10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x	Annual Report Under Section 13 or 15(d) of The Securities Exchange Act of 1934
	For The Fiscal Year December 31, 2008

Commission file number: 333-117053

CommunitySouth Financial Corporation

(Name of small business issuer in its charter)

South Carolina	20-0934786
(State or other jurisdiction ofincorporation or organization)	(I.R.S. Employer Identification No.)
6602 Calhoun Memorial Highway
Easley, South Carolina	29640
(Address of principal executive offices)	(Zip Code)

Issuer’s telephone number: (864) 306-2540

Securities registered under Section 12(b) of the Exchange Act:  None

Securities registered under Section 12(g) of the Exchange Act:  Common Stock

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes   o      No   x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes  o       No   x

Indicate by check mark whether the registrant (1) has 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   o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

The estimated aggregate market value of the Common Stock held by non-affiliates (shareholders holding less than 5% of an outstanding class of stock, excluding directors and executive officers) of the Company on June 30, 2008 was $28,086,499.

The number of shares outstanding of the issuer’s common stock, as of March 23, 2009 was 4,698,697.

DOCUMENTS INCORPORATED BY REFERENCE

Annual Report to Shareholders for the Year Ended December 31, 2008	Part II (Items 6 and 7)
Proxy Statement for the Annual Meeting of Shareholders to be held on May 19, 2009	Part III (Portions of Items 9-12 and 14)

Transitional Small Business Disclosure Format. (Check one): Yes o         Nox

Part I

Item 1.  Description of Business.

This Report, including information included or incorporated by reference in this document, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are based on many assumptions and estimates and are not guarantees of future performance.  Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control.  The words “may,”  “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to, those described below under Item 1A- Risk Factors and the following:

·significant increases in competitive pressure in the banking and financial services industries;

·changes in the interest rate environment which could reduce anticipated or actual margins;

·changes in political conditions or the legislative or regulatory environment;

·general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

·changes occurring in business conditions and inflation;

·changes in technology;

·changes in monetary and tax policies;

·adequacy of the level of our allowance for loan losses;

·the rate of delinquencies and amounts of charge-offs;

·the rates of loan growth and the lack of seasoning of our loan portfolio;

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

·loss of consumer confidence and economic disruptions resulting from terrorist activities;

·changes in the securities markets; and

·other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

General

CommunitySouth Financial Corporation was incorporated in South Carolina in March 2004 for purposes of operating as a bank holding company.  Our wholly-owned subsidiary, CommunitySouth Bank & Trust, commenced business on January 18, 2005, and is primarily engaged in the business of accepting savings, demand, and time deposits and providing mortgage, consumer and commercial loans to the general public.

Marketing Focus

Most of the banks in Anderson, Greenville, Pickens and Spartanburg Counties are now local branches of large regional banks.  Although size gives the larger banks certain advantages in competing for business from large corporations, including higher lending limits and the ability to offer services in all of South Carolina, we believe we have a niche in the community banking market in our market area.  As a result, we generally do not attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses and professional concerns.  The bank advertises to emphasize the company’s local ownership, community bank nature, and ability to provide more personalized service than its competition.

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Location and Service Area

Our main office is located at 6602 Calhoun Memorial Highway, Easley, South Carolina 29640.  Our telephone number is (864) 306-2540. Our site is approximately 1.2 acres in size, and the building is approximately 10,000 square feet. We have five full service branch sites in addition to the main office. The branch sites are in the towns of Anderson, Greenville, Greer, Mauldin and Spartanburg, South Carolina. Our full service branches service the entire upstate of South Carolina, which we refer to as the “Upstate,” but primarily the counties of Anderson, Greenville, Pickens and Spartanburg.  The Upstate is generally northwest portion of South Carolina along the I-85 corridor between Atlanta, Georgia and Charlotte, North Carolina.

Like much of the Upstate, Pickens County’s primary source of economic growth is manufacturing.  With its access to applied automobile materials research and technology at Clemson University and location in the automobile hub of the southeast, the area is also developing a reputation among leaders in the automobile industry.  Major employers in the area include Clemson University, Pickens County Schools, and Palmetto Health Alliance.

Anderson County is located along the I-85 corridor west of Pickens County. Significant industries in Anderson include manufacturers of automotive products, plastics, metal products, industrial machinery, publishing and textiles.

 Greenville County is located east of Pickens County and is South Carolina’s most populous county with over 407,000 residents. Greenville is also one of the state’s wealthiest counties, with a per capita income of $30,814 in 2005, compared to the state average of $27,185.  Greenville County is the home to more corporate headquarters than any other region in South Carolina.

Spartanburg County is also located east of Greenville County and has an economic history rooted in agriculture and textiles.  BMW Manufacturing Corporation calls Spartanburg home.  It began its assembly operation in Spartanburg in 1994.  The amenities and opportunities Spartanburg County offers are wide-ranging from housing, education, healthcare, shopping, recreation, and culture.  We believe these factors make the quality of life in the area attractive.  Additionally, Spartanburg’s mild climate and location and access to the mountains, the coast, and larger cities such as Atlanta and Charlotte add to the attractiveness of the area.

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Lending Activities

General.  We emphasize a range of lending services, including real estate, commercial, and equity-line and consumer loans to individuals, small- to medium-sized businesses, and professional concerns that are located in or conduct a substantial portion of their business in our bank’s market area.

Real Estate Loans.  Real estate loans generally fall into one of two categories: construction real estate loans or mortgage loans. Each of these categories is discussed in more detail below, including their specific risks.  Interest rates for all categories may be fixed or adjustable.  We generally charge an origination fee for each loan.

Real estate loans are subject to the same general risks as other loans.  Real estate loans are also sensitive to fluctuations in the value of the real estate securing the loan.  On first and second mortgage loans, we generally do not advance more than regulatory limits.  We require a valid mortgage lien on all real property loans along with a title lien policy which insures the validity and priority of the lien.  We also require borrowers to obtain hazard insurance policies and flood insurance, if applicable.  Additionally, certain types of real estate loans have specific risk characteristics that vary according to the collateral type securing the loan and the terms and repayment sources for the loan.

We have the ability to originate some real estate loans for sale into the secondary market.  We can limit our interest rate and credit risk on these loans by locking the interest rate for each loan with the secondary investor and receiving the investor’s underwriting approval prior to originating the loan.

·Real Estate Loans - Mortgage.  Mortgage real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis.  Inherent in mortgage real estate loans’ credit risk is the risk that the primary source of repayment, the operating commercial real estate company or residential borrower, will be insufficient to service the debt.  If a real estate loan is in default, we also run the risk that the value of the real estate securing the loan will decrease, and thereby be insufficient to satisfy the loan.  To mitigate these risks, we evaluate each borrower on an individual basis and attempt to determine its business risks and credit profile.  We attempt to reduce credit risk in the real estate portfolio by emphasizing loans on owner-occupied office/residential and retail buildings where the loan-to-value ratio is established by independent appraisals.  We typically review the personal financial statements of the principal owners/borrower and require their personal guarantees.  These reviews often reveal secondary sources of payment and liquidity to support a loan request.

·Real Estate Loans - Construction.We offer adjustable and fixed rate residential and commercial construction loans to builders and developers and to consumers who wish to build their own home.  The term of construction and development loans generally is limited to 18 months, although payments may be structured on a longer amortization basis.  Most loans mature and require payment in full upon the sale of the property.  Construction loans generally carry a higher degree of risk than long term financing of existing properties.  Repayment usually depends on the ultimate completion of the project within cost estimates and on the sale of the property.  Specific risks include:

·cost overruns;

·mismanaged construction;

·inferior or improper construction techniques;

·economic changes or downturns during construction;

·a downturn in the real estate market;

·rising interest rates which may prevent sale of the property; and

·failure to sell completed projects in a timely manner.

We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages.  We also reduce risk by selling participations in larger loans to other institutions when possible.

Commercial Loans.  We make loans for commercial purposes in various lines of businesses.  Equipment loans typically are made for a term of five years or less at 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

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and are usually secured by accounts receivable, inventory, or personal guarantees of the principals of the business.  For loans secured by accounts receivable or inventory, principal is typically repaid as the assets securing the loan are converted into cash, and in other cases principal is due at maturity.  Trade letters of credit, standby letters of credit, and foreign exchange are handled through a correspondent bank as agent for the bank.  Commercial loans primarily have risk that the primary source of repayment, the borrowing business, will be insufficient to service the debt.  Often this occurs as the result of changes in local economic conditions or in the industry in which the borrower operates which impact cash flow or collateral value.

Consumer Loans.  We make a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit such as credit cards.  Installment loans typically carry balances of less than $50,000 and are amortized over periods up to 60 or more months.  Consumer loans are offered on a single maturity basis where a specific source of repayment is available.  Revolving loan products typically require monthly payments of interest and a portion of the principal.

Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because the value of the secured property may depreciate rapidly, they are often dependent on the borrower’s employment status as the sole source of repayment, and some of them are unsecured.  To mitigate these risks, we analyze selective underwriting criteria for each prospective borrower, which may include the borrower’s employment history, income history, credit bureau reports, or debt to income ratios.  If the consumer loan is secured by property, such as an automobile loan, we also attempt to offset the risk of rapid depreciation of the collateral with a shorter loan amortization period.  Despite these efforts to mitigate our risks, consumer loans have a higher rate of default than real estate loans.  For this reason, we attempt to reduce our loss exposure to these types of loans by limiting their sizes relative to other types of loans.

We also offer home equity loans.  Our underwriting criteria for and assessment of the risks associated with home equity loans and lines of credit are generally the same as those for first mortgage loans.  Home equity lines of credit typically have terms of 10 years or less, carry balances less than $125,000, and may extend up to 90% of the available equity of each property.

We also have the ability to offer small business loans utilizing government enhancements such as the Small Business Administration’s 7(a) program and SBA’s 504 and “LowDoc” programs.  These loans will typically be partially guaranteed by the government which may help to reduce the bank’s risk.  Government guarantees of SBA loans will not exceed 80% of the loan value, and will generally be less.

Relative Risks of Loans.  Each category of loan has a different level of credit risk.  Real estate loans are generally safer than loans secured by other assets because the value of the underlying security, real estate, is generally ascertainable and does not fluctuate as much as some other assets.  Certain real estate loans are less risky than others.  Residential real estate loans are generally the least risky type of real estate loans, followed by commercial real estate loans and construction and development loans.  Commercial loans, which can be secured by real estate or other assets, or which can be unsecured, are generally more risky than real estate loans, but less risky than consumer loans.  Finally, consumer loans, which can also be secured by real estate or other assets, or which can also be unsecured, are generally considered to be the most risky of these categories of loans.  Any type of loan which is unsecured is generally more risky than secured loans.  These levels of risk are general in nature, and many factors including the creditworthiness of the borrower or the particular nature of the secured asset may cause any type of loan to be more or less risky than another.  Additionally, these levels of risk are limited to an analysis of credit risk, and they do not take into account other risk factors associated with making loans such as the interest rate risk inherent in long-term, fixed-rate loans.

Loan Approval and Review.  Our loan approval policies provide for various levels of officer lending authority.  When the amount of aggregate loans to a single borrower exceeds that individual officer’s lending authority, the loan request is considered and approved by an officer with a higher lending limit, the management loan committee or the board of directors’ loan committee.  We do not make any loans to any director of the bank unless the loan is approved by the board of directors of the bank and is made on terms not more favorable to the person than would be available to a person not affiliated with the bank.  We adhere to Federal National Mortgage Association and Federal Home Loan Mortgage Corporation guidelines in its mortgage loan review process, but we may choose to alter this policy in the future.

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Lending Limits.  Our lending activities are subject to a variety of lending limits imposed by federal law.  In general, we are subject to a legal limit on loans to a single borrower equal to 15% of the bank’s capital and unimpaired surplus.  Different limits may apply based on the type of loan or the nature of the borrower, including the borrower’s relationship to the bank.  These limits will increase or decrease as the bank’s capital increases or decreases.

Banking Services

We offer a full range of deposit services that are typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, commercial accounts, savings accounts, 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 our principal market area at rates competitive to those offered in the upstate South Carolina region.  In addition, we offer certain retirement account services, including IRAs.

Other Banking Services

We also offer safe deposit boxes, cashier’s checks, banking by mail, direct deposit of payroll and social security checks, U.S. Savings Bonds, and travelers checks.  Our bank is associated with the Star and Plus ATM networks that may be used by our customers throughout the country.  We believe that by being associated with a shared network of ATMs, we will be better able to serve our customers and will be able to attract customers who are accustomed to the convenience of using ATMs.  We also offer a debit card and credit card services through a correspondent bank as an agent for the bank.

Competition

The banking business is highly competitive.  We compete as a financial intermediary with other commercial banks, savings banks, credit unions, finance companies, and money market mutual funds operating in Anderson, Greenville, Pickens and Spartanburg Counties.  The competition among the various financial institutions is based upon a variety of factors, including interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of services rendered, the convenience of banking facilities and, in the case of loans to large commercial borrowers, relative lending limits.  In addition to banks and savings associations, we compete with other financial institutions including securities firms, insurance companies, credit unions, leasing companies and finance companies.  Size gives larger banks certain advantages in competing for business from large corporations.  These advantages include higher lending limits and the ability to offers services in other areas of South Carolina.  As a result, we do not generally attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses and individuals.  We believe we have competed effectively in this market by offering quality and personal service.

Employees

As of December 31, 2008, we had 80 full-time employees and 10 part-time employees.

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SUPERVISION AND REGULATION

Both CommunitySouth Financial Corporation, and CommunitySouth Bank and Trust are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations.  These laws generally are intended to protect depositors and not shareholders.  The following summary is qualified by reference to the statutory and regulatory provisions discussed.  Changes in applicable laws or regulations may have a material effect on our business and prospects.  Our operations may be affected by legislative changes and the policies of various regulatory authorities.  We cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations.  It is intended only to briefly summarize some material provisions.

CommunitySouth Financial Corporation

We own 100% of the outstanding capital stock of the bank, and therefore we are considered to be a bank holding company under the federal Bank Holding Company Act of 1956 (the “Bank Holding Company Act”).  As a result, we are primarily subject to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve (the “Federal Reserve”) under the Bank Holding Company Act and its regulations promulgated thereunder.  As a bank holding company located in South Carolina, the South Carolina Board of Financial Institutions also regulates and monitors all significant aspects of our operations.

Permitted Activities.Under the Bank Holding Company Act, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in, the following activities:

·banking or managing or controlling banks;

·furnishing services to or performing services for our subsidiaries; and

·any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

·factoring accounts receivable;

·making, acquiring, brokering or servicing loans and usual related activities;

·leasing personal or real property;

·operating a non-bank depository institution, such as a savings association;

·trust company functions;

·financial and investment advisory activities;

·conducting discount securities brokerage activities;

·underwriting and dealing in government obligations and money market instruments;

·providing specified management consulting and counseling activities;

·performing selected data processing services and support services;

·acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and

·performing selected insurance underwriting activities.

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As a bank holding company we also can elect to be treated as a “financial holding company,” which would allow us engage in a broader array of activities.  In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities.  We have not sought financial holding company status, but may elect such status in the future as our business matures.  If we were to elect in writing for financial holding company status, each insured depository institution we control would have to be well capitalized, well managed and have at least a satisfactory rating under the CRA (discussed below).

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

Change in Control.  In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with regulations promulgated there under, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company.  Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company.  Following the relaxing of these restrictions by the Federal Reserve in September 2008, control will be rebuttably presumed to exist if a person acquires more than 33% of the total equity of a bank or bank holding company, of which it may own, control or have the power to vote not more than 15% of any class of voting securities.

Source of Strength.  In accordance with Federal Reserve Board policy, we are expected to act as a source of financial strength to the bank and to commit resources to support the bank in circumstances in which we might not otherwise do so.  Under the bank Holding Company Act, the Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of the bank holding company.  Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition.

Capital Requirements.  The Federal Reserve Board imposes certain capital requirements on the bank holding company under the Bank Holding Company Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets.  These requirements are described below under “CommunitySouth Bank and Trust - Capital Regulations.”  Subject to our capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to the bank, and these loans may be repaid from dividends paid from the bank to the company.  Our ability to pay dividends is subject to regulatory restrictions as described below in “CommunitySouth Bank and Trust– Dividends.”  We are also able to raise capital for contribution to the bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

South Carolina State Regulation.  As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the South Carolina Board of Financial Institutions.  We are not required to obtain the approval of the South Carolina Board prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so.  We must receive the Board’s approval prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.

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CommunitySouth Bank and Trust

The bank operates as a state bank incorporated under the laws of the State of South Carolina and is subject to examination by the South Carolina Board of Financial Institutions.  Deposits in the bank are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to a maximum amount, which is currently $100,000 for each non-retirement depositor and $250,000 for certain retirement-account depositors.  However, the FDIC has increased the coverage up to $250,000 for each non-retirement depositor through December 31, 2009, and the bank is participating in the FDIC’s Temporary Liquidity Guarantee Program (discussed below in greater detail) which, in part, fully insures non-interest bearing transaction accounts.

The South Carolina Board of Financial Institutions and the FDIC regulate or monitor virtually all areas of the bank’s operations, including:

·security devices and procedures;

·adequacy of capitalization and loss reserves;

·loans;

·investments;

·borrowings;

·deposits;

·mergers;

·issuances of securities;

·payment of dividends;

·interest rates payable on deposits;

·interest rates or fees chargeable on loans;

·establishment of branches;

·corporate reorganizations;

·maintenance of books and records; and

·adequacy of staff training to carry on safe lending and deposit gathering practices.

The South Carolina Board of Financial Institutions requires the bank to maintain specified capital ratios and imposes limitations on the bank’s aggregate investment in real estate, bank premises, and furniture and fixtures.  The South Carolina Board of Financial Institutions also requires the bank to prepare quarterly reports on the bank’s financial condition in compliance with its minimum standards and procedures.

All insured institutions must undergo regular on site examinations by their appropriate banking agency.  The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate.  Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and their state supervisor when applicable.  The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution.  The FDIC Improvement Act (the “FDICIA”) also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

·internal controls;

·information systems and audit systems;

·loan documentation;

·credit underwriting;

·interest rate risk exposure; and

·asset quality.

Prompt Corrective Action.  As an insured depository institution, the bank is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the regulations thereunder, which set forth five capital categories, each with specific regulatory consequences.  Under these regulations, the categories are:

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·Well Capitalized – The institution exceeds the required minimum level for each relevant capital measure.  A well capitalized institution is one (i) having a total capital ratio of 10% or greater, (ii) having a tier 1 capital ratio of 6% or greater, (iii) having a leverage capital ratio of 5% or greater and (iv) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

·Adequately Capitalized – The institution meets the required minimum level for each relevant capital measure.  No capital distribution may be made that would result in the institution becoming undercapitalized.  An adequately capitalized institution is one (i) having a total capital ratio of 8% or greater, (ii) having a tier 1 capital ratio of 4% or greater and (iii) having a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.

·Undercapitalized – The institution fails to meet the required minimum level for any relevant capital measure.  An undercapitalized institution is one (i) having a total capital ratio of less than 8% or (ii) having a tier 1 capital ratio of less than 4% or (iii) having a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMELS rating system, a leverage capital ratio of less than 3%.

·Significantly Undercapitalized – The institution is significantly below the required minimum level for any relevant capital measure.  A significantly undercapitalized institution is one (i) having a total capital ratio of less than 6% or (ii) having a tier 1 capital ratio of less than 3% or (iii) having a leverage capital ratio of less than 3%.

·Critically Undercapitalized – The institution fails to meet a critical capital level set by the appropriate federal banking agency.  A critically undercapitalized institution is one having a ratio of tangible equity to total assets that is equal to or less than 2%.

If the FDIC determines, after notice and an opportunity for hearing, that the bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

If the bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval and, if approval is granted, cannot offer an effective yield in excess of 75 basis points on interests paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area, or national rate paid on deposits of comparable size and maturity for deposits accepted outside the bank’s normal market area.  Moreover, if the bank becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the FDIC.  The bank also would become subject to increased regulatory oversight, and is increasingly restricted in the scope of its permissible activities.  Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan.  Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow.  An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate Federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action.  The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency.  A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution, would be undercapitalized.  In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized.  Thus, if payment of such a management fee or the making of such would cause the bank to become undercapitalized, it could not pay a management fee or dividend to us.

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As of December 31, 2008, the bank was deemed to be “well capitalized.”

Transactions with Affiliates and Insiders.  The company is a legal entity separate and distinct from the bank and its other subsidiaries. Various legal limitations restrict the bank from lending or otherwise supplying funds to the company or its non-bank subsidiaries. The company and the bank are subject to Section 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the bank’s capital and surplus and, as to all affiliates combined, to 20% of the bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The bank is forbidden to purchase low quality assets from an affiliate.

Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.

The bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

Branching.  Under current South Carolina law, we may open branch offices throughout South Carolina with the prior approval of the South Carolina Board of Financial Institutions.   In addition, with prior regulatory approval, the bank will be able to acquire existing banking operations in South Carolina.  Furthermore, federal legislation has been passed that permits interstate branching by banks if allowed by state law, and interstate merging by banks.  However, South Carolina law, with limited exceptions, currently permits branching across state lines only through interstate mergers.

Anti-Tying Restrictions. Under amendments to the Bank Holding Company Act and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.

Community Reinvestment Act.  The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, a financial institution’s primary regulator, which is the FDIC for the bank, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate income neighborhoods.  These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility.  Failure to adequately meet these criteria could impose additional requirements and limitations on our bank.  Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

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Finance Subsidiaries.  Under the Gramm-Leach-Bliley Act (the “GLBA”), subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form “financial subsidiaries” that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible.  The GLBA imposes several safeguards and restrictions on financial subsidiaries, including that the parent bank’s equity investment in the financial subsidiary be deducted from the bank’s assets and tangible equity for purposes of calculating the bank’s capital adequacy.  In addition, the GLBA imposes new restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and non-bank affiliates.

Consumer Protection Regulations. Activities of the bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the bank are subject to state usury laws and federal laws concerning interest rates. The bank’s loan operations are also subject to federal laws applicable to credit transactions, such as the:

·The federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

·The Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

·The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

·The Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;

·The Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

·The Rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

The deposit operations of the bank also are subject to:

·the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

·the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that Act, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

Enforcement Powers. The bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,000,000 a day for such violations. Criminal penalties for some financial institution crimes have been increased to twenty years. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ power to issue cease-and-desist orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.

Anti-Money Laundering. Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The company and the bank are also prohibited from entering into specified financial transactions and account relationships and must meet

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enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA Patriot Act, enacted in 2001 and renewed in 2006. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing “cease and desist” orders and money penalty sanctions against institutions found to be violating these obligations.

USA PATRIOT Act.  The USA PATRIOT Act became effective on October 26, 2001, amended, in part, the Bank Secrecy Act, and provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.

Under the USA PATRIOT Act, the Federal Bureau of Investigation (“FBI”) can send our banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities.  The bank can be requested, to search its records for any relationships or transactions with persons on those lists.  If the bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.

The Office of Foreign Assets Control (“OFAC”), which is a division of the U.S. Department of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress.  OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts.  If the bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI.  The bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications.  The bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files.  The bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

Privacy and Credit Reporting.  Financial institutions are required to disclose their policies for collecting and protecting confidential information.  Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party.  Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.  It is the bank’s policy not to disclose any personal information unless required by law.

Like other lending institutions, the bank utilizes credit bureau data in its underwriting activities.  Use of such data is regulated under the Federal Credit Reporting Act on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates, and the use of credit data.  The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) authorizes states to enact identity theft laws that are not inconsistent with the conduct required by the provisions of the FACT Act.

Payment of Dividends. A South Carolina state bank may not pay dividends from its capital.  All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts.  The bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions, provided that the bank received a composite rating of one or two at the last federal or state regulatory examination.  The bank must obtain approval

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from the South Carolina Board of Financial Institutions prior to the payment of any other cash dividends.  In addition, under the FDICIA, the bank may not pay a dividend if, after paying the dividend, the bank would be undercapitalized.

Check 21.  The Check Clearing for the 21st Century Act gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check.  Some of the major provisions include:

·allowing check truncation without making it mandatory;

·demanding that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their rights under the law;

·legalizing substitutions for and replacements of paper checks without agreement from consumers;

·retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;

·requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and

·requiring the re-crediting of funds to an individual’s account on the next business day after a consumer proves that the financial institution has erred.

Effect of Governmental Monetary Policies.  Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies.  The Federal Reserve bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession.  The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits.  It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.

Insurance of Accounts and Regulation by the FDIC.   Our deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC.  The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged effective March 31, 2006.  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions.  It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund.  The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

Under regulations effective January 1, 2007, the FDIC adopted a new risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based upon supervisory and capital evaluations.   For deposits held as of March 31, 2009, institutions are assessed at annual rates ranging from 12 to 50 basis points, depending on each institution’s risk of default as measured by regulatory capital ratios and other supervisory measures.   Effective April 1, 2009, assessments will take into account each institution’s reliance on secured liabilities and brokered deposits.   This will result in assessments ranging from 7 to 77.5 basis points.  We anticipate our future insurance costs to be higher than in previous periods.

FDIC insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s.  For the first quarter of 2009, the Financing Corporation assessment equaled 1.14 basis points for domestic deposits.  These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.

The FDIC may terminate the deposit insurance of any insured depository institution, including the bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC.  It also may suspend deposit insurance temporarily during the hearing process for

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the permanent termination of insurance, if the institution has no tangible capital.  If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC.  Management of the bank is not aware of any practice, condition or violation that might lead to termination of the bank’s deposit insurance.

Proposed Legislation and Regulatory Action.  New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nation’s financial institutions.  We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises.  The Congress, Treasury Department and the federal banking regulators, including the FDIC, have taken broad action since early September 2008 to address volatility in the U.S. banking system.

In October 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. The EESA authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”).  The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other.  The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”).  Under the CPP, Treasury will purchase debt or equity securities from participating institutions.  The TARP also will include direct purchases or guarantees of troubled assets of financial institutions. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications.

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000.  This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry.

Following a systemic risk determination, the FDIC established the Temporary Liquidity Guarantee Program (“TLGP”) on October 14, 2008.  The TLGP includes the Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit insurance coverage through December 31, 2009 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts.  Institutions participating in the TLGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place.  The TLGP also includes the Debt Guarantee Program (“DGP”), under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies.  The unsecured debt must be issued on or after October 14, 2008 and not later than June 30, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012.  On March 17, 2009, the FDIC adopted an interim rule that extends the DGP and imposes surcharges on existing rates for certain debt issuances.  This extension allows institutions that have issued guaranteed debt before April 1, 2009 to issue guaranteed debt during the extended issuance period that ends on October 31, 2009. For such institutions, the guarantee on debt issued on or after April 1, 2009, will expire no later than December 31, 2012.  The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their liabilities as of September 30, 2008.  Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 60 to 110 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012 and 75 to 125 basis points (annualized) for covered debt outstanding until after June 30, 2012.  The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008.  We will participate in the TAGP and the DGP.

On February 17, 2009 President Obama signed into law The American Recovery and Reinvestment Act of 2009 (the “Recovery Act”), more commonly known as the economic stimulus or economic recovery package.  The Recovery Act includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, the Recovery Act imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients that are in addition to those previously announced by the Treasury Department, until the TARP recipient has repaid the Treasury Department,

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which is now permitted under the Recovery Act without penalty and without the need to raise new capital, subject to the Treasury Department’s consultation with the recipient’s appropriate regulatory agency.

Further regulatory actions may arise as the Federal government continues to attempt to address the economic situation.

Item 1A.     Risk Factors.

Our business, financial condition, and results of operations could be harmed by any of the following risks, or other risks that have not been identified or which we believe are immaterial or unlikely.  Shareholders should carefully consider the risks described below in conjunction with the other information in this Form 10-K and the information incorporated by reference in this Form 10-K, including our consolidated financial statements and related notes.

Recent negative developments in the financial industry and the domestic and international credit markets may adversely affect our operations and results.

Negative developments in the latter half of 2007 and during 2008 in the global credit and securitization markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing into 2009.  As a result of this “credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly.  In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline.  Global securities markets, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets.  As a result, significant new federal laws and regulations relating to financial institutions, including, without limitation, the EESA and the Treasury Department’s CPP, have been adopted.  Furthermore, the potential exists for additional federal or state laws and regulations regarding, among other matters, lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders.  Negative developments in the financial industry and the domestic and international credit markets, and the impact of new legislation in response to those developments, may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance.  We can provide no assurance regarding the manner in which any new laws and regulations will affect us.

There can be no assurance that recently enacted legislation will help stabilize the U.S. financial system.

The EESA was signed into law on October 3, 2008 in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions.  Pursuant to EESA, the Treasury Department has the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.  The Treasury announced the CPP under EESA pursuant to which it has purchased and may continue to purchase senior preferred stock in participating financial institutions.

In addition, the FDIC created the Temporary Liquidity Guarantee Program (“TLGP”) as part of a larger government effort to strengthen confidence and encourage liquidity in the nation’s banking system.  The TLGP has two components. First, the TLGP includes the Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit insurance coverage through December 31, 2009 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts.  Institutions participating in the TLGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place.  Second, the TLGP includes the Debt Guarantee Program (“DGP”), under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies.  The unsecured debt must be issued on or after October 14, 2008 and not later than June 30, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012.  On March 17, 2009, the FDIC adopted an interim rule that extends the DGP and imposes surcharges on existing rates for certain

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debt issuances.  This extension allows institutions that have issued guaranteed debt before April 1, 2009 to issue guaranteed debt during the extended issuance period that ends on October 31, 2009. For such institutions, the guarantee on debt issued on or after April 1, 2009, will expire no later than December 31, 2012.  The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their liabilities as of September 30, 2008.  Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 60 to 110 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012 and 75 to 125 basis points (annualized) for covered debt outstanding until after June 30, 2012.  The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008.  We will participate in the TAGP and the DGP.

On February 17, 2009, the Recovery Act was signed into law in an effort to, among other things, create jobs and stimulate growth in the United States economy.  The Recovery Act specifies appropriations of approximately $787 billion for a wide range of Federal programs and will increase or extend certain benefits payable under the Medicaid, unemployment compensation, and nutrition assistance programs.  The Recovery Act also reduces individual and corporate income tax collections and makes a variety of other changes to tax laws.  The Recovery Act also imposes certain limitations on compensation paid by participants in the Treasury Department’s TARP, which includes programs under TARP such as the CPP.

There can be no assurance that these government actions will achieve their purpose.  The failure of the financial markets to stabilize, or a continuation or worsening of the current financial market conditions, could have a material adverse affect on our business, our financial condition, the financial condition of our customers, our common stock trading price, as well as our ability to access credit.  It could also result in declines in our investment portfolio which could be “other-than-temporary impairments.”

Continuation of the economic downturn could reduce our customer base, our level of deposits, and demand for financial products such as loans.

Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets.  The current economic downturn has negatively affected the markets in which we operate and, in turn, the quality of our loan portfolio.  If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally remain unfavorable, our business may not succeed.  A continuation of the economic downturn or prolonged recession would likely result in the continued deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business.  Interest received on loans represented approximately 89.0% of our interest income for the year ended December 31, 2008.  If the economic downturn continues or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled.  Moreover, in many cases the value of real estate or other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be negatively affected.  Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies.  A continued economic downturn could, therefore, result in losses that materially and adversely affect our business.

Our small- to medium-sized business target markets may have fewer financial resources to weather a downturn in the economy.

We target the banking and financial services needs of small- and medium-sized businesses.  These businesses generally have fewer financial resources in terms of capital borrowing capacity than larger entities.  If general economic conditions continue to negatively impact these businesses in the markets in which we operate, our business, financial condition, and results of operation may be adversely affected.

We are exposed to changes in the regulation of financial services companies.

Proposals for further regulation of the financial services industry are continually being introduced in the Congress of the United States of America and the General Assembly of the State of South Carolina.  The agencies regulating the financial services industry also periodically adopt changes to their regulations.  On September 7, 2008, the Treasury Department announced that Fannie Mae (along with Freddie Mac) has been placed into conservatorship under the control of the newly created Federal Housing Finance Agency.  On October 3, 2008,

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EESA was signed into law, on October 14, 2008 the Treasury Department announced the CPP under EESA, and on February 17, 2009 the Recovery Act was signed into law.  It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business.  See “Risk Factors – We are subject to extensive regulation that could restrict our activities” above.

The FDIC Deposit Insurance assessments that we are required to pay may materially increase in the future, which would have an adverse effect on our earnings and our ability to pay our liabilities as they come due.

As a member institution of the FDIC, we are required to pay semi-annual deposit insurance premium assessments to the FDIC.  During the year ended December 31, 2008, we paid $230,675 in deposit insurance assessments.  Due to the recent failure of several unaffiliated FDIC insurance depository institutions, and the FDIC’s new TLGP, the deposit insurance premium assessments paid by all banks will likely increase.  In addition, new FDIC requirements shift a greater share of any increase in such assessments onto institutions with higher risk profiles, including banks with heavy reliance on brokered deposits, such as our bank.

We may need to raise additional capital in the future, but that capital may not be available when it is needed.

We are required by regulatory authorities to maintain adequate levels of capital to support our operations.  Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control.  Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us.  If we cannot raise additional capital when needed, our ability to maintain our operations could be materially impaired.  In addition, if we decide to raise additional equity capital, your interest could be diluted.

We depend heavily on out of market deposits as a source of funding.

As of December 31, 2008, 62.8% of our deposits were obtained from out of market sources.  To continue to have access to this source of funding, we are required to be classified as a “well capitalized” bank by the FDIC; whereas, if we only “meet” the capital requirement, we must obtain permission from the FDIC in order to continue utilizing this source of funding.

We are exposed to the possibility of technology failure.

                We rely on our computer systems and the technology of outside service providers. Our daily operations depend on the operational effectiveness of their technology. We rely on our systems to accurately track and record our assets and liabilities. If our computer systems or outside technology sources become unreliable, fail, or experience a breach of security, our ability to maintain accurate financial records may be impaired, which could materially affect our business operations and financial condition.

We are dependent on key individuals and the loss of one or more of these key individuals could adversely affect our operations.

Allan Ducker, our chief executive officer, and David Miller, our president, have extensive and long-standing ties within our market area and substantial experience with our operations.  If we lose the services of Mr. Ducker and/or Mr. Miller, they would be difficult to replace and our business and development could be materially and adversely affected.  We maintain key man life insurance policies in the amount of $500,000, each on Mr. Ducker and Mr. Miller.

Our success also depends, in part, on our continued ability to attract and retain experienced loan originators, as well as other management personnel.  Competition for personnel is intense, and we may not be successful in attracting or retaining qualified personnel.  Our failure to compete for these personnel, or the loss of the services of several of such key personnel, could adversely affect our business, results of operations, and financial condition.

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The success of our maintaining our upstate franchise depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to operate.

To maintain our upstate franchise successfully, we must identify and retain experienced key management members with local expertise and relationships in these markets.  Competition for qualified management in the markets in which we operate is intense and there are a limited number of qualified persons with knowledge of and experience in the community banking industry in these markets.  In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy requires both management and financial resources and is often lengthy.  Our inability to identify, recruit, and retain talented personnel to manage offices effectively could materially adversely affect our business, financial condition, and results of operations.

Our decisions regarding credit risk and allowances for loan losses may materially and adversely affect our business.

Making loans and other extensions of credit is an essential element of our business.  Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid.  The risk of nonpayment is affected by a number of factors, including:

·the duration of the credit;

·credit risks of a particular customer;

·changes in economic and industry conditions; and

·in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio.  We periodically determine the amount of the allowance based on consideration of several factors, including:

·an ongoing review of the quality, mix, and size of our overall loan portfolio;

·our historical loan loss experience;

·evaluation of economic conditions;

·regular reviews of loan delinquencies and loan portfolio quality; and

·the amount and quality of collateral, including guarantees, securing the loans.

There is no precise method of predicting credit losses.  Therefore, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required.  Additions to the allowance for loan losses would result in a decrease of our net income, and possibly our capital.

While we generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both.  As of December 31, 2008, approximately $22.9 million of our loans, or 65% of our company’s capital, had loan-to-value ratios that exceeded regulatory supervisory guidelines, of which 18 loans totaling approximately $6.8 million had loan-to-value ratios of 100% or more. At December 31, 2007, $24.1 million of our loans, or 76.7% of our company’s capital, exceeded the supervisory loan to value ratio.  The number of loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio.

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.

A significant portion of our loan portfolio is secured by real estate.  As of December 31, 2008, approximately 89% of our loans had real estate as a primary or secondary component of collateral.  The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  A weakening of the real estate market in our primary market area could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality.  If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced

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real estate values, our earnings and capital could be adversely affected.  Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

We may have higher loan losses than we have allowed for in our allowance for loan losses.

Our loan losses could exceed our allowance for loan losses. Approximately 85% of our loan portfolio is composed of construction, commercial mortgage and commercial loans. Repayment of such loans is generally considered more subject to market risk than residential mortgage loans. Industry experience shows that a portion of loans will become delinquent and a portion of loans will require partial or entire charge-off. Regardless of the underwriting criteria utilized, losses may be experienced as a result of various factors beyond our control, including among other things, changes in market conditions affecting the value of loan collateral and problems affecting the credit of our borrowers.

Lack of seasoning of our loan portfolio may increase the risk of credit defaults in the future.

Due to our short operating history, all of the loans in our loan portfolio and our lending relationships are of relatively recent origin.  In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process we refer to as “seasoning.”  As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio.  Because our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels.  If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.

Changes in prevailing interest rates may reduce our profitability.

Our results of operations depend in large part upon the level of our net interest income, which is the difference between interest income from interest-earning assets, such as loans and mortgage-backed securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings.  Depending on the terms and maturities of our assets and liabilities, a significant change in interest rates could have a material adverse effect on our profitability.  Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions.  While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective and our financial condition and results of operations could suffer.

We are subject to extensive regulation that could limit or restrict our activities.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies.  Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices.  We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth.

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability.  Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.

The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission that are now applicable to us, have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices.

We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher interest rates to attract customers.

The banking business is highly competitive, and we experience competition in our market from many other financial institutions.  We compete with commercial banks, credit unions, savings and loan associations, mortgage

20

banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and elsewhere.  We compete with these institutions both in attracting deposits and in making loans.  In addition, we have to attract our client base from other existing financial institutions and from new residents.  Many of our competitors are well-established, larger financial institutions.  These institutions offer some services, such as extensive and established branch networks, that we do not currently provide.  There is a risk that we will not be able to compete successfully with other financial institutions in our market, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability.  In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us.

We will face risks with respect to future expansion and acquisitions or mergers.

Although we do not have any current plans to do so, we may seek to acquire other financial institutions or parts of those institutions.  We may also expand into new markets or lines of business or offer new products or services.  These activities would involve a number of risks, including:

·taking additional time and creating expense associated with identifying and evaluating potential acquisitions and merger partners;

·using inaccurate estimates and judgments to evaluate credit, operations, management, and market risks with respect to the target institution or assets;

·diluting our existing shareholders in an acquisition;

·taking additional time and creating expense associated with evaluating new markets for expansion, hiring experienced local management, and opening new offices, as there may be a substantial time lag between these activities before we generate sufficient assets and deposits to support the costs of the expansion;

·taking a significant amount of time negotiating a transaction or working on expansion plans, resulting in management’s attention being diverted from the operation of our existing business;

·taking time and creating expense integrating the operations and personnel of the combined businesses;

·creating an adverse short-term effect on our results of operations; and

·losing key employees and customers as a result of an acquisition that is poorly received.

We have never acquired another institution before, so we lack experience in handling any of these risks.  There is also a risk that any expansion effort will not be successful.

The costs of being an SEC registered company are proportionately higher for smaller companies such as CommunitySouth Financial Corporation because of the requirements imposed by the Sarbanes-Oxley Act.

The Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices. These regulations are applicable to our company. We have experienced, and expect to continue to experience, increasing compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act. These necessary costs are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors.

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Item 2.  Properties.

Our main office is located at 6602 Calhoun Memorial Highway, Easley, South Carolina 29640. Our site is approximately 1.2 acres in size, and the building is approximately 10,000 square feet. We own our main office and lease all others. We have five full service branch sites in addition to the main office. The branch sites are in the towns of Anderson, Greenville, Greer, Mauldin and Spartanburg, South Carolina. Our full service branches service the entire upstate of South Carolina, but primarily the counties of Anderson, Greenville, Pickens and Spartanburg.

We have a ten year lease that began in November 2005 for our Spartanburg office.   The office is located at 531 East Main Street, Spartanburg, S.C. 29302.

We have a ten year lease that began in November 2005 for our Mauldin office. The office is located at 787 East Butler Road, Mauldin, S.C. 29662.

We have a ten year lease that began in June 2006 for our Anderson office.  The office is located at 1510 North Main Street, Anderson, S.C. 29621.

We have a ten year lease that began in November 2006 for our Greer office.  The office is located at 530 West Wade Hampton Blvd., Greer, S.C. 29650.

We have a three year lease that began in May 2007 for our Loan Operations center.  The operations center is located at 6606 Calhoun Memorial Highway, Easley, S.C. 29640.

We have a ten year lease that began in October 2007 for our Greenville office.  The office is located at 2415 Laurens Road, Greenville, S.C. 29607.

We have a ten year lease that begins upon occupancy of our West Spartanburg office.  The office will be located at 1600 John B. White, Sr. Boulevard, Spartanburg, S.C.  It is currently under construction.

We believe that all of our properties are adequately covered by insurance.

Item 3.  Legal Proceedings.

In the ordinary course of operations, we may be a party to various legal proceedings from time to time.  We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.

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

No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

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Part II

Item 5.  Market for Common Equity and Related Stockholder Matters.

On January 16, 2007, the company effected a 5-for-4 stock split in the form of a stock dividend for shareholders of record as of December 15, 2006.   All per share data has been adjusted for all periods prior to the splits.

Since March 15, 2006, our common stock has been quoted on the OTC Bulletin Board under the symbol “CBSO.” Quotations on the OTC Bulletin Board reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not represent actual transactions.  Transactions of our common stock did not begin to occur on the OTC Bulletin Board until March 16, 2006.

The following is a summary of the high and low bid prices for our common stock reported by the OTC Bulletin Board for the periods indicated (the bids prices have been adjusted for all stock splits):

2008	High		Low
First Quarter	$	10.00	$	7.30
Second Quarter	9.00		5.50
Third Quarter	7.00		2.53
Fourth Quarter	5.50		1.75

2007	High		Low
First Quarter	$	18.00	$	13.68
Second Quarter	15.90		12.75
Third Quarter	13.50		11.00
Fourth Quarter	11.40		8.55

Our articles of incorporation authorize us to issue up to 10,000,000 shares of common stock, of which 4,698,697 shares were outstanding as of December 31, 2008. We had approximately 908 shareholders of record as of March 23, 2009.

We have not declared or paid any cash dividends on our common stock since our inception.  For the foreseeable future we do not intend to declare cash dividends.  We intend to retain earnings to grow our business and strengthen our capital base.  Our ability to pay dividends depends on the ability of our subsidiary, CommunitySouth Bank & Trust, to pay dividends to us.  As a South Carolina state bank, the bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts.  In addition, the bank is prohibited from declaring a dividend on its shares of common stock unless its surplus equals or exceeds its stated capital. At December 31, 2008, the bank had a deficit of $872,916.

The following table sets forth the equity compensation plan information at December 31, 2008.  All option and warrant information has been adjusted to reflect all prior stock splits and dividends.

Equity Compensation Plan Information

Plan Category	(A) Number of securities to be issued upon exercise of outstanding options, warrants and rights	(B) Weighted-average exercise price of outstanding options, warrants and rights		(C) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column(a))
Equity compensation plans approved by security holders	764,113	$	7.08	222,613
Equity compensation plans not approved by security holders	171,404	$	6.40	0
Total	935,517	$	6.96	222,613

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(1)The shares available for issuance is currently set at 21% of our outstanding shares. On January 16, 2006 the company adopted a resolution that terminated the “evergreen” provision of the company’s 2005 Stock Incentive Plan. As a result, the number of shares of common stock issuable under the plan shall not be further increased in connection with any future share issuances by the company.

(2)Each of our organizers received, for no additional consideration, a warrant to purchase one share of common stock for $10.00 per share for every two shares they purchased in the offering, up to a maximum of 10,000 shares per organizer.  The warrants are represented by separate warrant agreements.  The warrants vested on May 18, 2005, 120 days after the date of the opening of the bank, and they are exercisable in whole or in part during the 10 year period following that date.  If the South Carolina Board of Financial Institutions or the FDIC issues a capital directive or other order requiring the bank to obtain additional capital, the warrants will be forfeited, if not immediately exercised.

Item 6.  Selected Financial Data.

The information required by Item 6 is hereby incorporated by reference from our annual report to shareholders for the year ended December 31, 2008.

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operation.

The information required by Item 7 is hereby incorporated by reference from our annual report to shareholders for the year ended December 31, 2008.

Item 8.  Financial Statements and Supplementary Data.

The information required by Item 8 is hereby incorporated by reference from our annual report to shareholders for the year ended December 31, 2008.

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None

Item 9A(T).  Controls and Procedures.

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of December 31, 2008.   There have been no significant changes in our internal controls over financial reporting during the fourth fiscal quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events.  There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

Management’s Report on Internal Controls Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f). A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and

24

the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, the Company’s management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2008 based on the criteria established in a report entitled “Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission” and the interpretive guidance issued by the Commission in Release No. 34-55929. Based on this evaluation, the Company’s management has evaluated and concluded that the Company’s internal control over financial reporting was effective as of December 31, 2008.

The Company is continuously seeking to improve the efficiency and effectiveness of its operations and of its internal controls. This results in modifications to its processes throughout the Company. However, there has been no change in its internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. The Company’s registered public accounting firm was not required to issue an attestation on its internal controls over financial reporting pursuant to temporary rules of the Securities and Exchange Commission.

Part III

Item 10.  Directors, Executive Officers and Corporate Governance.

The information required by Item 10 is hereby incorporated by reference from our proxy statement for our 2009 annual meeting of shareholders to be held on May 19, 2009.

Item 11.  Executive Compensation.

The information required by Item 11 is hereby incorporated by reference from our proxy statement for our 2009 annual meeting of shareholders to be held on May 19, 2009.

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information required by Item 12 is hereby incorporated by reference from our proxy statement for our 2008 annual meeting of shareholders to be held on May 19, 2009.

Item 13.  Certain Relationships and Related Transactions, and Director Independence.

The information required by Item 13 is hereby incorporated by reference from our proxy statement for our 2008 annual meeting of shareholders to be held on May 19, 2009.

Item 14.  Principal Accountant Fees and Services.

The information required by Item 14 is hereby incorporated by reference from our proxy statement for our 2009 annual meeting of shareholders to be held on May 19, 2009.

Item 15.  Exhibits.

3.1.	Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form SB-2, File No. 333-117053).
3.2.	Bylaws (incorporated by reference to Exhibit 3.2 of the Company’s Form SB-2, File No. 333-117053).

25

4.1.	See Exhibits 3.1 and 3.2 for provisions in CommunitySouth Bancshares, Inc.’s Articles of Incorporation and Bylaws defining the rights of holders of the common stock (incorporated by reference to Exhibit 4.1 of the Company’s Form SB-2, File No. 333-117053).
4.2.	Form of certificate of common stock (incorporated by reference to Exhibit 4.2 of the Company’s Form SB-2, File No. 333-117053).
10.1	Form of Stock Warrant Agreement (incorporated by reference to Exhibit 10.1 of the Company’s Form 10-QSB filed on August 15, 2005).*
10.2	Master Loan Purchase Agreement between Bank of Tennessee and CommunitySouth Bank and Trust (incorporated by reference to Exhibit 10.6 of the Company’s Form SB-2, File No. 333-117053).
10.3	Commercial Loan Agreement between Nexity Bank and Community Bancshares, Inc. dated July 26, 2004 (incorporated by reference to Exhibit 10.9 of the Company’s Form SB-2, File No. 333-117053).
10.4	Option and Agreement of Sale dated August 18, 2004 by and between CommunitySouth Bancshares, Inc. and Daniel E. Youngblood (incorporated by reference to Exhibit 10.10 of the Company’s Form SB-2 as, File No. 333-117053).
10.5	Ground Lease Agreement dated August 18, 2004 by and between CommunitySouth Bancshares, Inc. and Daniel E. Youngblood (incorporated by reference to Exhibit 10.11 of the Company’s Form SB-2, File No. 333-117053).
10.6	CommunitySouth Bancshares, Inc. 2005 Stock Incentive Plan and Form of Option Agreement (incorporated by reference to Exhibit 10.9 of the Company’s Form 10-KSB for the year ended December 31, 2004).*
10.7	Standard Form of Design-Build Agreement and General Conditions between CommunitySouth Bancshares, Inc. and Trehel Corporation dated August 3, 2005 (incorporated by reference to Exhibit 10.1 of the Company’s Form 10-QSB filed on November 14, 2005).
10.8	Employment Agreement by and between C. Allan Ducker III and CommunitySouth Financial Corporation dated December 31, 2008 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed January 5, 2009).*
10.9	Employment Agreement by and between David A. Miller and CommunitySouth Financial Corporation dated December 31, 2008 (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed January 5, 2009).*
10.10	Employment Agreement by and between John W. Hobbs and CommunitySouth Financial Corporation dated December 31, 2008 (incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K filed January 5, 2009).*
10.11	Amendment No. 1 to the CommunitySouth Bancshares, Inc. 2005 Stock Incentive Plan and Form of Option Agreement, adopted November 18, 2008.*
10.12	Subordinated Note Purchase Agreement, dated August 22, 2008 (incorporated by reference as Exhibit 10.1 to the Company’s Form 8-K filed August 28, 2008).*
10.13	Form of CommunitySouth Financial Corporation 11.5% Subordinated Note Due 2018 (incorporated by reference as Exhibit 10.2 to the Company’s Form 8-K filed August 28, 2008).*
13	Annual Report of the Company for the year ended 2008.
21.1	Subsidiaries of the Company.
23.1	Consent of Elliott Davis, LLC

26

24.1.	Power of Attorney (filed as part of the signature page herewith).
31.1	Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2	Rule 13a-14(a) Certification of the Chief Financial Officer.
32	Section 1350 Certifications.

* Management contract of compensatory plan or arrangement required to be filed as an Exhibit to this Annual Report on Form 10-K.

If you wish to receive a paper copy of any exhibit to our reports filed with or furnished to the SEC, the exhibit may be obtained, upon payment of reasonable expenses, by writing to: CommunitySouth Financial Corporation, Attn: John W. Hobbs, Chief Financial Officer, 6602 Calhoun Memorial Highway, Easley, South Carolina 29640.

27

SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

			COMMUNITYSOUTH FINANCIAL CORPORATION
Date:	March 27, 2009	By:	/s/ C. Allan Ducker, III
			C. Allan Ducker, III
			Chief Executive Officer

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints C. Allan Ducker, III, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

Signature	Title	Date
/s/ David Larry Brotherton	Director	March 27, 2009
David Larry Brotherton
/s/ G. Dial Dubose	Director	March 27, 2009
G. Dial DuBose
/s/ C. Allan Ducker, III	Chief Executive Officer, Director	March 27, 2009
C. Allan Ducker, III
/s/ David W. Edwards	Director	March 27, 2009
David W. Edwards
/s/ R. Wesley Hammond	Director	March 27, 2009
R. Wesley Hammond
/s/ David A. Miller	President, Director	March 27, 2009
David A. Miller
/s/ John W. Hobbs	Chief Financial Officer and	March 27, 2009
John W. Hobbs	Principal Accounting Officer,
	Director
/s/ Arnold J. Ramsey*	Director	March 27, 2009
Arnold J. Ramsey
/s/ W. Michael Riddle	Director	March 27, 2009
W. Michael Riddle
/s/ Joanne M. Rogers	Director	March 27, 2009
Joanne M. Rogers

28

/s/ B. Lynn Spencer	Director	March 27, 2009
B. Lynn Spencer
/s/ J. Neal Workman, Jr.	Director	March 27, 2009
J. Neal Workman, Jr.
/s/ Daniel E. Youngblood	Director	March 27, 2009
Daniel E. Youngblood

29

Exhibit Index

3.1.	Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form SB-2, File No. 333-117053).
3.2.	Bylaws (incorporated by reference to Exhibit 3.2 of the Company’s Form SB-2, File No. 333-117053).
4.1.	See Exhibits 3.1 and 3.2 for provisions in CommunitySouth Bancshares, Inc.’s Articles of Incorporation and Bylaws defining the rights of holders of the common stock (incorporated by reference to Exhibit 4.1 of the Company’s Form SB-2, File No. 333-117053).
4.2.	Form of certificate of common stock (incorporated by reference to Exhibit 4.2 of the Company’s Form SB-2, File No. 333-117053).
10.1	Form of Stock Warrant Agreement (incorporated by reference to Exhibit 10.1 of the Company’s Form 10-QSB filed on August 15, 2005).*
10.2	Master Loan Purchase Agreement between Bank of Tennessee and CommunitySouth Bank and Trust (incorporated by reference to Exhibit 10.6 of the Company’s Form SB-2, File No. 333-117053).
10.3	Commercial Loan Agreement between Nexity Bank and Community Bancshares, Inc. dated July 26, 2004 (incorporated by reference to Exhibit 10.9 of the Company’s Form SB-2, File No. 333-117053).
10.4	Option and Agreement of Sale dated August 18, 2004 by and between CommunitySouth Bancshares, Inc. and Daniel E. Youngblood (incorporated by reference to Exhibit 10.10 of the Company’s Form SB-2 as, File No. 333-117053).
10.5	Ground Lease Agreement dated August 18, 2004 by and between CommunitySouth Bancshares, Inc. and Daniel E. Youngblood (incorporated by reference to Exhibit 10.11 of the Company’s Form SB-2, File No. 333-117053).
10.6	CommunitySouth Bancshares, Inc. 2005 Stock Incentive Plan and Form of Option Agreement (incorporated by reference to Exhibit 10.9 of the Company’s Form 10-KSB for the year ended December 31, 2004).*
10.7	Standard Form of Design-Build Agreement and General Conditions between CommunitySouth Bancshares, Inc. and Trehel Corporation dated August 3, 2005 (incorporated by reference to Exhibit 10.1 of the Company’s Form 10-QSB filed on November 14, 2005).
10.8	Employment Agreement by and between C. Allan Ducker III and CommunitySouth Financial Corporation dated December 31, 2008 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed January 5, 2009).*
10.9	Employment Agreement by and between David A. Miller and CommunitySouth Financial Corporation dated December 31, 2008 (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed January 5, 2009).*
10.10	Employment Agreement by and between John W. Hobbs and CommunitySouth Financial Corporation dated December 31, 2008 (incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K filed January 5, 2009).*
10.11	Amendment No. 1 to the CommunitySouth Bancshares, Inc. 2005 Stock Incentive Plan and Form of Option Agreement, adopted November 18, 2008.*
10.12	Subordinated Note Purchase Agreement, dated August 22, 2008 (incorporated by reference as Exhibit 10.1 to the Company’s Form 8-K filed August 28, 2008).*

10.13	Form of CommunitySouth Financial Corporation 11.5% Subordinated Note Due 2018 (incorporated by reference as Exhibit 10.2 to the Company’s Form 8-K filed August 28, 2008).*
13	Annual Report of the Company for the year ended 2008.
21.1	Subsidiaries of the Company.
23.1	Consent of Elliott Davis, LLC
24.1.	Power of Attorney (filed as part of the signature page herewith).
31.1	Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2	Rule 13a-14(a) Certification of the Chief Financial Officer.
32	Section 1350 Certifications.

EX-10.11

Exhibit 10.11

COMMUNITYSOUTH FINANCIAL CORPORATION

2005 STOCK INCENTIVE PLAN

AMENDMENT ADOPTED BY THE BOARD OF DIRECTORS

November 18, 2008

First, the Board amended the definition of “Fair Market Value” found in Article I by deleting it in its entirety and replacing it with the following:

“Fair Market Value” on any date shall mean:

(i)            if the Stock is readily tradable on an established securities market (as defined in Treasury Regulation § 1.897-1(m)), the closing sales price of the Stock on the trading day immediately preceding such date on the securities exchange having the greatest volume of trading in the Stock during the 30-day period preceding the day the value is to be determined or, if such exchange was not open for trading on such date, the next preceding date on which it was open;

(ii)           if the Stock is not traded on any securities exchange (as defined in Treasury Regulation §1.897-1(m)), the average of the closing high bid and low asked prices of the Stock on the over-the-counter market on the day such value is to be determined, or in the absence of closing bids on such day, the closing bids on the next preceding day on which there were bids; or

(iii)          if the Stock also is not traded on the over-the-counter market, the fair market value as determined in good faith by the Board or the Committee by application of a reasonable valuation method consistently applied and taking into consideration all available information material to the value of the Company; factors to be considered may include, as applicable, the value of tangible and intangible assets of the Company, the present value of future cash-flows of the Company, the market value of stock or equity interests in similar corporations which can be readily determined through objective means (such as through trading prices on an established securities market or an amount paid in an arm’s length private transaction), and other relevant factors such as control premiums or discounts for lack of marketability.  For purposes of the foregoing, a valuation prepared in accordance with any of the methods set forth in Treasury Regulation § 1.409A-1(b)(5)(iv)(B)(2), consistently used, shall be rebuttably presumed to result in a reasonable valuation.  This paragraph is intended to comply with the definition of “fair market value” contained in Treasury Regulation § 1.409A-1(b)(5)(iv) and should be interpreted consistently therewith.

Second, the Board adopted, and made an integral part of the Plan, Article X, Section 10.7 to read as follows:

10.7         Amendment to Meet the Requirements of Code Section 409A.  It is intended that this Plan and any Options granted under this Plan comply with or meet an exemption from Section 409A of the Code, so that the income inclusion provisions of Code Section 409A(a)(1) do not apply to an Optionee. Optionee acknowledges that the Board shall have the sole discretion and authority to amend the Plan and any Stock Option Agreement hereunder including, but not limited to, increasing the Exercise Price and/or changing the exercise period, payment periods, or restrictions of any Option in the event that the Fair Market Value of the Stock is subsequently determined to be greater than the Exercise Price initially established at the time of grant, to the extent necessary to cause the Plan or such Options to comply with the provisions of Code Section 409A. Such amendment may be retroactive to the extent permitted by Section 409A of the Code, and shall not require the consent of the Optionee.

IN WITNESS WHEREOF, the Company has caused this Amendment to the Plan to be executed as of November 18, 2008 in accordance with the authority provided by the Board of Directors.

COMMUNITYSOUTH FINANCIAL CORPORATION
	By:	/s/ C. Allan Ducker, III
		Name: C. Allan Ducker, III
		Title:  Chief Executive Officer

EX-13

Exhibit 13

CommunitySouth Bank & Trust

2008 Annual Report

[Photo of CommunitySouth Bank & Trust branch with lighted sign]

Dear Shareholders, Customers and Friends:

It is no secret that 2008 represented a period unprecedented in the banking industry.  The real estate crisis and resulting economic downturn led to the failure of 25 US banks in 2008, including the $300 billion Washington Mutual, the largest bank failure in history.  Financial services industry stalwarts Wachovia, Bear Stearns, and Merrill Lynch were merged into other institutions while Lehman Brothers is no longer in existence.  The two largest mortgage government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, were placed in conservatorship by the federal government.  The Federal Reserve cut interest rates an unprecedented number of times in 2008, resulting in a significant contraction in many banks’ net interest margin.  These significant market events and economic forces have taken their toll on banks’ performances and their stock prices — including ours.

Despite the challenges present in our industry, the banking sector remains highly capitalized and well prepared to endure the current economic climate.  As of December 2008, equity capital in the industry exceeded $1.3 trillion with an additional $173 billion held in reserve as a safeguard against possible losses.  In fact, 97.6% of insured financial institutions, including CommunitySouth, are “well capitalized,” the highest regulatory capital standard.  We are pleased to report that as of December 31, 2008, the Bank’s total risk-based capital, Tier 1 risk-based capital, and leverage ratios of 10.18%, 8.92%, and 7.98%, respectively, all exceed well capitalized standards.

In conjunction with the difficulties present in the banking industry, 2008 was a year marked by many challenges at CommunitySouth.  For the first time since our inaugural year we reported a loss.  In the second quarter of 2008 we placed an additional $2.5 million into the allowance for loan losses for potential loan losses in a residential development on Lake Keowee in Seneca, South Carolina.  Subsequently, in the fourth quarter of 2008, we charged off $3.0 million of the total $4.9 million outstanding on these loans.  We continue to investigate whether fraud was involved in these loans and have filed a notice of loss under our Financial Institution Bond.  We do believe these losses to be an isolated event and not indicative of the overall quality of our loan portfolio.  However, the rest of our loan portfolio has not been immune from the problems caused by the current economic downturn. Given the challenges in the overall economy and the general pessimistic outlook for 2009, we have contributed an additional $4.3 million to the loan loss reserve in the fourth quarter 2008.

At the end of fiscal year 2008 CommunitySouth reports total assets of $387.8 million, an increase of 2.63% for the year. Given current industry and market conditions, significant asset growth is not an objective for 2009.  In fact, one of our focused objectives for 2009 is to continue to manage our balance sheet in order to enhance our total risk-based capital percentage.  Other 2009 objectives include: reduce portfolio concentration of construction and land development loans, enhance credit risk management practices, tightly manage overhead expense, increase non-interest income through our mortgage and services divisions, improve margins, and lower our overall funding costs by growing core deposits.

This past year was a disappointing and challenging year for all financial institutions, including CommunitySouth, especially considering our strong historical performance.  However, we believe we are well positioned to manage through this economic downturn and are poised to take advantage of opportunities when economic conditions improve.

Our management team, employees, and Board of Directors greatly appreciate your continued loyalty and support as we work toward our vision of being The Financial Services Provider of Choice in the Markets We Serve.

Sincerely,

/s/ Daniel E. Youngblood	/s/ C. Allan Ducker, III
Daniel E. Youngblood	C. Allan Ducker, III
Chairman of the Board	Chief Executive Officer

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Selected Financial Data

The following selected financial data for the years ended December 31, 2008 and 2007 was derived from the consolidated financial statements and other data of CommunitySouth Financial Corporation and its subsidiary, CommunitySouth Bank and Trust (the “Bank”) (collectively, the “Company”).  The selected financial data should be read in conjunction with the consolidated financial statements of the Company, including the accompanying notes, included elsewhere herein.

On January 16, 2007, the Company effected a 5-for-4 stock split in the form of a stock dividend for shareholders of record as of December 15, 2006.

(Dollars in thousands except per share data)	2008			2007
Income Statement Data:
Interest income – loans	$	20,163		$	21,403
Interest income – investments	2,547			1,813
Total interest income	22,710			23,216
Interest expense – deposits	(12,580		)	(13,069		)
Net interest income	10,130			10,147
Provision for loan losses	(7,168		)	(1,188		)
Net interest income after provision for loan losses	2,962			8,959
Non-interest income	1,392			1,575
Non-interest expense	(9,510		)	(8,184		)
Income (loss) before income taxes	(5,156		)	2,350
Income tax (expense) benefit	1,806			(782		)
Net income (loss)	$	(3,350	)	$	1,568
Balance Sheet Data:
Total assets	$	387,816		$	377,867
Earning assets	374,939			361,890
Investment securities, available for sale (1)	47,602			24,844
Other investments (2)	1,805			447
Loans (3)	320,907			302,934
Allowance for loan losses	(8,088		)	(4,214		)
Deposits	296,643			327,664
Shareholders’ equity	28,528			31,471
Per-Share Data:
Net income (loss) – basic	$	(0.71	)	$	0.33
Net income (loss) – diluted	(0.71		)	0.31
Book value	6.07			6.70
Return on Equity and Assets:
Return on average assets	(0.87		)%	0.50		%
Return on average equity	(10.91		)%	5.12		%
Average equity to average assets ratio	7.99		%	9.76		%

(1)Marketable securities are stated at fair value.

(2)Non-marketable securities are stated at cost.

(3)Loans are stated at gross amounts before allowance for loan losses.

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Forward Looking Statements

This report contains “forward-looking statements” within the meaning of the securities laws.  All statements that are not historical facts are “forward-looking statements.”  You can identify these forward-looking statements through our use of words such as “may,” “will,” “expect,” “anticipate,” “believe,” “intend,” “estimate,” “project,” “continue,” or other similar words.  Forward-looking statements include, but are not limited to, statements regarding our future business prospects, revenues, working capital, liquidity, capital needs, interest costs, income, business operations and proposed services.

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 our 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 we are a 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:

·our rapid growth to date and short operating history;

·significant increases in competitive pressure in the banking and financial services industries;

·changes in the interest rate environment which could reduce anticipated or actual margins;

·changes in political conditions or the legislative or regulatory environment;

·general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

·changes occurring in business conditions and inflation;

·changes in technology;

·changes in monetary and tax policies;

·the lack of seasoning of our loan portfolio, especially given our rapid loan growth;

·the level of allowance for loan losses;

·the rate of delinquencies and amounts of charge-offs;

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

·loss of consumer confidence and economic disruptions resulting from terrorist activities;

·changes in the securities markets; and

·other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

We undertake 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 may not occur.

A copy of the our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, as filed with the Securities and Exchange Commission, which contains a discussion of certain risks and uncertainties that could affect our forward-looking statements, will be sent to any shareholder without charge upon written request to: CommunitySouth Financial Corporation, Attn: John W. Hobbs, Chief Financial Officer, 6602 Calhoun Memorial Highway, Easley, South Carolina 29640.

Market for Common Stock and Dividends

Since March 15, 2006, our common stock has been quoted on the OTC Bulletin Board under the symbol “CBSO.” Quotations on the OTC Bulletin Board reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not represent actual transactions.  Transactions of our common stock did not begin to occur on the OTC Bulletin Board until March 16, 2006.

The following is a summary of the high and low bid prices for our common stock reported by the OTC Bulletin Board for the periods indicated (the bids prices have been adjusted for all stock splits):

2008	High		Low
Fourth Quarter	$	5.50	$	1.75
Third Quarter	7.00		2.53
Second Quarter	9.00		5.50
First Quarter	10.00		7.30

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2007	High		Low
Fourth Quarter	$	11.40	$	8.55
Third Quarter	13.50		11.00
Second Quarter	15.90		12.75
First Quarter	18.00		13.68

As of December 31, 2008, there were 4,698,697 shares of common stock outstanding held by approximately 907 shareholders of record.

We have not declared or paid any cash dividends on our common stock since our inception.  For the foreseeable future we do not intend to declare cash dividends.  We intend to retain earnings to grow our business and strengthen our capital base.  Our ability to pay dividends depends on the ability of our subsidiary, CommunitySouth Bank and Trust, to pay dividends to us.  As a South Carolina state bank, CommunitySouth Bank and Trust may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. In addition, the Bank is prohibited from declaring a dividend on its shares of common stock unless its surplus equals or exceeds its stated capital. At December 31, 2008, the Bank had a deficit of $872,916.

5

COMMUNITYSOUTH FINANCIAL CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Basis of Presentation

The following discussion should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto and the other financial data included elsewhere in this Annual Report.  The financial information provided below has been rounded in order to simplify its presentation.  However, the ratios and percentages provided below are calculated using the detailed financial information contained in the Consolidated Financial Statements, the Notes thereto and the other financial data included elsewhere in this Annual Report.

General

CommunitySouth Financial Corporation is a bank holding company headquartered in Easley, South Carolina. Its subsidiary, CommunitySouth Bank and Trust, opened for business on January 18, 2005.  The principal business activity of the Bank is to provide banking services to domestic markets, principally in the upstate of South Carolina.  The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the “FDIC”). The Company completed an initial public offering of its common stock in which it sold a total of 4,681,069 shares at $6.40 per share (as adjusted for all previous stock splits).  Proceeds of the offering were used to pay organizational costs and provide the initial capital for the Bank.

Overview

The following discussion describes our results of operations for the years ended December 31, 2008 and 2007 and also analyzes our financial condition as of December 31, 2008 and 2007.  We received approvals from the FDIC, the Federal Reserve Board (“FRB”) and the State Board of Financial Institutions during January 2005, and commenced business on January 18, 2005.

Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. We have included a detailed discussion of this process in the following section.

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

Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises

The Congress, Treasury Department and the federal banking regulators, including the FDIC, have taken broad action since early September 2008 to address volatility in the U.S. banking system.

In October 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. The EESA authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”).  The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other.  The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”).  Under the CPP, the Treasury Department will purchase debt or equity securities from participating institutions.  The TARP also will include direct purchases or guarantees of troubled assets of financial institutions. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications.

6

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000.  This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry.

Following a systemic risk determination, the FDIC established the Temporary Liquidity Guarantee Program (“TLGP”) on October 14, 2008.  The TLGP includes the Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit insurance coverage through December 31, 2009 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts.  Institutions participating in the TLGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place.  The TLGP also includes the Debt Guarantee Program (“DGP”), under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies.  The unsecured debt must be issued on or after October 14, 2008 and not later than June 30, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012.  The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their liabilities as of September 30, 2008.  Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 50 to 100 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012.  The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008.  CommunitySouth opted to participate in both programs.

On February 17, 2009, President Obama signed into law The American Recovery and Reinvestment Act of 2009 (“ARRA”), more commonly known as the economic stimulus or economic recovery package.  ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs.  In addition, ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients that are in addition to those previously announced by the U.S. Treasury, until the institution has repaid the Treasury Department, which is now permitted under ARRA without penalty and without the need to raise new capital, subject to the Treasury Department’s consultation with the recipient’s appropriate regulatory agency.

Further regulatory actions may arise as the Federal government continues to attempt to address the economic situation.

Results of Operations

Results of operations are only presented for the years ended December 31, 2008 and 2007.

Net interest income decreased $16,628, or 0.16%, to $10.13 million in 2008, down from $10.15 million in 2007. The primary component of interest income in 2008 was interest on loans, including fees, of $20.2 million, as compared to $21.4 million in 2007. The decrease in net interest income was due primarily to a decrease in rates, translating into lower loan yields.

The Company’s net interest spreads were 2.27% and 2.75% in 2008 and 2007, respectively. The Company’s net interest margins were 2.74% and 3.38% in 2008 and 2007, respectively.  This decline of 64 basis points in the net interest margin was due the decline in market rates.  Yields on average earning assets decreased from 7.74% in 2007 to 6.13% in 2008. Rates on average interest bearing liabilities decreased from 4.99% in 2007 to 3.86% in 2008. These changes in yields and rates resulted in a net decrease in net interest spread of 48 basis points. Average shareholder equity was 9.5% of average interest bearing liabilities in 2008 and 11.7% of average interest bearing liabilities in 2007.

The provision for loan losses was $7.2 million in 2008, compared to $1.2 million in 2007.  The charges to the provision were to maintain the allowance for loan losses at a level sufficient to cover estimated losses inherent in the loan portfolio, given the current economic downturn which has affected the entire banking industry.  CommunitySouth, like many community banks, has a significant amount of loans that directly or indirectly rely on the home building industry, which has also experienced an extremely turbulent year.

Non-interest income decreased $182,428, or 11.59%, to $1.4 million in 2008, down from non-interest income of $1.6 million in 2007. The decrease is attributable to the $528,582 decrease, or 52.96%, in mortgage loan origination fees, which was $469,529 for the year ended December 31, 2008.  The decrease is due to our decreased volume in mortgage loan originations and departmental restructuring. Income from bank-owned life insurance was $210,525 in 2008, a slight decline from income of $222,048 in 2007.  Service charges on deposit accounts increased $173,752, or 117.1%, to $322,090 in 2008, as compared to service charges on deposit accounts of $148,338 in 2007, due to the increased volume in deposit accounts.

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Non-interest expense increased $1.3 million, or 16.2%, to $9.5 million in 2008, compared to non-interest expense of $8.2 million in 2007. Non-interest expense increased in most categories as a result of our continued growth. Salaries and employee benefits increased $491,843 to $4.8 million for the year ended December 31, 2008. This increase is attributable to normal pay increases, hiring of additional staff to meet the needs associated with our growth. The Company’s efficiency ratio was 82.5% in 2008 compared to 69.8% in 2007. The efficiency ratio is defined as non-interest expense divided by the sum of net interest income and non-interest income, net of gains and losses on sales of assets.  The deterioration in our efficiency ratio is primarily attributable to the increased expenses described above, which we incurred to position our Bank for anticipated growth.

The Company’s net loss was $3.4 million in 2008, compared to net income of $1.6 million in 2007. Return on average assets during 2008 was -0.87% compared to a return of 0.50% in 2007. Net loss in 2008 was after an income tax benefit of $1.8 million and net income in 2007 was after an income tax expense of $781,656. The income tax expenses for 2008 and 2007 resulted in effective tax rates of 35.0% and 33.3%, respectively. See Notes 1 and 12 to the consolidated financial statements for additional information about income taxes.

Net Interest Income

General.  The largest component of the Company’s net income is its net interest income, which is the difference between the income earned on assets and interest paid on deposits and borrowings used to support such assets.  Net interest income is determined by the yields earned on the Company’s interest-earning assets and the rates paid on its interest-bearing liabilities, as well as the relative amounts of interest-earning assets and interest-bearing liabilities.  Net interest income divided by average interest-earning assets represents the Company’s net interest margin.  The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities.

Rate/Volume Analysis.  Net interest income can be analyzed in terms of the impact of changing interest rates and changing volumes.  The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in the net interest income for the periods presented.

	December 31, 2008 vs. 2007
	Increase (decrease) Due to
							Rate /
(Dollars in thousands)	Volume			Rate			Volume			Total
Interest Income
Loans	$	4,067		$	(4,460	)	$	(847	)	$	(1,240	)
Investment securities (1)	1,926			(72		)	(209		)	1,645
Federal funds	(754		)	(454		)	298			(910		)
Total Interest Income	$	5,239		$	(4,986	)	$	(758	)	$	(505	)
Interest Expense
Deposits	$	1,232		$	(2,549	)	$	(241	)	$	(1,558	)
Other borrowings	1,076			—			(7		)	1,069
Total Interest Expense	$	2,308		$	(2,549	)	$	(248	)	$	(489	)
Net Interest Income	$	2,931		$	(2,437	)	$	(510	)	$	(16	)

(1)For the purpose of this table, the investment securities include marketable and non-marketable securities.

8

Average Balances, Income and Expenses and Rates.  The following table sets forth, for the years ended December 31, 2008 and 2007, information related to the Company’s average balance sheet and its average yields on earning assets and average costs of interest-bearing liabilities.  Such yields are derived by dividing income or expense by the average balance of the corresponding earning assets or interest-bearing liabilities.  Average balances have been derived from the daily balances throughout the periods indicated.

	2008							2007
	Average			Income /		Yield/		Average			Income /		Yield /
(Dollars in thousands)	Balance			Expense		Rate		Balance			Expense		Rate
Assets
Earning assets:
Loans (1)	$	315,175		$	20,163	6.40	%	$	264,844		$	1,403	8.08	%
Investment securities (2)	47,130			2,308		4.90	%	12,067			663		5.49	%
Federal funds sold and other	7,884			239		3.04	%	22,914			1,150		5.02	%
Total earning assets	370,189			22,710		6.13	%	299,825			23,216		7.74	%
Cash and due from banks	5,579							4,720
Premises and equipment	4,873							4,953
Other assets	8,944							7,856
Allowance for loan losses	(5,528		)					(3,686		)
Total assets	$	384,057						$	313,668
Liabilities
Interest-bearing liabilities:
Repurchase agreements	$	28,525		700		2.46	%	$	2,315		63		2.72	%
Federal funds purchased	1,312			24		1.85	%	—			—		—	%
Federal Home Loan Bank advances	9,645			224		2.33	%	—			—		—	%
Note Payable	916			34		3.71	%	—			—		—	%
Subordinated Debt	1,294			149		11.50	%	—			—		—	%
Interest-bearing transaction accounts	15,300			324		2.12	%	11,520			196		1.70	%
Savings deposits	18,881			223		1.18	%	19,107			648		3.39	%
Time deposits	249,765			10,902		4.36	%	228,748			12,162		5.32	%
Total interest-bearing liabilities	325,638			12,580		3.86	%	261,690			13,069		4.99	%
Demand deposits	23,739							18,864
Accrued interest and other liabilities	3,967							2,492
Total liabilities	353,344							283,046
Shareholders’ equity	30,713							30,622
Total liabilities and shareholders’ equity	$	384,057						$	313,668
Net interest income				$	10,130						$	10,147
Net interest spread						2.27	%						2.75	%
Net interest margin						2.74	%						3.38	%

(1)There were $9.9 million and $35,172 of loans in non-accrual status as of December 31, 2008 and 2007, respectively.  The effect of fees collected on loans in 2008 and 2007 totaled $260,966 and $654,596, respectively, and increased the annualized yield on loans by 9 basis points from 6.31% for 2008 and by 25 basis points from 7.83% for 2007.  The effect of such fees on the annualized yield on earning assets was an increase of 7 basis points from 6.06% in 2008 and an increase of 22 basis points from 7.52% in 2007.  The effects of such fees on net interest spread were an increase of 7 basis points from 2.20% for 2008 and an increase of 22 basis points from 2.53% for 2007.  The effects of such fees on net interest margin were an increase of 17 basis points from 2.57% for 2008 and an increase of 21 basis points from 3.17% for 2007.

(2)For the purpose of this table, the investment securities include marketable and non-marketable securities.

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Interest Sensitivity.  The Company monitors and manages the pricing and maturity of its assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on its net interest income.  The principal monitoring technique employed by the Company is the measurement of the Company’s interest sensitivity “gap”, which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time.  Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates.

The following table sets forth the Company’s interest rate sensitivity at December 31, 2008.

				After
				Three			One			Greater
	Within			Through			Through			Than
	Three			Twelve			Five			Five
(Dollars in thousands)	Months			Months			Years			Years			Total
Assets
Earning assets:
Loans, gross	$	182,297		$	19,515		$	110,307		$	8,788		$	320,907
Investment securities, available for sale	1,500			1,500			17,594			27,008			47,602
Other investments	—			—			—			1,805			1,805
Fed Funds	4,625			—			—			—			4,625
Total earning assets	188,422			21,015			127,901			37,601			374,939
Liabilities
Interest-bearing liabilities:
Interest-bearing deposits:
Repurchase agreements	—			—			15,000			15,000			30,000
Other Borrowings	25,000			1,570			—			4,325			30,895
Demand deposits	16,449			—			—			—			16,449
Savings deposits	14,461			—			—			—			14,461
Time deposits	199,302			40,349			3,920			—			243,571
Total interest-bearing liabilities	255,212			41,919			18,920			19,325			335,376
Period gap	$	(66,790	)	$	(20,904	)	$	108,981		$	18,276		$	39,563
Cumulative gap	$	(66,790	)	$	(87,694	)	$	21,287		$	39,563
Ratio of cumulative gap to total earning assets	(17.81		)%	(23.39		)%	5.68		%	10.55		%

The above table reflects the balances of interest-earning assets and interest-bearing liabilities at the earlier of their repricing or maturity dates.  Overnight federal funds are reflected at the earliest pricing interval due to the immediately available nature of the instruments.  Scheduled payment amounts of fixed rate amortizing loans are reflected at each scheduled payment date.  Scheduled payment amounts of variable rate amortizing loans are reflected at each scheduled payment date until the loan may be repriced contractually; the unamortized balance is reflected at that point.  Interest-bearing liabilities with no contractual maturity, such as savings deposits and interest-bearing transaction accounts, are reflected in the earliest repricing period due to contractual arrangements which give the Company the opportunity to vary the rates paid on those deposits within a thirty-day or shorter period.  Fixed rate time deposits, principally certificates of deposit, are reflected at their contractual maturity date.

The Company generally would benefit from increasing market rates of interest when it has an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when it is liability-sensitive.  The Company is cumulatively liability sensitive over the three-month to twelve-month period and asset sensitive over all periods greater than one year.  However, the Company’s gap analysis is not a precise indicator of its interest sensitivity position.  The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally.  Net interest income may be impacted by other significant factors in a given interest rate environment, including changes in the volume and mix of earning assets and interest-bearing liabilities.

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Provision and Allowance for Loan Losses

General.  The Company has developed policies and procedures for evaluating the overall quality of its credit portfolio and the timely identification of potential problem loans.  On a quarterly basis, the Company’s Board of Directors reviews and approves the appropriate level for the Company’s allowance for loan losses based upon management’s recommendations, the results of the internal monitoring and reporting system, and an analysis of economic conditions in its market.

Additions to the allowance for loan losses, which are expensed through the provision for loan losses on the Company’s income statement, are made periodically to maintain the allowance at an appropriate level based on management’s analysis of the estimated losses inherent in the loan portfolio.  Loan losses and recoveries are charged or credited directly to the allowance.  The amount of the provision is a function of the level of loans outstanding, the level of non-performing loans, historical loan loss experience, the amount of loan losses actually charged against the reserve during a given period, and current and anticipated economic conditions.

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

Based on present information and an ongoing evaluation, management considers the allowance for loan losses to be adequate to meet presently known and inherent losses in the loan portfolio.  Management’s judgment about the adequacy of the allowance is based upon a number of assumptions about future events which it believes to be reasonable but which may or may not be accurate.  Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required, especially considering the overall weakness in the commercial real estate market in our market areas.

The following table sets forth certain information with respect to the Company’s allowance for loan losses and the composition of charge-offs and recoveries for the years ended December 31, 2008 and 2007.

Allowance for Loan Losses

(Dollars in thousands)	2008			2007
Total loans outstanding at end of period	$	320,907		$	302,934
Average loans outstanding	$	315,175		$	264,844
Balance of allowance for loan losses at beginning of year	$	4,214		$	3,091
Provision for loan losses	7,168			1,188
Charge-offs	(3,294		)	(65		)
Balance of allowance for loan losses at end of year	$	8,088		$	4,214
Allowance for loan losses to period end loans	2.52		%	1.39		%

Non-performing Assets

Non-performing Assets. There were $9.9 million and $35,172 of non-accrual loans at December 31, 2008 and December 31, 2007, respectively. There were $6,035 of loans past due 90 days or more and still accruing interest or restructured loans at December 31, 2008.  There were no loans past due 90 days or more and still accruing interest or restructured loans at December 31, 2007.  There was $415,229 and $0 in Other Real Estate Owned at December 31, 2008 and 2007, respectively.

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The Company’s policy with respect to non-performing assets is as follows.  Accrual of interest will be discontinued on a loan when management believes, after considering economic and business conditions and collection efforts that the borrower’s financial condition is such that the collection of interest is doubtful.  A delinquent loan will generally be placed in non-accrual status when it becomes 90 days or more past due unless the estimated net realizable value of collateral exceeds the principal balance and accrued interest.  When a loan is placed in non-accrual status, all interest which has been accrued on the loan but remains unpaid is reversed and deducted from current earnings as a reduction of reported interest income.  No additional interest will be accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.  When a problem loan is finally resolved, there may ultimately be an actual write-down or charge-off of the principal balance of the loan to the allowance for loan losses.

Potential Problem Loans.  Potential problem loans are loans that are not included in impaired loans, but about which management has become aware of information about possible credit problems of the borrowers that causes doubt about their ability to comply with current repayment terms. At December 31, 2008 and December 31, 2007, the Company had identified $424,844 and $1,625,150, respectively, of potential problem loans through its internal review procedures.  The results of this internal review process are considered in determining management’s assessment of the adequacy of the allowance for loan losses.

Non-interest Income and Expense

Non-interest Income.  The largest component of non-interest income was mortgage origination fees which totaled $469,529 and $998,111 for the years ended December 31, 2008 and 2007, respectively.

The following table sets forth the principal components of non-interest income for the years ended December 31, 2008 and 2007.

(Dollars in thousands)	2008		2007
Mortgage origination fees	$	470	$	998
Service charges on deposit accounts	322		148
Bank-owned life insurance	211		222
Other income	389		206
Total non-interest income	$	1,392	$	1,574

Non-interest Expense.  Salaries and employee benefits comprised the largest component of non-interest expense which totaled $4.8 million and $4.3 million for the years ended December 31, 2008 and 2007, respectively.  All of the other categories of non-interest expense totaled $4.7 million and $3.9 million for the years ended December 31, 2008 and 2007, respectively.

The following table sets forth the primary components of non-interest expense for the years ended December 31, 2008 and 2007.

(Dollars in thousands)	2008		2007
Salaries and benefits	$	4,828	$	4,336
Net occupancy	638		500
Depreciation	718		601
Equipment maintenance and rental	194		109
Advertising	248		270
Professional fees	449		335
Office supplies	95		146
Telephone	148		145
Data processing	758		603
Other	1,435		1,139
Total non-interest expense	$	9,511	$	8,184

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Earning Assets

Loans. Loans are the largest category of earning assets and typically provide higher yields than the other types of earning assets.  Loans also entail greater credit and liquidity risks than most of the Company’s other investments and short-term interest-earning cash and cash equivalents, which management attempts to control and counterbalance.  Loans averaged $315.2 million and $264.8 million in 2008 and 2007, respectively. Total loans were $320.9 million and $302.9 million at December 31, 2008 and 2007, respectively.

The following table sets forth the composition of the loan portfolio by category at December 31, 2008 and 2007 and highlights the Company’s general emphasis on mortgage lending.

	2008					2007
				Percent					Percent
(Dollars in thousands)	Amount			Of Total		Amount			Of Total
Real estate – construction	$	129,777		40.44	%	$	124,016		40.94	%
Real estate – mortgage	154,838			48.25	%	149,369			49.31	%
Commercial and industrial	33,303			10.38	%	26,095			8.61	%
Consumer	2,989			0.93	%	3,454			1.14	%
Total loans, gross	320,907			100.00	%	302,934			100.00	%
Allowance for loan losses	(8,088		)			(4,214		)
Net loans	$	312,819				$	298,720

The largest component of loans in the Company’s loan portfolio is real estate mortgage loans.  At December 31, 2008 and 2007, real estate mortgage loans, which consist of first and second mortgages on single or multi-family residential dwellings, loans secured by commercial and industrial real estate and other loans secured by multi-family properties and farmland, totaled $154.8 million and $149.4 million, respectively and represented 48.25% and 49.31%, respectively of the total loan portfolio.  In the context of this discussion, a “real estate mortgage loan” is defined as any loan, other than a loan for construction purposes, secured by real estate, regardless of the purpose of the loan.  It is common practice for financial institutions in the Company’s market area to obtain a security interest in real estate whenever possible, in addition to any other available collateral.  This collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the magnitude of the real estate loan portfolio component.  Real estate mortgage loans represent 25% of our impaired loans.

The demand for residential and commercial real estate loans in the upstate South Carolina market is strong due to the historically low interest rate environment.  Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans.  They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt.  Cash flows may be affected significantly by general economic conditions (including rising interest rates), a downturn in the local economy, or a decline in occupancy rates in the local economy where the property is located.  Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our level of non-performing loans.  An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the related provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

Real estate construction loans totaled $129.8 million and $124.0 million at December 31, 2008 and 2007, respectively. In the context of this discussion, a “real estate construction loan” is defined as any loan for construction purposes, secured by real estate.  Real estate construction loans represent 74% of our impaired loans.

Commercial and industrial loans totaled $33.3 million and $26.1 million at December 31, 2008 and 2007, respectively and comprised 10.38% and 8.61%, respectively of the total portfolio. In the context of this discussion, a “commercial and industrial loan” is defined as any loan for a non-consumer purpose, not secured by real estate.

The Company’s loan portfolio also includes consumer loans.  At December 31, 2008 and 2007, consumer loans totaled $3.0 million and $3.5 million, respectively and represented 0.93% and 1.14%, respectively of the total loan portfolio.

The Company’s loan portfolio reflects the diversity of its upstate South Carolina market.  The Company’s offices are located in Easley, Spartanburg, Mauldin, Greer, Anderson and Greenville, South Carolina.  Management expects the area to remain stable with continued growth in the near future.  The diversity of the economy creates opportunities for all types of lending.  The Company does not engage in foreign lending.

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The repayment of loans in the loan portfolio as they mature is also a source of liquidity for the Company.  The following tables set forth the Company’s loans maturing within specified intervals at December 31, 2008 and 2007.

2008

			Over One
			Year
			Through		Over
	One Year		Five		Five
(Dollars in thousands)	or Less		Years		Years		Total
Real estate – construction	$	76,579	$	51,914	$	1,284	$	129,777
Real estate – mortgage	24,951		106,620		23,267		154,838
Commercial and industrial	17,384		13,863		2,056		33,303
Consumer	686		1,641		662		2,989
	$	119,600	$	174,038	$	27,269	$	320,907
Loans maturing after one year with:
Fixed interest rates							$	169,843
Floating interest rates							31,464
							$	201,307

2007

			Over One
			Year
			Through		Over
	One Year		Five		Five
(Dollars in thousands)	or Less		Years		Years		Total
Real estate – construction	$	66,972	$	49,908	$	7,136	$	124,016
Real estate – mortgage	34,964		93,976		20,429		149,369
Commercial and industrial	13,351		11,313		1,431		26,095
Consumer	1,408		1,262		784		3,454
	$	116,695	$	156,459	$	29,780	$	302,934
Loans maturing after one year with:
Fixed interest rates							$	132,590
Floating interest rates							53,649
							$	186,239

The information presented in the above table is based on the contractual maturities of the individual loans, including loans which may be subject to renewal at their contractual maturity.  Renewal of such loans is subject to review and credit approval as well as modification of terms upon their maturity.  Consequently, management believes this treatment presents fairly the maturity and repricing structure of the loan portfolio shown in the above table.

Investment Securities and Other Investments. The investment securities portfolio, which averaged $47.1 million and $12.0 million in 2008 and 2007, respectively, is a component of the Company’s total earning assets.  At December 31, 2008 and 2007, the total investment securities portfolio was $49.4 million and $25.3 million, respectively.  Investment securities were primarily marketable investments recorded at their fair value. Other investments consisted of Federal Home Loan Bank of Atlanta (“FHLB”) stock recorded at cost.

The following table sets forth the fair value of the securities held by the Company at December 31, 2008 and 2007.

(Dollars in thousands)	2008		2007
Investment securities	$	47,602	$	24,844
Other investments	1,805		447
Total investment securities portfolio	$	49,407	$	25,291

Short-Term Investments.  Short-term investments, which consist primarily of federal funds sold, averaged $7.9 million and $22.9 million in 2008 and 2007, respectively with a weighted average yield of 3.04% and 5.02% in 2008 and 2007, respectively.  These funds are an important source of the Company’s liquidity. Federal funds are generally invested in an earning capacity on an overnight basis. At December 31, 2008 and 2007, federal funds were $4.6 million and $33.7 million at an annualized overnight rate of 0.50% and 4.15%, respectively. The maximum outstanding balance of federal funds sold at any month end during the years 2008 and 2007 was $16.4 million and $40.8 million, respectively.

14

Deposits

General.  Average interest-bearing liabilities totaled $325.8 million and $261.7 million in 2008 and 2007, respectively.  Average total deposits totaled $307.7 million and $278.2 million during 2008 and 2007, respectively.  At December 31, 2008 and 2007 total deposits were $296.6 million and $327.7 million, respectively.

The following table sets forth the average deposits of the Company by category for the year ended December 31, 2008 and 2007.

	2008				2007
			Average				Average
(Dollars in thousands)	Amount		Rate		Amount		Rate
Non-interest bearing demand	$	23,739	—	%	$	18,864	—	%
Interest bearing demand	15,300		2.12	%	11,520		1.70	%
Savings	18,881		1.18	%	19,107		3.39	%
Time	249,765		4.36	%	228,748		5.32	%
Total	$	307,685			$	278,239

The following table sets forth the deposits of the Company by category as of December 31, 2008 and 2007.

	2008				2007
			% of				% of
(Dollars in thousands)	Amount		Deposits		Amount		Deposits
Non-interest bearing demand	$	22,162	7.47	%	$	24,464	7.46	%
Interest bearing demand	16,449		5.55	%	13,721		4.19	%
Savings	14,461		4.87	%	24,634		7.52	%
Time deposits less than $100	32,111		10.82	%	59,528		18.17	%
Time deposits of $100 or over	25,162		8.49	%	47,118		14.38	%
Brokered deposits	186,298		62.80	%	158,199		48.28	%
Total	$	296,643	100.00	%	$	327,664	100.00	%

Core deposits, which exclude certificates of deposit of $100,000 or more and brokered deposits, provide a relatively stable funding source for the Company’s loan portfolio and other earning assets.  The Company’s core deposits were $85.2 million and $122.3 million at December 31, 2008 and 2007, respectively, or 28.7% and 37.3%, respectively of total deposits.  Certificates of deposit of $100,000 or more and brokered deposits are not considered core deposits because their retention can be expected to be heavily influenced by rates offered at renewal.  Due to the developed national market for certificates of deposit, we anticipate being able to either renew or replace these deposits when they renew; however, no assurance can be given that we will be able to replace them with deposits with the same terms.

For the years ended December 31, 2008 and 2007, our non-core deposits included wholesale funding in the form of brokered CDs of $186.3 million and $158.2 million, respectively.  We generally obtain out-of-market time deposits of $100,000 or more through brokers with whom we maintain ongoing relationships.  The guidelines governing our participation in brokered CD programs are part of our Asset Liability Management Program Policy, which is reviewed, revised and approved annually by the Asset Liability Committee.  These guidelines limit our brokered CDs to 65% of total deposits, dictate that our current interest rate risk profile determines the terms and that we only accept brokered CDs from approved correspondents.  In addition, we do not obtain time deposits through the Internet.  These guidelines allow us to take advantage of the attractive terms that wholesale funding can offer while mitigating the inherent related risk.

Deposits have been a primary source of funding.  Management anticipates that deposits will continue to be the Company’s primary source of funding in the future.  The Company’s loan-to-deposit ratio was 108.17% and 92.45% at December 31, 2008 and 2007, respectively.  The maturity distribution of the Company’s time deposits of $100,000 or over at December 31, 2008 and 2007, is set forth in the following tables.

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Maturities of Certificates of Deposit of $100,000 or More (Including Brokered Deposits)

			After		After
			Three		Six
	Within		Through		Through		After
	Three		Six		Twelve		Twelve
(Dollars in thousands)	Months		Months		Months		Months		Total
December 31, 2008
Certificates of deposit of $100,000 or more	$	188,080	$	11,231	$	10,494	$	1,655	$	211,460
December 31, 2007
Certificates of deposit of $100,000 or more	$	17,479	$	81,361	$	98,331	$	8,146	$	205,317

Of the Company’s time deposits of $100,000 or over as of December 31, 2008 and 2007, 88.95% and 8.51% are scheduled maturities within three months, respectively. As of December 31, 2008 and 2007, 99.22% and 96.03%, respectively, of the Company’s time deposits of $100,000 or over had maturities within twelve months.

Other Borrowings

The following table outlines our various sources of borrowed funds during the years ended December 31, 2008 and December 31, 2007, the amounts outstanding at the end of each period and the weighted-average interest rates paid for each borrowing source.

							Weighted		Maximum
			Period-				-Average		Outstanding
	Ending		End		Average		Rate for		at any
(Dollars in thousands)	Balance		Rate		Balance		Year		Month End
December 31, 2008
Federal Home Loan Bank advances	$	25,000	1.49	%	$	9,645	2.33	%	$	30,000
Federal funds purchased	—		—	%	1,312		1.85	%	9,491
Securities sold under agreement to repurchase	30,000		3.24	%	28,525		2.46	%	30,000
Bank of Tennessee note payable	1,570		3.25	%	916		3.71	%	1,570
Subordinated debt	4,325		11.50	%	1,294		11.50	%	4,325
December 31, 2007
Securities sold under agreement to repurchase	15,000		2.58	%	2,315		2.72	%	15,000

Subordinated Debt.  During the third quarter of 2008, we commenced a subordinated debt offering to enhance and strengthen the levels of capital and liquidity at the holding company such that we could maintain the resources needed to maintain “well-capitalized” levels of regulatory capital at the bank. We raised $4.325 million in additional capital before we closed the offering on October 15, 2008.  The subordinated notes were sold to a limited number of purchasers in a private offering, bear an interest rate of 11.5%, are callable after September 30, 2011, at a premium, and mature in 2018. The subordinated debt has been structured to fully count as Tier 2 regulatory capital on a consolidated basis.

Capital

The FRB and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%.

16

The FRB guidelines contain an exemption from the capital requirements for “small bank holding companies” which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC.  Although our class of common stock is registered under Section 12 of the Securities Exchange Act, we believe that because our stock is not listed on any exchange or otherwise actively traded, the FRB will interpret its new guidelines to mean that we qualify as a small bank holding company.  Nevertheless, our Bank remains subject to these capital requirements.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the 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 classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.  Regardless, at December 31, 2008, our Bank is “well capitalized” under these minimum capital requirements as set per bank regulatory agencies.

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

At the bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies.  To be considered “adequately capitalized” under these capital guidelines, we must maintain a minimum total risk-based capital of 8%, with at least 4% being Tier 1 capital.  In addition, we must maintain a minimum Tier 1 leverage ratio of at least 4%.  To be considered “well-capitalized,” we must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.

Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a 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 classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

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

Analysis of Capital and Capital Ratios

(Dollars in thousands)	2008			2007
Tier 1 capital	$	30,836		$	30,102
Tier 2 capital	4,369			4,214
Total qualifying capital	$	35,205		$	34,316
Risk-adjusted total assets (including off-balance sheet exposures)	$	345,829		$	337,586
Total risk-based capital ratio	10.18		%	10.17		%
Tier 1 risk-based capital ratio	8.92		%	8.92		%
Tier 1 leverage ratio	7.98		%	8.26		%

Off-Balance Sheet Risk

Through its operations, the Bank has made contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to the Bank’s customers at predetermined interest rates for a specified period of time.  At December 31, 2008 and 2007, the Bank had issued commitments, including standby letters of credit, to extend credit of $39.7 million and $52.5 million, respectively through various types of commercial lending arrangements.

17

The following tables set forth the length of time until maturity for unused commitments to extend credit at December 31, 2008 and 2007.

			After		After
			One		Three				Greater
	Within		Through		Through		Within		Than
	One		Three		Twelve		One		One
(Dollars in thousands)	Month		Months		Months		Year		Year		Total
December 31, 2008
Unused commitments to extend credit	$	2,941	$	1,889	$	11,989	$	16,819	$	19,441	$	36,260
Standby letters of credit	717		80		2,617		3,414		74		3,488
	$	3,658	$	1,969	$	14,606	$	20,233	$	19,515	$	39,748
December 31, 2007
Unused commitments to extend credit	$	2,479	$	891	$	17,370	$	20,740	$	28,603	$	49,343
Standby letters of credit	578		833		—		1,411		1,766		3,177
	$	3,057	$	1,724	$	17,370	$	22,151	$	30,369	$	52,520

Approximately $30.9 million and $37.6 million of these commitments to extend credit had variable rates as of December 31, 2008 and 2007, respectively.

The Bank evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on its credit evaluation of the borrower.  Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate.

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 its financial statements.  Significant accounting policies are described in the footnotes to the consolidated financial statements at December 31, 2008, included in this Annual Report to Shareholders, and as filed with the Company’s Annual Report on Form 10-K.  Certain accounting policies involve significant judgments and assumptions which have a material impact on the carrying value of certain assets and liabilities. These accounting policies are considered to be critical accounting policies.  The judgments and assumptions used 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, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of assets and liabilities and results of operations.

Management believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of the consolidated financial statements.  Refer to the portion of this discussion that addresses the allowance for loan losses for a description of our processes and methodology for determining our allowance for loan losses.

Liquidity Management

Liquidity management involves monitoring the Company’s sources and uses of funds in order to meet its day-to-day cash flow requirements while maximizing profits.  Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities.  Without proper liquidity management, the Company would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves.

Liquidity management is made more complex because different balance sheet components are subject to varying degrees of management control.  For example, the timing of maturities of the investment portfolio is very predictable and subject to a high degree of control at the time investment decisions are made.  However, net deposit inflows and outflows are far less predictable and are not subject to nearly the same degree of control.  The Company also has the ability to obtain funds from various financial institutions should the need arise.

The bank has a policy to maintain a liquidity ratio of at least 12%. Liquidity for this purpose is defined as cash, cash equivalents, and securities available for sale divided by total assets plus one half of any outstanding loan commitments. The bank’s liquidity ratio at December 31, 2008 was 14.10%.

18

Impact of Inflation

Unlike most industrial companies, the assets and liabilities of financial institutions such as the Bank are primarily monetary in nature.  Therefore, interest rates have a more significant effect on the Bank’s performance than do the effects of changes in the general rate of inflation and change in prices.  In addition, interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services.  As discussed previously, management seeks to manage the relationships between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.

Recently Issued Accounting Standards

Accounting standards and pronouncements of a recent nature are discussed in Notes to Consolidated Financial Statements, Note 1 — Summary of Significant Accounting Policies.  Other accounting standards that have been issued or proposed by authoritative standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

19

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors

CommunitySouth Financial Corporation and Subsidiary

Easley, South Carolina

                We have audited the accompanying consolidated balance sheets of CommunitySouth Financial Corporation and Subsidiary (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive income, and cash flows for the years then ended.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

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

                In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CommunitySouth Financial Corporation and Subsidiary as of December 31, 2008 and 2007 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

                We were not engaged to examine management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008 included in the accompanying Management’s Report on Internal Controls Over Financial Reporting and, accordingly, we do not express an opinion thereon.

Greenville, South Carolina

March 28, 2009

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COMMUNITYSOUTH FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

	December 31,
	2008			2007
Assets
Cash and cash equivalents
Cash and due from bank	$	5,250,751		$	6,486,676
Federal funds sold	4,625,000			33,665,005
Total cash and cash equivalents	9,875,751			40,151,681
Investment securities, available for sale	47,601,552			24,844,007
Other investments, at cost	1,805,200			446,800
Loans, net of allowance for loan loss of $8,088,218 and $4,213,547 in 2008 and 2007, respectively	312,818,938			298,720,357
Accrued interest receivable	1,628,073			2,092,066
Property and equipment, net	4,618,188			5,073,685
Bank-owned life insurance	5,437,331			5,226,806
Other assets	4,031,269			1,311,799
Total assets	$	387,816,302		$	377,867,201
Liabilities and Shareholders’ Equity
Liabilities
Deposits
Non-interest bearing	$	22,161,873		$	24,464,433
Interest bearing	274,481,473			303,199,212
Total deposits	296,643,346			327,663,645
Repurchase agreements	30,000,000			15,000,000
Federal Home Loan Bank advances	25,000,000			—
Note payable	1,570,000			—
Subordinated debt	4,325,000			—
Accrued expenses	192,795			427,380
Accrued interest payable	1,405,712			3,238,298
Other liabilities	150,972			66,742
Total liabilities	359,287,825			346,396,065
Commitments and contingencies (Note 14)
Shareholders’ Equity
Preferred stock, par value $.01 per share 10,000,000 shares authorized, no shares issued	—			—
Common stock, par value $.01 per share 10,000,000 shares authorized; 4,698,697 issued and outstanding at December 31, 2008 and December 31, 2007	46,987			46,987
Additional paid-in capital	29,759,965			29,691,467
Accumulated other comprehensive income	491,384			152,050
Retained earnings (deficit)	(1,769,859		)	1,580,632
Total shareholders’ equity	28,528,477			31,471,136
Total liabilities and shareholders’ equity	$	387,816,302		$	377,867,201

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

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COMMUNITYSOUTH FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

	For the years ended December 31,
	2008			2007
Interest income
Interest and fees on loans	$	20,163,191		$	21,402,981
Interest and dividends on investments	2,547,461			1,813,059
Total interest income	22,710,652			23,216,040
Interest expense	12,579,825			13,068,585
Net interest income	10,130,827			10,147,455
Provision for loan losses	7,168,000			1,188,000
Net interest income after provision for loan losses	2,962,827			8,959,455
Non-interest income
Mortgage origination fees	469,529			998,111
Other	922,263			576,109
Total non-interest income	1,391,792			1,574,220
Non-interest expense
Salaries and benefits	4,827,948			4,336,105
Occupancy	637,881			500,458
Depreciation	717,735			601,017
Equipment maintenance and rental	194,012			108,856
Advertising	248,117			269,860
Professional fees	449,110			334,978
Office supplies	95,306			145,633
Telephone	147,967			144,771
Data processing	757,822			602,975
Other	1,435,018			1,139,254
Total non-interest expense	9,510,916			8,183,907
Income (loss) before income taxes	(5,156,297		)	2,349,768
Income tax expense (benefit)	(1,805,806		)	781,656
Net income (loss)	$	(3,350,491	)	$	1,568,112
Earnings (loss) per share (1)
Basic	$	(0.71	)	$	0.33
Diluted	$	(0.71	)	$	0.31
Weighted average basic shares outstanding (1)	4,698,697			4,698,634
Weighted average diluted shares outstanding (1)	4,698,697			5,126,601

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

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

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COMMUNITYSOUTH FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN

SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

For the years ended December 31, 2008 and December 31, 2007

	Common Stock			Additional Paid-in			Accumulated Other Comprehensive		Retained Earnings /			Total Shareholders’			Total Comprehensive
	Shares(1)	Amount(1)		Capital			Income		(Deficit)			Equity			Income (Loss)
Balance at December 31, 2006	4,697,697	46,977		29,635,458			—		12,520			29,694,955
Net income	—	—		—			—		1,568,112			1,568,112			$	1,568,112
Other comprehensive income:
Unrealized gains on securities, net of income taxes of $89,200	—	—		—			152,050		—			152,050			152,050
Total comprehensive income															$	1,720,162
Stock based compensation	—	—		55,320			—		—			55,320
Cash paid for fractional shares	—	—		(5,701		)	—		—			(5,701		)
Stock options exercised	1,000	10		6,390			—		—			6,400
Balance at December 31, 2007	4,698,697	$	46,987	$	29,691,467		$	152,050	$	1,580,632		$	31,471,136
Net loss	—	—		—			—		(3,350,491		)	(3,350,491		)	$	(3,350,491	)
Other comprehensive income (loss):
Unrealized gains on securities, net of income taxes of $148,678	—	—		—			339,334		—			339,334			39,334
Total comprehensive income (loss)															$	(3,011,157	)
Stock based compensation	—	—		68,498			—		—			68,498
Balance at December 31, 2008	4,698,697	$	46,987	$	29,759,965		$	491,384	$	(1,769,859	)	$	28,528,477

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

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

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COMMUNITYSOUTH FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

	For the years ended December 31,
	2008			2007
Operating activities
Net income (loss)	$	(3,350,491	)	$	1,568,112
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses	7,168,000			1,188,000
Stock based compensation	68,498			55,320
Depreciation	717,736			601,017
Appreciation of bank-owned life insurance	(210,525		)	(222,048		)
Deferred income tax benefit	(2,273,206		)	(275,892		)
Decrease (increase) in accrued interest receivable	463,993			(914,264		)
Increase (decrease) in accrued interest payable	(1,832,586		)	1,813,192
Increase (decrease) in accrued expenses	(234,585		)	327,050
Decrease (increase) in other assets	(598,314		)	237,534
Increase in other liabilities	84,230			45,038
Net cash provided by operating activities	2,750			4,423,059
Investing activities
Net increase in loans outstanding	(21,266,581		)	(85,335,311		)
Purchase of investments and FHLB stock, net	(23,624,561		)	(24,678,757		)
Purchase of property and equipment	(262,239		)	(931,536		)
Net cash used in investing activities	(45,153,381		)	(110,945,604		)
Financing activities
Net increase (decrease) in deposit accounts	(31,020,299		)	110,632,457
Increase in repurchase agreements	15,000,000			15,000,000
Change in Federal Home Loan Bank advances	25,000,000			—
Subordinated debt issuance	4,325,000			—
Bank of Tennessee note payable	1,570,000			—
Cash paid for fractional shares	—			(5,701		)
Stock options exercised	—			6,400
Net cash provided by financing activities	14,874,701			125,633,156
Net increase (decrease) in cash and cash equivalents	(30,275,930		)	19,110,611
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR	40,151,681			21,041,070
CASH AND CASH EQUIVALENTS, END OF YEAR	$	9,875,751		$	40,151,681
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for:
Interest	$	14,412,411		$	11,255,393
Income taxes	$	619,500		$	900,197
SCHEDULE OF NON-CASH TRANSACTIONS:
Unrealized gain on investment securities, net of income taxes	$	491,384		$	152,050
Loans charged-off	$	3,294,000		$	65,000

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

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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Activity and Organization - CommunitySouth Financial Corporation (the “Company”) is a South Carolina corporation organized for the purpose of owning and controlling all of the capital stock of CommunitySouth Bank and Trust (the “Bank”).  The Bank is a state chartered bank organized under the laws of South Carolina.  From inception on March 20, 2004 through January 18, 2005, the Company engaged in organizational and pre-opening activities necessary to obtain regulatory approvals and to prepare its subsidiary, the Bank, to commence business as a financial institution.  The Company received approval from the Federal Deposit Insurance Corporation (“FDIC”), the Federal Reserve Board (“FRB”) and the State Board of Financial Institutions in January 2005.

The Bank began operations on January 18, 2005. The Bank primarily is engaged in the business of accepting deposits insured by the FDIC, and providing commercial, consumer and mortgage loans to the general public.

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

Basis of Presentation - 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.

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

Management’s Estimates - The preparation of consolidated financial statements in conformity 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 at the date of the financial statements and the reported amounts of income and expenses during the reporting period.  Actual results could differ from those estimates.

Disclosure Regarding Segments - - The Company reports as one operating segment, as management reviews the results of operations of the Company as a single enterprise.

Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, short-term interest bearing deposits and federal funds sold. Cash and cash equivalents have an original maturity of three months or less.

Concentrations of Credit Risk - Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of loans receivable, investment securities, federal funds sold and amounts due from banks.

The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily in the upstate region of South Carolina.  The Company’s loan portfolio is not concentrated in loans to any single borrower or to a relatively small number of borrowers.  Additionally, management is not aware of any concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions.

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

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

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

1.Available for sale securities: These 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).

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.

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.   Premiums and discounts are amortized or accrued into interest income by a method that approximates a level yield.

Other Investments – CommunitySouth Bank and Trust, as a member institution, is required to own stock investments in the FHLB.  Investment in the FHLB is a condition of borrowing from the FHLB, and the stock is pledged to collateralize such borrowings.  No ready market exists for the stock and it has no quoted market value. However, redemption of these stocks has historically been at par value.  At December 31, 2008 and 2007, the Company’s investment in FHLB stock was $1,805,200 and $446,800, respectively. The dividend received on this stock is included in interest and dividends on investments.

Loans Receivable - Loans are stated at their unpaid principal balance less an allowance for loan losses and net deferred loan origination fees.  Interest income is computed using the simple interest method and is recorded in the period earned. Loan origination fees collected and certain loan origination costs are deferred and the net amount is accreted as income using a method that approximates the level yield method over the life of the related loans.

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

The Company identifies impaired loans through its normal internal loan review process.  Loans on the Company’s potential problem loan list are considered potentially impaired loans.  These loans are evaluated in determining whether all outstanding principal and interest are expected to be collected.  Loans are not considered impaired if a minimal payment delay occurs and all amounts due, including accrued interest at the contractual interest rate for the period of delay, are expected to be collected.  Management has determined that the Company had $9,921,917 and $35,172 in impaired loans at December 31, 2008 and 2007, respectively.

Allowance for Loan Losses – The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

26

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experiences, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of the loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

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

Advertising - Advertising, promotional, and other business development costs generally are 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.

Property and Equipment - Premises, furniture and equipment are stated at cost, less accumulated depreciation.  Depreciation expense is computed using the straight-line method, based on the estimated useful lives for furniture and equipment of 5 to 10 years and buildings of 39 years.  Leasehold improvements are amortized over the life of the lease.  Maintenance and repairs are charged to current expense.  The costs of major renewals and improvements are capitalized.

Residential Loan Origination Fees - The Company offers residential loan origination services to its customers in its immediate market area.  The loans are offered on terms and prices offered by the Company’s correspondents and are closed in the name of the correspondents. The Company receives fees for services it provides in conjunction with the origination services it provides.  The fees are recognized at the time the loans are closed by the Company’s correspondent.

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

27

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

Under SFAS 109 and FIN 48, deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns.  Income taxes are the sum of amounts currently payable to taxing authorities and the net changes in income taxes payable or refundable in future years.  Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled.  Income taxes deferred to future years are determined utilizing an asset and liability approach.  This method gives consideration to the future tax consequences associated with differences between financial accounting and tax bases of certain assets and liabilities which are principally the allowance for loan losses, depreciable premises and equipment, and net operating loss carry-forwards.

Earnings Per Share - Basic earnings per share represents the net income allocated to shareholders divided by the weighted-average number of common shares outstanding during the period.  Diluted earnings per share reflect the impact of additional common shares that would have been outstanding if dilutive potential common shares had been issued.  Potential common shares that may be issued by the Company relate to both outstanding warrants and stock options, and are determined using the treasury stock method.

Stock–based Compensation - On January 1, 2006, the Company adopted the fair value recognition provisions of the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, to account for compensation costs under its stock option plans.  The Company previously utilized the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (as amended) (“APB 25”).  Under the intrinsic value method prescribed by APB 25, no compensation costs were recognized for the Company’s stock options because the option exercise price in its plans equaled the market price on the date of grant.  Prior to January 1, 2006, the Company only disclosed the pro forma effects on net income and earnings per share as if the fair value recognition provisions of SFAS No. 123(R) had been utilized.

In adopting SFAS No. 123, the Company elected to use the modified prospective method to account for the transition from the intrinsic value method to the fair value recognition method.  Under the modified prospective method, compensation cost is recognized from the adoption date forward for all new stock options granted and for any outstanding unvested awards as if the fair value method had been applied to those awards as of the date of grant.

Off-Balance Sheet Financial Instruments - In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit.  These financial instruments are recorded in the financial statements when they become payable by the customer.

Recently Issued Accounting Standards - The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and / or disclosure of financial information by the Company.

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 141(R), “Business Combinations,” (“SFAS 141(R)”) which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisitions by the Company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations following existing accounting guidance until January 1, 2009. The Company will assess the impact of SFAS 141(R) if and when a future

28

acquisition occurs.

In February 2008, the FASB issued FASB Staff Position No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions,” (“FSP 140-3”).  This FSP provides guidance on accounting for a transfer of a financial asset and the transferor’s repurchase financing of the asset.  This FSP presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (linked transaction) under SFAS 140. However, if certain criteria are met, the initial transfer and repurchase financing are not evaluated as a linked transaction and are evaluated separately under SFAS 140.  FSP 140-3 was effective for the Company on January 1, 2009.  The adoption of FSP 140-3 had no impact on the Company’s financial position, results of operations or cash flows.

In May, 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS 162”).  SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy).  SFAS 162 is effective November 15, 2008.  The FASB has stated that it does not expect SFAS 162 will result in a change in current practice. The application of SFAS 162 had no effect on the Company’s financial position, results of operations or cash flows.

The SEC’s Office of the Chief Accountant and the staff of the FASB issued press release 2008-234 on September 30, 2008 (“Press Release”) to provide clarifications on fair value accounting.  The Press Release includes guidance on the use of management’s internal assumptions and the use of “market” quotes.  It also reiterates the factors in SEC Staff Accounting Bulletin (“SAB”) Topic 5M which should be considered when determining other-than-temporary impairment: the length of time and extent to which the market value has been less than cost; financial condition and near-term prospects of the issuer; and the intent and ability of the holder to retain its investment for a period of time sufficient to allow for any anticipated recovery in market value.

On October 10, 2008, the FASB issued FSP SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS 157-3”). This FSP clarifies the application of SFAS No. 157, “Fair Value Measurements” (see Note 24) in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that asset is not active.  The FSP is effective upon issuance, including prior periods for which financial statements have not been issued. For the Company, this FSP was effective for the quarter ended September 30, 2008.

The Company considered the guidance in the Press Release and in FSP SFAS 157-3 when conducting its review for other-than-temporary impairment as of December 31, 2008 as discussed in Note 24.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Risks and Uncertainties - In the normal course of its business, the Company encounters two significant types of risk: 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 speeds, or on different bases, than its interest-earning assets.  Credit risk is the risk of default on the Company’s loan portfolio that results from borrower’s 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.

Reclassifications - - Certain captions and amounts in the prior financial statements were reclassified to conform with the 2007 presentation. Such reclassifications had no effect on previously reported net income or shareholders’ equity.

29

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 FRB. At December 31, 2008 and 2007, these required reserves were met by vault cash.

NOTE 3 – INVESTMENT SECURITIES

The amortized costs and fair values of investment securities are as follows:

	Amortized		Gross Unrealized				Fair
	Cost		Gains		Losses		Value
As of December 31, 2008
Available for sale
Government sponsored enterprises	$	19,000,824	$	84,601	$	—	$	19,085,425
Mortgage-backed	27,768,143		647,984		—		28,416,127
Marketable securities	100,000		—		—		100,000
Total Available for sale	$	46,868,967	$	732,585	$	—	$	47,601,552

As of December 31, 2007
Available for sale
Government sponsored enterprises	$	15,488,584	$	136,049	$	—	$	15,624,633
Mortgage-backed	9,014,173		115,428		10,227		9,119,374
Marketable securities	100,000		—		—		100,000
Total Available for sale	$	24,602,757	$	251,477	$	10,227	$	24,844,007

The amortized costs and fair values of investment securities available for sale at December 31, 2008, by contractual maturity, are shown below.

	December 31, 2008				December 31, 2007
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Available for sale
Due within one year(1)	$	3,100,824	$	3,139,345	$	4,093,646	$	3,555,000
Due after one through five years	17,594,284		17,694,068		11,494,940		11,622,834
Due after five through ten years	5,224,429		5,436,898		6,755,981		6,293,676
Due after ten years	20,949,430		21,331,241		2,258,190		3,372,497
Total Available for sale	$	46,868,967	$	47,601,552	$	24,602,757	$	24,844,007

(1)   Marketable securities are included as due within one year.

At December 31, 2008, the Company did not have any securities in an unrealized loss position.

The table below summarizes gross unrealized losses on investment securities and the fair market value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007.

	Less than 12 months				12 months or longer				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Loss		Value		Gain/(Loss)		Value		Gain/(Loss)
As of December 31, 2007
Available for sale
Mortgage-backed	$	9,119,374	$	10,227	$	—	$	—	$	9,119,374	$	10,227
Total Available for sale	$	9,119,374	$	10,227	$	—	$	—	$	9,119,374	$	10,227

30

At December 31, 2007, the Company had mortgage-backed securities in an unrealized loss position.  The Company believes, based on industry analyst reports and credit ratings that the deterioration in value is attributed to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary.  The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature.

No investment securities were sold during 2008 or 2007. Accordingly, no gains or losses were recorded. At December 31, 2008, there were $36.1 million of securities pledged as collateral for repurchase agreements from brokers. There were $16 million of securities pledged as collateral for repurchase agreements from brokers at December 31, 2007.

Management limits its credit risk by generally investing its portfolio principally in obligations of the United States of America, its agencies or it corporations. Included in the investment portfolio at December 31, 2008, are mortgage-backed securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation totaling $20.7 million and $2.5 million, respectively.

NOTE 4 – OTHER INVESTMENTS

Other investments consisted of FHLB stock with a cost of $1,805,200 and $446,800 at December 31, 2008 and 2007, respectively.  All of the FHLB stock is used to collateralize advances with the FHLB.

NOTE 5 – LOANS RECEIVABLE

Major classifications of loans receivable for the years ended December 31, 2008 and 2007 are summarized as follows:

	December 31,
	2008			2007
Real estate - construction	$	129,776,522		$	124,016,089
Real estate - mortgage	154,838,390			149,369,530
Commercial and industrial	33,303,276			26,094,711
Consumer and other	2,988,968			3,453,574
Total loans, gross	320,907,156			302,933,904
Less allowance for loan losses	(8,088,218		)	(4,213,547		)
Total loans, net	$	312,818,938		$	298,720,357

Loans are stated net of deferred fees and costs.

The Bank had $9,915,883 and $35,172 of loans classified as non-accrual status as of December 31, 2008 and 2007, respectively.  At December 31, 2008 and 2007, loans past due 90 days or more and still accruing amounted to $6,035 and $0, respectively. See additional disclosures regarding Loans Receivable and Allowance for Loan Losses in Note 1.

Activity in the allowance for loan losses during the years ended December 31, 2008 and 2007 is summarized below:

	Year Ended December 31,
	2008			2007
Balance, beginning of year	$	4,213,547		$	3,090,500
Provision charged to operations	7,168,000			1,188,000
Charge-offs	(3,293,329		)	(64,953		)
Balance, end of year	$	8,088,218		$	4,213,547

	Year Ended December 31,
	2008		2007
Impaired Loans:
No valuation allowance required	$	2,590,369	$	10,643
Valuation allowance required	10,581,526		24,529
Total impaired loans	$	13,171,895	$	35,172
Allowance for loan losses on impaired loans at year end	$	2,801,565	$	24,529
Average investment in impaired loans	$	5,109,022	$	55,632
Interest income recognized on impaired loans:
Accrual basis	671,091		553

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NOTE 6 – PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

	December 31,
	2008			2007
Land	$	785,811		$	785,811
Buildings and leasehold improvements	2,845,179			2,837,874
Property and equipment	2,757,967			2,562,922
Construction in progress	95,411			—
Total	6,484,368			6,186,607
Less, accumulated depreciation	(1,866,180		)	(1,112,922		)
Property and equipment, net	$	4,618,188		$	5,073,685

The Company recorded $717,736 and $601,017 in depreciation expense of property and equipment for the years ended December 31, 2008 and 2007, respectively.  Construction in progress relates to a new branch in Spartanburg.

NOTE 7 – DEPOSITS

The following table sets forth the deposits of the Company by category as of December 31, 2008 and 2007.

	December 31,
	2008		2007
Non-interest bearing demand	$	22,161,873	$	24,463,939
Interest bearing demand	16,449,191		13,720,505
Savings	14,460,941		24,634,385
Time deposits less than $100,000	32,111,689		59,528,027
Time deposits of $100,000 or over	25,161,652		47,117,789
Brokered time deposits	186,298,000		158,199,000
Total deposits	$	296,643,346	$	327,663,645

Deposits from outside the Company’s market area obtained through brokers amounted to 62.80% and 48.28% of total deposits at December 31, 2008 and 2007, respectively.

Interest expense on time deposits of $100,000 or over was $2,050,217 and $2,551,994 for years ending December 31, 2008 and 2007, respectively.

At December 31, 2008, the scheduled maturities of certificates of deposit were as follows:

Maturing In:	Amount
2009	$	239,651,062
2010	3,691,021
2011	136,698
2012	—
2013	92,560
Thereafter	—
Total	$	243,571,341

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NOTE 8 – REPURCHASE AGREEMENTS

At December 31, 2008, the Bank had sold $30.0 million of securities under agreements to repurchase with brokers with a weighted average rate of 3.24% and an average maturity of 90 months.  The maximum amount outstanding at any month-end was $30.0 million.  The average balance for the year was $28,524,590.  These agreements were secured with approximately $36.1 million of investment securities.

At December 31, 2007, the Bank had sold $15.0 million of securities under agreements to repurchase with brokers with a weighted average rate of 2.58% and an average maturity of 82 months.  The maximum amount outstanding at any month-end was $15.0 million.  The average balance for the year was $2,315,068.  These agreements were secured with approximately $16.0 million of investment securities.

NOTE 9 – FEDERAL HOME LOAN BANK ADVANCES

At December 31, 2008, the bank had $25 million in FHLB advances.  The advances were secured with approximately $45.5 million in loans and $1.8 million of stock in the FHLB.  Listed below is a summary of the terms and maturities of the advances.

Amount		Rate		Maturity
$	10,000,000	1.53	%	January 14, 2009
10,000,000		1.03	%	March 23, 2009
5,000,000		2.32	%	March 31, 2009
$	25,000,000

NOTE 10 – NOTE PAYABLE

At December 31, 2008, the Company had a $1.6 million outstanding on a line of credit at the Bank of Tennessee.  The line of credit matures on September 2, 2009 and bears interest at Lender’s Prime, which at December 31, 2008 was 3.25%.  The company had pledged all of the stock of the Bank as collateral for this line of credit.  The Company repaid this note payable on February 27, 2009 and funds are no longer available to the Company.

NOTE 11 – SUBORDINATED DEBT

During the third quarter of 2008, we commenced a subordinated debt offering to enhance and strengthen the levels of capital and liquidity at the holding company such that we could maintain the “well-capitalized” levels of regulatory capital at the bank. We raised $4.325 million before we closed the offering on October 15, 2008.  The subordinated notes were sold to a limited number of purchasers in a private offering, bear an interest rate of 11.5%, are callable by the Company after September 30, 2011, at a premium, and mature in 2018. The subordinated debt has been structured to fully count as Tier 2 regulatory capital on a consolidated basis.

		Period-			Weighted-Average		Maximum Outstanding
	Ending	End		Average	Rate for		at any
(Dollars in thousands)	Balance	Rate		Balance	Year		Month End
December 31, 2008
Subordinated debt	4,325	11.50	%	1,485	11.50	%	4,325

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NOTE 12 – INCOME TAXES

Income tax expense for the year ended December 31, 2008 and 2007 is summarized as follows:

	2008			2007
Current portion:
Federal	$	(252,629	)	$	984,495
State	—			73,053
Total current income tax expense	(252,629		)	1,057,548
Deferred income tax expense (benefit)	(1,553,177		)	(275,892		)
Income tax expense (benefit)	$	(1,805,806	)	$	781,656

A reconciliation between the income tax expense and the amount is computed by applying the Federal statutory rate of 34% for 2008 and 2007 to income before income taxes follows:

	2008			2007
Federal income tax expense at statutory rate	$	(1,753,141	)	$	798,921
State income taxes, net of federal benefit	—			48,216
Other	(52,665		)	(65,481		)
Income tax expense	$	(1,805,806	)	$	781,656

The gross amounts of deferred tax assets and deferred tax liabilities are as follows:

	December 31,
	2008			2007
Deferred tax assets
Allowance for loan losses	$	2,416,674		$	1,122,861
Organization and start-up costs	84,431			114,168
Accrued interest on non-accrual loans	367,472			1,552
Other	8,500			33,497
Total deferred tax assets	2,877,077			1,272,078
Deferred tax liabilities
Loan origination costs	(89,236		)	(88,236		)
SFAS No. 115 mark-to-market adjustment	(237,878		)	(89,200		)
Depreciation	(138,716		)	(89,512		)
Prepaid expenses	(68,856		)	(67,238		)
Total deferred tax liabilities	(534,686		)	(334,186		)
Net deferred tax asset	$	2,342,391		$	937,892

Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value.  As of December 31, 2008 and 2007, management has determined that no valuation allowance is required as it is more likely than not that the recorded net deferred tax assets will be realized in full. The net deferred tax asset is included in the caption “other assets” on the balance sheet.

The Company has analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions in accordance with FIN 48.

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NOTE 13 — LEASES

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

2009	$	401,771
2010	428,364
2011	427,870
2012	441,471
2013	446,817
Thereafter	1,505,939
Total minimum future rental payments	$	3,652,232

NOTE 14 — COMMITMENTS AND CONTINGENCIES

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

The bank has entered into a lease for a new branch in Spartanburg.  It is a 10 year lease with annual payments of $96,000 in years 1-5 and $105,600 in years 6-10.  The lease begins at occupancy.  The project is currently in process.

NOTE 15 — RELATED PARTY TRANSACTIONS

Certain parties (principally certain directors and executive officers of the Company, their immediate families and business interests) (“affiliates”) are loan customers in the normal course of business with the Bank.  These loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectability.  As of December 31, 2008 and 2007 the Bank had related party loans totaling $20,539,348 and $21,946,890, respectively.  During 2008, advances on related party loans totaled $7,310,239 and repayments were $8,717,781. During 2007, advances on related party loans totaled $11,026,237 and repayments were $4,330,197.

Both at December 31, 2008 and 2007, affiliates had deposits with the Bank in the amounts of $2.5 million and $3.7 million, respectively.

The Company also enters into other transactions in the ordinary course of business with affiliates.  Company policy requires transactions with affiliates to be on terms no more favorable than could be obtained from an unaffiliated third party and to be approved by a majority of disinterested directors.  The following are transactions entered into with affiliates during the years ended December 31, 2008 and 2007:

·The Spartanburg branch location was leased from a partnership in which two Company directors have a partnership interest.  The property was sold to a third party in October 2007.  Lease payments on that office totaled $80,000 for the year ended December 31, 2007.

·The loan operations center in Easley was leased from a partnership in which a Company director has a partnership interest.  Lease payments on that office totaled $36,000 and $24,000 for the years ended December 31, 2008 and 2007, respectively.

NOTE 16 — SHARES OUTSTANDING AND EARNINGS PER SHARE

On January 16, 2007, the Company effected a 5-for-4 stock split in the form of a stock dividend for shareholders of record as of December 15, 2006. All share and per share data has been adjusted for all periods prior to the splits.

Basic earnings per share is computed by dividing the net income by the weighted-average number of common shares outstanding.  Diluted earnings per share is computed by dividing the net income by the sum of the weighted-average number of common shares outstanding and dilutive common share equivalents using the treasury stock method.  Dilutive common share equivalents include common shares issuable upon exercise of outstanding stock warrants and stock options.

35

The following is the basic and diluted income per share computation:

	December 31,
	2008			2007
Net income (loss) to common shareholders	$	(3,350,491	)	$	1,568,112
Weighted-average common shares outstanding — basic	4,698,697			4,698,634
Weighted-average common shares outstanding — diluted	4,698,697			5,126,601
Earnings (loss) per share — basic	$	(0.71	)	$	0.33
Earnings (loss) per share — diluted	$	(0.71	)	$	0.31

NOTE 17 — STOCK COMPENSATION PLANS

Upon completion of the offering, the Company agreed to issue warrants to the organizing directors for the purchase of one share of common stock at $6.40 per share for every two shares purchased in the stock offering, up to a maximum of 15,625 warrants per director. The warrants were fully vested 120 days after January 18, 2005 and will expire on January 18, 2015.  Warrants held by directors of the Company will expire 90 days after the director ceases to be a director or officer of the Company (365 days if due to death or disability). The Company issued a total of 171,404 warrants.  In addition, the Company has adopted a stock option plan.  As of December 31, 2008 the Company has 764,113 outstanding options to employees and directors. On January 16, 2006 the company adopted a resolution that terminated the “evergreen” provision of the Company 2005 Stock Incentive Plan. As a result, the number of shares of common stock issuable under the plan shall not be further increased in connection with any future share issuances by the company. The exercise price of each option is equal to the market price of the Company’s stock on the date of grant. The maximum term is ten years, and they vest in no greater than five years. When necessary, the Company may purchase shares on the open market to satisfy share option exercises. During the ensuing year, the Company is expected to acquire no shares.

The table set forth below summarizes stock option activity for the Company’s stock compensation plans for the years ended December 31, 2008 and 2007 as adjusted for all stock splits.

	Stock Options				Warrants
			Weighted-			Weighted-
			Average			Average
			Exercise			Exercise
	Number		Price		Number	Price
Outstanding at December 31, 2006	738,013		$	6.87	171,404	$	6.40
Granted	37,173		15.33		—	—
Forfeited	(12,693	)	13.31		—	—
Exercised	(1,000	)	6.40		—	—
Outstanding at December 31, 2007	761,493		7.17		171,404	6.40
Granted	28,600		7.82		—	—
Forfeited	(25,980	)	10.57		—	—
Exercised	—		—		—	—
Outstanding at December 31, 2008	764,113		$	7.08	171,404	$	6.40

At December 31, 2008 there was no intrinsic value for stock options outstanding and stock options exercisable.

36

The table set forth below summarizes non-vested stock options as of December 31, 2008 and 2007.

	Weighted-Average		Weighted-Average Grant Date
	Number		Fair Value
Outstanding at December 31, 2006	11,500		6.47
Granted	37,173		6.88
Vested during the year	(2,300	)	6.44
Forfeited during the year	(4,100	)	7.06
Outstanding at December 31, 2007	42,273		6.79
Granted	28,600		3.51
Vested during the year	7,913		7.12
Forfeited during the year	11,150		5.62
Outstanding at December 31, 2008	51,810		5.33

As of December 31, 2008, there was $223,689 in total unrecognized compensation cost related to non-vested share-based compensation arrangements, which is expected to be recognized over a weighted average period of 42 months. As of December 31, 2007, there was $255,917 in total unrecognized compensation cost related to non-vested share-based compensation arrangements, which is expected to be recognized over a weighted average period of 49 months.

The fair value of each option granted is estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions for 2008 and 2007:  dividend yield of 0%, expected term of 10 years, risk-free interest rate of 5.0%, expected life of 10 years, and expected volatility of 20%.

Stock compensation expense recognized in 2008 and 2007 was $68,498 and $55,320, respectively.

The following table summarizes information about stock options outstanding under the Company’s plans at December 31, 2008 and 2007 as adjusted for the 5-for-4 stock splits effective January 16, 2007.

	Outstanding		Exercisable
2008
Number of options	764,113		712,203
Weighted average remaining life	6.42 years		6.26 years
Weighted average exercise price	$	7.08	$	6.74
High exercise price	$	16.80	$	16.80
Low exercise price	$	6.40	$	6.40
2007
Number of options	761,493		719,220
Weighted average remaining life	7.35 years		7.25 years
Weighted average exercise price	$	7.17	$	6.71
High exercise price	$	16.80	$	16.80
Low exercise price	$	6.40	$	6.40

No options were exercised in 2008.  Cash received from the exercise of options during 2007 was $6,400. The intrinsic value of options exercised during 2007 was $2,880.

At December 31, 2008, all of the 171,404 warrants were exercisable and had an average remaining life of 6.05 years. At December 31, 2007, all of the 171,404 warrants were exercisable and had an average remaining life of 7.05 years.

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NOTE 18 — EMPLOYEE BENEFIT PLAN

The Bank maintains an employee benefit plan for all eligible employees of the Bank under the provisions of Internal Revenue Code Section 401(k).  The CommunitySouth 401(k) Plan (the “Plan”), adopted in 2006, allows for employee contributions.  The Bank matches 25% of employee contributions up to a maximum of 1.25% of annual compensation.  A total of $25,292 and $31,495 was charged to operations in 2008 and 2007, respectively, for the Company’s matching contribution.  Employees are immediately vested in their contributions to the Plan and become fully vested in the employer matching contribution after five years of service.

NOTE 19 — 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 possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on the Bank’s financial condition.  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 ratios of Tier 1 and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%.  Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets.  Tier 2 capital consists of the allowance for loan losses subject to certain limitations.  Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital.  The regulatory minimum requirements are 4% for Tier 1 and 8% for total risk-based capital.

The Bank is also required to maintain capital at a minimum level based on total assets, which is known as the leverage ratio.  Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios 1% to 2% above the minimum.

As of December 31, 2008, the most recent notification from the Bank’s primary regulator categorized it as well-capitalized under the regulatory framework for prompt corrective action.  There are no conditions or events that management believes have changed the Bank’s category.

The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at December 31, 2008 and December 31, 2007.

									To Be Well-
									Capitalized Under
					For Capital				Prompt Corrective
	Actual				Adequacy Purposes				Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
December 31, 2008
Tier 1 capital (to risk-weighted assets)	$	30,836,000	8.92	%	$	13,833,000	4.00	%	$	20,750,000	6.00	%
Total capital (to risk-weighted assets)	35,205,000		10.18		27,666,000		8.00		34,583,000		10.00
Tier 1 capital (to average assets)	30,836,000		7.98		15,450,000		4.00		19,313,000		5.00
December 31, 2007
Tier 1 capital (to risk-weighted assets)	$	30,102,000	8.92	%	$	13,503,000	4.00	%	$	20,255,000	6.00	%
Total capital (to risk-weighted assets)	34,316,000		10.17		27,007,000		8.00		33,759,000		10.00
Tier 1 capital (to average assets)	30,102,000		8.26		14,573,000		4.00		18,217,000		5.00

The FRB has similar requirements for bank holding companies. The Company currently is not subject to these requirements because the FRB applies its guidelines on a bank-only basis for bank holding companies with less than $500 million in consolidated assets.

38

NOTE 20 —LINES OF CREDIT

As of December 31, 2008 and 2007, the Bank had unused lines of credit to purchase federal funds from unrelated banks totaling $14,500,000 and $15,000,000, respectively.  These lines of credit are available on a one to fourteen day basis for general banking purposes.  As of December 31, 2008 and 2007, the Bank has no funds drawn from these lines. The Company also has a line of credit to borrow funds from the FHLB up to 15% in 2008 and 10% in 2007 of the Bank’s total assets subject to available collateral.  At December 31, 2008, the total line of credit was $57,240,000, with $25,000,000 having been drawn, leaving $32,240,000 available.  At December 31, 2007, the availability on this line of credit was $34,670,000 with no amount drawn on the line.

NOTE 21 — RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS, OR ADVANCES

The ability of CommunitySouth Financial Corporation to pay cash dividends is dependent upon receiving cash in the form of dividends from the Bank.  However, there are restrictions on the ability of the Bank to transfer funds to CommunitySouth Financial Corporation in the form of cash dividends, loans, or advances.  As a South Carolina state bank, the Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts.  In addition, the Bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital.  At December 31, 2007, the Bank was no longer prohibited from declaring a dividend because it had a surplus of $1,970,050. However, at December 31, 2008, the Bank had a deficit of $872,916.

NOTE 22 — FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments consist of commitments to extend credit and standby letters of credit.  Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  A commitment involves, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.  The Company’s exposure to credit loss in the event of non-performance by the other party to the instrument is represented by the contractual notional amount of the instrument.  Since certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company uses the same credit policies in making commitments to extend credit as it does for on-balance-sheet instruments.  Letters of credit are conditional commitments issued to guarantee a customer’s performance to a third party and have essentially the same credit risk as other lending facilities.  The Company has not recorded a liability for the current carrying amount of the obligation to perform as a guarantor and no contingent liability was considered necessary, as such amounts were not considered material.

Collateral held for commitments to extend credit and letters of credit varies but may include accounts receivable, inventory, property, plant, equipment and income-producing commercial properties.

The following table summarizes the Company’s off-balance sheet financial instruments whose contract amounts represent credit risk:

	December 31,
	2008		2007
Commitments to extend credit	$	36,259,688	$	49,342,960
Standby letters of credit	$	3,488,081	$	3,176,854

NOTE 23 — FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” (“SFAS 107”), requires disclosure of fair value information, whether or not recognized in the consolidated balance sheets, when it is practical to estimate the fair value.  SFAS 107 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations, which require the exchange of cash, or other financial instruments.  Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, premises and equipment, accrued interest receivable and payable, and other assets and liabilities.

39

The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.  Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments.  Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.

The Company has used management’s best estimate of fair value based on the above assumptions.  Thus, the fair values presented may not be the amounts, which could be realized, in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair values presented.

The following methods and assumptions were used to estimate the fair value of significant financial instruments:

Cash and Due from Banks - The carrying amount is a reasonable estimate of fair value.

Federal Funds Sold - Federal funds sold are for a term of one day, and the carrying amount approximates the fair value.

Investment Securities - The fair values of marketable equity securities are valued using quoted fair market prices.

Other Investments - The carrying value of non-marketable equity securities approximates the fair value since no ready market exists for the stocks.

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

Loans receivable- For certain categories of loans, such as variable rate loans which are repriced frequently and have no significant change in credit risk, fair values are based on the carrying amounts.  The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits - The fair value of demand deposits, savings, and money market accounts is the amount payable on demand at the reporting date.  The fair values of certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates to a schedule of aggregated expected maturities.

Repurchase Agreements - The carrying value of these instruments is a reasonable estimate of fair value.

FHLB Advances - The carrying value of these instruments is a reasonable estimate of fair value.

Note Payable - The carrying value of these instruments is a reasonable estimate of fair value.

Subordinated Debt - The carrying value of these instruments is a reasonable estimate of fair value.

The carrying values and estimated fair values of the Company’s financial instruments at December 31, 2008 and 2007 are shown in the following table.

40

	Carrying		Estimated
	Amount		Fair Value
December 31, 2008
Financial Assets
Cash and due from banks	$	5,250,751	$	5,250,751
Federal funds sold	4,625,000		4,625,000
Investment securities, available for sale	47,601,552		47,601,552
Other investments	1,805,200		1,805,200
Loans, gross	320,907,156		358,708,274
Bank-owned life insurance	5,437,331		5,437,331
Financial Liabilities
Demand deposit, interest-bearing transaction, and savings accounts	$	53,072,007	$	53,072,007
Certificates of deposit and other time deposits	243,571,339		244,000,955
Repurchase agreements	30,000,000		30,000,000
FHLB advances	25,000,000		25,000,000
Note payable	1,570,000		1,570,000
Subordinated debt	4,325,000		5,500,000
December 31, 2007
Financial Assets
Cash and due from banks	$	6,486,676	$	6,486,676
Federal funds sold	33,665,005		33,665,005
Investment securities, available for sale	24,844,007		24,884,007
Other investments	446,800		446,800
Loans, gross	302,933,904		302,838,045
Bank-owned life insurance	5,226,806		5,226,806
Financial Liabilities
Demand deposit, interest-bearing transaction, and savings accounts	$	62,819,326	$	62,819,326
Certificates of deposit and other time deposits	264,844,319		265,698,742
Repurchase agreements	15,000,000		15,000,000

	2008				2007
(Dollars in thousands)	Notional Amount		Estimated Fair Value		Notional Amount		Estimated Fair Value
Off-Balance Sheet Financial Instruments:
Commitments to extend credit	$	36,260	$	—	$	49,343	$	—
Standby Letters of Credit	3,488		$	—	3,177		$	—

The company adopted Statement No. 157 at the beginning of our 2008 fiscal year.  SFAS No. 157 applies to all assets and liabilities that are being measured and reported on a fair value basis.  SFAS No. 157 requires new disclosure that establishes a framework for measuring fair value in GAAP, and expands disclosure about fair value measurements.  This statement enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values.  The statement requires that assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:

·Level 1:  Quoted market prices in active markets for identical assets or liabilities.

·Level 2:  Observable market based inputs or unobservable inputs that are corroborated by market data.

·Level 3:  Unobservable inputs that are not corroborated by market data.

In determining appropriate levels, the Company performs a detailed analysis of the assets and liabilities that re subject to SFAS No. 157.  At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3.

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy.

	December, 31, 2008
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Investment securities, available for sale	$	47,602	$	47,602	$	—	$	—

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Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).  The following table presents the assets and liabilities carried on the balance sheet by caption and by level within the SFAS No. 157 valuation hierarchy (as described above) as of December 31, 2008 for which a nonrecurring change in fair value has been recorded during the year ended December 31, 2008.

	Carrying Value at December, 31, 2008
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Impaired Loans	$	13,172	$	—	$	13,172	$	—

NOTE 24 — COMMUNITYSOUTH FINANCIAL CORPORATION (PARENT COMPANY ONLY)

Presented below are the condensed financial statements for CommunitySouth Financial Corporation (Parent Company only).

Condensed Balance Sheets

	December 31,
	2008		2007
Assets
Cash	$	3,029,319	$	94,125
Investment securities, available for sale	100,000		100,000
Investment in the Bank	31,327,084		31,280,850
Other assets	96,945		6,692
Total assets	$	34,553,348	$	31,481,667
Liabilities and shareholders’ equity
Other liabilities	$	129,871	$	10,531
Other borrowings	1,570,000		—
Subordinated debt	4,325,000		—
Shareholders’ equity	28,528,477		31,471,136
Total liabilities and shareholders’ equity	$	34,553,348	$	31,481,667

Condensed Statements of Income

For the years ended December 31, 2008 and 2007

	2008			2007
Income	$	—		$	—
Expenses	(257,391		)	(55,320		)
Income (loss) before income taxes and equity in undistributed income of the Bank	(257,391		)	(55,320		)
Equity in undistributed income (loss) of the Bank	(3,093,100		)	1,623,432
Net income (loss) before taxes	(3,350,491		)	1,568,112
Income tax expense (benefit)	—			—
Net income (loss)	$	(3,350,491	)	$	1,568,112

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Condensed Statements of Cash Flows

For the year ended December 31, 2008 and December 31, 2007

	2008			2007
Cash flows from operating activities
Net income (loss)	$	(3,350,491	)	$	1,568,112
Adjustments to reconcile net income (loss) to net cash used in by operating activities:
Increase in other assets	(90,253		)	—
Stock based compensation	68,498			55,320
Equity in undistributed (income) loss of the Bank	2,753,766			(1,623,432		)
Change in accumulated other comprehensive income	339,334			—
Increase in other liabilities	119,340			—
Net cash used in operating activities	(159,806		)	—
Cash flows from investing activities
Investments in Bank subsidiary	(2,800,000		)	(900,000		)
Net cash used in investing activities	(2,800,000		)	(900,000		)
Cash flows from financing activities
Subordinated debt issue	4,325,000			—
Increase in other borrowings	1,570,000			—
Cash paid for fractional shares	—			(5,701		)
Stock options exercised	—			6,400
Net cash provided by financing activities	5,895,000			699
Net increase (decrease) in cash	2,935,194			(899,301		)
Cash, beginning of year	94,125			993,426
Cash, end of year	$	3,029,319		$	94,125

NOTE 25 — SUBSEQUENT EVENT

On February 27, 2009, the bank repaid the $1,570,000 note payable to the Bank of Tennessee.

43

—  Shareholder Information —

Headquarters

CommunitySouth Financial Corporation

6602 Calhoun Memorial Hwy

Easley, South Carolina 29640

866.421.CSBT

communitysouthbankandtrust.com

Annual Meeting

May 19, 2009 at 11:00 a.m.

Marriott Hotel

One Parkway East

Greenville, SC 29615

Counsel

Nelson, Mullins, Riley & Scarborough

104 South Main Street, Suite 900

Greenville, SC 29601

Independent Auditors

Elliott Davis, LLC

200 East Broad Street

PO Box 6286

Greenville, SC 29601

Stock Transfer Agent

Registrar and Transfer Company

10 Commerce Drive

Cranford, NJ 07016

CommunitySouth Online
Visit our investors resource center at communitysouthbankandtrust.com. Click on “Investors” for SEC filings, financial news, calculators, and more.

Annual Report & Form 10-K

Additional copies of CommunitySouth’s Annual Report and Form 10-K are available by writing to:

Shareholder Relations

CommunitySouth Financial Corporation

PO Box 2849

Easley, SC 29641

Stock Information

Symbol: CBSO

Over the Counter Bulletin Board Quotation System

44

—  Board of Directors  —

C. Allan Ducker, III

Chief Executive Officer, CommunitySouth

David A. Miller

President / Chief Operating Officer, CommunitySouth

John W. Hobbs

Chief Financial Officer, CommunitySouth

Daniel E. Youngblood

Board Chairman

Owner and President

Youngblood Development Corp.

David W. Edwards

Board Vice Chairman

Owner and President

Dave Edwards Toyota

David Larry Brotherton, Ph.D.
Owner and President
Ortec, Inc.

G. Dial DuBose

Vice President of Operations

Town and Country Realty of Easley, Inc.

President

Nalley Garrett Motels, Inc.

R. Wesley Hammond

Former President

HBJ Home Furnishings

Arnold J. Ramsey

Owner and President

Ramsey Appraisal Service

Dr. W. Michael Riddle

Oral and Maxillofacial Surgeon

Joanne M. Rogers

Partner and President

Lakeview Partners and Palmetto Storage

B. Lynn Spencer

Co-Owner and Broker-in-Charge

Spencer/Hines Properties

J. Neal Workman, Jr.

Owner, President and Chairman

Trehel Corporation

45

—  Senior Management Team  —

C. Allan Ducker, III

Chief Executive Officer

David A. Miller

President

Chief Operating Officer

John W. Hobbs

Chief Financial Officer

Joe Albright

Senior Vice President

Mortgage Department Manager

Barbra Anderson

Senior Vice President

Marketing Director

Lary Heichel

Senior Vice President

Chief Risk Officer

Kathy King

Senior Vice President

Branch Coordinator

Darlene Nations

Vice President

Human Resources Director

Jay Ratterree

Senior Vice President

Chief Credit Officer

Buddy White

Senior Vice President

Services Department Manager

46

[CommunitySouth Bank & Trust logo]

—  www.communitysouthbankandtrust.com —

47

EX-21.1

Exhibit 21.1

Subsidiaries

CommunitySouth Bank & Trust

All Seasons Properties, LLC

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

We consent to the incorporation by reference in the Registration Statement No. 333-132998 on Form S-8, of CommunitySouth Financial Corporation (formerly known as CommunitySouth Bancshares, Inc.) relating to the CommunitySouth Bancshares, Inc. 2005 Stock Incentive Plan, of our report, dated March 30, 2009, that is incorporated by reference in the Annual Report on Form 10-K of CommunitySouth Financial Corporation for the year ended December 31, 2008.

/s/ Elliott Davis, LLC

Greenville, South Carolina

March 30, 2009

EX-31.1

Exhibit 31.1

Rule 13a-14(a) Certification of the Chief Executive Officer

I, C. Allan Ducker, III, chief executive officer, certify that:

1.I have reviewed this annual report on Form 10-K of CommunitySouth Financial Corporation.

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a—15(e) and 15d—15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a—15(f) and 15d—15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	March 27, 2009	By:	/s/ C. Allan Ducker, III
			C. Allan Ducker, III
			Chief Executive Officer

EX-31.2

Exhibit 31.2

Rule 13a-14(a) Certification of the Chief Financial Officer

I, John W. Hobbs, chief financial officer, certify that:

1.I have reviewed this annual report on Form 10-K of CommunitySouth Financial Corporation.

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a—15(e) and 15d—15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a—15(f) and 15d—15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	March 27, 2009	By:	/s/ John W. Hobbs
			John W. Hobbs
			Chief Financial Officer

EX-32

Exhibit 32

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

The undersigned, the Chief Executive Officer and the Chief Financial Officer of CommunitySouth Financial Corporation (the “Company”), each certify that, to his knowledge on the date of this certification:

1.The annual report of the Company for the period ended December 31, 2008 as filed with the Securities and Exchange Commission on this date (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2.The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date:	March 27, 2009	By:	/s/ C. Allan Ducker, III
			C. Allan Ducker, III
			Chief Executive Officer
Date:	March 27, 2009	By:	/s/ John W. Hobbs
			John W. Hobbs
			Chief Financial Officer