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U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549



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FORM 10-QSB



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|x | Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------

For the quarterly period ended June 30, 2006



| ̈ | Transition Report Under Section 13 or 15(d) of the Exchange Act
|- | ---------------------------------------------------------------

For the transition period ended

Commission File Number 0-21083



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SOUTH STREET FINANCIAL CORP.

(Exact name of small business issuer as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|NORTH CAROLINA                                                 |  | 56-1973261                          
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification Number)

155 WEST SOUTH STREET, ALBEMARLE, NC 28001

(Address of principal executive office)

(704) 982-9184

(Issuers telephone number)



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Check whether the issuer (1) filed all
reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.    Yes  x    No ̈

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

As of July 31, 2006, 2,954,696 shares of the issuers common stock,
no par value, were outstanding.

This report contains 14 pages.



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|         |  |                                                                                            |  |         
|-------- |  | ------------------------------------------------------------------------------------------ |  | --------
|         |  |                                                                                            |  | Page No.
|Part I.  |  | FINANCIAL INFORMATION                                                                      |  |         
|         |  |                                                                                           
|Item 1 - |  | Financial Statements (Unaudited)                                                           |  |         
|         |  |                                                                                           
|         |  | Consolidated Statements of Financial Condition June 30, 2006 and December 31, 2005         |  | 3       
|         |  |                                                                                           
|         |  | Consolidated Statements of Income Three Months and Six Months Ended June 30, 2006 and 2005 |  | 4       
|         |  |                                                                                           
|         |  | Consolidated Statements of Cash Flows Six Months Ended June 30, 2006 and 2005              |  | 5       
|         |  |                                                                                           
|         |  | Notes to Consolidated Financial Statements                                                 |  | 6       
|         |  |                                                                                           
|Item 2 - |  | Managements Discussion and Analysis of Financial Condition and Results of Operations      |  | 8       
|         |  |                                                                                           
|Item 3 - |  | Controls and Procedures                                                                    |  | 11      
|         |  |                                                                                           
|Part II. |  | OTHER INFORMATION                                                                          |  |         
|         |  |                                                                                           
|Item 2 - |  | Unregistered Sales of Equity Securities and Use of Proceeds                                |  | 12      
|         |  |                                                                                           
|Item 4 - |  | Submission of Matters to a Vote of Security Holders                                        |  | 12      
|         |  |                                                                                           
|Item 6 - |  | Exhibits                                                                                   |  | 13      



- 2 -



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Part I. FINANCIAL INFORMATION

Item 1 - Financial Statements

South Street Financial Corp. and Subsidiary

Consolidated Statements of Financial Condition



|                                                                                                                                                 |  |                        |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                 |  | June 30,2006           |         |   | December 31,2005* |  
|                                                                                                                                                 |  | (Unaudited)            |         |   |                   |  
|                                                                                                                                                 |  | (Dollars in thousands) |        
|ASSETS                                                                                                                                           |  |                        |         |   |                   |   |         |  
|Cash and cash equivalents:                                                                                                                       |  |                        |         |   |                   |   |         |  
|Non-interest-bearing deposits                                                                                                                    |  | $                      | 5,898   |   |                   | $ | 5,692   |  
|Interest-bearing deposits                                                                                                                        |  |                        | 7,367   |   |                   |   | 6,245   |  
|Federal funds sold                                                                                                                               |  |                        | 2,039   |   |                   |   | 2,363   |  
|Securities held to maturity, fair value June 30, 2006, $4,570; December 31, 2005, $5,119                                                         |  |                        | 4,853   |   |                   |   | 5,254   |  
|Securities available for sale                                                                                                                    |  |                        | 24,002  |   |                   |   | 24,101  |  
|Federal Home Loan Bank stock                                                                                                                     |  |                        | 930     |   |                   |   | 1,100   |  
|Loans receivable                                                                                                                                 |  |                        | 197,384 |   |                   |   | 183,886 |  
|Allowance for loan losses                                                                                                                        |  |                        | (726    | ) |                   |   | (674    | )
|                                                                                                                                                 |  |                        |         |   |                   |   |         |  
|Net loans                                                                                                                                        |  |                        | 196,658 |   |                   |   | 183,212 |  
|                                                                                                                                                 |  |                       
|Real estate held for investment                                                                                                                  |  |                        | 653     |   |                   |   | 653     |  
|Foreclosed real estate                                                                                                                           |  |                        | 229     |   |                   |   | 229     |  
|Premises and equipment, net                                                                                                                      |  |                        | 5,159   |   |                   |   | 4,608   |  
|Bank owned life insurance                                                                                                                        |  |                        | 7,683   |   |                   |   | 7,573   |  
|Prepaid expenses and other assets                                                                                                                |  |                        | 2,416   |   |                   |   | 2,203   |  
|                                                                                                                                                 |  |                        |         |   |                   |   |         |  
|Total assets                                                                                                                                     |  | $                      | 257,887 |   |                   | $ | 243,233 |  
|                                                                                                                                                 |  |                        |         |   |                   |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                             |  |                        |         |   |                   |   |         |  
|Liabilities:                                                                                                                                     |  |                        |         |   |                   |   |         |  
|Deposits                                                                                                                                         |  | $                      | 218,696 |   |                   | $ | 198,634 |  
|Borrowings                                                                                                                                       |  |                        | 10,000  |   |                   |   | 15,000  |  
|Accrued expenses and other liabilities                                                                                                           |  |                        | 3,407   |   |                   |   | 3,629   |  
|                                                                                                                                                 |  |                        |         |   |                   |   |         |  
|Total liabilities                                                                                                                                |  |                        | 232,103 |   |                   |   | 217,263 |  
|                                                                                                                                                 |  |                        |         |   |                   |   |         |  
|Stockholders Equity:                                                                                                                            |  |                        |         |   |                   |   |         |  
|Preferred stock, no par value; authorized 5,000,000 shares; none issued                                                                          |  |                        |        |   |                   |   |        |  
|Common stock, no par value, authorized 20,000,000 shares; issued 2,954,696 shares at June 30, 2006 and 2,999,594 December 31,
2005, respectively |  |                        | 5,961   |   |                   |   | 6,428   |  
|Unearned compensation                                                                                                                            |  |                        | (113    | ) |                   |   | (159    | )
|Unearned ESOP                                                                                                                                    |  |                        | (445    | ) |                   |   | (534    | )
|Retained earnings, substantially restricted                                                                                                      |  |                        | 20,606  |   |                   |   | 20,483  |  
|Accumulated other comprehensive loss                                                                                                             |  |                        | (225    | ) |                   |   | (248    | )
|                                                                                                                                                 |  |                        |         |   |                   |   |         |  
|Total stockholders equity                                                                                                                       |  |                        | 25,784  |   |                   |   | 25,970  |  
|                                                                                                                                                 |  |                        |         |   |                   |   |         |  
|Total liabilities and stockholders equity                                                                                                       |  | $                      | 257,887 |   |                   | $ | 243,233 |  
|                                                                                                                                                 |  |                        |         |   |                   |   |         |  

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|* | Derived from audited consolidated financial statements.
|- | -------------------------------------------------------

See
accompanying notes.



- 3 -



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South Street Financial Corp. and Subsidiary

Consolidated Statements of Income (Unaudited)



|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|------------------------------------------------------------- |  | ----------------------------------------------- | --------- | ------------------------- | - | --------- |  | ---- | --------- |  | - | ---------
|                                                              |  | Three Months EndedJune 30,                      |           | Six Months Ended June 30,
|                                                              |  | 2006                                            |           | 2005                      |   | 2006      |  | 2005
|                                                              |  | (In thousands, except share and per share data)
|INTEREST INCOME                                               |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|Loans, including fees                                         |  | $                                               | 3,434     |                           | $ | 2,761     |  | $    | 6,706     |  | $ | 5,307    
|Investment securities                                         |  |                                                 | 258       |                           |   | 298       |  |      | 508       |  |   | 506      
|Other interest-earnings deposits                              |  |                                                 | 121       |                           |   | 33        |  |      | 227       |  |   | 164      
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|TOTAL INTEREST INCOME                                         |  |                                                 | 3,813     |                           |   | 3,092     |  |      | 7,441     |  |   | 5,977    
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|INTEREST EXPENSE                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|Deposits                                                      |  |                                                 | 1,756     |                           |   | 1,198     |  |      | 3,283     |  |   | 2,321    
|Borrowings                                                    |  |                                                 | 170       |                           |   | 20        |  |      | 337       |  |   | 20       
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|TOTAL INTEREST EXPENSE                                        |  |                                                 | 1,926     |                           |   | 1,218     |  |      | 3,620     |  |   | 2,341    
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|NET INTEREST INCOME                                           |  |                                                 | 1,887     |                           |   | 1,874     |  |      | 3,821     |  |   | 3,636    
|PROVISION FOR LOAN LOSSES                                     |  |                                                 | 30        |                           |   | 30        |  |      | 60        |  |   | 60       
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES           |  |                                                 | 1,857     |                           |   | 1,844     |  |      | 3,761     |  |   | 3,576    
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|NON-INTEREST INCOME                                           |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|Service charges and fees                                      |  |                                                 | 110       |                           |   | 105       |  |      | 217       |  |   | 197      
|Income from bank-owned life insurance                         |  |                                                 | 58        |                           |   | 55        |  |      | 110       |  |   | 134      
|Other                                                         |  |                                                 | 18        |                           |   | 43        |  |      | 37        |  |   | 36       
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|TOTAL NON-INTEREST INCOME                                     |  |                                                 | 186       |                           |   | 203       |  |      | 364       |  |   | 367      
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|NON-INTEREST EXPENSE                                          |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|Compensation and benefits                                     |  |                                                 | 1,023     |                           |   | 984       |  |      | 2,032     |  |   | 1,879    
|Net occupancy and equipment                                   |  |                                                 | 139       |                           |   | 118       |  |      | 273       |  |   | 220      
|Data processing                                               |  |                                                 | 90        |                           |   | 86        |  |      | 171       |  |   | 180      
|Other                                                         |  |                                                 | 271       |                           |   | 291       |  |      | 505       |  |   | 534      
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|TOTAL NON-INTEREST EXPENSE                                    |  |                                                 | 1,523     |                           |   | 1,479     |  |      | 2,981     |  |   | 2,813    
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|INCOME BEFORE INCOME TAXES                                    |  |                                                 | 520       |                           |   | 568       |  |      | 1,144     |  |   | 1,130    
|INCOME TAXES                                                  |  |                                                 | 201       |                           |   | 220       |  |      | 441       |  |   | 433      
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|NET INCOME                                                    |  | $                                               | 319       |                           | $ | 348       |  | $    | 703       |  | $ | 697      
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|PER SHARE DATA:                                               |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|Basic and diluted net income per common share                 |  | $                                               | .11       |                           | $ | .12       |  | $    | .24       |  | $ | .24      
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|Dividends                                                     |  | $                                               | .10       |                           | $ | .10       |  | $    | .20       |  | $ | .20      
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          
|Weighted average common shares outstanding, basic and diluted |  |                                                 | 2,907,311 |                           |   | 2,950,649 |  |      | 2,914,787 |  |   | 2,950,495
|                                                              |  |                                                 |           |                           |   |           |  |      |           |  |   |          

See accompanying notes.



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South Street Financial Corp. and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)



|                                                                                          |  |                          |         |   |      |   |         |  
|----------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                          |  | Six Months EndedJune 30, |        
|                                                                                          |  | 2006                     |         |   | 2005 |  
|                                                                                          |  | (In thousands)           |        
|CASH FLOWS FROM OPERATING ACTIVITIES                                                      |  |                          |         |   |      |   |         |  
|Net income                                                                                |  | $                        | 703     |   |      | $ | 697     |  
|Adjustments to reconcile net income to net cash provided by operating activities:         |  |                          |         |   |      |   |         |  
|Net accretion of premiums and discounts on securities                                     |  |                          | 34      |   |      |   | 32      |  
|Amortization of deferred loan fees                                                        |  |                          | (2      | ) |      |   | (216    | )
|Depreciation                                                                              |  |                          | 99      |   |      |   | 66      |  
|Provision for loan losses                                                                 |  |                          | 60      |   |      |   | 60      |  
|Loss on disposal of fixed assets                                                          |  |                          |        |   |      |   | 4       |  
|Amortization of unearned compensation                                                     |  |                          | 46      |   |      |   | 50      |  
|Income from Bank Owned Life Insurance                                                     |  |                          | (110    | ) |      |   | (134    | )
|Amortization of ESOP compensation                                                         |  |                          | 48      |   |      |   | 42      |  
|Change in assets and liabilities:                                                         |  |                          |         |   |      |   |         |  
|Increase in other assets                                                                  |  |                          | (227    | ) |      |   | (650    | )
|Increase (decrease) in accrued expenses and other liabilities                             |  |                          | (222    | ) |      |   | 1,409   |  
|                                                                                          |  |                          |         |   |      |   |         |  
|NET CASH PROVIDED BY OPERATING ACTIVITIES                                                 |  |                          | 429     |   |      |   | 1,360   |  
|                                                                                          |  |                          |         |   |      |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                                      |  |                          |         |   |      |   |         |  
|Purchase of securities available for sale                                                 |  |                          | (2,000  | ) |      |   | (6,018  | )
|Proceeds from maturities, calls and principal repayments of securities available for sale |  |                          | 2,119   |   |      |   | 227     |  
|Proceeds from maturities, calls and principal repayments of securities held to maturity   |  |                          | 384     |   |      |   | 552     |  
|Loan originations and principal payments on loans, net                                    |  |                          | (13,504 | ) |      |   | (18,781 | )
|Purchase of property and equipment                                                        |  |                          | (650    | ) |      |   | (465    | )
|Purchase of FHLB stock                                                                    |  |                          |        |   |      |   | (216    | )
|Proceeds from redemption of FHLB stock                                                    |  |                          | 170     |   |      |   |        |  
|                                                                                          |  |                          |         |   |      |   |         |  
|NET CASH USED BY INVESTING ACTIVITIES                                                     |  |                          | (13,481 | ) |      |   | (24,701 | )
|                                                                                          |  |                          |         |   |      |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                                      |  |                          |         |   |      |   |         |  
|Net increase in deposits                                                                  |  |                          | 20,062  |   |      |   | 6,424   |  
|Payment of dividends                                                                      |  |                          | (580    | ) |      |   | (587    | )
|Purchases and retirement of common stock                                                  |  |                          | (426    | ) |      |   | (96     | )
|Advances from FHLB                                                                        |  |                          |        |   |      |   | 5,000   |  
|Repayments of FHLB advances                                                               |  |                          | (5,000  | ) |      |   |        |  
|                                                                                          |  |                          |         |   |      |   |         |  
|NET CASH PROVIDED BY FINANCING ACTIVITIES                                                 |  |                          | 14,056  |   |      |   | 10,741  |  
|                                                                                          |  |                          |         |   |      |   |         |  
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                      |  |                          | 1,004   |   |      |   | (12,600 | )
|CASH AND CASH EQUIVALENTS, BEGINNING                                                      |  |                          | 14,300  |   |      |   | 25,546  |  
|                                                                                          |  |                          |         |   |      |   |         |  
|CASH AND CASH EQUIVALENTS, ENDING                                                         |  | $                        | 15,304  |   |      | $ | 12,946  |  
|                                                                                          |  |                          |         |   |      |   |         |  

See accompanying notes.



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South Street Financial Corp. and Subsidiary

Notes to Consolidated Financial Statements

NOTE A - BASIS OF PRESENTATION

In
managements opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of June 30, 2006 and for
the three month and six month periods ended June 30, 2006 and 2005, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of South Street
Financial Corp. (the Company) and its wholly-owned subsidiary, Home Savings Bank of Albemarle, S.S.B., (Home Savings or the Bank), the Banks wholly-owned subsidiary, South Street Development Corporation
(SSDC), and SSDCs wholly-owned subsidiary, Park Ridge Associates, LLC (Park Ridge). All significant intercompany transactions and balances have been eliminated in consolidation. Operating results for the three month and
six month periods ended June 30, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2006.

The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Companys 2005 annual report on
Form 10-KSB. This quarterly report should be read in conjunction with such annual report.

NOTE B - EARNINGS PER SHARE

The Companys basic earnings per share is based on net income divided by the weighted average number of shares outstanding from the beginning of the period to the
end of the period. Diluted earnings per share is adjusted for all potential common stock instruments having a dilutive effect. For purposes of this computation, the number of shares of common stock purchased by the ESOP that have not been allocated
to participant accounts are not assumed to be outstanding.

At June 30, 2006 and 2005, there were 449,650 exercisable
options outstanding, all of which were antidilutive.

NOTE C - COMPREHENSIVE INCOME

For the quarters ended June 30, 2006 and 2005, total comprehensive income, consisting of net income and unrealized securities gains and losses, net of taxes, was $313,000 and $449,000, respectively.

For the six months ended June 30, 2006 and 2005, total comprehensive income, consisting of net income and unrealized securities gains and losses, net of taxes,
was $726,000 and $645,000, respectively.



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South Street Financial Corp. and Subsidiary

Notes to Consolidated Financial Statements

NOTE D - EMPLOYEE BENEFIT PLANS

The accompanying table details the components of pension expense recognized in the Companys
Consolidated Statements of Income:



|                                   |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------- |  | -------------------------- | ------- | - | ------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                   |  | Three Months EndedJune 30, |         |   | Six Months EndedJune 30, |  
|                                   |  | 2006                       |         |   | 2005                     |   |         | 2006 |  |   | 2005    |  
|                                   |  | (Dollars in thousands)     |        
|Service cost                       |  | $                          | 39,698  |   |                          | $ | 31,020  |      |  | $ | 79,396  |   |  | $ | 62,040  |  
|Interest cost                      |  |                            | 50,233  |   |                          |   | 44,045  |      |  |   | 100,466 |   |  |   | 88,090  |  
|Expected return on plan assets     |  |                            | (35,278 | ) |                          |   | (31,511 | )    |  |   | (70,556 | ) |  |   | (63,022 | )
|Amortization of prior service cost |  |                            | 18,098  |   |                          |   | 15,766  |      |  |   | 36,196  |   |  |   | 31,532  |  
|                                   |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Net periodic pension cost          |  | $                          | 72,751  |   |                          | $ | 59,320  |      |  | $ | 145,502 |   |  | $ | 118,640 |  
|                                   |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  

For the 2006 Plan Year, no tax-deductible contributions are required or allowed.

The adoption of Statement of Financial Accounting Standards No. 123R, Share Based Payment, on January 1, 2006 did not have a material
impact on the Companys consolidated financial statements.



- 7 -



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Item 2 - Managements Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly
Report on Form 10-QSB contains certain forward-looking statements with respect to the financial condition, results of operations and business of the Company and the Bank. These forward-looking statements involve risks and uncertainties, and are
based on the beliefs and assumptions of management of the Company and the Bank and on the information available to management at the time that these disclosures were prepared. These statements can be identified by the use of words like
expect, anticipate, estimate and believe, variations of these words, and other similar expressions. Readers should not place undue reliance on forward-looking statements as a number of important
factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, (1) competition in the Banks markets,
(2) changes in the interest rate environment, (3) general national, regional or local economic conditions that are less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible
impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environment and tax laws, (6) the impact of
changes in monetary and fiscal policies, laws, rules and regulations, and (7) other risks and factors identified in the Companys other filings with the SEC. The Company undertakes no obligation to update any forward-looking
statements.

Comparison of Financial Condition at

June 30, 2006 and December 31, 2005

The Companys total consolidated
assets increased $14.7 million during the six months ended June 30, 2006 from $243.2 million at December 31, 2005 to $257.9 million. This increase in our assets resulted primarily from an increase in net loans receivable. Cash and cash
equivalents increased by $1.0 million, from $14.3 million at December 31, 2005 to $15.3 million at June 30, 2006. This increase in liquid assets occurred principally from the increase in funds in the FHLB overnight account. In comparison
to prior years, loan rates have been adjusted aggressively to grow the portfolio. As a consequence, the Companys loan portfolio increased by $13.4 million, from $183.2 million at December 31, 2005 to $196.6 million at June 30, 2006.
The Company has utilized the liquidity provided by the increase in deposits from our customers of $20.0 million to fund the increase in the loan portfolio.

Comparison of Operating Results for the

Three Months Ended June 30, 2006 and 2005

General.Net income for the three-month period ended June 30, 2006 was $319,000 or $29,000 less than the $348,000 earned during the
same period in 2005. This decrease in our earnings resulted principally from the increase in interest expense of $708,000 during the quarter, which is explained below.

Interest income. Interest income increased by $721,000 from $3.1 million for the three months ended June 30, 2005 to $3.8 million for the three months ended June 30, 2006. The level of our average
interest-earning assets increased from approximately $203.8 million during the second quarter of 2005 to approximately $232.8 million during the second quarter of 2006, which is the result of loan growth for the period. The yield on our average
interest-earning assets increased approximately 48 basis points. This increase in our yield resulted primarily from the shift in our earning assets from interest earning deposits to loans and investment securities, which have significantly higher
rates than do our interest earning deposits.

Interest expense.Interest expense on deposits and borrowed funds increased by $708,000 from $1.2
million for the three months ended June 30, 2005 to $1.9 million for the three months ended June 30, 2006. As with our interest-earning assets, the volume of our interest-bearing liabilities increased from approximately $191.3 million in
the second quarter of 2005, to $224.8 million in the second quarter of 2006. The average rates for our interest-bearing liabilities increased approximately 88 basis points in comparison to the second quarter of 2005.



- 8 -



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Net interest income. Net interest income increased by $13,000 from $1.87 million for the three months ended
June 30, 2005 to $1.89 million for the three months ended June 30, 2006. This increase resulted primarily from the increase in our interest income discussed above.

Provision for loan losses. The provision for loan losses charged to income during the three months ended June 30, 2006 and 2005 was $30,000. Provisions, which are charged to operations, and the resulting
loan loss allowance are amounts the Companys management believes will be adequate to absorb losses inherent in our loan portfolio. Loans are charged off against the allowance when management believes that collectibility is unlikely.

At June 30, 2006 the Companys allowance for loan losses amounted to $726,000, which management believes is adequate to absorb losses inherent
in its loan portfolio.

Non-interest expense. Non-interest expense increased by $44,000 for the three months ended June 30, 2006 compared to
the three months ended June 30, 2005. This increase resulted partially from an increase in compensation expense associated with normal and expected compensation adjustments, additional personnel, and increases in the cost of employee benefits
such as health insurance net of a decrease in expenses associated with the ESOP.

Provision for income taxes. The Companys effective tax rate
(income taxes as a percentage of income before income taxes) was 38.7% for the periods ending June 30, 2006 and 2005.

Comparison
of Operating Results for the

Six Months Ended June 30, 2006 and 2005

General.Net income for the six-month period ended June 30, 2006 was $703,000 or $6,000 more than the $697,000 earned during the same period in 2005. This
increase in our earnings resulted principally from the increase in interest income of $1.5 million during the quarter, which is explained below.

Interest income. Interest income increased by $1.5 million from $6.0 million for the six months ended June 30, 2005 to $7.4 million for the six months ended June 30, 2006. The level of our average interest-earning assets
increased from approximately $203.7 million during the first half of 2005 to approximately $229.0 million during the first half of 2006, which is the result of loan growth for the period. The yield on our average interest-earning assets increased
approximately 127 basis points. This increase in our yield resulted primarily from the shift in our earning assets from interest earning deposits to loans and investment securities, which have significantly higher rates than do our interest earning
deposits.

Interest expense.Interest expense on deposits and borrowed funds increased by $1.3 million from $2.3 million for the six months ended
June 30, 2005 to $3.6 million for the six months ended June 30, 2006. As with our interest-earning assets, the volume of our average interest-bearing liabilities increased from approximately $191.3 million in the first half of 2005, to
$220.9 million in the first half of 2006. The average rates for our interest-bearing liabilities increased approximately 166 basis points in comparison to the first half of 2005.

Net interest income. Net interest income increased by $185,000 from $3.64 million for the six months ended June 30, 2005 to $3.82 million for the six months ended June 30, 2006. This increase resulted
primarily from the increase in our interest income discussed above.



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Provision for loan losses. The provision for loan losses charged to income during the six months ended
June 30, 2006 and 2005 was $60,000. Provisions, which are charged to operations, and the resulting loan loss allowance are amounts the Companys management believes will be adequate to absorb losses inherent in our loan portfolio. Loans
are charged off against the allowance when management believes that collectibility is unlikely.

Non-interest income. The Company earned
non-interest income of $364,000 during the six months ended June 30, 2006 compared to the $367,000 that was earned during the same period in 2005. This decrease in non-interest income of $3,000 was primarily attributable to an increase in
income from service charges on deposit accounts during the quarter off-set by a decrease in income from bank-owned life insurance.

Non-interest
expense. Non-interest expense increased by $168,000 for the six months ended June 30, 2006 compared to the six months ended June 30, 2005. This increase resulted partially from an increase in compensation expense associated with normal
and expected compensation adjustments, additional personnel, and increases in the cost of employee benefits such as health insurance net of a decrease in expenses associated with the ESOP.

Provision for income taxes. The Companys effective tax rate (income taxes as a percentage of income before income taxes) was 38.5% for the period ending
June 30, 2006 as compared to 38.3% for the period ending June 30, 2005.

Liquidity and Capital Resources

The term liquidity generally refers to an organizations ability to generate adequate amounts of funds to meet its needs for cash. More specifically
for financial institutions, liquidity ensures that adequate funds are available to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses, and provide funds for debt service,
dividends to stockholders, and other institutional commitments. Funds are primarily provided through financial resources from operating activities, expansion of the deposit base, borrowings, through the sale or maturity of investments, the ability
to raise equity capital, or maintenance of shorter-term interest bearing deposits.

As a state chartered stock savings bank, the Bank must meet certain
liquidity requirements that are established by the North Carolina Commissioner of Banks. The Banks liquidity ratio at June 30, 2006, as computed under such regulations, was considerably in excess of such requirements. Given its excess
liquidity and its ability to borrow from the FHLB of Atlanta, the Bank believes that it will have sufficient funds available to meet anticipated future loan commitments, unexpected deposit withdrawals, or other cash requirements.

The FDIC requires the Bank to have a minimum leverage ratio of Tier I Capital (principally consisting of retained earnings and any common stockholders equity, less
any intangible assets) to all assets of at least 3%, provided that it receives the highest rating during the examination process. For institutions that receive less than the highest rating, the Tier I capital requirement is 1% to 2% above the stated
minimum. The FDIC also requires the Bank to have a ratio of total capital to risk-weighted assets of 8%, of which at least 4% must be in the form of Tier I capital. The Commissioner requires a net worth equal to at least 5% of total assets. The Bank
complied with all of the capital requirements of both the FDIC and the Commissioner at June 30, 2006.



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Item 3. Controls and Procedures

As of the end of the period covered by this Report, the Companys management carried
out an evaluation, under the supervision and with the participation of the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures
pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934 (the Exchange Act). Based upon that evaluation, the Companys management, including its Chief Executive Officer and Chief Financial Officer, concluded that the
Companys disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Companys Exchange Act filings.

There have been no changes in internal control over financial reporting during the period covered by this Report that have materially affected, or are
reasonably likely to materially affect, the Companys internal control over financial reporting.



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Part II. OTHER INFORMATION

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

The following table provides information with respect
to purchases made by or on behalf of the Company or any affiliated purchases (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of the Companys common stock during the three months ended June 30,
2006.



|                                |  |                                |  |                            |  |                                                                  |   |                                                                  |       
|------------------------------- |  | ------------------------------ |  | -------------------------- |  | ---------------------------------------------------------------- | - | ---------------------------------------------------------------- | ------
|Period                          |  | Total Numberof SharesPurchased |  | Average PricePaid perShare |  | Total Numberof SharesPurchased asPart ofPubliclyAnnouncedProgram |   | Maximum Numberof Shares ThatMay Yet BePurchased Underthe Program
|April 1, 2006 to April 30, 2006 |  | 0                              |  | $                          |  |                                                                  | 0 |                                                                  | 28,237
|May 1, 2006 to May 31, 2006     |  | 0                              |  | $                          |  |                                                                  | 0 |                                                                  | 28,237
|June 1, 2006 to June 30, 2006   |  | 0                              |  | $                          |  |                                                                  | 0 |                                                                  | 28,237
|                                |  |                                |  |                            |  |                                                                  |   |                                                                  |       
|                                |  | 0                              |  |                            |  |                                                                  | 0 |                                                                  |       
|                                |  |                                |  |                            |  |                                                                  |   |                                                                  |       

Note: On June 8, 2004, the Company publicly announced a share repurchase program. Under the program,
the Company may repurchase up to 153,408 outstanding shares. The program has no termination date.

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

The Annual Meeting of Stockholders was held on May 22,
2006. Of 2,964,594 shares entitled to vote at the meeting, 2,643,892 were voted. The following matters were voted on at the meeting:



|Proposal 1: | To elect six members of the Board of Directors for a one-year term until the Annual Meeting of Shareholders in 2007. Votes for each nominee were as follows:
|----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------



|                          |  |           |  |         
|------------------------- |  | --------- |  | --------
|Name                      |  | For       |  | Withheld
|J. Banks Garrison, Jr.    |  | 2,633,696 |  | 10,196  
|Caldwell A. Holbrook, Jr. |  | 2,634,206 |  | 9,686   
|Joel A. Huneycutt         |  | 2,635,392 |  | 8,500   
|Douglas D. Stokes         |  | 2,634,306 |  | 9,586   
|R. Ronald Swanner         |  | 2,628,092 |  | 15,800  
|Greg E. Underwood         |  | 2,633,031 |  | 10,861  



|Proposal 2: | To ratify the appointment of Dixon Hughes PLLC as our independent auditors for the year ending December 31, 2006.
|----------- | -----------------------------------------------------------------------------------------------------------------



|          |  |         |  |        
|--------- |  | ------- |  | -------
|For       |  | Against |  | Abstain
|2,639,415 |  | 4,336   |  | 141    



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Item 6. Exhibits



|                  |  |                                                                                                                                                                                                                                                                                                                                        
|----------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                  | 
|Exhibit (3)(i)    |  | Certificate of Incorporation, incorporated herein by reference to Exhibit (3)(i) to the Registration Statement on Form S-1, Registration No. 333-04509, dated May 24, 1996, and
amended on July 25, 1996                                                                                                                               
|                  | 
|Exhibit (3)(ii)   |  | Bylaws, incorporated herein by reference to Exhibit (3)(ii) to the Registration Statement on Form S-1, Registration No. 333-04509, dated May 24, 1996, and amended on July 25,
1996                                                                                                                                                    
|                  | 
|Exhibit (4)       |  | Specimen Stock Certificate, incorporated herein by reference to Exhibit (4) to the Registration Statement on Form S-1, Registration No. 333-04509, dated May 24, 1996, and amended on July
25, 1996                                                                                                                                    
|                  | 
|Exhibit (10)(i)   |  | Employment Agreement between R. Ronald Swanner and Home Savings Bank of Albemarle, Inc., S.S.B., incorporated herein by reference to the Form 10-K dated September 30, 1996                                                                                                                                                            
|                  | 
|Exhibit (10)(ii)  |  | South Street Financial Corp. Stock Option Plan, incorporated herein by reference to the Form 10-K dated September 30, 1997                                                                                                                                                                                                             
|                  | 
|Exhibit (10)(iii) |  | 2003 Supplemental Executive Retirement Plan Agreements with R. Ronald Swanner, Christopher F. Cranford, David L. Smith and Cris D. Turner, dated June 27, 2003, incorporated herein by
reference to the Form 10-KSB dated December 31, 2003                                                                                            
|                  | 
|Exhibit (10)(iv)  |  | 2003 Executive Life Insurance Endorsement Method Split Dollar Plan Agreements with R. Ronald Swanner, Christopher F. Cranford, David L. Smith and Cris D. Turner, dated June 27, 2003,
incorporated herein by reference to the Form 10-KSB dated December 31, 2003. On February 1, 2005, Melody M. Goins was added to this plan.       
|                  | 
|Exhibit (10)(v)   |  | 2003 Director Supplemental Retirement Plan Agreements with Caldwell A. Holbrook, Jr., Joel A. Huneycutt, Douglas Dwight Stokes, R. Ronald Swanner and Greg E. Underwood, dated June 27, 2003,
incorporated herein by reference to the Form 10-KSB dated December 31, 2003. On February 1, 2005, Melody M. Goins was added to this plan.
|                  | 
|Exhibit (10)(vi)  |  | 2003 Director Deferral Plan Agreements with Caldwell A. Holbrook, Jr., Joel A. Huneycutt, J. Banks Garrison, Jr., Douglas Dwight Stokes, R. Ronald Swanner and Greg E. Underwood, dated June
27, 2003, incorporated herein by reference to the Form 10-KSB dated December 31, 2003                                                     
|                  | 
|Exhibit (10)(vii) |  | 2003 Director Life Insurance Endorsement Method Split Dollar Plan Agreements with Caldwell A. Holbrook, Jr., Joel A. Huneycutt, J. Banks Garrison, Jr., Douglas Dwight Stokes, R. Ronald
Swanner and Greg E. Underwood, dated June 27, 2003, incorporated herein by reference to the Form 10-KSB dated December 31, 2003               
|                  | 
|Exhibit (11)      |  | Statement Regarding Computation of Per Share Earnings                                                                                                                                                                                                                                                                                  
|                  | 
|Exhibit (31.1)    |  | Certification of Principal Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                     
|                  | 
|Exhibit (31.2)    |  | Certification of Principal Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                     
|                  | 
|Exhibit (32)      |  | Certification of Periodic Financial Report Pursuant to Section 906 of Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                       



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SIGNATURES

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



|                      |  |                              |  |                                      
|--------------------- |  | ---------------------------- |  | -------------------------------------
|                      |  | SOUTH STREET FINANCIAL CORP.
|                      |  |                             
|Date: August 11, 2006 |  | By:                          |  | /s/ R. Ronald Swanner                
|                      |  |                              |  | R. Ronald Swanner                    
|                      |  |                              |  | President and Chief Executive Officer
|                      |  |                             
|Date: August 11, 2006 |  | By:                          |  | /s/ Christopher F. Cranford          
|                      |  |                              |  | Christopher F. Cranford              
|                      |  |                              |  | Treasurer and Chief Financial Officer



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