The following presents management's discussion and analysis of our financial condition and results of operations and should be read in conjunction with the financial statements and related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of our operations.

The Company's accounting policies are in accordance with accounting principles generally accepted in the United States and with general practices within the banking industry. Management makes a number of estimates and assumptions relating to reported amounts of assets, liabilities, revenues and expenses in the preparation of the financial statements and disclosures. Estimates and assumptions that are most significant to the Company are related to the determination of the allowance for loan losses, goodwill and other intangible assets and income taxes.

Allowance for Loan Losses

The allowance for loan losses represents management's estimate of probable losses inherent in the loan portfolio. Determining the appropriate level of the allowance is one of the most critical and complex accounting estimates for any financial institution. Management's judgments include those involved in risk grading the loan portfolio, determining specific allowances for loans considered impaired, and evaluating the impact of current economic conditions on the levels of the allowance. Loans are considered impaired when it is probable that all amounts due will not be collected in accordance with the contractual terms of the loan agreement. While management believes that the allowance for loan losses is appropriate and adequate to cover probable losses inherent in the portfolio, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed herein. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations. For further discussion, see "Nonperforming Assets" and "Analysis of Allowance for Loan Losses" under "ASSET QUALITY."

Goodwill and Other Intangibles

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased intangible assets that can be separately distinguished from goodwill. Goodwill impairment testing is performed annually or more frequently if events or circumstances indicate possible impairment. The evaluation of goodwill for impairment uses both the income and market approaches to value the Company. The income approach consists of discounting projected long-term future cash flows, which are derived from internal forecasts and economic expectations for the Company. The significant inputs to the income approach include the long-term target tangible equity to tangible assets ratio and the discount rate, which is determined utilizing the Company's cost of capital adjusted for a company-specific risk factor. The company-specific risk factor is used to address the uncertainty of growth estimates and earnings projections of management. Under the market approach, a value is calculated from an analysis of comparable acquisition transactions based on earnings, book value, assets and deposit premium multiples from the sale of similar financial institutions. Our goodwill testing for 2008, which was updated as of December 31, 2008, indicated that the goodwill booked at the time of the acquisition of The Community Bank continues to properly value the acquired company and has not been impaired. No impairment has been recorded as a result of goodwill testing performed during 2008 or 2007. Given the substantial decline in our common stock price and the economic outlook for our industry, the excess of the fair value over carrying value has narrowed compared with previous assessments. If our stock price continues to decline, if the Company does not produce anticipated cash flows, or if comparable banks begin selling at significantly lower prices than in the past, our goodwill may be impaired in the future.

Intangible assets with finite lives include core deposits and other intangibles. Intangible assets other than goodwill are subject to impairment testing at least annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Core deposit intangibles are amortized on the straight-line method over a period not to exceed 10 years. Note 7 contains additional information regarding goodwill and other intangible assets.

Income Taxes

Accrued taxes represent the estimated amount payable to or receivable from taxing jurisdictions, either currently or in the future, and are reported, on a net basis, as a component of "other assets" in the consolidated balance sheets. The calculation of the Company's income tax expense is complex and requires the use of many estimates and judgments in its determination.

Management's determination of the realization of the net deferred tax asset is based upon management's judgment of various future events and uncertainties, including the timing and amount of future income and the implementation of various tax plans to maximize realization of the deferred tax asset. Management believes that the Company will generate sufficient operating earnings to realize the deferred tax benefits.

From time to time, management bases the estimates of related tax liabilities on its belief that future events will validate management's current assumptions regarding the ultimate outcome of tax-related exposures. While the Company has obtained the opinion of advisors that the anticipated tax treatment of these transactions should prevail and has assessed the relative merits and risks of the appropriate tax treatment, examination of the Company's income tax returns, changes in tax law and regulatory guidance may impact the treatment of these transactions and resulting provisions for income taxes.

Southern Community's founders recognized an opportunity to fulfill the financial service needs of individuals and organizations left underserved by consolidation within the financial services industry. To fill a part of this void, the founders began in 1995 the process by which Southern Community Bank and Trust was created, and began operations on November 18, 1996. From inception, Southern Community has strived to serve the financial needs of small to medium-sized businesses, individuals, residential homebuilders and others in and around our markets in North Carolina. We offer a broad array of banking and other financial products; many of which are similar to those offered by our larger competitors, but we deliver them with an emphasis on superior customer service. We believe that our emphasis on quality customer service is the single most important factor among many that have fueled our growth to $1.8 billion in total assets in just over twelve years of operations.

The Company began operations in November 1996 with $11.0 million in capital, a single branch facility and thirteen employees. Through December 31, 2008, Southern Community Financial Corporation has grown to a total of twenty-two full-service banking offices with $1.2 billion in customer deposit accounts. In support of this growth, the Company has generated additional capital through issuing common stock and retaining operating earnings. At December 31, 2008, the Company had $187.7 million in total stockholders' equity. Through our banking subsidiary we offer traditional banking products as well as a full array of financial services. In October 2001, Southern Community Financial Corporation, a financial holding company, became the parent company of Southern Community Bank and Trust. On January 12, 2004 we acquired The Community Bank, a $240.0 million asset community bank with 10 banking offices in contiguous markets. The Company created Southern Community Advisors, our wealth management division, and has developed and acquired mortgage banking operations. While these operations are currently not significant to our results of operations, we intend to pursue growth in these businesses to enhance our non-interest income.

Real estate secured loans, including construction loans and loans secured by existing commercial and residential properties, comprise the majority of our loan portfolio, with the balance of our loans consisting of commercial and industrial loans and loans to individuals. We originate residential mortgages, at both fixed and variable rates, earning fees for loans originated and additional income for loans sold to others. It has been our strategy to recruit skilled banking professionals who are well trained and highly knowledgeable about our market area, enabling us to develop and maintain a loan portfolio of sound credit quality.

Management recognizes that our growth may expose the Company to increased operational and market risk, primarily with respect to managing overhead, funding costs and credit quality. The Company has developed critical functions such as Credit Administration, Training, Audit and Compliance to assist in managing and monitoring these and other risks. We are committed to creating and maintaining a solid and diversified financial services organization with a focus on customer service. It is management's firm belief that this foundation will continue building our loyal customer base while attracting new clients and providing opportunities for future growth. As bank consolidations continue to take place in our markets, Southern Community Financial Corporation is positioned to continue to benefit from their effects.

During the year ended December 31, 2008, our total assets increased by $234.6 million, or 15.0%, to $1.8 billion. Of the increase in total assets, $230.2 million represented growth in interest earning assets. Investment securities increased $105.5 million or 46.1% to provide sufficient liquidity to fund loan growth and manage scheduled deposit and borrowing maturities as well as unforeseen deposit outflows. Loan demand remained strong through the first three quarters of 2008, resulting in an increase of $124.8 million for the year; however, loans decreased $9.2 million in the fourth quarter due largely to the economic slowdown. The increase in earning assets was funded primarily by increased deposit growth, especially through the growth in certificates of deposit. Total deposits grew to $1.2 billion at December 31, 2008, an increase of $187.9 million or 18.0% from the year ago period. Other assets increased $15.2 million in 2008 including the purchase of an additional $10.0 million in Bank Owned Life Insurance which reduced the Company's effective tax rate for the year.

Our total loan growth of $124.8 million in 2008 was concentrated in residential mortgage loans, commercial mortgage loans and commercial and industrial loans which increased by $75.3 million, $28.3 million and $23.4 million respectively. A portion of the increase in residential mortgage loans was attributable to real estate collateral which was used to secure commercial and industrial loans. Construction loans increased $809 thousand as this segment of our portfolio reflected the reduction in housing starts and related current economic conditions throughout our market area. During 2008 the Bank continued our program of originating residential mortgage loans primarily for sale. At the year-end 2008, mortgage loans held for sale were $316 thousand compared to $1.9 million at the prior year end due to the significant decrease in mortgage origination volumes in fourth quarter 2008 as the economy experienced further slowing.

Our total liquid assets, defined as cash and due from banks, federal funds sold, interest-bearing deposits and investment securities, increased by $98.7 million during the year, to $361.9 million at December 31, 2008. Liquid assets represented 20.1% of total assets at December 31, 2008 as compared to 16.8% at the beginning of the year. Cash equivalents and federal funds sold decreased $6.8 million while investment securities increased $105.5 million. The investment portfolio was built to a more normal percentage of assets to provide adequate liquidity to fund the loan growth and provide resources to manage current as well as unforeseen deposit and borrowing outflows. As of year-end, we believe our liquidity is adequate to fund future loan demand and manage deposit and borrowing outflows.

Customer deposits which have traditionally been our primary funding source supplemented by wholesale funding provided the funding for loan growth during 2008. Deposits totaled $1.23 billion, an increase of $187.9 million or 18.0% from year-end 2007. Deposit growth during the current year shifted from non-maturity deposits to time deposits as customers focused on higher yields and longer terms during the falling interest rate environment. The change in market conditions were reflected in a $27.5 million or 11.1% decrease year-over-year in demand, money market, NOW and savings account deposits, which ended the year at $577.8 million. Time deposits which increased $215.4 million or 49.0% were generated through our growing branch network and out-of-market and brokered deposits. Brokered and out-of-market deposits totaling $262.1 million and $132.6 million at year-end 2008 and 2007, respectively, increased as a funding source to meet loan funding demands during the first three quarters of 2008. Management will continue to focus on growing the core deposit base; however, we will continue to monitor the costs of our various funding alternatives and our funding mix may change from time to time as a result.

Total borrowings aggregated $373.2 million at December 31, 2008, and included $154.1 million of advances from the Federal Home Loan Bank of Atlanta (FHLB), junior subordinated debentures with a carrying value of $45.9 million, securities sold under agreements to repurchase of $113.2 million and Term Auction Facility advances from the Federal Reserve Bank of $60.0 million. The Company began borrowing funds from the Term Auction Facility during the second quarter of 2008 as an additional source of funds. The Bank has entered into long-term financing through term repurchase agreements with various parties, which total $90.0 million at December 31, 2008. Management will use FHLB advances and other funding sources as necessary to support balance sheet management and growth. However, management expects that as our branch network grows and matures, the volume of core deposits will become an increasingly larger portion of our funding mix, which over time should contribute to a reduction in our overall funding cost.

The Company's capital position remains strong with all of our regulatory capital ratios at levels that make us "well capitalized" under federal bank regulatory capital guidelines. At December 31, 2008, our stockholders' equity totaled $187.7 million, an increase of $45.4 million from the December 31, 2007 balance. This net change includes $5.9 million of net income, $408 thousand of proceeds from shares purchased through stock option and stock purchase plans, $155 thousand of stock-based compensation, and $2.0 million in other comprehensive income due primarily to unrealized holding gains on available for sale investment securities. These increases in capital were offset by decreases from shares repurchased at a cost of $2.7 million, cash dividends paid of $2.8 million, $185 thousand of dividends accrued on preferred stock and $185 thousand from the cumulative effect of change in accounting method. The most significant increase in capital during 2008 was the issuance of non-voting cumulative perpetual preferred stock for $40.7 million and common stock warrants for $2.1 million as the Company elected to participate in the United States Treasury's Capital Purchase Program (CPP) at the maximum amount available to the Company. The dividend on this preferred stock is payable quarterly at an annualized rate of 5% for the first five years and 9% thereafter. The issuer may redeem this preferred stock after three years at par plus any accrued interest. Until the third anniversary of the preferred stock, the issuer needs Treasury consent to increase common stock dividends or to conduct share repurchases of common stock or junior preferred stock. The Treasury received warrants to purchase common shares having an aggregate market value equal to 15% of the preferred stock issued. These warrants have a term of 10 years and a strike price of $3.95 per share. These warrants are transferable by the Treasury. The total amount of the new securities issued qualifies as Tier 1 capital.

Like most financial institutions, the primary component of our earnings is net interest income. Net interest income is the difference between interest income, principally from loans and investments and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume and changes in interest rates earned and paid. By volume, we mean the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Spread and margin are influenced by the levels and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities. During the years ended December 31, 2008, 2007 and 2006, our average interest-earning assets were $1.59 billion, $1.37 billion and $1.23 billion, respectively. During these same years, our net interest margins were 2.99%, 3.19% and 3.30%, respectively.

During 2008, the Federal Reserve decreased the targeted federal funds rate seven times for a total of 400 basis points to end the year at a range of 0.00% to 0.25%. The Federal Reserve's reductions in the federal funds rate along with the introduction of new programs provided increased liquidity into credit markets in response to unprecedented systemic shocks to the United States and world financial markets caused by failures and near collapses of major market participants and large banking institutions, slumping consumer confidence and the overall weakening of the economy in the United States. The federal funds rate is currently at an historical low surpassing the previous low of 1.00% in June of 2003. The rate reductions in 2008 continued a trend of three decreases totaling 100 basis points in the last quarter of 2007. The rate reductions of 2008 and 2007 were preceded by four increases for 100 basis points during 2006. As the federal funds rate decreased, the prime interest rate changed by the same amount resulting in a 300 basis point spread between the two rates leaving the prime rate at 3.25% at the end of the year. Margin compression resulted during 2008 as asset yields declined faster than deposit costs due to increased competition for deposits and the resulting irrational pricing. Competition for deposits intensified in 2008 as large regional banks turned to retail markets to replace commercial paper and other wholesale funding sources that became limited to non-existent as credit markets underwent severe stress. While it is management's goal to remain relatively interest rate neutral, the Bank's interest rate sensitivity has been slightly liability sensitive in 2007 and 2008, as the funding mix has remained relatively stable. Net interest income totaled $47.5 million, an increase of $3.7 million or 8.4% over the $43.8 million for the same period in 2007. Net interest income benefited from strong growth in average earning assets; however the Bank's asset yields decreased at a faster pace (1.13% from 7.22% to 6.09%) than cost of funds (1.07% from 4.41% to 3.34%), leading to a shrinkage in net interest margin from 3.19% to 2.99%. Due to strong loan demand during the first three quarters and increased levels of investment securities, the level of average earning assets has increased $218.1 million or 15.9% for the year ending December 31, 2008. Average interest bearing liabilities increased $223.6 million or 17.9% to $1.5 billion from $1.3 billion for the period ended December 31, 2008.

Average Balances and Average Rates Earned and Paid. The following table sets forth, for the years 2006 through 2008, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or costs, net interest income, net interest spread, net interest margin and ratio of average interest-earning assets to average interest-bearing liabilities. Average loans include nonaccruing loans, the effect of which is to lower the average yield.

                              NET INTEREST INCOME

                                                                                               For the Years Ended December 31,
                                                           2008                                              2007                                              2006
                                         Average         Interest          Average         Average         Interest          Average         Average         Interest          Average
                                         balance        earned/paid      yield/cost        balance        earned/paid      yield/cost        balance        earned/paid      yield/cost
                                                                                                    (Dollars in thousands)

Interest-earning assets:
Loans (1)                              $ 1,279,041     $      82,125            6.42 %   $ 1,114,677     $      86,673            7.78 %   $   958,001     $      73,492            7.67 %
Investment securities available for
sale                                       257,153            12,378            4.81 %       179,995             8,819            4.90 %       185,713             8,529            4.59 %
Investment securities held to
maturity                                    48,252             2,184            4.53 %        71,510             3,208            4.49 %        86,328             3,390            3.93 %
Federal funds sold                           4,096                55            1.34 %         4,231               208            4.92 %         2,263               109            4.82 %

Total interest-earning assets            1,588,542            96,742            6.09 %     1,370,413            98,908            7.22 %     1,232,305            85,520            6.94 %
Other assets                               150,326                                           143,206                                           135,918
Total assets                           $ 1,738,868                                       $ 1,513,619                                       $ 1,368,223

Interest-bearing liabilities:
Deposits:
NOW and money market                   $   512,717     $      11,412            2.23 %   $   441,716     $      15,499            3.51 %   $   348,486     $      10,552            3.03 %
Time deposits greater than $100,000        137,841             6,695            4.86 %       311,125            14,135            4.54 %       326,864            14,303            4.38 %
Other time deposits                        428,950            16,541            3.86 %       169,236             8,889            5.25 %       208,733             8,564            4.10 %
Borrowings                                 395,031            14,634            3.70 %       328,909            16,618            5.05 %       231,664            11,379            4.91 %
Total interest-bearing liabilities       1,474,539            49,282            3.34 %     1,250,986            55,141            4.41 %     1,115,747            44,798            4.02 %

Demand deposits                            104,978                                           108,874                                           105,755
Other liabilities                           13,597                                            15,066                                            11,835
Stockholders' equity                       145,754                                           138,693                                           134,886

Total liabilities and stockholders'
equity                                 $ 1,738,868                                       $ 1,513,619                                       $ 1,368,223

Net interest income and net interest
spread                                                 $      47,460            2.75 %                   $      43,767            2.81 %                   $      40,722            2.92 %

Net interest margin                                                             2.99 %                                            3.19 %                                            3.30 %

Ratio of average interest-earning
assets to average interest-bearing
liabilities                                                   107.73 %                                          109.55 %                                          110.45 %

(1) Nonaccrual notes are included in the loan amounts.

The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior period's rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period's volume), and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) has been allocated equally to both the changes attributable to volume and the changes attributable to rate.

                             December 31, 2008 vs. 2007                 December 31, 2007 vs. 2006
                             Increase (Decrease) Due to                 Increase (Decrease) Due to
                         Volume         Rate          Total         Volume         Rate          Total
                                                     (Amounts in thousands)
Interest income:
Loans                   $  11,667     $ (16,215 )   $  (4,548 )   $   12,101     $   1,080     $  13,181
Investment securities
available for sale          3,747          (188 )       3,559           (271 )         561           290
Investment securities
held to maturity           (1,048 )          24        (1,024 )         (623 )         441          (182 )
Federal funds sold             (4 )        (149 )        (153 )           96             3            99

Total interest income      14,362       (16,528 )      (2,166 )       11,302         2,086        13,388

Interest expense:
. . .