Forward Looking Statements

This report contains certain forward-looking statements that represent the Company's expectations or beliefs concerning future events. Such forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic, and competitive uncertainties and contingencies, many of which are beyond our control. These forward-looking statements are based on assumptions with respect to future business strategies and decisions that are subject to change based on changes in the economic and competitive environment in which we operate. Forward-looking statements speak only as of the date they are made and the Company is under no duty to update these forward-looking statements or to reflect the occurrence of unanticipated events. A number of factors could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. Factors that could cause such a difference include, but are not limited to, the timing and amount of revenues that may be recognized by the Company, changes in local or national economic trends, increased competition among depository and financial institutions, continuation of current revenue and expense trends (including trends affecting chargeoffs and provisions for loan losses), changes in interest rates, changes in the shape of the yield curve, and adverse legal, regulatory or accounting changes. Because of the risks and uncertainties inherent in forward-looking statements, readers are cautioned not to place undue reliance on these statements. Readers should carefully review the risk factors described in other documents the Company files from time to time with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q, and Current Reports on Form 8-K.

Executive Summary

Citizens South Banking Corporation is a Delaware corporation that owns all of the outstanding shares of common stock of Citizens South Bank (the "Bank"). The Company's principal business activities are overseeing and directing the business of the Bank. The Company's assets consist primarily of the outstanding capital stock of the Bank, deposits held at the Bank, and investment securities. The shares of common stock of the Company trade on the Nasdaq Global Market under the ticker symbol "CSBC." Citizens South Bank, which was chartered in 1904, is a federally chartered savings bank headquartered in Gastonia, North Carolina. The Bank's principal business activity is offering FDIC-insured deposits to local customers through its 15 branch offices and investing those deposits, together with funds generated from operations and borrowings, in residential and nonresidential real estate loans, construction loans, commercial business loans, consumer loans, investment securities, and mortgage-backed securities. The Bank also acts as a broker in both the origination of loans secured by one-to-four family dwellings and in the sale of uninsured financial products. The Bank's results of operations are heavily dependent on net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. Results of operations are also materially affected by the Bank's provision for loan losses, noninterest income, and noninterest expense. Noninterest income includes fee income generated from deposit and loan accounts, mortgage banking fees, commissions earned from the sale of uninsured investment products, increases in the cash value of bank-owned life insurance policies, net gains (losses) from the sale of assets and other noninterest income items. The Bank's noninterest expense primarily consists of compensation and employee benefits, occupancy expense, professional services, advertising, amortization of intangible assets and other noninterest expenses. Results of operations are also significantly affected by local economic and competitive conditions, changes in interest rates, and actions of regulatory and governmental authorities.

The following discussion is provided to assist in understanding and evaluating the Company's results of operations and financial condition and is designed to provide a general overview of the Company's performance for the three-month periods ended March 31, 2009 and 2008. Readers seeking a more in-depth analysis should read the detailed discussions below, as well as the condensed consolidated financial statements and related notes. Financial highlights for the comparable periods are presented in the following table.

                                                      Three months     Three months
Financial Highlights: (unaudited)                        ended            ended
                                                       March 31,        March 31,
(Dollars in thousands, except per share data)             2009             2008          % Change
Summary Income Statement:
Interest income - taxable equivalent                  $      9,829     $     11,096           (11.4 ) %
Interest expense                                             4,702            6,185           (24.0 )
Net interest income - taxable equivalent                     5,127            4,911             4.4
Less: Taxable-equivalent adjustment                            144              124            16.1
Net interest income                                          4,983            4,787             4.1
Provision for loan losses                                      900              345           160.9
Noninterest income                                           1,249            1,680           (25.7 )
Noninterest expense                                          4,937            4,882             1.1
Income tax expense (benefit)                                   (61 )            270          (122.6 )
Net income                                                     456              970            53.0
Dividends on preferred stock                                   253                -              NM
Net Income available to common stockholders                    203              970            79.1

Per Common Share Data:
Earnings:
Basic                                                 $       0.03     $       0.13           (76.9 ) %
Diluted                                                       0.03             0.13           (76.9 )
Cash dividends paid                                          0.085             0.08             6.3
Book value                                                   11.19            11.21            (0.2 )
Tangible book value                                           7.14             7.12             0.3
Weighted average shares:
Basic                                                    7,392,742        7,406,656            (0.2 )
Diluted                                                  7,392,742        7,447,544            (0.8 )
End of period shares outstanding                         7,515,957        7,552,644            (0.5 )

Performance Ratios:
Return on average assets                                      0.10 %           0.50 %         (80.0 ) %
Return on average common stockholders' equity                 0.98             4.61           (78.7 )
Net interest margin - taxable equivalent                      2.81             2.89            (2.8 )
Efficiency ratio                                             79.22            75.49             4.9
Noninterest expense to average assets                         2.38             2.52            (5.6 )

Credit Quality Data:
Nonperforming loans                                   $      6,267     $      2,477           153.1 %
Nonperforming assets                                         7,939            3,006           164.1
Nonperforming loans to total loans                            0.98 %           0.43 %         127.9
Nonperforming assets to total assets                          0.93             0.39           138.5
Nonperforming assets to total loans and OREO                  1.25             0.53           135.9
Net charge-offs                                                196               62           216.1
Net charge-offs to average loans                              0.03             0.01           200.0
Allowance for loan losses                                    8,730            6,427            35.8
Allowance for loan losses to total loans                      1.37             1.12            22.3
Allowance for loan losses to nonperforming loans...           1.39 x           2.54 x         (46.3 )

Average Balances:
Total assets                                          $    829,319     $    774,030            7.14 %
Loans, net of unearned income                              626,722          567,039           10.53
Interest-earning assets                                    740,404          680,566            8.79
Deposits                                                   593,166          579,802            2.30
Interest-bearing liabilities                               692,789          636,875            8.78
Stockholders' equity                                       104,884           84,568           24.02

At Period End:
Total assets                                          $    851,390     $    776,583            9.63 %
Loans, net of unearned income                              635,008          571,938           11.03
Interest-earning assets                                    765,747          685,977           11.63
Deposits                                                   628,571          582,567            7.90
Interest-bearing liabilities                               696,085          642,115            8.41
Stockholders' equity                                       104,663           84,701           23.57

NM = Not Meaningful

Critical Accounting Policies

The accounting and financial policies of the Company and its subsidiaries are prepared in accordance with accounting principles generally accepted in the United States and conform to general practices in the banking industry. We consider accounting policies that require significant judgment and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. Changes in underlying factors, assumptions or estimates could have a material impact on our future financial condition and results of operations. Based on the size of the item or significance of the estimate, the following accounting policies are considered critical to our financial results.

Allowance for Loan Losses. The allowance for loan losses is calculated with the objective of maintaining an allowance sufficient to absorb estimated probable loan losses inherent in the Bank's portfolio at the measurement date. Management's determination of the adequacy of the allowance is based on quarterly evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss for each type of loan and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of the collateral. Management has established a systematic method for periodically evaluating the credit quality of the loan portfolio in order to establish an allowance for loan losses. The methodology is set forth in a formal policy and includes a review of all loans in the portfolio on which full collectability may or may not be reasonably assured. The loan review considers among other matters, the estimated fair value of the collateral, economic conditions, historical loan loss experience, our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Specific allowances are established for certain individual loans that management considers impaired under SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." The remainder of the portfolio is segmented into groups of loans with similar risk characteristics for evaluation and analysis. In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower, the term of the loan, general economic conditions, and in the case of a secured loan, the quality of the collateral. We increase our allowance for loan losses by charging provisions for loan losses against our current period income. Management's periodic evaluation of the adequacy of the allowance is consistently applied and is based on our past loan loss experience, particular risks inherent in the different kinds of lending that we engage in, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, current economic conditions, and other relevant internal and external factors that affect loan collectability. Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.

Other-Than-Temporary Impairment of Securities. On at least a quarterly basis management reviews all investment securities with significant declines in fair value for potential other-than-temporary impairment pursuant to the guidance provided by SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." In November 2007, the FASB issued Staff Position ("FSP") FAS No. 115-1 and FAS No. 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The FSP addressed the determination as to when an investment is considered impaired, whether the impairment is other-than-temporary, and the measurement of an impairment loss. It also included accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amended SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," FAS No. 124,"Accounting for Certain Investments Held by Not-for-Profit Organizations," and APB Opinion 18, "The Equity Method of Accounting for Investments in Common Stock."

Based on management's ongoing evaluation of its investment portfolio effective March 31, 2009, management determined that a $123,000 impairment on two equity investments was other-than-temporary. The first equity investment was determined to have a $71,000 impairment on the Company's $161,000 of common stock in its correspondent bank. Management determined that the impairment was other-than-temporary because the correspondent bank is under a regulatory directive to raise additional capital due to credit losses in its loan portfolio. Its ability to raise additional capital and comply with the regulatory directive was uncertain as of March 31, 2009. The Company's remaining equity investment in the correspondent bank was $92,000 after the recognition of the impairment. Subsequent to March 31, 2009, the correspondent bank was placed into receivership by the federal regulators. This will likely result in an other-than-temporary impairment of the remaining $92,000 investment during the second quarter of 2009. The other equity investment was determined to have a $52,000 impairment on the Company's $144,000 of common stock in a closely held trust company. Management determined that the impairment was other-than-temporary due to declining asset balances under management and lack of growth in new customers. The Company's remaining investment in the trust company was $92,000 as of March 31, 2009, after the recognition of the impairment. In accordance with SFAS No. 157, "Fair Value Measurements," the Company uses valuation techniques that are appropriate and consistently applied. A fair value hierarchy is used to prioritize valuation inputs into the following three levels to determine fair value:

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

Level 2: Observable inputs other than the quoted prices included in Level 1.

Level 3: Unobservable inputs.

Due to the lack of liquidity for both of these equity investments, the security was valued using Level 3. The fair values were prepared based on the Company's most recent capital position and total common shares outstanding based on information prepared by the individual companies.

Effective March 31, 2009, management evaluated the Company's investment portfolio and determined that all other unrealized losses were the direct result of temporary changes in interest rates and that such losses may be recovered in the foreseeable future. The Company has the ability to hold these investments to maturity if necessary in order to recover any temporary losses that may presently exist. As a result, management did not consider any additional unrealized losses as "other-than-temporary" as of March 31, 2009.

Comparison of Financial Condition

Assets. Total assets of the Company increased by $34.2 million, or 4.2%, from $817.2 million at December 31, 2008, to $851.4 million at March 31, 2009. This increase was primarily due to a $21.5 million increase in interest-earning bank balances, an $8.3 million increase in loans, a $3.6 million increase in investment securities and a $2.1 million increase in mortgage-backed securities ("MBS"). These increases were partly offset by a $929,000 decrease in other real estate owned and a $644,000 decrease in Federal Home Loan Bank stock.

Interest-earning bank balances increased by $21.5 million from $613,000 at December 31, 2008, to $22.1 million at March 31, 2009. This increase was primarily attributable to strong deposit growth of $47.1 million during the first quarter of 2009. Management expects that the level of interest-bearing bank balances will be substantially reduced in the second quarter of 2009 as the excess liquidity from this rapid deposit growth are invested in higher yielding loans and investment securities.

During the quarter ended March 31, 2009, loans receivable increased by $8.3 million, or 1.3%, to $635.0 million. The growth in loans was primarily comprised of a $19.7 million, or 6.1%, increase in commercial real estate loans, a $4.4 million, or 12.9%, increase in commercial business loans, and a $1.4 million, or 1.2%, increase in consumer loans. These increases were partly offset by a $3.7 million, or 4.4%, decrease in permanent one-to-four family residential loans and a $24.2 million, or 33.8%, decrease in construction loans. The large decrease in construction loans was primarily due to the reclassification of several larger commercial projects which converted from construction status to permanent status during the quarter. Loan production amounted to $26.1 million during the first quarter of 2009 as compared to $68.5 million during the first quarter of 2008. The economy in the Charlotte region continued to slow during the first quarter of 2009, but remains stronger than most other large metropolitan areas of the country. However, the slowdown in housing starts and demand for commercial real estate has resulted in decreased loan demand. A continued slowdown in the local economy would have a negative impact on the Company's ability to increase the current level of loan growth. Management will seek to continue to grow the loan portfolio in a prudent manner with an emphasis on borrowers that have a demonstrated capacity to meet their debt obligations, even if the local economy continues to slow.

During the three-month period ended March 31, 2009, investment securities increased by $3.7 million, or 12.7%, to $32.6 million. The increase in investment securities was primarily due to the purchases of $5.2 million in securities with funds generated from excess liquidity generated from deposit growth during the quarter. These purchases were partly offset by normal maturities of $1.1 million, a $379,000 increase in unrealized losses on investments available-for-sale, and a $123,000 other-than-temporary impairment. MBS increased $2.1 million, or 2.6%, to $82.4 million. The increase in MBS was due to the purchase of $5.1 million of MBS during the quarter and a $727,000 increase in unrealized gains on the sale of MBS available-for-sale. The effects of these increases were partly offset by $3.7 million of normal principal amortization. Management expects the investment and MBS portfolios to increase as a percentage of total assets over the next quarter as the excess liquidity generated from rapid deposit growth in the first quarter of 2009 is invested in higher-yielding assets.

Other real estate owned, which includes all properties acquired by the Company through foreclosure, totaled $1.7 million at March 31, 2009, compared to $2.6 million at December 31, 2008. At March 31, 2009, other real estate owned consisted of eight one-to-four family residential dwellings, two residential lots, and one commercial property. During the first quarter of 2009, the Company foreclosed on one residential lot and sold four foreclosed residential properties for a loss of $171,000. Also, the Company decreased the book value of one residential property by $125,000 during the quarter, due to a drop in housing prices for comparably priced residences in the property's neighborhood. All foreclosed properties are written down to their estimated fair value (market value less estimated disposition costs) at acquisition and are located in the Bank's primary lending area. Management will continue to aggressively market foreclosed properties for a timely disposition.

Allowance for loan losses and nonperforming assets. The Company has established a systematic methodology for determining the adequacy of the allowance for loan losses. This methodology is set forth in a formal policy and considers all loans in the portfolio. Specific allowances are established for certain individual loans that management considers impaired. The remainder of the portfolio is segmented into groups of loans with similar risk characteristics for evaluation and analysis. Management's periodic evaluation of the allowance is consistently applied and based on inherent losses in the portfolio, past loan loss experience, risks inherent in the different types of loans, the estimated value of any underlying collateral, current economic conditions, the borrower's financial position, and other relevant internal and external factors that may affect loan collectibility. The allowance for loan losses is increased by charging provisions for loan losses against income. As of March 31, 2009, the allowance for loan losses was $8.7 million, or 1.37% of total loans. Management believes that this amount meets the requirement for losses on loans that management considers to be impaired, for known losses, and for losses inherent in the remaining loan portfolio. Although management believes that it uses the best information available to make such determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly adversely affected if circumstances differ substantially from the assumptions used in making the determinations. The following table presents an analysis of changes in the allowance for loan losses for the comparable periods and information with respect to nonperforming assets at the dates indicated.

                                                               At and For the Three Months Ended
                                                                           March 31,
                                                                  2009                   2008
                                                                     (Dollars in thousands)
Allowance for loan losses:
Beginning of period                                            $     8,026            $     6,144
Add: Provision for loan losses                                         900                    345
Recoveries                                                             141                     14
Less: Charge-offs                                                      337                     76
End of period                                                  $     8,730            $     6,427

Nonperforming assets:
Nonaccrual loans                                               $     6,267            $     2,477
Other real estate owned                                              1,672                    529
Nonperforming assets                                           $     7,939            $     3,066

Credit Quality Ratios:
Nonperforming loans to total loans                                    0.98 %                 0.43 %
Nonperforming assets to total assets                                  0.93 %                 0.39 %
Nonperforming assets to total loans and OREO                          1.25 %                 0.53 %
Allowance for loan losses as a percentage of total loans              1.37 %                 1.12 %
Ratio of allowance for loan losses to nonperforming loans             1.39 x                 2.59 x

Premises and equipment decreased by $202,000, or 1.2%, to $16.6 million at March 31, 2009. This decrease was primarily due to normal depreciation. During the first quarter of 2009, the Company opened a loan production office located in a leased facility in Charlotte, North Carolina. No significant changes to the Company's premises and equipment are anticipated for the remainder of 2009.

Liabilities. Total liabilities increased by $34.2 million, or 4.8%, from $712.5 million at December 31, 2008, to $746.7 million at March 31, 2009. This increase was primarily due to a $47.1 million increase in total deposits which was partly offset by an $11.7 million decrease in borrowed money.

During the first quarter of 2009 total deposits increased by $47.1 million, or 8.1%, to $628.6 million at March 31, 2009. This increase in deposits was fueled in part by positive publicity that the Company received relating to our nationally recognized program for utilization of TARP funds for low interest mortgage loans. The Company's low interest rate mortgage program was featured in an article in The Washington Post and was subsequently covered by several other nationally recognized print and electronic media organizations. Our deposit growth was also partly due to increased numbers of customers moving funds out of brokerage accounts and a continued emphasis on increasing the Company's number of retail and business customers through employee incentive plans and enhanced treasury service products. The deposit growth occurred in all categories of deposits. During the first quarter of 2009 demand deposits (checking accounts) increased by $14.1 million, or 11.5%, to $136.8 million, money market deposit accounts increased by $10.8 million, or 10.5%, to $114.1 million, savings accounts increased by $437,000, or 4.1%, to $11.1 million and time deposits increased by $21.8 million, or 6.3%, to $366.5 million. The Company will continue to actively market the Company's deposit products at pricing points that management believes to be profitable. Management has always focused on increasing deposits by building customer relationships and typically avoids growing deposits by offering the highest rates in the market. From time to time management may use brokered deposits as an alternative funding source for additional loan growth or liquidity needs. At March 31, 2009, brokered deposits totaled only $99,000.

Borrowed money decreased by $11.7 million, or 9.4%, to $112.7 million at March 31, 2009. This decrease was primarily due to the repayment of short-term Federal Home Loan Bank ("FHLB") advances that were obtained primarily for the purpose of . . .