UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________________

FORM 10-Q

____________________

[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2012

[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______ to _____

Commission File Number 0-23971

______________________________

Citizens South Banking Corporation

(Exact name of registrant as specified in its charter)

______________________________

Delaware	54-2069979
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)

519 South New Hope Road, Gastonia, NC	28054
(Address of principal executive offices)	(Zip code)

(704) 868-5200

(Registrant's telephone number, including area code)

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

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports). Yes [x] No [ ]

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 definitions of “accelerated filer”, “large accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer [ ]	Accelerated filer [ ]
Non-accelerated filer [ ]	Smaller Reporting Company [x]

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

As of August 14, 2012, there were 11,506,324 shares outstanding of the Registrant’s common stock, $0.01 par value.

Citizens South Banking Corporation

Index

		Page
Part I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

	Condensed Consolidated Statements of Financial Condition at June 30, 2012 and December 31, 2011	1

	Condensed Consolidated Statements of Operations for the Three and Six months Ended June 30, 2012 and 2011	2

	Condensed Consolidated Statements of Comprehensive Income for the Three and Six months Ended June 30, 2012 and 2011	3

	Condensed Consolidated Statements of Shareholders’ Equity for the Six months Ended June 30, 2012 and 2011	4

	Condensed Consolidated Statements of Cash Flows for the Six months Ended June 30, 2012 and 2011	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations		30

Item 3. Quantitative and Qualitative Disclosures About Market Risk		44

Item 4. Controls and Procedures		45

Part II. OTHER INFORMATION

Item 1. Legal Proceedings		45

Item 1A. Risk Factors		45

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		45

Item 3. Defaults Upon Senior Securities		45

Item 4. Mine Safety Disclosures		45

Item 5. Other Information		45

Item 6. Exhibits		45

Signatures

Certifications

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

CITIZENS SOUTH BANKING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

	June 30, 2012			December 31, 2011 *
(Dollars in thousands, except share and per share data)	(unaudited)

ASSETS
Cash and cash equivalents:
Cash and due from banks	$	11,839		$	13,296
Interest bearing deposits		116,985			75,048
Cash and cash equivalents		128,824			88,344
Investment securities available for sale, at fair value		18,358			52,136
Investment securities held to maturity, at amortized cost		82,276			95,763
Federal Home Loan Bank stock, at cost		4,443			5,067
Presold loans in process of settlement		2,146			2,146
Loans:
Covered by FDIC loss-share agreements		128,874			159,688
Not covered by FDIC loss-share agreements		587,498			574,100
Loans, net of deferred fees and costs		716,372			733,788
Allowance for loan losses		(11,735	)		(11,713	)
Loans, net		704,637			722,075
Other real estate owned		21,405			17,571
Premises and equipment, net		25,396			25,888
FDIC loss share receivable		28,863			38,931
Accrued interest receivable		1,840			2,773
Bank-owned life insurance		18,723			18,978
Intangible assets		1,141			1,373
Other assets		11,125			9,415
Total assets	$	1,049,177		$	1,080,460

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits	$	852,764		$	876,056
Securities sold under repurchase agreements		7,554			9,787
Borrowed money		76,706			78,688
Subordinated debt		15,464			15,464
Other liabilities		7,216			7,806
Total liabilities		959,704			987,801

Shareholders' Equity
Preferred stock, $0.01 par value, Authorized: 1,000,000 shares; Issued and outstanding: 20,500 shares		20,500			20,500
Common stock, $0.01 par value, Authorized: 20,000,000 shares; Issued: 11,561,464 shares; Outstanding: 11,506,324 shares at June 30, 2012 and December 31, 2011		124			124
Additional paid-in-capital		64,209			63,888
Retained earnings, substantially restricted		4,647			7,854
Accumulated other comprehensive income (loss)		(7	)		293
Total shareholders' equity		89,473			92,659
Total liabilities and shareholders' equity	$	1,049,177		$	1,080,460

* Derived from audited consolidated financial statements

See accompanying notes to condensed consolidated financial statements.

CITIZENS SOUTH BANKING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
(Dollars in thousands, except per share data)

Interest Income
Interest and fees on loans	$	9,355		$	10,329		$	19,002		$	19,790
Investment securities:
Taxable interest income		606			983			1,343			1,776
Tax-exempt interest income		25			69			62			137
Other interest income		65			38			114			103
Total interest income		10,051			11,419			20,521			21,806
Interest Expense
Deposits		1,121			1,981			2,357			3,982
Repurchase agreements		7			19			14			37
Borrowed money		680			753			1,371			1,516
Subordinated debt		80			73			163			145
Total interest expense		1,888			2,826			3,905			5,680

Net interest income		8,163			8,593			16,616			16,126
Provision for loan losses		2,555			1,700			8,855			4,700
Net interest income after provision for loan losses		5,608			6,893			7,761			11,426
Noninterest Income
Service charges on deposit accounts		1,092			1,046			2,147			2,004
Mortgage banking income		393			254			710			491
Commissions on sales of financial products		67			69			153			136
Income from bank-owned life insurance		184			214			368			397
Gain (loss) from acquisition		(175	)		4,418			(175	)		4,163
Gain on sale of investments, available for sale		-			1			664			1
Gain (loss) on sale of other assets		85			(338	)		(53	)		(326	)
Other		1,054			222			1,608			500
Total noninterest income		2,700			5,886			5,422			7,366
Noninterest Expense
Compensation and benefits		3,902			3,806			7,748			7,454
Occupancy and equipment		898			873			1,806			1,701
Data processing and other technology		235			296			491			530
Professional services		308			249			583			502
Advertising and business development		74			71			142			125
Loan collection and other expenses		864			204			1,116			494
Deposit insurance		(49	)		361			369			695
Amortization of intangible assets		109			136			231			275
Office supplies		53			62			112			132
Telephone and communications		107			111			213			207
Other real estate owned valuation adjustments		1,784			1,476			2,784			1,984
Other real estate owned expenses		388			596			858			597
Acquisition and integration expenses		-			566			-			611
Other		859			463			1,767			1,638
Total noninterest expense		9,532			9,270			18,220			16,945

Income (Loss) before income tax expense (benefit)		(1,224	)		3,509			(5,037	)		1,847
Income tax expense (benefit)		(576	)		1,213			(2,249	)		442
Net income (loss)		(648	)		2,296			(2,788	)		1,405
Dividends on preferred stock		68			256			190			512

Net income (loss) allocable to common shareholders	$	(716	)	$	2,040		$	(2,978	)	$	893

Net income (loss) per common share - basic	$	(0.06	)	$	0.18		$	(0.26	)	$	0.08
Net income (loss) per common share - diluted		(0.06	)		0.18			(0.26	)		0.08

See accompanying notes to condensed consolidated financial statements.

CITIZENS SOUTH BANKING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
(Dollars in thousands)

Net income (loss)	$	(648	)	$	2,296		$	(2,788	)	$	1,405

Other comprehensive income (loss):
Investment securities, available for sale:
Unrealized holding gains arising during period		41			827			175			876
Tax expense		(16	)		(319	)		(67	)		(338	)
Reclassification for realized gains included in net income		-			(1	)		(664	)		(1	)
Tax benefit		-			-			256			-
Other comprehensive income (loss)		25			507			(300	)		537
Total comprehensive income (loss)	$	(623	)	$	2,803		$	(3,088	)	$	1,942

See accompanying notes to condensed consolidated financial statements.

CITIZENS SOUTH BANKING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (unaudited)

	Preferred Stock		Common Stock		Additional Paid-in Capital		Retained Earnings, Substantially Restricted			Accumulated Other Comprehensive Income (Loss)			Total Shareholders' Equity
(Dollars in thousands)

Balances, January 1, 2011	$	20,672	$	124	$	63,000	$	9,663		$	(16	)	$	93,443

Net income		-		-		-		1,405			-			1,405
Other comprehensive income, net of tax		-		-		-		-			538			538
Accretion of discount on preferred stock		41		-		-		(41	)		-			-
Allocation from shares purchased with loan to ESOP		-		-		22		-			-			22
Vesting of Recognition and Retention Plan ("RRP")		-		-		50		-			-			50
Stock-based compensation		-		-		53		-			-			53
Cash dividends on preferred stock, net of accretion		-		-		-		(512	)		-			(512	)
Cash dividends on common stock		-		-		-		(228	)		-			(228	)
														-
Balances, June 30, 2011	$	20,713	$	124	$	63,125	$	10,287		$	522		$	94,771



Balances, January 1, 2012	$	20,500	$	124	$	63,888	$	7,854		$	293		$	92,659

Net loss		-		-		-		(2,788	)		-			(2,788	)
Other comprehensive loss, net of tax		-		-		-		-			(300	)		(300	)
Allocation from shares purchased with loan to ESOP		-		-		25		-			-			25
Vesting of RRP		-		-		246		-			-			246
Stock-based compensation		-		-		50		-			-			50
Cash dividends on preferred stock		-		-		-		(190	)		-			(190	)
Cash dividends on common stock		-		-		-		(229	)		-			(229	)
														-
Balances, June 30, 2012	$	20,500	$	124	$	64,209	$	4,647		$	(7	)	$	89,473

See accompanying notes to condensed consolidated financial statements.

CITIZENS SOUTH BANKING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

	Six Months Ended June 30,
	2012			2011
(Dollars in thousands)

Cash flows from operating activities
Net income (loss)	$	(2,788	)	$	1,405
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Provision for loan losses		8,855			4,700
Depreciation of premises and equipment		649			645
Deferred income tax benefit		(1,363	)		(304	)
(Gain) loss on acquisition		175			(4,163	)
Gain on sale of investment securities available for sale		(664	)		(1	)
Loss on sale of other real estate owned and repossessed assets		53			326
Valuation adjustment on other real estate owned		2,784			1,984
Net purchase accounting adjustments		(13,072	)		5,828
Net decrease in presold loans in process of settlement		-			1,925
Deferred loan origination fees		117			101
Amortization of intangible assets		231			275
Allocation from shares purchased with loan to ESOP		25			22
Stock-based compensation		50			53
Vesting of shares issued for the RRP		246			50
Decrease in accrued interest receivable		932			223
Decrease in other assets		2,972			14,956
Decrease in other liabilities		(588	)		(1,178	)
Net cash provided by (used in) operating activities		(1,386	)		26,847

Cash flows from investing activities
Net decrease in loans made to customers		8,180			14,840
Proceeds from sales of investment securities available for sale		35,520			2,351
Proceeds from sales of other real estate owned		6,705			4,420
Proceeds from maturities/issuer calls of investment securities available for sale		13,745			5,607
Proceeds from maturities/issuer calls of investment securities held to maturity		26,691			6,594
Purchases of investment securities available for sale		(8,311	)		-
Purchases of investment securities held to maturity		(13,204	)		(48,714	)
Net cash received in acquisition		-			7,912
Redemption of FHLB stock		624			507
Purchases of premises and equipment		(157	)		(2,056	)
Net cash provided by (used in) investment activities		69,793			(8,539	)

Cash flows from financing activities
Net decrease in deposits		(23,542	)		(42,602	)
Dividends paid to common stockholders		(229	)		(228	)
Dividends paid to preferred stockholders		(190	)		(512	)
Net decrease in borrowed money and repurchase agreements		(4,216	)		(6,882	)
Increase in advances from borrowers for insurance and taxes		250			354
Net cash used in financing activities		(27,927	)		(49,870	)

Net increase (decrease) in cash and cash equivalents		40,480			(31,562	)
Cash and cash equivalents at beginning of year		88,344			120,899
Cash and cash equivalents at end of year	$	128,824		$	89,337

Supplemental non-cash investing activity
Loans transferred to other real estate owned	$	13,358		$	10,469

See accompanying notes to condensed consolidated financial statements.

CITIZENS SOUTH BANKING CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the interim financial statements as of and for the three- and six-month periods ended June 30, 2012 and 2011, and have been included as required by Regulation S-X Rule 10-01. They do not include all of the information and footnotes required by such accounting principles for complete financial statements, and therefore should be read in conjunction with the audited consolidated financial statements and accompanying footnotes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The accompanying unaudited condensed consolidated financial statements include management estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The more significant estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, other-than-temporary impairments on securities, and the fair value of acquired loans. Actual results could differ from those estimates.

The accompanying unaudited condensed consolidated financial statements include the accounts of Citizens South Banking Corporation, its wholly-owned subsidiary, Citizens South Bank, and the Bank’s wholly-owned subsidiaries, Citizens South Financial Services, Inc. and Citizens Properties, LLC. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain of the prior year amounts have been reclassified to conform to current year presentation. Such reclassifications were immaterial to the financial statements. Results for the three- and six-month periods ended June 30, 2012, are not necessarily indicative of the results that may be expected for future periods, including the year ending December 31, 2012.

Note 2 – Merger with Park Sterling Corporation

On May 14, 2012, the Company announced the signing of a definitive merger agreement with Park Sterling Corporation (“Park Sterling”) under which Park Sterling will acquire Citizens South for a total value of approximately $77.8 million, excluding the exchange of $20.5 million in preferred stock issued to the United States Department of the Treasury in connection with Citizen South’s participation in the Small Business Lending Fund. The merger agreement has been unanimously approved by the board of directors of each company. Closing of the transaction, which is expected to occur in the fourth quarter of 2012, is subject to customary conditions, including approval by Citizens South’s shareholders, approval by Park Sterling’s shareholders and receipt of regulatory approval. Under the terms of the merger agreement, Citizens South shareholders will have the right to receive either $7.00 in cash or 1.4799 Park Sterling shares for each Citizens South share they hold, subject to the limitation that the total consideration will consist of 30.0% in cash and 70.0% in Park Sterling shares. Those Citizens South shares exchanged for stock will convert to Park Sterling shares in what is intended to be a tax-free exchange. Cash will also be paid in lieu of fractional shares. The transaction value at the time of the proposed merger may change due to potential fluctuations in the price of Park Sterling stock.

Note 3 - Recent Accounting Pronouncements

A summary of the accounting policies followed by the Company may be found in Note 1 – Organization and Summary of Significant Accounting Policies in the 2011 Annual Report on Form 10-K filed with the SEC. Updates to the significant accounting policies are reported in the Company’s quarterly reports filed with the SEC on Form 10-Q as new or revised accounting pronouncements are made. The following paragraphs update that information for the second quarter of 2012.

In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-11 “Balance Sheet (Topic 210) - Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 requires an entity to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. Retrospective disclosure is required for all comparative periods presented. The Company does not expect an impact on its financial condition or results of operations.

Several other new accounting standards became effective during the periods presented or will be effective subsequent to June 30, 2012. None of these new standards had or is expected to have a material impact on the Company’s consolidated financial statements.

Note 4 – Earnings per Common Share

The Company has presented both basic and diluted earnings per common share (“EPS”). Basic EPS is calculated by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period, without considering any dilutive items. Diluted EPS is calculated by dividing net income (loss) available to common shareholders by the sum of the weighted average number of common shares outstanding for the period and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury method.

The potential common stock of the Company includes stock options and unvested shares issued for the Recognition and Retention Plan (“RRP”) granted to various directors and officers of the Bank and unexercised warrants issued to the U.S. Treasury. The Company excluded 659,794 outstanding options for the three- and six-month periods ended June 30, 2012, and 745,602 outstanding options for the three- and six-month periods ended June 30, 2011. In addition, the exercise price of all of these options exceeded the average closing price of the shares of common stock during the three and six month periods ended June 30, 2012 and 2011 and, accordingly would have been anti-dilutive and therefore excluded from the diluted EPS calculation. At June 30, 2011, all of the 450,314 warrants had an exercise price which was in excess of the market value of the stock, so no warrants were included in the calculation of diluted earnings per share for this period since they would have also been anti-dilutive. There were no warrants outstanding at June 30, 2012.

The following is a reconciliation of the diluted earnings per share calculation for the three- and six-month periods ended June 30, 2012 and 2011:

	Three Months Ended June 30,					Six Months Ended June 30,
	2012			2011		2012			2011
	(Dollars in thousands, except per share amounts)

Net income (loss) allocable to common shareholders	$	(716	)	$	2,040	$	(2,978	)	$	893
Weighted average number of shares outstanding		11,463,396			11,455,642		11,460,110			11,451,619
Basic net income (loss) per common share	$	(0.06	)	$	0.18	$	(0.26	)	$	0.08

Net income (loss) allocable to common shareholders	$	(716	)	$	2,040	$	(2,978	)	$	893
Weighted average number of shares outstanding		11,463,396			11,455,642		11,460,110			11,451,619
Incremental shares from assumed exercise of stock options and warrants		-			-		-			-
Weighted average number of shares outstanding - diluted		11,463,396			11,455,642		11,460,110			11,451,619
Diluted net income (loss) per common share	$	(0.06	)	$	0.18	$	(0.26	)	$	0.08

Note 5 – Investment Securities

The following is a summary of the amortized cost, unrealized gains and losses, and estimated fair value of the investment securities portfolio at June 30, 2012 and December 31, 2011 by major classification:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
	(Dollars in thousands)
June 30, 2012
Available for Sale:
Municipal bonds	$	1,675	$	3	$	-	$	1,678
Mortgage-backed securities		14,994		74		13		15,055
Other securities		1,701		44		120		1,625
Subtotal		18,370		121		133		18,358

Held to Maturity:
U.S. Treasury obligations		9,981		38		0		10,019
U.S. Government Agency obligations		13,996		59		-		14,055
Municipal bonds		3,272		91		-		3,363
Mortgage-backed securities		45,992		2,499		-		48,491
SBA securities		5,035		70		-		5,105
Other securities		4,000		-		186		3,814
Subtotal		82,276		2,757		186		84,847
Total investment securities	$	100,646	$	2,878	$	319	$	103,205


December 31, 2011
Available for Sale:
U.S. Government Agency obligations	$	7,168	$	73	$	-	$	7,241
Municipal bonds		6,578		133		-		6,711
Mortgage-backed securities		35,170		330		8		35,492
SBA securities		1,255		71		-		1,326
Other securities		1,488		44		166		1,366
Subtotal		51,659		651		174		52,136

Held to Maturity:
U.S. Treasury obligations		9,972		61		-		10,033
U.S. Government Agency obligations		25,989		74		4		26,059
Municipal bonds		3,300		99		-		3,399
Mortgage-backed securities		52,502		2,277		-		54,779
Other securities		4,000		-		155		3,845
Subtotal		95,763		2,511		159		98,115
Total investment securities	$	147,422	$	3,162	$	333	$	150,251

The amortized cost and estimated fair value of investment securities available for sale and held to maturity at June 30, 2012, by contractual maturity are shown in the following table. Actual maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Fair Value
	(Dollars in thousands)

Available for Sale:

Due in one year or less	$	3,181	$	3,188
Due after one year through five years		4,365		4,384
Due after five years through ten years		3,333		3,363
Due after ten years		5,804		5,856
Equities		1,687		1,567
Total	$	18,370	$	18,358

Held to Maturity:
		-		-
Due in one year or less	$	14,865	$	15,170
Due after one year through five years		29,996		30,607
Due after five years through ten years		25,350		25,733
Due after ten years		12,065		13,337
Total	$	82,276	$	84,847

The following table shows the amount of the fair values and gross unrealized losses of the investment securities by investment types segregated between those that have been in a continuous unrealized-loss position for less than twelve months and those investments that have been in a continuous unrealized-loss position for more than twelve months at June 30, 2012 and December 31, 2011. At June 30, 2012, the unrealized losses related to four mortgage-backed securities, four corporate bonds and two equity securities. Of these ten securities, five have been in a continuous unrealized-loss position for more than 12 months. At December 31, 2011, the unrealized losses related to one U.S. Government Agency obligation, six mortgage-backed securities and six other securities. Of these thirteen securities, five have been in a continuous unrealized-loss position for more than 12 months.

Management periodically evaluated each investment security for other than temporary impairment, relying primarily on industry analyst reports, market conditions, and interest rate fluctuations. As of June 30, 2012, and December 31, 2011, management concluded that the unrealized losses presented in the table below were temporary in nature since the unrealized losses were largely attributable to changes in interest rates and not a deterioration of the credit quality of the issuers. Also, the Company has the intent and ability to hold these investment securities until maturity or until such unrealized losses are eliminated.

	Less Than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
June 30, 2012
Available for Sale:
Mortgage-backed securities	$	3,493	$	13	$	-	$	-	$	3,493	$	13
Other securities		-		-		240		120		240		120
Subtotal		3,493		13		240		120		3,733		133

Held to Maturity:
Other securities		896		104		2,918		82		3,814		186
Subtotal		896		104		2,918		82		3,814		186
Total temporarily impaired securities	$	4,389	$	117	$	3,158	$	202	$	7,547	$	319

December 31, 2011
Available for Sale:
Mortgage-backed securities	$	4,619	$	8	$	88	$	-	$	4,707	$	8
Other securities		165		93		29		73		194		166
Subtotal		4,784		101		117		73		4,901		174

Held to Maturity:
U.S. Government Agency obligations		1,996		4		-		-		1,996		4
Other securities		997		3		2,848		152		3,845		155
Subtotal		2,993		7		2,848		152		5,841		159

Total temporarily impaired securities	$	7,777	$	108	$	2,965	$	225	$	10,742	$	333

From time to time the Company will pledge investment securities as collateral to secure public deposits and for other purposes as required or allowed by law. The amortized cost of these pledged investment securities was $78.1 million at June 30, 2012, and $82.1 million at December 31, 2011.

Note 6 - Loans

The Company makes various business and consumer loans in the normal course of business. A brief description of these types of loans is as follows:

One-to-four family residential – This portfolio primarily consists of loans secured by residential properties located in the Company’s normal lending area. These are amortizing loans with either fixed or adjustable rates for terms of 10 to 30 years, including conventional and jumbo loans. These loans generally have an original loan-to-value ratio (“LTV”) of 80% or less. Those loans with an initial LTV of more than 80% typically have private mortgage insurance to protect the Company. This type of loan has historically possessed a lower than average level of loss to the Company compared to the Company’s entire loan portfolio.

Multifamily residential – This portfolio is moderately seasoned and is generally secured by multifamily residential properties in the Company’s normal lending area. These loans generally have an initial LTV of 75% and an initial debt service coverage ratio of 1.2x to 1.0x. The Company has not experienced any significant losses in this loan portfolio over the past 24 months.

Construction – This portfolio has decreased significantly over the past several years as fewer construction loans have been made during the economic downturn. These loans are generally located in the Company’s normal lending area and were originated with an initial LTV of 80%. Approximately 57% of these loans are secured by residential properties and 43% are secured by commercial properties. The Company has not experienced any significant losses in this loan portfolio over the past 24 months.

Commercial land and residential development – These categories include raw undeveloped land and developed residential lots held by builders and developers. Generally, the initial LTV for raw land was 65% and the initial LTV for developed lots was 90%. Given the significant decline in value for both developed and undeveloped land due to reduced demand, these loan portfolios possess a much higher level of risk compared to other loan categories. These portfolios have experienced the highest level of losses for the Company over the past 24 months.

Other commercial real estate – This portfolio consists of nonresidential improved real estate which includes churches, shopping centers, office buildings, etc. These loans typically have an initial LTV of 75% and an initial debt service ratio of 1.2x to 1.0x. Approximately 43% of this portfolio is secured by owner-occupied nonresidential properties. These properties are generally located in the Company’s normal lending area. Decreased rental income due to the economic slowdown has caused some deterioration in collateral values. However, this loan portfolio has historically possessed a slightly lower than average loan loss ratio compared to the Company’s entire loan portfolio over the past 24 months.

Consumer real estate – Approximately 85% of this category includes home equity lines of credit (“HELOCs”) and approximately 15% of these loans are secured by residential lots purchased by consumers. The HELOCs generally have an adjustable rate tied to prime rate and a term of 15 years. The HELOCs initially had an LTV of up to 85%. The residential lot loans typically have a term of five years or less and were made at an initial LTV of up to 90%. Many of these properties have declined in value over the past several years. The portfolio of consumer lot loans has experienced a higher than average level of loan losses over the past 24 months. However, the portfolio of HELOCs has experienced a lower than average loan loss ratio over the past 24 months.

Commercial business – This category includes loans to small and medium-sized businesses that are not secured by real estate. These loans are typically secured by accounts receivable, inventory, equipment, etc. These loans are typically granted to local businesses that have a strong track record of profitability and performance. This category of loans incurred slightly lower than average losses for the Company over the past 24 months.

Other consumer - These loans are either unsecured or secured by automobiles, marketable securities, etc. They are generally granted to local customers that have an established banking relationship with our Bank. The loss history for this category of loans has been much lower than the Company’s historical average over the past 24 months.

The following is a summary of loans outstanding by category at the periods presented:

	June 30, 2012						December 31, 2011
	Loans Covered by FDIC Loss Share Agreements		Loans Not Covered by FDIC Loss Share Agreements		Total		Loans Covered by FDIC Loss Share Agreements		Loans Not Covered by FDIC Loss Share Agreements		Total
	(Dollars in thousands)

Real estate:
One-to-four family residential	$	29,026	$	114,321	$	143,347	$	34,641	$	116,859	$	151,500
Multifamily residential		2,882		17,074		19,956		2,926		16,759		19,685
Construction		33		27,114		27,147		1,255		19,602		20,857
Commercial land		8,782		22,885		31,667		13,670		28,122		41,792
Residential development		6,026		10,068		16,094		8,095		16,444		24,539
Owner occupied commercial real estate		17,872		116,435		134,307		20,027		95,990		116,017
Non-owner occupied commercial real estate		47,344		131,840		179,184		56,285		129,993		186,278
Consumer real estate		9,457		99,162		108,619		11,148		103,521		114,669
Total real estate		121,422		538,899		660,321		148,047		527,290		675,337
Commercial business		4,795		43,635		48,430		7,866		41,161		49,027
Other consumer		2,657		4,964		7,621		3,775		5,649		9,424
Total loans, net of deferred fees and costs	$	128,874	$	587,498		716,372	$	159,688	$	574,100		733,788
Less: Allowance for loan losses						11,735						11,713
Total loans, net					$	704,637					$	722,075

The Company, through its normal lending activity, originates substantially all of its loans to borrowers that are located in the Piedmont (central) Region of North and South Carolina and the North Georgia Region. The Company also has presold loans in process of settlement which totaled $2.1 million at June 30, 2012 and December 31, 2011. These presold loans in process of settlement were not included in the table above.

As of June 30, 2012, the Company had $128.9 million in loans covered by FDIC loss-share agreements as a result of the acquisition of loans from Bank of Hiawassee and New Horizons Bank in separate FDIC-assisted transactions (referred to as “covered loans”). The loans acquired in the Bank of Hiawassee transaction in March 2010 are covered by two loss-share agreements between the FDIC and the Bank, which afford the Bank significant protection against future loan losses. Under these loss-share agreements, the FDIC will cover 80% of net loan losses up to $102 million and 95% of net loan losses that exceed $102 million. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans and five years for losses and eight years on recoveries on nonresidential loans. At acquisition, the Bank recorded an estimated receivable from the FDIC in the amount of $36.3 million, which represented the discounted value of the FDIC’s estimated portion of the expected future loan losses. New loans made after the acquisition date are not covered by the FDIC loss-share agreements. These covered loans totaled $93.7 million at June 30, 2012.

In April 2011 the Company acquired New Horizons Bank in an FDIC-assisted transaction. As part of this transaction, the Company acquired $49.3 million in loans at fair value. Of the acquired loans, $47.4 million are covered by two loss-share agreements between the FDIC and the Bank. Under these loss-share agreements, the FDIC will cover 80% of net loan losses and qualified expenses. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans and five years for losses and eight years on recoveries on nonresidential loans. At acquisition, the Bank recorded an estimated receivable from the FDIC in the amount of $19.9 million, which represented the discounted value of the FDIC’s estimated portion of the expected future loan losses. The remaining $1.9 million in loans acquired in the New Horizons Bank transaction were not covered by FDIC loss-share agreements. As such, any losses incurred on these non-covered loans will be the sole responsibility of the Bank. New loans made after the acquisition date are not covered by the FDIC loss-share agreements. These covered loans totaled $35.2 million at June 30, 2012.

Note 7 – Credit Quality of Loans

Aging Analysis of Loans. The Company considers a loan to be past due when the terms of the contractual obligation are not met by the borrower. The following table presents an aging analysis of the Company’s loans not covered by FDIC loss-share agreements, loans covered by FDIC loss-share agreements and total loans summarizing current loans, past due loans, and nonaccrual loans by category at June 30, 2012 and December 31, 2011.

June 30, 2012	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due and Accruing		Nonaccrual		Total Past Due		Current		Total Loans		Recorded Investment 90 Days or More and Accruing
	(Dollars in thousands)

Not covered by FDIC loss-share agreements
Real estate:
One-to-four family residential	$	489	$	88	$	-	$	4,230	$	4,807	$	109,514	$	114,321	$	-
Multifamily residential		-		-		-		-		-		17,074		17,074		-
Construction		-		-		-		-		-		27,114		27,114		-
Commercial land		-		-		151		3,018		3,169		19,716		22,885		154
Residential development		-		-		-		3,000		3,000		7,068		10,068		-
Other commercial real estate		235		682		-		8,489		9,406		238,869		248,275		-
Consumer real estate		255		-		-		961		1,216		97,946		99,162		-
Total real estate		979		770		151		19,698		21,598		517,301		538,899		154
Commercial business		24		-		-		945		969		42,666		43,635		-
Other consumer		32		7		-		15		54		4,910		4,964		-
Total	$	1,035	$	777	$	151	$	20,658	$	22,621	$	564,877	$	587,498	$	154


Covered by FDIC loss-share agreements
Real estate:
One-to-four family residential	$	759	$	135	$	61	$	7,566	$	8,521	$	20,505	$	29,026	$	63
Multifamily residential		-		-		-		380		380		2,502		2,882		-
Construction		-		-		-		-		-		33		33		-
Commercial land		-		106		-		3,944		4,050		4,732		8,782		-
Residential development		-		-		-		3,759		3,759		2,267		6,026		-
Other commercial real estate		29		206		-		17,785		18,020		47,196		65,216		-
Consumer real estate		229		-		-		967		1,196		8,261		9,457		-
Total real estate		1,017		447		61		34,401		35,926		85,496		121,422		63
Commercial business		8		-		163		1,422		1,593		3,202		4,795		169
Other consumer		23		-		-		413		436		2,221		2,657		-
Total	$	1,048	$	447	$	224	$	36,236	$	37,955	$	90,919	$	128,874	$	232


Total at June 30, 2012
Real estate:
One-to-four family residential	$	1,248	$	223	$	61	$	11,796	$	13,328	$	130,019	$	143,347	$	63
Multifamily residential		-		-		-		380		380		19,576		19,956		-
Construction		-		-		-		-		-		27,147		27,147		-
Commercial land		-		106		151		6,962		7,219		24,448		31,667		154
Residential development		-		-		-		6,759		6,759		9,335		16,094		-
Other commercial real estate		264		888		-		26,274		27,426		286,065		313,491		-
Consumer real estate		484		-		-		1,928		2,412		106,207		108,619		-
Total real estate		1,996		1,217		212		54,099		57,524		602,797		660,321		217
Commercial business		32		-		163		2,367		2,562		45,868		48,430		169
Other consumer		55		7		-		428		490		7,131		7,621		-
Total	$	2,083	$	1,224	$	375	$	56,894	$	60,576	$	655,796	$	716,372	$	386

December 31, 2011	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due and Accruing		Nonaccrual		Total Past Due		Current		Total Loans		Recorded Investment 90 Days or More and Accruing
	(Dollars in thousands)

Not covered by FDIC loss-share agreements
Real estate:
One-to-four family residential	$	80	$	1,634	$	-	$	2,407	$	4,121	$	112,738	$	116,859	$	-
Multifamily residential		-		-		-		-		-		16,759		16,759		-
Construction		-		93		-		-		93		19,509		19,602		-
Commercial land		-		-		-		2,631		2,631		25,491		28,122		-
Residential development		-		-		-		6,474		6,474		9,970		16,444		-
Other commercial real estate		81		1,873		-		4,173		6,127		219,856		225,983		-
Consumer real estate		761		388		335		2,543		4,027		99,494		103,521		338
Total real estate		922		3,988		335		18,228		23,473		503,817		527,290		338
Commercial business		7		-		-		168		175		40,986		41,161		-
Other consumer		13		3		-		80		96		5,553		5,649		-
Total	$	942	$	3,991	$	335	$	18,476	$	23,744	$	550,356	$	574,100	$	338


Covered by FDIC loss-share agreements
Real estate:
One-to-four family residential	$	1,530	$	2,220	$	215	$	8,441	$	12,406	$	22,235	$	34,641	$	219
Multifamily residential		-		-		-		216		216		2,710		2,926		-
Construction		-		-		-		1,191		1,191		64		1,255		-
Commercial land		140		11		10		6,704		6,865		6,805		13,670		11
Residential development		-		-		-		4,578		4,578		3,517		8,095		-
Other commercial real estate		351		466		495		17,454		18,766		57,546		76,312		511
Consumer real estate		236		15		-		634		885		10,263		11,148		-
Total real estate		2,257		2,712		720		39,218		44,907		103,140		148,047		741
Commercial business		90		39		23		3,484		3,636		4,230		7,866		24
Other consumer		141		133		57		554		885		2,890		3,775		58
Total	$	2,488	$	2,884	$	800	$	43,256	$	49,428	$	110,260	$	159,688	$	823


Total at December 31, 2011
Real estate:
One-to-four family residential	$	1,610	$	3,854	$	215	$	10,848	$	16,527	$	134,973	$	151,500	$	219
Multifamily residential		-		-		-		216		216		19,469		19,685		-
Construction		-		93		-		1,191		1,284		19,573		20,857		-
Commercial land		140		11		10		9,335		9,496		32,296		41,792		11
Residential development		-		-		-		11,052		11,052		13,487		24,539		-
Other commercial real estate		432		2,339		495		21,627		24,893		277,402		302,295		511
Consumer real estate		997		403		335		3,177		4,912		109,757		114,669		338
Total real estate		3,179		6,700		1,055		57,446		68,380		606,957		675,337		1,079
Commercial business		97		39		23		3,652		3,811		45,216		49,027		24
Other consumer		154		136		57		634		981		8,443		9,424		58
Total	$	3,430	$	6,875	$	1,135	$	61,732	$	73,172	$	660,616	$	733,788	$	1,161

Troubled Debt Restructurings. The Company adopted the amendments in Accounting Standards Update (“ASU”) No. 2011-02 Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring, during the quarter ended September 30, 2011, and has reassessed all restructurings that occurred on or after the beginning of the 2011 fiscal year for identification as troubled debt restructurings (“TDRs”). The Company identified as TDRs certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology (ASC 450-20). Upon identifying the reassessed receivables as TDRs, the Company also identified them as impaired under the new guidance in ASC 310-10-35. The amendments in ASU No. 2011-02 require prospective application of the impairment measurement guidance in Section 310-10-35 for those receivables newly identified as impaired. At the end of the second interim period of adoption for the Company, the recorded investment in the receivables for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired under Section 310-10-35 was $1.3 million (310-40-65-1(b)), and there was no allowance for credit losses associated with those receivables, on the basis of a current evaluation of loss (310-40-65-1(b)).

The modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession to the borrowers that we would not otherwise consider. Some examples of modifications are described below:

Rate modification – A modification in which only the interest rate is changed.

Term modification – A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest only modification – A modification in which the loan is converted to interest only payments for a period of time.

Debt Reduction Modification – A modification in which a portion of the debt is reduced.

Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Transfer of Assets Modification – A modification in which a transfer of assets has occurred to partially satisfy debt, including foreclosure and repossession.

Combination Modification – Any other type of modification, including the use of multiple categories above.

The following table presents the Bank’s loans classified as TDRs by loan type as of June 30, 2012 and December 31, 2011:

	Accrual Status		Non-accrual Status		Total Contracts		Total TDRs
	(Dollars in thousands)
June 30, 2012

One-to-four family residential	$	220	$	-	$	2	$	220
Commercial land		875		678		3		1,553
Residential development		-		141		1		141
Other commercial real estate		4,450		4,936		23		9,386
Commercial business		-		885		1		885
Total	$	5,545	$	6,640	$	30	$	12,185


December 31, 2011

One-to-four family residential	$	12	$	-		1	$	12
Commercial land		195		89		2		284
Residential development		633		-		2		633
Other commercial real estate		6,955		1,159		24		8,114
Total	$	7,795	$	1,248	$	29	$	9,043

The following table presents new TDRs that were restructured during the six months ended June 30, 2012, and June 30, 2011:

	Six Months Ended June 30, 2012						Six Months Ended June 30, 2011
	Total Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Total Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
	(Dollars in thousands)

Interest only modification:
Commercial real estate		1		590		590		3		1,050		1,050
Subtotal		1	$	590	$	590		3	$	1,050	$	1,050

Term modification:
Residential real estate		1	$	208	$	208		-	$	-	$	-
Commercial business		-		-		-		3		598		598
Subtotal		1	$	208	$	208		3	$	598	$	598

Debt reduction reduction:
Commercial land		3	$	4,576	$	3,285		-	$	-	$	-
Subtotal		3	$	4,576	$	3,285		-	$	-	$	-

Total		5	$	5,374	$	4,083		6	$	1,648	$	1,648

All TDRs are not automatically placed on nonaccrual status. Generally, those TDRs that are placed on non-accrual status may return to accrual status when the borrower has sustained repayment performance in accordance with the modified terms. The number of payments needed to meet these criteria varies from loan to loan. However, as a general rule, most non-accrual loans should be able to return to accrual status after the payment of six consecutive regular scheduled payments. During the six month period ended June 30, 2012, there were no payment defaults on any TDRs. During the 12 month period ended December 31, 2011, there was one payment default on a residential TDR. The collateral for this residential loan was acquired through foreclosure and was sold during the third quarter of 2011. The loan had an original principal balance of $1.1 million and the resulting loss from disposition of the collateral was approximately $335,000.

Also, in the normal course of business, the Company will make loan restructurings or modifications to borrowers for reasons unrelated to the borrower’s financial condition. These restructurings or modifications are made based on the prevailing interest rates and terms offered to other borrowers for similar types of loans at the time of the modification. These types of debt restructurings or loan modifications would not be considered troubled debt restructurings.

Impaired Loans. The Company evaluates impairment of its non-covered residential mortgage and consumer loans on a collective basis, while non-covered commercial and construction loans are evaluated individually for impairment. The Company identifies a non-covered loan as impaired when it is probable that principal and interest will not be collected when due according to the contractual terms of the loan agreement. Principal write-downs may be recognized for individual non-covered loans that management considers impaired. The remainder of the portfolio of non-covered loans is segmented into groups of loans with similar risk characteristics for evaluation and analysis. Since all estimated impairments resulted in principal writedowns, there were no specific related allowances for the impaired loans at June 30, 2012, or December 31, 2011.

The following table details the Company’s impaired loans by type at June 30, 2012, and December 31, 2011:

	June 30, 2012								December 31, 2011
	Recorded Investment		Unpaid Principal Balance		Net Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Net Principal Balance		Related Allowance
	(Dollars in thousands)

June 30, 2012
One-to-four family residential	$	4,696	$	5,143	$	4,488	$	-	$	2,781	$	2,739	$	2,739	$	-
Commercial land		3,355		4,343		3,194		-		3,062		4,523		2,826		-
Residential development		3,679		5,427		3,472		-		8,428		10,173		8,262		-
Commercial real estate - office		7,449		8,584		7,375		-		6,322		7,573		6,305		-
Commercial real estate - residential rental		2,288		2,933		2,244		-		4,076		4,808		4,029		-
Commercial real estate - owner-occupied		2,721		3,301		2,614		-		-		-

CITIZENS SOUTH BANKING CORP 10-Q