering added approximately $6.0 million to the Company's total
capitalization.

         The Bank provides full commercial  banking services to customers and is
subject to  regulation by the Office of the  Controller of the Currency  ("OCC")
and the  Federal  Deposit  Insurance  Corporation.  The  Company  is  subject to
regulation by Federal  Reserve and to limited  regulation by the South  Carolina
State Board of Financial  Institutions.  The Bank maintains  branch locations in
Greenville  and  Piedmont,  South  Carolina in addition to its  headquarters  in
Easley, South Carolina. In 2004, the Bank established a wholly owned subsidiary,
Crescent Financial Services, Inc. ("Crescent"), which is an insurance agency. In
2005 and 2004,  Crescent's  transactions  were  immaterial  to the  consolidated
financial statements.

   Basis of presentation

     The consolidated  financial  statements include the accounts of the Company
     and its  wholly-owned  subsidiary,  the Bank.  The Company  operates as one
     business segment.  All significant  intercompany  balances and transactions
     have been  eliminated.  The  accounting and reporting  policies  conform to
     accounting  principles  generally  accepted in the United States of America
     and to general  practices  in the banking  industry.  The Company  uses the
     accrual basis of accounting.

   Estimates

     The  preparation of  consolidated  financial  statements in conformity with
     accounting  principles  generally  accepted in the United States of America
     requires  management  to make  estimates  and  assumptions  that affect the
     reported  amounts of assets and  liabilities  and  disclosure of contingent
     assets and  liabilities as of the date of the financial  statements and the
     reported amount of income and expenses during the reporting periods. Actual
     results could differ from those  estimates.  The Company's most significant
     estimates relate to the allowance for loan losses and income taxes.

   Concentrations of credit risk

     The Company makes loans to individuals and businesses in and around Upstate
     South Carolina for various personal and commercial purposes. The Bank has a
     diversified loan portfolio and the borrowers'  ability to repay their loans
     is not  dependent  upon any specific  economic  sector.  The Bank  monitors
     concentrations in its customer base using the North American Industry Codes
     ("NAIC"). As of December 31, 2005, the Bank has concentrations of credit in
     real estate rental and leasing,  construction,  retail trade, professional,
     scientific and technical  services,  manufacturing,  accommodation and food
     services,  health care and social assistance,  and other services, which by
     NAIC category  comprise over 25 percent of Tier 1 Capital  adjusted for the
     allowance for loan losses.

   Investment securities

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

1.      Available-for-sale   securities:  These  are  securities  that  are  not
        classified  as either held to maturity or as trading  securities.  These
        securities  are  reported at fair  market  value.  Unrealized  gains and
        losses are  reported,  net of income  taxes,  as separate  components of
        shareholders' equity (accumulated other comprehensive income).

                                                                     (Continued)


                                       25
<PAGE>

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

2.      Held-to-maturity  securities:  These are investment  securities that the
        Company  has the  ability  and  intent  to hold  until  maturity.  These
        securities are stated at cost, adjusted for amortization of premiums and
        the accretion of discounts.

3.      Trading  securities:  These  are  securities  that are  bought  and held
        principally  for the  purpose  of selling  in the near  future.  Trading
        securities  are reported at fair market  value,  and related  unrealized
        gains and losses are recognized in the income statement. The Company has
        no trading securities.

    The Company reviews all investments with unrealized losses as of the balance
    sheet date for possible impairment. Our review consists of an examination of
    each security with regard to its issuer, credit rating, time to maturity and
    likelihood of sale prior to maturity. Any losses determined to be other than
    temporary are recognized through the income statement.

     Other  investments  include  the Bank's  stock  investments  in the Federal
     Reserve Bank of Richmond ("Reserve Bank") and the Federal Home Loan Bank of
     Atlanta  ("FHLB").  The Bank, as a member  institution,  is required to own
     certain  stock  investments  in the  Reserve  Bank and  FHLB.  The stock is
     generally pledged against any borrowings from the Reserve Bank and FHLB. No
     ready  market  exists  for the  stock and it has no  quoted  market  value.
     However, redemption of these stock investments has historically been at par
     value.

     Gains or losses on dispositions  of investment  securities are based on the
     differences  between the net proceeds and the adjusted  carrying  amount of
     the securities sold, using the specific identification method.

   Loans, interest and fee income on loans

     Loans are stated at the principal  balance  outstanding.  Unearned discount
     and the allowance for possible loan losses are deducted from total loans in
     the balance sheet.  Interest income is recognized over the term of the loan
     based on the principal amount outstanding.

     Generally,  the accrual of interest will be  discontinued on impaired loans
     when  principal  or interest  becomes 90 days past due, or when  payment in
     full is not anticipated,  and any previously accrued interest on such loans
     will be reversed  against  current income.  Any subsequent  interest income
     will be recognized on a cash basis when received unless collectibility of a
     significant  amount  of  principal  is in  serious  doubt.  In such  cases,
     collections are credited first to the remaining principal balance on a cost
     recovery  basis.  An impaired  loan will not be returned to accrual  status
     unless principal and interest are current and the borrower has demonstrated
     the ability to continue  making payments as agreed.  Non-performing  assets
     include real estate acquired  through  foreclosure or deed taken in lieu of
     foreclosure, and loans on non-accrual status.

     Fee  income  on  loans is  recognized  as  income  at the  time  loans  are
     originated.  Due to the  short-term  nature of the  majority  of the Bank's
     loans  and  the  immateriality  of the net  deferred  amount,  this  method
     approximates  the income that would be earned if the Company  deferred loan
     fees and costs under SFAS 91.

   Allowance for possible loan losses

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

                                                                     (Continued)

                                       26
<PAGE>

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

     The Bank  accounts  for  impaired  loans in  accordance  with SFAS No. 114,
     "Accounting by Creditors for Impairment of a Loan." This standard  requires
     that all  lenders  value a loan at the loan's  fair value if it is probable
     that the lender will be unable to collect all amounts due  according to the
     terms of the loan agreement.

     Fair value may be determined  based upon the present value of expected cash
     flows,  market price of the loan, if available,  or value of the underlying
     collateral. Expected cash flows are required to be discounted at the loan's
     effective interest rate.

     Under SFAS No. 114, when the ultimate  collectibility of an impaired loan's
     principal is in doubt,  wholly or partially,  all cash receipts are applied
     to principal. Once the reported principal balance has been reduced to zero,
     future cash receipts are applied to interest income, to the extent that any
     interest  has  been  foregone.   Further  cash  receipts  are  recorded  as
     recoveries of any amounts previously charged off.

     A loan is also considered  impaired if its terms are modified in a troubled
     debt  restructuring.  For these accruing  impaired loans, cash receipts are
     typically  applied to principal and interest  receivable in accordance with
     the terms of the restructured loan agreement. Interest income is recognized
     on these loans using the accrual method of accounting.

   Property and equipment

     Property and equipment are stated at cost, net of accumulated depreciation.
     Depreciation is computed using the straight-line  method over the estimated
     useful lives of the related assets.  Maintenance and repairs are charged to
     operations, while major improvements are capitalized. Upon retirement, sale
     or other  disposition of property and equipment,  the cost and  accumulated
     depreciation are eliminated from the accounts, and gain or loss is included
     in income from operations.

   Income taxes

     The Company  accounts  for income  taxes in  accordance  with SFAS No. 109,
     "Accounting for Income Taxes".  Under SFAS No. 109, deferred tax assets and
     liabilities  are recognized  for the expected  future tax  consequences  of
     events that have been recognized in the consolidated  financial  statements
     or tax return.  Deferred tax assets and  liabilities are measured using the
     enacted tax rates expected to apply to taxable income in the years in which
     those temporary differences are expected to be realized or settled.

   Advertising and public relations expense

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

   Cash surrender value of life insurance policies

     Cash surrender value of life insurance  policies  represents the cash value
     of policies on certain officers of the Bank.

   Earnings per common share

     Basic  earnings  per common  share is computed on the basis of the weighted
     average  number of common shares  outstanding  in accordance  with SFAS No.
     128, "Earnings per Share." The treasury stock method is used to compute the
     effect of stock  options on the weighted  average  number of common  shares
     outstanding for diluted  earnings per common share. As of December 31, 2005
     there were 33,620  common stock  equivalents,  all of which were related to
     options  issued by the  Company.  The  Company  declared  10 percent  stock
     dividends to shareholders of record as of May 10, 2005, May 11, 2004, March
     17,  2003 and April 30,  2002.  All  share  and per  share  amounts  on the
     Consolidated  Statements  of Income  have been  restated  to reflect  these
     transactions.



                                                                     (Continued)


                                       27
<PAGE>

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

Statement of cash flows

For purposes of reporting cash flows,  cash and cash  equivalents are defined as
those  amounts  included in the balance sheet caption "Cash and Due From Banks".
Cash and due from  banks  have an  original  maturity  of three  months or less.
Federal funds sold are reported  separately  due to the  materiality of balances
from time to time.

Fair values of financial instruments

     SFAS No. 107,  "Disclosures About Fair Value of Financial  Instruments," as
     amended by SFAS No. 119, requires  disclosure of fair value information for
     financial instruments, whether or not recognized in the balance sheet, when
     it is  practicable  to  estimate  the fair  value.  SFAS No. 107  defines a
     financial  instrument  as cash,  evidence  of an  ownership  interest in an
     entity or  contractual  obligations  that  require the  exchange of cash or
     other financial  instruments.  Certain items are specifically excluded from
     the  disclosure  requirements,  including  the Company's  common stock.  In
     addition, other nonfinancial instruments such as premises and equipment and
     other   assets  and   liabilities   are  not  subject  to  the   disclosure
     requirements.

      The  following  methods  and  assumptions  were  used  by the  Company  in
      estimating fair values of financial instruments as disclosed herein:

         Cash and due from  banks - The  carrying  amounts  of cash and due from
         banks approximate their fair value.

         Federal  funds  sold - The  carrying  amounts  of  federal  funds  sold
         approximate their fair value.

         Investment securities - Fair values for investment securities are based
         on quoted market prices.  The carrying amounts of Reserve Bank and FHLB
         stocks approximate their fair values.

         Cash surrender  value of life  insurance  policies - The cash surrender
         value of life  insurance  policies held by the Bank  approximates  fair
         values of the policies.

         Loans - For variable rate loans that reprice  frequently  and for loans
         that mature within one year, fair values are based on carrying  values.
         Fair values for all other loans are  estimated  using  discounted  cash
         flow analyses,  with interest rates  currently  being offered for loans
         with similar terms to borrowers of similar credit quality.  Fair values
         for impaired loans are estimated using discounted cash flow analyses or
         underlying collateral values, where applicable.

         Deposits - The fair  values  disclosed  for  demand  deposits  are,  by
         definition,  equal to their carrying  amounts.  The carrying amounts of
         variable  rate,   fixed-term   money  market  accounts  and  short-term
         certificates of deposit  approximate their fair values at the reporting
         date. Fair values for long-term fixed-rate  certificates of deposit are
         estimated  using  a  discounted  cash  flow  calculation  that  applies
         interest rates currently being offered on certificates to a schedule of
         aggregated expected monthly maturities.

         Customer  repurchase  agreements - The carrying  amounts of  securities
         sold under repurchase agreements approximate their fair value.

         Borrowings from Federal Home Loan Bank of Atlanta - Borrowings from the
         FHLB which have variable  rates of interest are deemed to be carried at
         fair  value.  Fair  values of fixed  rate  advances  estimated  using a
         discounted cash flow  calculation that applies interest rates currently
         being  offered  on  advances  to  a  schedule  of  aggregated  expected
         maturities.

Stock Based Compensation

     The  Company  has  issued  stock  options  to  certain  directors  who were
     organizers of the Company and the Bank, and also has a stock-based director
     and employee  compensation  plan (the "2003 Plan") as further  described in
     Note 16. The Company  accounts for stock options under the  recognition and
     measurement  principles of Accounting  Principles Board ("APB") Opinion No.
     25,   "Accounting   for   Stock   Issued   to   Employees,"   and   related
     Interpretations.  No  stock-based  compensation  cost is  reflected  in net
     income, as all stock options granted had an

                                                                     (Continued)


                                       28
<PAGE>

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

     exercise price equal to the market value of the underlying  common stock on
     the date of grant.  Under the 2003 Plan, 18,000 options were granted during
     2004 and during 2005.  Subsequent to the grant dates,  10% stock  dividends
     were  declared,  which  converted  the  number of options  outstanding  and
     decreased  the  exercise   price  as  well.  See  Note  16  for  additional
     information.

     In 2006 the Company will adopt the  provisions  of SFAS No.  123(R)  "Share
     Based Payment." SFAS No. 123(R) requires  companies to measure all employee
     stock-based  compensation  awards using a fair value method and record such
     expense in their financial  statements.  In preparation for adoption of the
     standard,  the Company elected to accelerate the vesting of options granted
     in 2004 and 2005 under the 2003 Plan.

     The following  table  illustrates the effect on net income and earnings per
     share if the Company had applied the fair value  recognition  provisions of
     SFAS No. 123 (R), "Accounting for Stock-Based Compensation," to stock-based
     compensation. It includes the effect of accelerating the vesting of options
     granted under the 2003 plan.

<TABLE>
<CAPTION>
                                                                                                 Year ended December 31,
                                                                                                 -----------------------
                                                                                          2005              2004             2003
                                                                                          ----              ----             ----
Net income:
<S>                                                                                  <C>                <C>              <C>
As reported ...................................................................      $   1,061,265      $   664,057      $   356,048
Deduct:  Total stock-based compensation expense determined
under fair value based method for all awards,  net of related tax
effects .......................................................................            105,581            5,844                -
                                                                                     -------------      -----------      -----------
Pro forma .....................................................................      $     955,684      $   658,213      $   356,048
                                                                                     =============      ===========      ===========

Basic earnings per common share
As reported ...................................................................      $         .89       $      .57       $      .30
Pro forma .....................................................................      $         .80       $      .56       $      .30

Diluted earnings per common share
As reported ...................................................................      $         .86       $      .56       $      .30
Pro forma .....................................................................      $         .77       $      .55       $      .30
</TABLE>
     The fair value of the option  grant is estimated on the date of grant using
     the  Black-Scholes  option pricing model.  The risk free interest rate used
     was an  average  of  approximately  4.01  percent,  which  was  the 10 Year
     Constant Maturity Rate on US Treasury  Securities during the month in which
     the  options  were  granted.  The  assumed  dividend  rate was zero and the
     expected  option  life was 10 years.  Volatility  is  difficult  to measure
     accurately  due to the low volume of trading of the  Company's  stock.  The
     above  estimates were  calculated  assuming 6% volatility for 2005 and 2004
     option grants.

   Recently issued accounting standards

     The  following  is a summary of recent  authoritative  pronouncements  that
     affect accounting,  reporting,  and disclosure of financial  information by
     the Company:

     In December 2004, the Financial  Accounting Standards Board ("FASB") issued
     Statement  of  Financial  Accounting  Standards  ("SFAS")  No. 123 (revised
     2004),  "Share-Based  Payment"  ("SFAS No.  123(R)").  SFAS No. 123(R) will
     require companies to measure all employee  stock-based  compensation awards
     using  a fair  value  method  and  record  such  expense  in its  financial
     statements.   In  addition,  the  adoption  of  SFAS  No.  123(R)  requires
     additional  accounting  and  disclosure  related to the income tax and cash
     flow effects  resulting from  share-based  payment  arrangements.  SFAS No.
     123(R) is  effective  beginning  as of the first  annual  reporting  period
     beginning  after  December 15, 2005.  SFAS No.  123(R)  allows for adoption
     using either the modified  prospective or modified  retrospective  methods.
     The Company  anticipates  using the modified  prospective  method when this
     statement is adopted in the first quarter of 2006. The Company is currently
     evaluating the impact upon adoption of SFAS No. 123(R).

     In April 2005, the Securities and Exchange Commission's Office of the Chief
     Accountant and its Division of Corporation  Finance issued Staff Accounting
     Bulletin ("SAB") No.107 to provide guidance regarding the
                                                                     (Continued)


                                       29
<PAGE>

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

     application of SFAS No.123(R).  SAB No. 107 provides  interpretive guidance
     related to the  interaction  between SFAS No.  123(R) and certain SEC rules
     and  regulations,  as well as the staff's views  regarding the valuation of
     share-based  payment  arrangements for public  companies.  SAB No. 107 also
     reminds public companies of the importance of including  disclosures within
     filings  made  with the SEC  relating  to the  accounting  for  share-based
     payment  transactions,  particularly  during  the  transition  to SFAS  No.
     123(R).

     During the last half of 2005,  the FASB  issued  four FASB Staff  Positions
     ("FSP's")  related to the  implementation  of SFAS No. 123(R).  These FSP's
     related to (1) the classification and measurement of freestanding financial
     instruments  originally issued in exchange for employee  services,  (2) the
     application of grant date as defined in SFAS No. 123(R), (3) the transition
     election  related to accounting for the tax effects of share-based  payment
     awards,  and (4) the  classification  of options  and  similar  instruments
     issued as employee  compensation  that allow for cash  settlement  upon the
     occurrence of a contingent  event.  The issuance of these FSP's by the FASB
     are intended to clarify the interpretation of the guidance related to these
     specific issues when implementing SFAS No. 123(R).

     In December 2004,  the FASB issued SFAS No. 153,  "Exchanges of Nonmonetary
     Assets - an  amendment of APB Opinion No. 29." The standard is based on the
     principle that exchanges of nonmonetary  assets should be measured based on
     the fair value of the assets  exchanged and eliminates the exception  under
     ABP  Opinion  No. 29 for an  exchange  of  similar  productive  assets  and
     replaces it with an exception for exchanges of  nonmonetary  assets that do
     not have  commercial  substance.  A  nonmonetary  exchange  has  commercial
     substance  if the future  cash flows of the entity are  expected  to change
     significantly  as a result of the  exchange.  The standard is effective for
     nonmonetary  exchanges occurring in fiscal periods beginning after June 15,
     2005. The adoption of SFAS 153 is not expected to have a material impact on
     the Company's financial position or results of operations.

     In May 2005,  the FASB issued SFAS No. 154,  "Accounting  Changes and Error
     Corrections  - a replacement  of APB Opinion No. 20 and FASB  Statement No.
     3." SFAS No. 154  establishes  retrospective  application  as the  required
     method  for  reporting  a change  in  accounting  principle,  unless  it is
     impracticable,  in which case the  changes  should be applied to the latest
     practicable date presented. SFAS No. 154 also requires that a correction of
     an error be reported as a prior period adjustment by restating prior period
     financial statements.  SFAS No. 154 is effective for accounting changes and
     corrections  of errors made in fiscal years  beginning  after  December 15,
     2005.

     In March 2005,  the FASB  issued FIN No. 47,  "Accounting  for  Conditional
     Asset Retirement Obligations--an interpretation of FASB Statement No. 143."
     This  Interpretation  clarifies that the term conditional  asset retirement
     obligation  as used in SFAS  No.  143,  "Accounting  for  Asset  Retirement
     Obligations,"  refers to a legal  obligation to perform an asset retirement
     activity in which the timing and (or) method of settlement are  conditional
     on a future  event that may or may not be within the control of the entity.
     The obligation to perform the asset  retirement  activity is  unconditional
     even  though  uncertainty  exists  about  the  timing  and (or)  method  of
     settlement.  Thus,  the  timing  and  (or)  method  of  settlement  may  be
     conditional  on a future  event.  Accordingly,  an  entity is  required  to
     recognize a liability for the fair value of a conditional  asset retirement
     obligation if the fair value of the liability can be reasonably  estimated.
     The  fair  value  of a  liability  for  the  conditional  asset  retirement
     obligation should be recognized when  incurred--generally upon acquisition,
     construction,  or development and (or) through the normal  operation of the
     asset.  Uncertainty  about the timing and (or)  method of  settlement  of a
     conditional  asset  retirement  obligation  should  be  factored  into  the
     measurement of the liability when sufficient information exists. FIN No. 47
     is effective  no later than the end of fiscal  years ending after  December
     15,  2005.  The Company  adopted FIN No. 47 in 2005 and its adoption had no
     material effect on financial position or results of operations.

     In March 2004,  the FASB issued  Emerging  Issues Task Force ("EITF") Issue
     No.  03-1,  "The  Meaning  of   Other-Than-Temporary   Impairment  and  its
     Application to Certain  Investments."  This Issue  addresses the meaning of
     other-than-temporary   impairment   and  its   application  to  investments
     classified as either  available for sale or held to maturity under SFAS No.
     115  and  it  also  provides   guidance  on  quantitative  and  qualitative
     disclosures. The disclosure requirements in paragraph 21 of this Issue were
     effective  for annual  financial  statements  for fiscal years ending after
     December  15, 2003 and were adopted by the Company  effective  December 31,
     2003.

                                                                     (Continued)


                                       30
<PAGE>

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

     The recognition  and measurement  guidance in paragraphs 6-20 of this Issue
     was  to  be  applied  to  other-than-temporary  impairment  evaluations  in
     reporting  periods  beginning  after June 15, 2004, but was delayed by FASB
     action in October 2004 through the issuance of a proposed FSP on the issue.
     In July 2005, the FASB issued FSP FAS 115-1 and FSP FAS 124-1--"The Meaning
     of   Other-Than-Temporary   Impairment  and  its   Application  to  Certain
     Investments." This FSP addresses the determination as to when an investment
     is considered  impaired,  whether that  impairment is other than temporary,
     and  the  measurement  of  an  impairment  loss.  This  FSP  also  includes
     accounting   considerations   subsequent   to   the   recognition   of   an
     other-than-temporary  impairment  and requires  certain  disclosures  about
     unrealized  losses that have not been  recognized  as  other-than-temporary
     impairments. This FSP will be effective for other-than-temporary impairment
     analysis  conducted in periods  beginning  after  December  15,  2005.  The
     Company has evaluated the impact that the adoption of FSP FAS 115-1 and FSP
     FAS 124-1 and has  concluded  that the  adoption  will not have a  material
     impact on financial position and results of operations upon adoption.

     In December 2005,  the FASB issued FSP SOP 94-6-1,  "Terms of Loan Products
     that May Give Rise to a  Concentration  of  Credit  Risk."  The  disclosure
     guidance in this FSP is  effective  for interim and annual  periods  ending
     after  December  19,  2005.  The FSP states that the terms of certain  loan
     products  may  increase a  reporting  entity's  exposure to credit risk and
     thereby may result in a  concentration  of credit risk as that term is used
     in SFAS No.  107,  either as an  individual  product  type or as a group of
     products with similar  features.  SFAS No. 107 requires  disclosures  about
     each significant  concentration,  including "information about the (shared)
     activity,   region,   or  economic   characteristic   that  identifies  the
     concentration."  The FSP suggests possible shared  characteristics on which
     significant  concentrations  may be determined  which include,  but are not
     limited to:

              Borrowers  subject to significant  payment  increases;
              Loans with terms that permit negative amortization; and
              Loans with high loan-to-value ratios.

     This FSP requires entities to provide the disclosures  required by SFAS No.
     107 for loan products that are determined to represent a  concentration  of
     credit  risk in  accordance  with the  guidance of this FSP for all periods
     presented.  The Company adopted this disclosure standard effective December
     31, 2005.

     Accounting  standards that have been issued or proposed by the FASB that do
     not  require  adoption  until a  future  date  are not  expected  to have a
     material impact on the consolidated financial statements upon adoption.

Risks and Uncertainties

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

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


NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS

         The Bank is required to maintain average reserve balances,  computed by
applying prescribed percentages to its various types of deposits,  either at the
Bank or on deposit  with the Reserve  Bank.  At December 31, 2005 and 2004 these
required reserves were met by vault cash.



                                       31
<PAGE>

NOTE 3 - FEDERAL FUNDS SOLD

         When the Bank's cash  reserves  (Note 2) are in excess of the  required
amount,  it may lend any excess to other banks on a daily basis.  As of December
31, 2005 and 2004 federal  funds sold  amounted to  $3,183,000  and  $4,130,595,
respectively.

NOTE 4 - INVESTMENT SECURITIES

         The   amortized   cost  and  fair   value  of   investment   securities
available-for-sale are as follows:
<TABLE>
<CAPTION>
                                                                                          December 31, 2005
                                                                                          -----------------
                                                                                           Gross unrealized
                                                                     Amortized             ----------------                  Fair
                                                                       cost             Gains            Losses              value
                                                                       ----             -----            ------              -----
<S>                                                                 <C>               <C>               <C>               <C>
Federal agencies ...........................................        $7,762,658        $        -        $   87,089        $7,675,569
Mortgage-backed securities .................................           689,226                 -            26,147           663,079
Municipal bonds ............................................         1,361,229               116            10,328         1,351,017
                                                                    ----------        ----------        ----------        ----------
        Totalinvestmentsecuritiesavailable-
        for-sale ...........................................        $9,813,113        $      116        $  123,564        $9,689,665
                                                                    ==========        ==========        ==========        ==========
<CAPTION>
                                                                                          December 31, 2004
                                                                                          -----------------
                                                                                           Gross unrealized
                                                                     Amortized             ----------------                 Fair
                                                                       cost             Gains             Losses            value
                                                                       ----             -----             ------            -----
<S>                                                                 <C>              <C>                <C>              <C>
Federal agencies ............................................       $7,500,000       $    5,156         $   29,687       $7,475,469
Mortgage-backed securities ..................................          886,633            4,313             11,342          879,604
Corporate bonds .............................................          215,198            2,126                  -          217,324
Municipal bonds .............................................          404,241              980              2,090          403,131
                                                                    ----------       ----------         ----------       ----------
        Total investment securities available-
        for-sale ............................................       $9,006,072       $   12,575         $   43,119       $8,975,528
                                                                    ==========       ==========         ==========       ==========
</TABLE>

         While the  majority of the  Company's  U.S.  Government  agency  bonds,
municipal bonds and U.S. government agency mortgage-backed  securities are in an
unrealized  loss position as of December 31, 2005,  none of these  securities is
expected  to  have a loss of  principal  at  final  maturity.  Furthermore,  the
weighted  average life of the securities  portfolio is less than three years and
the majority of the  securities  with losses have a remaining  life of less than
two years. The Company has the intent and ability to hold these securities until
such time as the value recovers or the securities  mature. The Company believes,
based on industry analyst reports and credit ratings,  that the deterioration in
value is  attributable to changes in market interest rates and not in the credit
quality  of  the  issuers  and  therefore,   these  losses  are  not  considered
other-than-temporary.

         The   amortized   cost  and  fair   value  of   investment   securities
held-to-maturity  as of December 31, 2005 and 2004 are  summarized  in the table
below.
<TABLE>
<CAPTION>
                                                                                          December 31, 2005
                                                                                          -----------------
                                                                                           Gross unrealized
                                                                     Amortized             ----------------                  Fair
                                                                       cost             Gains            Losses              value
                                                                       ----             -----            ------              -----
<S>                                                               <C>               <C>               <C>                 <C>
Federal agencies held-to-maturity ..................              $3,704,861        $    5,079        $    2,815          $3,707,125
                                                                  ==========        ==========        ==========          ==========
<CAPTION>
                                                                                          December 31, 2004
                                                                                          -----------------
                                                                                           Gross unrealized
                                                                     Amortized             ----------------                  Fair
                                                                       cost             Gains            Losses              value
                                                                       ----             -----            ------              -----
<S>                                                                <C>               <C>               <C>                <C>
Federal agencies held-to-maturity ..................               $3,713,645        $   98,792        $       -          $3,812,437
                                                                   ==========        ==========        =========          ==========
</TABLE>
                                                                     (Continued)

                                       32
<PAGE>

NOTE 4 - INVESTMENT SECURITIES, Continued

         The Bank,  as a member  institution,  is  required  to own stock in the
Reserve  Bank and the  FHLB.  These  stocks  are  included  in the  accompanying
Consolidated  Balance  Sheets under the caption  "Other  investments".  No ready
market exists for these stock  investments and they have no quoted market value.
However, redemption of these stocks has historically been at par value.

         The  amortized  cost and fair value of securities at December 31, 2005,
by contractual  maturity,  are shown in the following chart. Expected maturities
may differ from contractual  maturities  because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.

                                                          December 31, 2005
                                                          -----------------
                                                      Amortized          Fair
                                                         Cost            Value
                                                         ----            -----
Within one year ................................     $ 6,702,756     $ 6,654,937
Due after one through five years ...............       4,264,763       4,227,756
Due after five through ten years ...............       2,550,455       2,514,097
Reserve Bank and FHLB stock (no maturity) ......         609,800         609,800
                                                     -----------     -----------

    Total investment securities ................     $14,127,774     $14,006,590
                                                     ===========     ===========

         At  December  31,  2005  and  2004,  securities  with a fair  value  of
$7,467,531 and $9,259,147,  respectively,  were pledged to collateralize  public
deposits,  sweep  accounts,  and  repurchase  agreements.  The Company  sold one
security in 2004 at a gain of $5,230. There were no realized gains or losses for
the years ended December 31, 2005 or 2003.

NOTE 5 - LOANS

         The composition of net loans by major loan category is presented below.

                                                             December 31,
                                                             ------------
                                                         2005             2004
                                                         ----             ----

Commercial .....................................     $19,092,140     $13,355,098
Real estate - construction .....................      21,267,137      16,011,109
Real estate - mortgage .........................      45,379,096      42,932,263
Consumer .......................................       1,593,527       2,859,683
                                                     -----------     -----------

Loans, gross ...................................      87,331,900      75,158,153

Less allowance for possible loan losses ........       1,058,295         919,384
                                                     -----------     -----------

Loans, net .....................................     $86,273,605     $74,238,769
                                                     ===========     ===========

         At  December  31, 2005 and 2004 there were no  nonaccruing  or impaired
loans.  Activity in the  allowance  for possible loan losses for the years ended
December 31, 2005, 2004, and 2003 is summarized in the table below.

<TABLE>
<CAPTION>
                                                                                               Year ended December 31,
                                                                                               -----------------------
                                                                                     2005                2004                2003
                                                                                     ----                ----                ----
<S>                                                                            <C>                  <C>                  <C>
Allowance for possible loan losses, beginning of year ................         $   919,384          $   727,971          $   553,372
Provision for loan losses ............................................             140,347              197,010              173,574
Charge-offs ..........................................................              (1,436)              (5,597)                   -
Recoveries ...........................................................                   -                    -                1,025
                                                                               -----------          -----------          -----------
Allowance for possible loan losses, end of year ......................         $ 1,058,295          $   919,384          $   727,971
                                                                               ===========          ===========          ===========
</TABLE>

         As of December 31, 2005,  approximately $51.5 million or 58.9% of total
gross loans were variable rate loans.  As of December 31, 2005,  the FHLB held a
lien on loans  identified  by the Bank to the FHLB as  eligible  collateral  for
borrowings.



                                       33
<PAGE>

NOTE 6 - PROPERTY AND EQUIPMENT

         Components of property and equipment  included in the balance sheet are
as follows:

                                                              December 31,
                                                              ------------
                                                         2005             2004
                                                         ----             ----
Land and improvements ........................       $1,477,328       $1,419,662
Bank premises ................................        2,801,162        2,165,975
Furniture, equipment and software ............        1,252,628          907,805
Vehicles .....................................           66,065           66,065
                                                     ----------       ----------
        Property and equipment ...............        5,597,183        4,559,507
Accumulated depreciation .....................        1,019,325          780,524
                                                     ----------       ----------
    Property and equipment, net ..............       $4,577,858       $3,778,983
                                                     ==========       ==========


         Depreciation  expense for the years ended  December 31, 2005 2004,  and
2003, amounted to $242,378, $212,605, and $203,841,  respectively.  Depreciation
is charged to  operations  over the  estimated  useful lives of the assets.  The
estimated  useful  lives and methods of  depreciation  for the  principal  items
follow:

<TABLE>
<CAPTION>
        Type of Asset                                 Life in Years                         Depreciation Method
--------------------------------            -------------------------------------          ---------------------------
<S>                                                         <C>                                 <C>
      Furniture, equipment and software                     3 to 7                              Straight-line
      Improvements                                          5 to 40                             Straight-line
      Vehicles                                              5                                   Straight-line
</TABLE>


NOTE 7 - DEPOSITS

         The following is a detail of the deposit accounts as of:

                                                            December 31,
                                                            ------------
                                                      2005               2004
                                                      ----               ----

Noninterest bearing ........................       $10,451,922       $ 9,405,078
Interest bearing:
     NOW accounts ..........................        15,965,816        13,416,502
     Money market accounts .................         6,244,480        15,372,975
     Savings ...............................         3,545,435         4,005,567
     Time, less than $100,000 ..............        29,438,852        23,306,873
     Time, $100,000 and over ...............        26,005,536        17,011,949
                                                   -----------       -----------

     Total deposits ........................       $91,652,041       $82,518,944
                                                   ===========       ===========

         Interest expense on time deposits greater than $100,000 was $699,928 in
2005, $374,435 in 2004, and $345,564 in
2003.

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

         2006 ......................................    $ 31,284,804
         2007 ......................................       9,528,229
         2008 ......................................       7,000,737
         2009 ......................................       5,978,506
         2010 ......................................       1,652,112
                                                        ------------
                                                        $ 55,444,388

                                       34
<PAGE>

NOTE 8 - CUSTOMER REPURCHASE AGREEMENTS

         Customer repurchase agreements consist of the following:

                                                             December 31,
                                                             ------------
                                                       2005                2004
                                                       ----                ----
Sweep accounts .............................        $1,783,884        $4,483,993
Retail repurchase agreements ...............         1,300,000         1,000,000
                                                    ----------        ----------
                                                    $3,083,884        $5,483,993
                                                    ==========        ==========

         The Bank enters into sweep and retail  repurchase  agreements  with its
customers.  The sweep  agreements  generally mature  overnight.  At December 31,
2005, the Bank had two retail  repurchase  agreements that mature in April 2006.
U. S. Government  securities with an amortized cost of $5,600,000 and $6,509,823
(fair value of $5,538,781 and $6,547,000)  were used as collateral for the sweep
accounts and repurchase agreements, at December 31, 2005 and 2004, respectively.


NOTE 9 -BORROWINGS FROM FEDERAL HOME LOAN BANK OF ATLANTA

         At December 31, 2005 and 2004,  the Bank had a line of credit to borrow
funds from the FHLB in the amount of 10% of the Bank's  assets.  Funds  borrowed
from the FHLB are collateralized by a blanket lien on loans. At December 31, the
Bank had advances outstanding as follows:

<TABLE>
<CAPTION>
                                  December 31,
                                  ------------
                             2005            2004               Interest Rate     Maturity Date           Terms
                             ----            ----               -------------     -------------           -----
<S>                      <C>               <C>                      <C>            <C>               <C>
                         $1,500,000        $1,500,000               2.91%          10/20/2006             Fixed rate
                          1,500,000         1,500,000               3.60           10/20/2008             Fixed rate
                            355,556           400,000               4.49           12/01/2013        Fixed rate, amortizing
                            324,074                 -               4.89            4/14/2014        Fixed rate, amortizing
                            666,875                 -               4.78            7/27/2015        Fixed rate, amortizing
                         ----------        ----------
                         $4,346,505        $3,400,000
                         ==========        ==========
</TABLE>

         During  2005,  the highest  balance as of any month end for  borrowings
from the FHLB was $6.7 million. The average rate paid on the advances during the
year was 3.56%.  The average balance of FHLB advances for 2005 was $3.9 million.
During 2004, the highest balance  outstanding at any month end was $5.0 million.
The average balance for 2004 during which an advances were  outstanding was $2.5
million. The average interest rate paid on advances in 2004 was 1.88%.


NOTE 10 - COMMITMENTS AND CONTINGENCIES

         The Bank may  become  party to  litigation  and  claims  arising in the
normal  course of business.  As of December 31,  2005,  there was no  litigation
pending.

         The Company has approximately four years remaining on its contract with
a  data  processing  service.   Monthly  data  processing  costs  are  currently
approximately $15,000.

         From time to time the Bank may guarantee  merchant credit card accounts
on behalf of certain customers. At December 31, 2005 the total amount guaranteed
by the Bank related to merchant credit card accounts was immaterial.

         Refer to Note 14  concerning  financial  instruments  with off  balance
sheet risk.


                                       35
<PAGE>

NOTE 11 - UNUSED LINES OF CREDIT

         At December 31,  2005,  the Bank had unused lines of credit to purchase
federal funds totaling  $4,350,000 from unrelated  banks.  These lines of credit
are available on a one to fourteen-day  basis for general corporate  purposes of
the Bank.  The lenders  have  reserved  the right to withdraw the lines at their
option.


NOTE 12 - INCOME TAXES

         The  provision  for income taxes is  reconciled to the amount of income
tax  computed at the federal  statutory  rate on income  before  income taxes as
follows:

<TABLE>
<CAPTION>
                                                                              Year ended December 31,
                                                                              -----------------------
                                                                2005                    2004                   2003
                                                               -----                    ----                   ----
<S>                                                  <C>              <C>      <C>           <C>       <C>            <C>
Tax expense at statutory rate ....................   $571,850         34%      $357,800      34%       $183,400       34%
Increase (decrease) in taxes resulting from:
     State income taxes, net of federal
          benefit ................................     32,500          2         20,800        2         10,600        2
     Other .......................................     16,308          1         10,298        1        (10,582)      (2)
                                                     --------         --       --------        -       --------       --
Income tax provision .............................   $620,658         37%      $388,898       37%      $183,418        34%
                                                     ========         ==       ========       ==       ========        ==
</TABLE>

         The income tax effect of cumulative  temporary  differences at December
31, are as follows:

                                                             2005         2004
                                                             ----         ----
Deferred tax asset:
  Allowance for loan losses ..........................   $ 358,732    $ 311,000
  Unrealized net loss on securities available for sale      41,972       10,400
  Depreciation .......................................    (121,678)    (107,000)
  Prepaid expenses ...................................     (32,432)           -
  Other ..............................................       9,121            -
                                                         ---------    ---------
         Net deferred tax assets .....................   $ 255,715    $ 214,400
                                                         =========    =========

         The net deferred taxes are included in other assets in the consolidated
balance sheets.

The following  summary of the provision for income taxes  includes tax deferrals
that arise from  temporary  differences  in the  recognition of certain items of
revenue and expense for tax and financial reporting purposes:

                                                      Year ended
                                                      December 31,
                                                      ------------
                                            2005          2004            2003
                                            ----          ----            ----

Income taxes currently payable .......    $ 630,401     $ 461,398     $ 222,618

Deferred income tax benefit ..........       (9,743)      (72,500)      (39,200)
                                          ---------     ---------     ---------

        Income tax provision .........    $ 620,658     $ 388,898     $ 183,418
                                          =========     =========     =========

                                       36
<PAGE>

NOTE 13 - RELATED PARTY TRANSACTIONS

         Certain directors, executive officers and companies with which they are
affiliated,  are  customers of and have loan  transactions  with the Bank in the
ordinary  course of business.  These loans were made on  substantially  the same
terms, including interest rates and collateral,  as those prevailing at the time
for comparable arms-length transactions.

         A  summary  of  loan  transactions  with  directors,   including  their
affiliates, and executive officers are as follows:

                                                Year ended December 31,
                                                -----------------------
                                           2005           2004           2003
                                           ----           ----           ----
Balance, beginning of year ........     $4,476,992     $3,725,723     $1,461,682
New loans or lines of credit ......      4,418,461      3,627,940      3,830,800
Less loan payments ................      2,625,854      2,876,671      1,566,759
                                        ----------     ----------     ----------
Balance, end of year ..............     $6,269,599     $4,476,992     $3,725,723
                                        ==========     ==========     ==========

         Deposits by directors, executive officers, and their related interests,
at December 31, 2005 and 2004 were $2,829,561 and $1,538,693, respectively.


NOTE 14 - FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK

         In the ordinary course of business,  and to meet the financing needs of
its customers,  the Bank is a party to various  financial  instruments  with off
balance sheet risk. These financial  instruments,  which include  commitments to
extend  credit  and  standby  letters of credit,  involve,  to varying  degrees,
elements of credit and interest rate risk in excess of the amounts recognized in
the balance sheet. The contract amounts of those instruments  reflect the extent
of involvement the Bank has in particular classes of financial instruments.

         The Bank's  exposure to credit loss in the event of  nonperformance  by
the other party to the financial instrument for commitments to extend credit and
standby  letters of credit is  represented by the  contractual  amounts of those
instruments.  The Bank uses the same credit  policies in making  commitments and
conditional obligations as it does for on balance sheet instruments.

         Commitments  to extend  credit are  agreements to lend to a customer as
long as there is no  violation  of any  material  condition  established  in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may  require  the  payment of a fee. At December  31, 2005 and 2004,
unfunded   commitments  to  extend  credit  were  $17,280,622  and  $14,897,187,
respectively,  and  outstanding  letters of credit were  $544,660 and  $464,308,
respectively.  At December 31, 2005, the unfunded commitments consisted of $14.1
million at variable  rates and  approximately  $3.1  million at fixed rates with
$11.5 million  expiring  within one year.  The Bank  evaluates  each  customer's
credit worthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit,  is based on management's
credit  evaluation of the borrower.  Collateral  varies but may include accounts
receivable, inventory, property, plant and equipment, commercial and residential
real estate.  Fair values of off balance sheet lending  commitments are based on
fees currently charged to enter into similar agreements, taking into account the
remaining  terms of the agreements and the  counterparties'  credit standing and
were immaterial in 2005 and 2004.

     The  Bank  also  offers  an   automatic   overdraft   protection   product.
Approximately  $1.1 million of  overdraft  protection  is  available  under this
product as of December  31, 2005.  The Bank  expects that much of this  capacity
will not be  utilized.  During  2005  the  average  balance  of  demand  deposit
overdrafts was approximately $19,000.


NOTE 15 - EMPLOYEE BENEFIT PLAN

         The Company  sponsors a Simple IRA Plan for the benefit of all eligible
employees.   The  Bank  contributes  up  to  three  percent  of  the  employee's
compensation.  Employer  contributions  made to the Plan in 2005, 2004, and 2003
amounted to $35,925, $31,822, and $29,831, respectively.


                                       37
<PAGE>

NOTE 16 - STOCK OPTION PLANS

         In 1999,  the Board of  Directors  awarded  options  (the  "Organizers'
Options") to purchase 4,000 shares of the Company's  common stock to each of the
organizing  directors  of the  Company  and the Bank  (an  aggregate  of  40,000
shares).  These  options  had an  exercise  price of $10.00 per share and became
exercisable  in one-third  increments  each year beginning on December 14, 2000.
The  Organizers'  Options  expire ten years from the date of grant,  unless they
terminate sooner as a result of the holder's ceasing to be a director.  Pursuant
to the option  agreements as further  discussed  below, the total number of such
options outstanding has been adjusted to 53,240, and the exercise price has been
adjusted to $7.51 per share as a result of the stock dividends discussed in Note
17 below.

         In 2003, the Company's  shareholders  approved the Cornerstone  Bancorp
2003 Stock Option Plan (the "2003 Plan"),  which reserved  125,000 shares of the
Company's  common stock for issuance upon  exercise of options.  Pursuant to the
2003 Plan as further discussed below, the number of shares reserved for issuance
has been  increased  to  151,250  shares as a result of the 10% stock  dividends
declared in 2004 and 2005,  which is discussed in Note 17 below.  Employees  and
Directors are eligible to participate  in the 2003 Plan,  which has a term of 10
years. Awards under the 2003 Plan must be made by the Board of Directors or by a
Committee of Directors designated by the Board at an exercise price equal to the
fair market value of the Company's  common stock on the date of grant. A summary
of the activity in the plans is presented below:

<TABLE>
<CAPTION>
                                                                                    Year ended December 31,
                                                                                    -----------------------
                                                                   2005                      2004                        2003
                                                                   ----                      ----                        ----
                                                                      Weighted                   Weighted                   Weighted
                                                                      Average                     Average                    Average
                                                                      Exercise                   Exercise                   Exercise
                                                          Shares       price        Shares         price        Shares        price
                                                          ------       -----        ------         -----        ------        -----
 <S>                                                      <C>           <C>         <C>            <C>        <C>              <C>
Outstanding at beginning of year ......................    74,487       $ 7.85       52,707        $ 6.83      56,611          $6.83
Granted (1) ...........................................    19,800        11.82       21,780         10.33           -              -
Exercised .............................................         -            -            -             -           -              -
Forfeited or expired ..................................         -            -            -             -      (3,904)         $6.83
 ......................................................         -                         -                   -------

Outstanding at end of year ............................    94,287       $ 8.68       74,487        $ 7.85      52,707          $6.83
                                                          =======                   =======                   =======

Options exercisable at end of year ....................    94,287       $ 8.68       52,707        $ 6.83      52,707          $6.83

Shares available for grant ............................   109,670                   129,470                   151,250
</TABLE>
(1)  As  described  in Note 1,  vesting of options  granted in 2004 and 2005 was
     accelerated to December 31, 2005.

         As  described  in Note 17  below,  the  Company's  Board  of  Directors
declared 10 percent stock  dividends to  shareholders of record on May 10, 2005,
May 11, 2004, March 17, 2003, and on April 30, 2002. The agreements  relating to
the Organizers'  Options provide for proportionate  adjustments in the number of
shares  subject to  options  and the  exercise  price of options in the event of
stock dividends,  stock splits and other similar stock transactions.  Similarly,
the 2003 Plan  provides for  proportionate  adjustments  in the number of shares
reserved  for  issuance  under the 2003 Plan,  the  number of shares  subject to
outstanding  options and the exercise prices of outstanding options in the event
of such transactions.


NOTE 17 - DIVIDENDS

         The Company has never paid cash dividends. The Company's ability to pay
cash  dividends  is within  the  discretion  of its Board of  Directors,  and is
dependent on the  Company's  receiving  cash  dividends  from the Bank.  Federal
banking  regulations  restrict the amount of dividends  that the Bank can pay to
the Company.  Furthermore,  because of its current growth plans, the Company has
no current plans to pay cash dividends even if it would be able to do so. Future
dividend  policy will depend on the Company's  earnings,  capital  requirements,
financial condition and other factors considered relevant by the Company's Board
of  Directors.  The  Company's  Board of  Directors  declared  10 percent  stock
dividends to  shareholders  of record on May 10, 2005,  May 11, 2004,  March 17,
2003 and on April 30, 2002.



                                       38
<PAGE>

         NOTE 18 - REGULATORY MATTERS

         The  Bank  is  subject  to  various  regulatory  capital   requirements
administered  by the federal banking  agencies.  Failure to meet minimum capital
requirements   can  initiate   certain   mandatory,   and  possible   additional
discretionary  actions by regulators  that, if  undertaken,  could have a direct
material  effect on the Bank's  financial  statements.  Under  capital  adequacy
guidelines and the regulatory  framework for prompt corrective  action, the Bank
must meet specific capital guidelines that involve quantitative  measures of the
Bank's assets,  liabilities,  and certain  off-balance-sheet items as calculated
under  regulatory   accounting   practices.   The  Bank's  capital  amounts  and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.

         Quantitative  measures  established  by  regulation  to ensure  capital
adequacy  require the Bank to maintain  minimum amounts and ratios (set forth in
the table  below) of total and Tier 1 capital to  risk-weighted  assets,  and of
Tier 1 capital to average assets.  Management believes, as of December 31, 2005,
that the Bank meets all capital adequacy requirements to which it is subject.

         As of December 31, 2005,  the most recent  notification  of the banking
regulators  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  institution's
category.  The Bank's actual capital  amounts and ratios and minimum  regulatory
amounts and ratios are presented as follows:

<TABLE>
<CAPTION>
                                                                                                             To be well capitalized
                                                                                          For capital        under prompt corrective
                                                                                        adequacy purposes        action provisions
                                                                     Actual                   Minimum                  Minimum
                                                                     ------                   -------                  -------
                                                              Amount        Ratio         Amount     Ratio       Amount        Ratio
                                                              ------        -----         ------     -----       ------        -----
                                                                                      (Dollars in thousands)
As of December 31, 2005
<S>                                                          <C>             <C>       <C>            <C>      <C>            <C>
Total Capital (to risk weighted assets) ..............       $12,082         12.79%    $ 7,557        8.0%     $ 9,447        10.0%
Tier 1 Capital (to risk weighted assets) .............        11,024         11.67       3,779        4.0        5,668         6.0
Tier 1 Capital (to average assets) ...................        11,024          9.95       4,433        4.0        5,541         5.0

As of December 31, 2004
Total Capital (to risk weighted assets) ..............       $ 8,850         11.1%     $ 6,395        8.0%     $ 7,994        10.0%
Tier 1 Capital  (to risk weighted assets) ............         7,930          9.9        3,198        4.0        4,797         6.0
Tier 1 Capital  (to average assets) ..................         7,930          8.4        3,778        4.0        4,723         5.0
</TABLE>

The Company is also subject to capital  adequacy  guidelines  established by the
Reserve Bank,  but in 2005 and 2004 for holding  companies  with total assets of
$150  million or less,  capital  adequacy  was  measured  by the Bank's  capital
adequacy.


                                       39
<PAGE>

NOTE 19 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

         The estimated fair values of the Company's  financial  instruments were
as follows:

<TABLE>
<CAPTION>
                                                                                                December 31,
                                                                                                ------------
                                                                                    2005                            2004
                                                                                    ----                            ----
                                                                        Carrying           Fair           Carrying           Fair
                                                                         Amount            Value           Amount            Value
                                                                         ------            -----           ------            -----
FINANCIAL ASSETS
<S>                                                                   <C>              <C>              <C>              <C>
      Cash and due from banks ..................................      $ 2,716,965      $ 2,716,965      $ 3,008,847      $ 3,008,847
      Federal funds sold .......................................        3,183,000        3,183,000        4,130,595        4,130,595
      Investment securities ....................................       14,004,326       14,006,590       13,221,273       13,221,273
      Loans, gross .............................................       87,331,900       86,975,740       75,158,153       75,178,968
     Cash surrender value of life insurance policies ...........        1,573,038        1,573,038        1,515,172        1,515,172
FINANCIAL LIABILITIES
      Deposits .................................................       91,652,041       88,379,085       82,518,944       80,057,167
      Customer repurchase agreements ...........................        3,083,884        3,051,367        5,483,993        5,483,993
      Borrowings from FHLB .....................................        4,346,505        4,277,218        3,400,000        3,366,174
</TABLE>


NOTE 20 - PARENT COMPANY INFORMATION

         Following is condensed  financial  information of  Cornerstone  Bancorp
(parent company only):
<TABLE>
<CAPTION>

                                                                                                             December 31,
                                                                                                             ------------
                                                                                                       2005                2004
                                                                                                       ----                ----
ASSETS
<S>                                                                                               <C>                    <C>
     Cash and interest bearing deposits ..............................................            $ 2,860,340            $   836,037
     Investment in subsidiary ........................................................             10,942,761              7,909,750
     Other assets ....................................................................                 40,000                 40,000
                                                                                                  -----------            -----------
                  Total Assets .......................................................            $13,843,101            $ 8,785,787
                                                                                                  ===========            ===========

LIABILITIES AND SHAREHOLDERS' EQUITY
     Accrued expenses ................................................................            $    15,116            $     8,327
     Shareholders' equity ............................................................             13,827,985              8,777,460
                                                                                                  -----------            -----------
                  Total Liabilities and Shareholders' Equity .........................            $13,843,101            $ 8,785,787
                                                                                                  ===========            ===========
</TABLE>










                                                                     (Continued)

                                       40
<PAGE>

NOTE 20 - PARENT COMPANY INFORMATION, Continued

                         CONDENSED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                                            Year ended December 31,
                                                                                            -----------------------
                                                                                  2005                2004                  2003
                                                                                  ----                ----                  ----
INCOME
<S>                                                                           <C>                  <C>                  <C>
    Interest ........................................................         $    13,031          $     9,469          $    11,839

EXPENSES
    Sundry ..........................................................              46,094               44,428               54,794
                                                                              -----------          -----------          -----------
         Loss before equity in undistributed net
           income of bank subsidiary ................................             (33,063)             (34,959)             (42,955)

    Equity in undistributed net income of subsidiary
                                                                                1,094,328              699,016              399,003
                                                                              -----------          -----------          -----------
         Net income .................................................         $ 1,061,265          $   664,057          $   356,048
                                                                              ===========          ===========          ===========
</TABLE>

                       CONDENSED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                                Year ended December 31,
                                                                                                -----------------------
                                                                                       2005               2004              2003
                                                                                       ----               ----              ----
OPERATING ACTIVITIES
<S>                                                                               <C>                <C>                <C>
    Net income ............................................................       $ 1,061,265        $   664,057        $   356,048
         Adjustments to reconcile net income to net
             cash provided by (used for) operating  activities
         Equity in undistributed net income of subsidiary .................        (1,094,328)          (699,016)          (399,003)
         Increase (decrease) in accrued expenses ..........................             6,789              2,337              5,732
                                                                                  -----------        -----------        -----------
                   Net cash used for operating activities .................           (26,274)           (32,622)           (37,223)

INVESTING ACTIVITIES
    Investment in bank subsidiary .........................................        (2,000,000)                 -                  -

FINANCING ACTIVITIES
       Proceeds from sale of common stock, net ............................         4,053,147
    Cash paid in lieu of fractional shares ................................            (2,570)            (1,360)              (317)
                                                                                  -----------        -----------        -----------
                Net cash provided by (used for)
                    financing activities ..................................         4,050,577             (1,360)              (317)
                                                                                  -----------        -----------        -----------

         Net increase (decrease) in cash ..................................         2,024,303            (33,982)           (37,540)

Cash, beginning of year ...................................................           836,037            870,019            907,559
                                                                                  -----------        -----------        -----------

Cash, end of year .........................................................       $ 2,860,340        $   836,037        $   870,019
                                                                                  ===========        ===========        ===========
</TABLE>


                                       41