The following discussion reviews our results of operations and assesses our financial condition. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements. The commentary should be read in conjunction with the discussion of forward-looking statements, the financial statements, and the related notes and the other statistical information included in this report.

DISCUSSION OF FORWARD-LOOKING STATEMENTS

This report contains "forward-looking statements" relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words "may," "will," "anticipate," "should," "would," "believe," "contemplate," "expect," "estimate," "continue," and "intend," as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties that include, without limitation, those described under the heading "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission (the "SEC") and the following:

† our rapid growth to date and short operating history;

† the opening of additional full-service branches and the resulting pressure this could cause on our management team;

† 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 deposits flows;

† changes in monetary and tax policies;

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

† the amount of our real estate based loans, and the weakness in the commercial real estate market;

† 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 SEC.

The above risks are exacerbated by the recent developments in national and international financial markets, and we are unable to predict what effect these uncertain market conditions will have on our Company. During 2008 and thus far in 2009, the capital and credit markets have experienced extended volatility and disruption. There can be no assurance that these unprecedented recent developments will not materially and adversely affect our business, financial condition and results of operations.

All forward-looking statements in this report are based on information available to us as of the date of this report. 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.

Overview

CommunitySouth Financial Corporation (the "Company") is a bank holding company headquartered in Easley, South Carolina. Our subsidiary, CommunitySouth Bank and Trust (the "Bank"), opened for business on January 18, 2005. In addition to the main office in Easley, the Bank has five branch locations in the upstate region of South Carolina. We opened our Mauldin branch in the fourth quarter of 2005, our Spartanburg branch in the first quarter of 2006, our Anderson branch in the third quarter of 2006, our Greer branch in the fourth quarter of 2006 and our Greenville branch in the third quarter of 2007. The Bank provides banking services to domestic markets, principally in the Upstate of South Carolina. The deposits of the Bank are insured by the FDIC.

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.

We have approximately $45.5 million of acquisition and development (A&D) loans outstanding at March 31, 2009. A&D loans are typically comprised of loans to borrowers for real estate to be developed (into properties such as sub-divisions or spec houses). Normally, these loans are repaid with the proceeds from the sale of the developed property. Collateral for these types of loans normally consists of real estate.

Our outstanding A&D loans are located primarily in the Upstate of South Carolina and Western North Carolina. The current economic environment in our market area has resulted in a downturn in the real estate market, which has placed greater pressure on our borrowers' repayment capabilities. We are experiencing higher levels of loan delinquencies, defaults and foreclosures. Further, the downturn in the real estate market has adversely impacted the value of the underlying collateral (real estate) for the A&D loans. The greater degree of strain on these types of loans and the significance to our overall loan portfolio has caused us to apply a greater degree of scrutiny in analyzing the ultimate collectability of amounts due. Our analysis has resulted in significant increases to our allowance for loan losses and significant increases in the corresponding expense charged to our provision for loan losses.

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. In the following section we have included a detailed discussion of this process.

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 following discussion.

Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises

Markets in the United States and elsewhere have experienced extreme volatility and disruption for more than 12 months. These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes, and have resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence. Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans. Dramatic slowdowns in the housing industry, due in part to falling home prices and increasing foreclosures and unemployment, have created strains on financial institutions. Many borrowers are now unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance. In response to the challenges facing the financial services sector, several regulatory and governmental actions have recently been announced including:

† The Emergency Economic Stabilization Act of 2008 ("EESA"), approved by Congress and signed by President Bush on October 3, 2008, which, among other provisions, allowed the U.S. Treasury to 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. EESA also temporarily raised the basic limit of FDIC deposit insurance from $100,000 to $250,000; the legislation contemplated a return to the $100,000 limit on December 31, 2009;

† On October 7, 2008, the FDIC approved a plan to increase the rates banks pay for deposit insurance;

† On October 14, 2008, the U.S. Treasury announced the creation of a new program, the Troubled Asset Relief Program (the "TARP") Capital Purchase Program (the "CPP") that encourages and allows financial institutions to build capital through the sale of senior preferred shares to the U.S. Treasury on terms that are non-negotiable;

† On October 14, 2008, the FDIC announced the creation of the Temporary Liquidity Guarantee Program (the "TLGP"), which seeks to strengthen confidence and encourage liquidity in the banking system. The TLGP has two primary components that are available on a voluntary basis to financial institutions:

† 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 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.

† 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, including our Company, that are in addition to those previously announced by the U.S. Treasury. These new limits are in place until the institution has repaid the Treasury, which is now permitted under ARRA without penalty and without the need to raise new capital, subject to the Treasury's consultation with the recipient institution's appropriate regulatory agency.

† On March 23, 2009, the U.S. Treasury, in conjunction with the FDIC and the Federal Reserve, announced the Public-Private Partnership Investment Program for Legacy Assets which consists of two separate plans, addressing two distinct asset groups:

† The Legacy Loan Program, in which the primary purpose will be to facilitate the sale of troubled mortgage loans by eligible institutions, which include FDIC-insured federal or state banks and savings associations. Eligible assets may not be strictly limited to loans; however, what constitutes an eligible asset will be determined by participating banks, their primary regulators, the FDIC and the Treasury. Additionally, the Loan Program's requirements and structure will be subject to notice and comment rulemaking, which may take some time to complete.

† The Securities Program, which will be administered by the Treasury, involves the creation of public-private investment funds to target investments in eligible residential mortgage-backed securities and commercial mortgage-backed securities issued before 2009 that originally were rated AAA or the equivalent by two or more nationally recognized statistical rating organizations, without regard to rating enhancements (collectively, "Legacy Securities"). Legacy Securities must be directly secured by actual mortgage loans, leases or other assets, and may be purchased only from financial institutions that meet TARP eligibility requirements.

It is likely that further regulatory actions may arise as the Federal government continues to attempt to address the economic situation.

Results of Operations

Three Months ended March 31, 2009 and 2008

Overview

Our net loss was $36,000 for the three months ended March 31, 2009 as compared to net income of $341,000 for the three months ended March 31, 2008. For the three months ended March 31, 2009, we realized $4,933,000 in interest income, of which $563,000 was from investment activities and $4,370,000 was from loan activities. For the three months ended March 31, 2008, we realized $6,249,000 in interest income, of which $731,000 was from investment activities and $5,518,000 was from loan activities. The primary source of funding for our loan portfolio is deposits that are acquired both locally and via the national brokered certificate market. We incurred interest expense of $2,080,000 and $3,653,000 for the three months ended March 31, 2009 and March 31, 2008, respectively. We have experienced an increase in our net interest margin to 3.05% from 2.81% for the quarters ended March 31, 2009 and 2008, respectively. The increase was a result of declining deposit costs.

Provision for Loan Losses

Our provision for loan losses for the three months ended March 31, 2009 was $1,305,000 compared to $125,000 for the comparable prior year period. This was a result of the general weakening of the economy and an analysis of our loan portfolio. As noted earlier, we have approximately $45.5 of acquisition and development (A&D) loans outstanding at March 31, 2009. We are experiencing higher levels of loan delinquencies, defaults and foreclosures. Further, the downturn in the real estate market has adversely impacted the value of the underlying collateral (real estate) for the A&D loans. The greater degree of strain on these types of loans and the significance to our overall loan portfolio has caused us to apply a greater degree of scrutiny in analyzing the ultimate collectability of amounts due. Our analysis has resulted in significant increases to our allowance for loan losses and significant increases in the corresponding expense charged to our provision for loan losses. Charges to our provision for loan losses have increased $1.2 million (or 944%) compared to the first quarter of 2008 as a result of our evaluation of the deterioration in our asset quality.

Non-interest Income

We had non-interest income of $814,000 and $370,000 for the three months ended March 31, 2009 and 2008, respectively. Mortgage origination fee income for the three months ended March 31, 2009 was $62,000. We had $163,000 in mortgage origination fee income in the first quarter of 2008. The decrease is due to our decreased volume in mortgage loan originations due to the current economic conditions and departmental restructuring. We also had a gain on sale of available for sale securities of $520,000 for the three months ended March 31, 2009.

Non-interest Expense

We incurred non-interest expense of $2,416,000 during the three months ended March 31, 2009. Included in the expense was $1,239,000 of salaries and employee benefits, $222,000 of data processing expense, $91,000 of professional fees expense, $36,000 of advertising expense, $23,000 of expense related to office supplies, $37,000 of telephone expense and $96,000 of assessments related to FDIC. The non-interest expense incurred in the three months ended March 31, 2008 was $2,317,000. Included in the expense was $1,235,000 of salaries and employee benefits, $191,000 of data processing expense, $78,000 of professional fee expense, $11,000 of advertising expense, $28,000 of expense related to office supplies, $36,000 of telephone expense and $53,000 of assessments related to FDIC.

For the three months ended March 31, 2009, we incurred other property and equipment expenses of $180,000 in depreciation and $42,000 in equipment maintenance and rental. For the three months ended March 31, 2008, we incurred other property and equipment expenses of $181,000 in depreciation and $48,000 in equipment maintenance and rental. We incurred $171,000 and $162,000 in occupancy expense related to all of our office locations for the three months ended March 31, 2009 and 2008, respectively.

The increase in non-interest expense is the result of the increased administrative expenses including FDIC assessments, advertising, professional fees, and data processing, resulting from an increase in customer volume.

Assets and Liabilities

General

At March 31, 2009, total assets decreased 0.7% to $385.0 million as compared to $387.8 million at December 31, 2008. Gross loans decreased $4.3 million, or 1.3%, during the first three months of 2009. As described below, federal funds sold increased to $5.5 million at March 31, 2009 compared to $4.6 million at December 31, 2008. Cash and cash equivalents increased $3.5 million, or 35.8%, since December 31, 2008. As described below, deposits increased $24.8 million, or 8.4%, during the first three months of 2009. At March 31, 2009, shareholders' equity was $28.2 million.

Investment Securities

Investments available for sale increased by $2.3 million, or 4.8%, since December 31, 2008 due to the purchase of and the appreciation related to government agency bonds and mortgaged-backed securities.

Other Investments

Other investments increased by $19,000 since December 31, 2008 due to the purchase of additional FHLB stock. All of the FHLB stock is used to collateralize advances with the FHLB.

Loans

Since loans typically provide higher interest yields than other types of interest earning assets, we allocate the majority of our earning assets to our loan portfolio. Gross loans decreased by $4.3 million, or 1.3%, during the first three months of 2009. Loan demand has slowed during the first quarter of 2009 due to general economic conditions and the real estate market, along with management's decision to shrink the size of the bank's loan portfolio, to help improve the bank's risk based capital ratios. We expect this trend to continue during the next quarter.

Balances within major loan categories are as follows:

(dollar amounts in thousands)     March 31, 2009     December 31, 2008
Real estate - construction       $        125,397   $           129,777
Real estate - mortgage                    156,116               154,838
Commercial and industrial                  32,209                33,303
Consumer and other                          2,908                 2,989
Total loans, gross                        316,630               320,907
Less allowance for loan losses             (9,414 )              (8,088 )
Total loans, net                 $        307,216   $           312,819

We discontinue accrual of interest on a loan when we conclude it is doubtful that we will be able to collect principal and/or interest from the borrower. We reach this conclusion by taking into account factors such as the borrower's financial condition, economic and business conditions, and the results of our previous collection efforts. Generally, we place a delinquent loan in non-accrual status when the loan becomes 90 days or more past due. When we place a loan in non-accrual status, we reverse all interest which has been accrued on the loan but remains unpaid and we deduct this interest from earnings as a reduction of reported interest income. We do not accrue any additional interest on the loan balance until we conclude the collection of both principal and interest is reasonably certain. At March 31, 2009, there were $16.7 million in loans that were non-accruing and $7.3 million in loans that were 30 days past due, excluding non-accrual loans. At December 31, 2008, there were $9.9 million in loans that were non-accruing and $2.4 million in loans that were 30 days past due, excluding non-accrual loans.

We have approximately $45.5 of acquisition and development (A&D) loans outstanding at March 31, 2009. A&D loans are typically comprised of loans to borrowers for real estate to be developed (into properties such as sub-divisions or spec houses). Normally, these loans are repaid with the proceeds from the sale of the developed property. Collateral for these types of loans normally consists of real estate.

Our outstanding A&D loans are located primarily in the Upstate of South Carolina and Western North Carolina. The current economic environment in our market area has resulted in a downturn in the real estate market, which has placed greater pressure on our borrowers' repayment capabilities. We are experiencing higher levels of loan delinquencies, defaults and foreclosures. Further, the downturn in the real estate market has adversely impacted the value of the underlying collateral

(real estate) for the A&D loans. The greater degree of strain on these types of loans and the significance to our overall loan portfolio has caused us to apply a greater degree of scrutiny in analyzing the ultimate collectability of amounts due. Our analysis has resulted in significant increases to our allowance for loan losses and significant increases in the corresponding expense charged to our provision for loan losses.

Changes in the allowance for loan losses for were as follows (dollars in thousands):

                                  Three-months ended    Three-months ended
                                    March 31, 2009        March 31, 2008
Balance, beginning of period      $             8,088   $             4,214
Provision charged to operations                 1,305                   125
Net collections (charge-offs)                      20                   (50 )
Balance, end of period            $             9,413   $             4,289

In April 2009, conditions warranted the bank to charged-off $1.4 million of loans which had been previously identified and reserved for in the above allowance for loan losses as of March 31, 2009.

Impaired Loans

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 $18,090,000 and $13,172,000 million in impaired loans at March 31, 2009 and December 31, 2008, respectively.

Potential Problem Loans

Potential problem loans are loans that are not included in impaired loans (non-accrual loans or loans past due 90 days or more and still accruing), 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 March 31, 2009 and December 31, 2008, the Company had identified $1.9 million and $424,844, 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.

Provision and Allowance for Loan Losses

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 of 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.

In addition, the current downturn in the real estate market has resulted in an . . .