U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                ________________

                                    FORM 10-Q

(Mark One)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

     For the quarterly period ended December 31, 2002

     OR

[ ]  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: 0-25859

                             1st STATE BANCORP, INC.
--------------------------------------------------------------------------------
             (Exact Name of Registrant as Specified in Its Charter)


          VIRGINIA                                               56-2130744
-------------------------------                             --------------------
(State or Other Jurisdiction of                              (I.R.S. Employer
 Incorporation or Organization)                              Identification No.)

445 S. MAIN STREET, BURLINGTON, NORTH CAROLINA                          27215
--------------------------------------------------------------------------------
(Address of Principal Executive Offices)                             (Zip Code)


Registrant' s Telephone Number, Including Area Code (336) 227-8861
                                                    --------------

                                       N/A
--------------------------------------------------------------------------------
               Former Name, Former Address and Former Fiscal Year,
                          if Changed Since Last Report

          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
                                             ---    ---

          As of February 10,  2003,  the issuer had  2,999,407  shares of common
stock issued and outstanding.
<PAGE>

                                    CONTENTS

                                                                            PAGE
                                                                            ----

PART I.  FINANCIAL INFORMATION
         ---------------------

Item 1.  Financial Statements

         Consolidated Balance Sheets as of December 31, 2002
             (unaudited) and September 30, 2002......................... .....1

         Consolidated Statements of Income for the Three Months Ended
             December 31, 2002 and 2001 (unaudited)...........................2

         Consolidated Statements of Stockholders' Equity and
             Comprehensive Income for the Three Months Ended December
             31, 2002 and 2001 (unaudited)....................................3

         Consolidated Statements of Cash Flows for the Three Months
             Ended December 31, 2002 and 2001 (unaudited).....................4

         Notes to Consolidated Financial Statements...........................6

Item 2.  Management's Discussion and Analysis of Financial Condition
            and Results of Operations.........................................8

Item 3.  Quantitative and Qualitative Disclosures About Market Risk..........16

Item 4. Controls and Procedures..............................................16


PART II.  OTHER INFORMATION
          -----------------

Item 1.  Legal Proceedings...................................................17

Item 2.  Changes in Securities and Use of Proceeds...........................17

Item 3.  Defaults Upon Senior Securities.....................................17

Item 4.  Submission of Matters to a Vote of Security Holders.................17

Item 5.  Other Information...................................................17

Item 6.  Exhibits and Reports on Form 8-K....................................17


SIGNATURES...................................................................18

<PAGE>

                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS

                    DECEMBER 31, 2002 AND SEPTEMBER 30, 2002

                        (IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
                                                                          AT            AT
                                                                      DECEMBER 31,   SEPTEMBER 30,
                                                                         2002             2002
                                                                      ------------   -------------
                                                                      (Unaudited)
<S>                                                                    <C>                <C>

                                      ASSETS

Cash and cash equivalents                                              $ 15,311           18,865
Investment securities:
     Held to maturity (fair value of $11,509 and $11,558
         at December 31, 2002 and September 30, 2002, respectively)      11,110           11,114
     Available for sale (cost of $75,232 and $77,213
         at December 31, 2002 and September 30, 2002, respectively)      76,278           78,572
Loans held for sale, at lower of cost or fair value                       8,429            6,798
Loans receivable (net of allowance for loan losses of $3,790
    and $3,732 at December 31, 2002 and September 30, 2002,
    respectively)                                                       219,915          220,047
Federal Home Loan Bank stock, at cost                                     1,382            1,750
Real estate owned                                                           183              183
Premises and equipment                                                    8,464            7,972
Accrued interest receivable                                               1,722            2,272
Other assets                                                              2,651            2,896
                                                                      ---------        ---------
Total assets                                                          $ 345,445          350,469
                                                                      =========        =========

                LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
  Deposit accounts                                                    $ 251,234          260,667
  Advances from Federal Home Loan Bank                                   25,000           20,000
  Advance payments by borrowers for property taxes and insurance            130               54
  Dividend payable                                                          240              241
  Other liabilities                                                       6,739            7,938
                                                                      ---------        ---------
          Total liabilities                                             283,343          288,900
                                                                      ---------        ---------

Stockholders' Equity:
   Preferred stock, $0.01 par value, 1,000,000 shares authorized;
         none issued                                                         --               --
   Common stock, $0.01 par value, 7,000,000 shares authorized;
         2,999,432 and 3,008,682 shares issued and outstanding at
         December 31, 2002 and September 30, 2002, respectively              33               33
   Additional paid-in capital                                            35,662           35,623
   Unearned ESOP shares                                                  (3,588)          (3,739)
   Deferred compensation payable in treasury stock                        5,466            5,466
   Treasury stock                                                       (12,123)         (11,899)
   Retained income - substantially restricted                            36,016           35,258
   Accumulated other comprehensive income - net unrealized
        gain on investment securities available for sale                    636              827
                                                                      ---------        ---------
        Total stockholders' equity                                       62,102           61,569
                                                                      ---------        ---------
        Total liabilities and stockholders' equity                    $ 345,445          350,469
                                                                      =========        =========
</TABLE>

See accompanying notes to the consolidated financial statements

                                       1
<PAGE>
                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                       CONSOLIDATED STATEMENTS OF INCOME

             FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001

                     (IN THOUSANDS, EXCEPT PER SHARE DATA)

                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                                               FOR THE THREE MONTHS ENDED
                                                                       DECEMBER 31,
                                                               --------------------------
                                                                 2002              2001
                                                               -------           -------
<S>                                                            <C>                 <C>
Interest income:
   Interest and fees on loans                                  $ 3,372             3,905
   Interest and dividends on investments                         1,152             1,222
   Overnight deposits                                               43                89
                                                               -------           -------
         Total interest income                                   4,567             5,216
                                                               -------           -------

Interest expense:
    Deposit accounts                                             1,291             2,094
    Borrowings                                                     276               276
                                                               -------           -------
         Total interest expense                                  1,567             2,370
                                                               -------           -------

         Net interest income                                     3,000             2,846

Provision for loan losses                                           60                60
                                                               -------           -------
         Net interest income after provision for loan losses     2,940             2,786
                                                               -------           -------

Other income:
   Service fees on loans sold                                      (15)                6
   Customer service fees                                           217               249
   Commissions from sales of annuities and mutual funds             86               122
   Mortgage banking income,  net                                   449               416
   Other                                                            56                50
                                                               -------           -------
         Total other income                                        793               843
                                                               -------           -------
Operating expenses:
   Compensation and related benefits                             1,377             1,564
   Occupancy and equipment                                         351               303
   Real estate operations, net                                       6                18
   Other expenses                                                  445               372
                                                               -------           -------
         Total operating expenses                                2,179             2,257
                                                               -------           -------
         Income before income taxes                              1,554             1,372

Income taxes                                                       571               527
                                                               -------           -------
         Net income                                            $   983               845
                                                               =======           =======
Net income per share:

         Basic                                                 $  0.35           $  0.28
         Diluted                                               $  0.33           $  0.27
</TABLE>
See accompanying notes to the consolidated financial statements.

                                       2
<PAGE>

                             1ST STATE BANCORP, INC.
    CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
        FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001 (UNAUDITED)
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                                                            DEFERRED
                                                              ADDITIONAL    UNEARNED       UNEARNED       COMPENSATION
                                                  COMMON       PAID-IN        ESOP       COMPENSATION      PAYABLE IN
                                                   STOCK       CAPITAL       SHARES           MRP        TREASURY STOCK
                                                  -------     ----------    --------     ------------    --------------
<S>                                              <C>            <C>           <C>             <C>             <C>
Balance at September 30, 2001                    $     33       35,588        (4,373)          (518)          4,173

Comprehensive income:
     Net income                                        --           --            --             --              --
     Other comprehensive loss-unrealized
       loss on securities available-for-sale,
       net of income taxes of $443                     --           --            --             --              --

Total comprehensive income
Allocation of ESOP shares                              --            8           171             --              --
Deferred compensation                                  --           --            --             --             151
Treasury stock held for deferred compensation          --           --            --             --              --
Vesting of MRP shares                                  --           --            --            194              --
Cash dividend declared                                 --           --            --             --              --
Cash dividend on unallocated ESOP shares
     and unvested MRP shares                           --           --            --             --              --
                                                 --------      -------       -------          -----          ------
Balance at December 31, 2001                     $     33       35,596        (4,202)          (324)          4,324
                                                 ========      =======       =======          =====          ======

Balance at September 30, 2002                    $     33       35,623        (3,739)            --           5,466

Comprehensive income:
     Net income                                        --           --            --             --              --
     Other comprehensive loss-unrealized
       loss on securities available-for-sale,
       net of income taxes of $122                     --           --            --             --              --

Total comprehensive income
Allocation of ESOP shares                              --           39           151             --              --
Acquisition of treasury shares                         --           --            --             --              --
Cash dividends declared                                --           --            --             --              --
Cash dividend on unallocated ESOP shares               --           --            --             --              --
                                                 --------      -------       -------          -----          ------
Balance at December 31, 2002                     $     33       35,662        (3,588)            --           5,466
                                                 ========      =======       =======          =====          ======

<CAPTION>
                                                                                     ACCUMULATED
                                                                                        OTHER           TOTAL
                                                     TREASURY         RETAINED      COMPREHENSIVE   STOCKHOLDERS'
                                                      STOCK            INCOME       INCOME (LOSS)       EQUITY
                                                     --------         --------      --------------  -------------
<S>                                                    <C>              <C>                 <C>         <C>
Balance at September 30, 2001                          (4,173)          32,404              510         63,644

Comprehensive income:
     Net income                                            --              845              --             845
     Other comprehensive loss-unrealized
       loss on securities available-for-sale,
       net of income taxes of $443                         --               --            (689)           (689)
                                                                                                       -------

Total comprehensive income                                                                                 156
Allocation of ESOP shares                                  --               --              --             179
Deferred compensation                                      --               --              --             151
Treasury stock held for deferred compensation            (151)              --              --            (151)
Vesting of MRP shares                                      --               --              --             194
Cash dividend declared                                     --             (263)             --            (263)
Cash dividend on unallocated ESOP shares
     and unvested MRP shares                               --               27              --              27
                                                     --------          -------           -----         -------
Balance at December 31, 2001                           (4,324)          33,013            (179)         63,937
                                                     ========          =======           =====         =======

Balance at September 30, 2002                         (11,899)          35,258             827          61,569

Comprehensive income:
     Net income                                            --              983              --             983
     Other comprehensive loss-unrealized
       loss on securities available-for-sale,
       net of income taxes of $122                         --               --            (191)           (191)
                                                                                                       -------

Total comprehensive income                                                                                 792
Allocation of ESOP shares                                  --               --              --             190
Acquisition of treasury shares                           (224)              --              --            (224)
Cash dividends declared                                  (240)              --              --            (240)
Cash dividend on unallocated ESOP shares                   --               15              --              15
                                                     --------          -------           -----         -------
Balance at December 31, 2002                          (12,123)          36,016             636          62,102
                                                     ========          =======           =====         =======

</TABLE>

See accompanying notes to the consolidated financial statements.

                                       3
<PAGE>
                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

              FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001

                                   (UNAUDITED)

                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                              FOR THE THREE MONTHS ENDED
                                                                                      DECEMBER 31,
                                                                              --------------------------
                                                                                2002             2001
                                                                               --------        --------
<S>                                                                            <C>                  <C>
Cash flows from operating activities:
   Net income                                                                  $    983             845
   Adjustment to reconcile net income to net cash provided by
       (used in) operating activities:
           Provision for loan losses                                                 60              60
           Depreciation                                                             178             153
           Deferred tax expense                                                      32             155
           Amortization of premiums and discounts, net                              (32)            (13)
           Deferred compensation                                                     60              92
           Release of  ESOP shares                                                  190             179
           Vesting of MRP shares and dividends on unvested MRP shares                --             260
           Loan origination fees and unearned discounts
               deferred, net of current amortization                                (15)            (54)
           Net (gain) loss on sale of loans                                         (10)            211
           Proceeds from sales of loans held for sale                            24,839          25,264
           Originations of loans held for sale                                  (26,460)        (32,948)
           Decrease in other assets                                                 335             232
           Decrease in accrued interest receivable                                  550             473
           Increase (decrease) in other liabilities                              (1,261)             15
                                                                               --------        --------
                Net cash used in operating activities                              (551)         (5,076)
                                                                               --------        --------

Cash flows from investing activities:
    Proceeds from sale of FHLB stock                                                368              --
    Purchases of investment securities available for sale                       (32,233)        (46,326)
    Purchases of investment securities held to maturity                              --          (2,454)
    Proceeds from maturities and issuer calls of investment securities
        available for sale                                                       34,250          17,231
    Proceeds from maturities and issuer calls of investment securities
        held to maturity                                                              1           3,001
    Net decrease in loans receivable                                                 87           8,315
    Purchases of premises and equipment                                            (670)            (86)
                                                                               --------        --------

                Net cash provided by (used in) investing activities               1,803         (20,319)
                                                                               --------        --------

                                                                                            (Continued)
</TABLE>

                                       4
<PAGE>

                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

              FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001

                                   (UNAUDITED)

                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                              FOR THE THREE MONTHS ENDED
                                                                                      DECEMBER 31,
                                                                              --------------------------
                                                                                2002             2001
                                                                               --------        --------
<S>                                                                            <C>            <C>
Cash flows from financing activities:
   Net (decrease)  increase in deposits                                        $ (9,433)       $  8,904
   Advances from the Federal Home Loan Bank                                       5,000           5,000
   Purchase of treasury stock                                                      (224)           (151)
   Dividends paid on common stock                                                  (225)           (236)
   Increase in advance payments by borrowers for
       property taxes and insurance                                                  76             176
                                                                               --------        --------
Net cash provided by (used in)  financing activities                             (4,806)         13,693
                                                                               --------        --------
        Net decrease in cash and cash equivalents                                (3,554)        (11,702)

Cash and cash equivalents at beginning of period                                 18,865          25,981
                                                                               --------        --------
Cash and cash equivalents at end of period                                     $ 15,311        $ 14,279
                                                                               ========        ========
Payments are shown below for the following:
       Interest                                                                $  1,583        $  2,375
                                                                               ========        ========
       Income taxes                                                            $     54        $     68
                                                                               ========        ========
Noncash activities:

     Unrealized losses on investment securities
          available for sale                                                   $   (313)       $ (1,132)
                                                                               ========        ========
     Cash dividends declared but not paid                                      $    225        $    236
                                                                               ========        ========
     Cash dividends on unallocated ESOP shares                                 $     15        $     24
                                                                               ========        ========
Transfer from loans to real estate acquired in settlement of loans             $     --        $    347
                                                                               ========        ========
</TABLE>

See accompanying notes to the consolidated financial statements.

                                       5
<PAGE>

                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

              DECEMBER 31, 2002 (UNAUDITED) AND SEPTEMBER 30, 2002

NOTE 1.  NATURE OF BUSINESS

     1st State Bancorp,  Inc. (the "Company") was incorporated under the laws of
the Commonwealth of Virginia for the purpose of becoming the holding company for
1st State Bank (the  "Bank") in  connection  with the Bank's  conversion  from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank (the  "Converted  Bank")  pursuant to its Plan of  Conversion  (the
"Stock Conversion"). Upon completion of the Stock Conversion, the Bank converted
from  a  North  Carolina-chartered  stock  savings  bank  to  a  North  Carolina
commercial bank (the "Bank Conversion"),  retaining the name 1st State Bank (the
"Commercial  Bank"),  and the Commercial Bank succeeded to all of the assets and
liabilities of the Converted Bank. The Stock  Conversion and the Bank Conversion
were  consummated  on April 23,  1999.  The common  stock of the  Company  began
trading on the Nasdaq  National  Market  System under the symbol "FSBC" on April
26, 1999.

NOTE 2.  BASIS OF PRESENTATION

     The accompanying  consolidated  financial  statements (which are unaudited,
except for the  consolidated  balance  sheet at  September  30,  2002,  which is
derived from the September 30, 2002 audited consolidated  financial  statements)
have been prepared in accordance with accounting  principles  generally accepted
in the United States of America for interim  financial  information and with the
rules and  regulations of the Securities and Exchange  Commission.  Accordingly,
they do not include all of the information and footnotes  required by accounting
principles  generally  accepted  in the United  States of America  for  complete
financial  statements.  In the opinion of management,  all adjustments  (none of
which  were  other  than  normal  recurring   accruals)  necessary  for  a  fair
presentation of the financial position and results of operations for the periods
presented have been included.

     The results of  operations  for the three month period  ended  December 31,
2002 are not  necessarily  indicative of the results of  operations  that may be
expected for the year ended  September 30, 2003. The preparation of consolidated
financial statements in accordance with accounting principles generally accepted
in the United States of America requires  management to make certain  estimates.
These amounts may be revised in future  periods  because of changes in the facts
and circumstances underlying their estimation.

     Certain amounts in the December 31, 2001 consolidated  financial statements
(which are unaudited) have been  reclassified  to conform with the  presentation
adopted  in  2002.  Such   reclassifications   did  not  change  net  income  or
stockholders' equity as previously reported.

NOTE 3.  EARNINGS PER SHARE

     For purposes of computing  basic and diluted  earnings per share,  weighted
average shares outstanding  excludes  unallocated ESOP shares that have not been
committed to be released. The deferred compensation obligation discussed in note
5 that is funded with shares of the Company's  common stock has no net impact on
the  Company's  earnings  per share  computations.  Diluted  earnings  per share
includes the potentially  dilutive effects of the Company's benefit plans. There
were no antidilutive  stock options for the three months ended December 31, 2002
and 2001. A reconciliation of the denominators of the basic and diluted earnings
per share computations is as follows:
<TABLE>
<CAPTION>
                                                         2002           2001
                                                         ----           ----

<S>                                                    <C>            <C>
Average shares issued and outstanding                  3,002,877      3,289,607
Less: Unvested MRP shares                                     --        (42,156)
Less: Unallocated ESOP shares                           (187,229)      (232,123)
                                                       ---------      ---------
Average basic shares for earnings per share            2,815,648      3,015,328

Add: Unvested MRP shares                                      --         42,156
Add: Potential common stock pursuant to stock
      option plan  (See Note 7)                          126,396         88,550
                                                       ---------      ---------
Average dilutive shares for earnings per share         2,942,044      3,146,034
                                                       =========      =========
</TABLE>

                                                                     (continued)

                                       6
<PAGE>

NOTE 4.  EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP")

     The Company  sponsors an employee stock ownership plan (the "ESOP") whereby
an aggregate  number of shares amounting to 253,050 or 8% of the stock issued in
the  conversion was purchased for future  allocation to employees.  The ESOP was
funded by an 11 year term loan from the Company in the amount of $4,899,000. The
loan is secured by the shares of stock  purchased by the ESOP.  During the three
months ended  December  31, 2002 and 2001,  7,728 and 8,696 shares of stock were
committed to be released and approximately $190,000 and $179,000 of compensation
expense was recognized, respectively.

NOTE 5.  DEFERRED COMPENSATION

     Directors  and  certain  executive  officers   participate  in  a  deferred
compensation plan, which was approved by the Board of Directors on September 24,
1997.  This plan  generally  provides  for fixed  payments  beginning  after the
participant  retires.  Each  participant is fully vested in his account  balance
under the plan. Directors may elect to defer their directors' fees and executive
officers may elect to defer 25% of their salary and 100% of bonus compensation.

     Prior to the Conversion,  amounts deferred by each participant  accumulated
interest  at a rate equal to the  highest  rate of  interest  paid on the Bank's
one-year   certificates   of  deposit.   In  connection   with  the  Conversion,
participants  in the plan were given the opportunity to  prospectively  elect to
have their  deferred  compensation  balance  earn a rate of return  equal to the
total  return of the  Company's  stock.  All  participants  elected  this option
concurrent  with the  Conversion,  so the Company  purchases its common stock to
fund this  obligation.  Refer to the Company's notes to  consolidated  financial
statements,  incorporated  by reference in the  Company's  2002 Annual Report on
Form 10-K for a discussion  of the Company's  accounting  policy with respect to
this deferred  compensation plan and the related treasury stock purchased by the
Company to fund this obligation.

     The expense  related to this plan for the three months  ended  December 31,
2002 and 2001 was $60,000 and $92,000, respectively. This expense is included in
compensation expense.

NOTE 6.  MANAGEMENT RECOGNITION PLAN

     The Company has a Management  Recognition  Plan  ("MRP")  which serves as a
means of providing existing directors and officers of the bank with an ownership
interest in the  company.  On June 6, 2000,  restricted  stock awards of 126,482
shares  were  granted.  The  shares  awarded  under  the MRP  were  issued  from
authorized but unissued shares of common stock at no cost to the recipients. The
shares vest at a rate of 33 1/3% per year with a one-third immediate vest on the
date of the grant and annually thereafter.  The Company recorded no compensation
expense  associated with the MRP during the three months ended December 31, 2002
as all shares became fully vested in June 2002. Compensation expense of $260,000
associated  with the MRP was recorded during the three months ended December 31,
2001.

NOTE 7.  STOCK OPTION AND INCENTIVE PLAN

     On June 6, 2000 the Company's  stockholders approved the 1st State Bancorp,
Inc. 2000 Stock Option and Incentive Plan (the "Plan"). The purpose of this plan
is to  advance  the  interests  of the  Company  through  providing  select  key
employees and directors of the Bank with the opportunity to acquire  shares.  By
encouraging  such stock  ownership,  the Company  seeks to  attract,  retain and
motivate  the  best   available   personnel   for   positions   of   substantial
responsibility  and to provide  incentives to the key  employees and  directors.
Under the Plan, the Company  granted  316,312  options to purchase its $0.01 par
value common  stock.  The  exercise  price per share is equal to the fair market
value per share on the date of the grant. Options granted under the Stock Option
Plan are 100% vested on the date of the grant,  and all options  expire 10 years
from the date of the grant.  As a result of the one-time  cash dividend of $5.17
paid on October 2, 2000, the exercise price for the options repriced from $18.44
to $14.71.  No options were  exercised or granted  during the three months ended
December  31,  2002  and  2001.  At  December  31,  2002,  316,312  options  are
outstanding, all of which are exercisable.

NOTE 8. MORTGAGE SERVICING RIGHTS

     The rights to service  mortgage  loans for  others  are  included  in other
assets on the consolidated balance sheet. Mortgage servicing rights ("MSRs") are
capitalized  based on the allocated cost which is determined when the underlying
loans are sold. MSRs are amortized over a period which  approximates the life of
the underlying loan as an adjustment of servicing income.  Impairment reviews of
MSRs are performed on a quarterly  basis.  As of December 31, 2002 and September
30, 2002,  MSRs totaled  $407,000 and $370,000,  respectively,  and no valuation
allowance was required.

                                       7
<PAGE>
ITEM 2. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD-LOOKING STATEMENTS

     When used in this Form 10-Q,  the words or phrases  "will  likely  result,"
"are expected to," "will continue," "is anticipated,"  "estimate,"  "project" or
similar expressions are intended to identify "forward-looking statements" within
the  meaning of the  Private  Securities  Litigation  Reform  Act of 1995.  Such
statements are subject to certain risks and  uncertainties  including changes in
economic  conditions  in our market  area,  changes in  policies  by  regulatory
agencies,  fluctuations in interest rates,  demand for loans in our market area,
and  competition  that could  cause  actual  results to differ  materially  from
historical  earnings and those  presently  anticipated or projected.  We wish to
caution you not to place undue reliance on any such forward-looking  statements,
which  speak  only as of the date made.  We wish to advise you that the  factors
listed above could affect our financial  performance  and could cause our actual
results for future periods to differ  materially from any opinions or statements
expressed with respect to future periods in any current statements.

     We do not undertake, and specifically disclaim any obligation,  to publicly
release  the result of any  revisions  which may be made to any  forward-looking
statements to reflect events or circumstances  after the date of such statements
or to reflect the occurrence of anticipated or unanticipated events.

GENERAL

     1st State Bancorp,  Inc. was formed in November 1998 and became the holding
company  for 1st State Bank on April 23,  1999.  As a result,  portions  of this
discussion  (as of dates and for periods  prior to April 23, 1999) relate to the
financial condition and results of operations of 1st State Bank.

     Our business consists  principally of attracting  deposits from the general
public and investing these funds in loans secured by  single-family  residential
and commercial real estate,  secured and unsecured commercial loans and consumer
loans. Our  profitability  depends primarily on our net interest income which is
the  difference  between  the  income  we  receive  on our loan  and  investment
securities  portfolios and our cost of funds, which consists of interest paid on
deposits  and  borrowed  funds.  Net  interest  income  also is  affected by the
relative amounts of interest-earning  assets and  interest-bearing  liabilities.
When interest-earning assets approximate or exceed interest-bearing liabilities,
any  positive  interest  rate spread will  generate  net  interest  income.  Our
profitability  also is  affected  by the  level of other  income  and  operating
expenses.  Other income consists of miscellaneous  fees related to our loans and
deposits,  mortgage  banking income and commissions  from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits, occupancy
related  expenses,   federal  deposit  insurance   premiums,   data  processing,
advertising and other expenses.

     Our operations are influenced  significantly  by local economic  conditions
and by policies of financial  institution  regulatory  authorities.  Our cost of
funds is  influenced  by interest  rates on competing  investments  and by rates
offered on similar investments by competing financial institutions in our market
area,  as well as  general  market  interest  rates.  These  factors  can  cause
fluctuations in our net interest income and other income. Lending activities are
affected  by the demand for  financing  of real estate and other types of loans,
which in turn is affected by the interest  rates at which such  financing may be
offered.  In addition,  local economic  conditions can impact the credit risk of
our loan  portfolio,  in that  local  employers  may be  required  to  eliminate
employment  positions of many of our borrowers,  and small  businesses and other
commercial  borrowers may experience a downturn in their  operating  performance
and become unable to make timely payments on their loans.  Management  evaluates
these factors in estimating its allowance for loan losses,  and changes in these
economic  conditions could result in increases or decreases to the provision for
loan losses.

     Our business emphasis has been to operate as a well-capitalized, profitable
and independent  community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of the
communities  in which we operate.  We believe  that we can be more  effective in
servicing our  customers  than many of our nonlocal  competitors  because of our
ability to quickly  and  effectively  provide  senior  management  responses  to
customer needs and inquiries.  Our ability to provide these services is enhanced
by the stability of our senior management team.

     Beginning  in the late  1980's,  we have sought to  gradually  increase the
percentage of our assets  invested in commercial  real estate loans,  commercial
loans and consumer loans, which have shorter terms and adjust more frequently to
changes in interest rates than single-family  residential  mortgage loans. These
loans  generally  carry added risk when compared to a single family  residential
mortgage loan, so we have  concurrently  increased our allowance for loan losses
as we have originated these loans.

                                       8
<PAGE>
CRITICAL ACCOUNTING POLICIES

     The Company's  significant  accounting  policies are set forth in note 1 of
the consolidated  financial  statements as of September 30, 2002 which was filed
on Form 10-K. Of these significant  accounting  policies,  the Company considers
its policy  regarding  the  allowance  for loan  losses to be its most  critical
accounting policy,  because it requires management's most subjective and complex
judgments.  In addition,  changes in economic  conditions can have a significant
impact on the  allowance  for loan losses and  therefore  the provision for loan
losses and results of operations. The Company has developed appropriate policies
and  procedures  for  assessing  the adequacy of the  allowance for loan losses,
recognizing  that this process  requires a number of  assumptions  and estimates
with respect to its loan portfolio. The Company's assessments may be impacted in
future  periods by  changes in  economic  conditions,  the impact of  regulatory
examinations,  and the discovery of information  with respect to borrowers which
is not  known to  management  at the time of the  issuance  of the  consolidated
financial statements.

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2002 AND SEPTEMBER 30, 2002

     Total  assets  decreased  by $5.0  million or 1.4% from  $350.5  million at
September 30, 2002 to $345.4  million at December 31, 2002. An increase in loans
held  for  sale was  offset  by  decreases  in cash  and  cash  equivalents  and
investment  securities.  This increase was funded by a $5.0 million  increase in
short-term  borrowings  from the  Federal  Home Loan Bank of  Atlanta.  Deposits
decreased by $9.4 million or 3.6% from $260.7  million at September  30, 2002 to
$251.2 million at December  31,2002.  This decrease  resulted from the runoff of
$10.4 million of certificates of deposits held by  municipalities as part of the
Company's asset liability strategy. This decrease in certificates of deposit was
offset partially by growth in transaction accounts.

     Cash and cash  equivalents  decreased  $3.6  million,  or 19.0%  from $18.9
million at September 30, 2002 to $15.3 million at December 31, 2002.  Because of
the decrease in the  overnight  interest  rate to 1.25% during the quarter ended
December 31, 2002,  we minimized  our  investment  in cash and cash  equivalents
during the quarter ended December 31, 2002.

     Investment  securities available for sale decreased $2.3 million from $78.6
million at September 30, 2002 to $76.3 million at December 31, 2002.  During the
quarter ended  December 31, 2002, we purchased  $32.2 million of securities  and
received  $34.3  million  in  proceeds  from  maturities  and  issuer  calls  of
investment  securities  available for sale. As market rates  remained low during
the quarter ended December 31, 2002, many of the Company's callable  investments
were called by the issuers.

     Loans  held for  sale  increased  by $1.6  million  from  $6.8  million  at
September 30, 2002 to $8.4 million at December 31, 2002. Loans  receivable,  net
decreased  $132,000 from $220.0  million at September 30, 2002 to $219.9 million
at  December  31,  2002.  The  increase  in loans  held for sale  resulted  from
increased lending activity and timing  differences in the funding of loan sales.
During the quarter our mortgage originations and prepayments continued at record
levels.  Mortgage  rates  declined to record low levels during the quarter,  and
many borrowers took  advantage of this  opportunity to refinance  their existing
mortgage loans.  Mortgage loans secured by single family dwellings  decreased by
$4.8  million  during  the  quarter  as a result of the  tremendous  refinancing
activity.  During the quarter ended December 31, 2002,  increases in commercial,
construction  and home  equity  line loans  offset  most of this  mortgage  loan
decrease.

     Stockholders'  equity increased by $533,000 from $61.6 million at September
30,  2002 to $62.1  million at  December  31,  2002 as a result of net income of
$983,000 and release of ESOP shares of $190,000.  These increases were offset by
cash dividends to stockholders declared of $225,000, purchases of treasury stock
of $224,000 and a decrease in unrealized  gain on available for sale  securities
of $191,000

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND
2001

     Net Income.  We  recorded  net income of  $983,000  for the  quarter  ended
December 31, 2002,  as compared to $845,000 for the quarter  ended  December 31,
2001, representing an increase of $138,000, or 16.0%. For the three months ended
December  31, 2002,  basic and diluted  earnings per share were $0.35 and $0.33,
respectively,  compared  to the basic  and  diluted  earnings  per share for the
quarter ended December 31, 2001 of $0.28 and $0.27,  respectively.  The increase
in net  income  resulted  primarily  from  increased  net  interest  income  and
decreased  operating  expenses  that were offset  partially by  decreased  other
income and  increased  income tax expense.  The increase in net interest  income
resulted from higher net interest  margins.  The average prime interest rate for
the quarter  ended  December  31, 2002 was 4.46%,  a decrease of 71 basis points
from 5.17% which was the average prime for the quarter ended  December 31, 2001.
The repricing of certificates of deposits  decreased the Company's cost of funds
to offset the decrease in asset yield which  resulted from the lower  prevailing
interest rates during the quarter ended December 31, 2002.

     Net Interest Income.  Net interest income,  the difference between interest
earned  on  loans  and  investments   and  interest  paid  on   interest-bearing
liabilities,  increased by $154,000 or 5.4% for the three months ended  December
31, 2002,  compared to the same quarter in the prior year. This decrease results
from a $649,000  decrease  in  interest  income that was more than offset by

                                       9
<PAGE>

the $803,000 decrease in total interest  expense.  The average net interest rate
spread  increased 43 basis points from 2.80% for the three months ended December
31, 2001 to 3.23% for the quarter ended December 31, 2002.

     Interest Income. The decrease in interest income for the three months ended
December  31,  2002 was the  result of a  decrease  of $2.2  million  in average
interest-earning  assets  compared  to the same  quarter in the prior year and a
decrease in yield on  interest-earning  assets of 75 basis points from 6.38% for
the three  months  ended  December  31, 2001 to 5.63% for the three months ended
December 31, 2002. Average investment  securities decreased $518,000 and average
interest-bearing overnight funds decreased $4.4 million for the quarter compared
to the prior year. These decreases were offset in part by an increase in average
loans  receivable of $2.7 million.  We experienced  unusually heavy  prepayments
during the quarter as borrowers took advantage of the attractive  mortgage rates
and  refinanced  existing  mortgage  loans.  The majority of the mortgage  loans
originated during the quarter were sold in the secondary market. The origination
of  commercial,  construction  and home equity  loans  during the quarter  ended
December 31, 2002 offset the decrease in first mortgage loans.

     Interest  Expense.  Interest  expense  decreased  in the three months ended
December 31, 2002 due to a decrease in average  interest-bearing  liabilities of
$3.4 million and a decrease in the cost of  interest-bearing  liabilities of 118
basis points from 3.58% for the three  months  ended  December 31, 2001 to 2.40%
for the three months ended December 31, 2002. Average interest-bearing  deposits
decreased by $3.6 million while average FHLB advances increased $218,000 for the
three months ended  December 31, 2002  compared to the same quarter in the prior
year. The decrease in average  interest-bearing  liabilities  decreased interest
expense  by  approximately  $28,000  and the  decrease  in the  average  cost of
interest-bearing   liabilities   decreased  interest  expense  by  approximately
$775,000.

     The following table presents average balances and average rates earned/paid
by the Company for the quarter  ended  December 31, 2002 compared to the quarter
ended December 31, 2001.
<TABLE>
<CAPTION>
                                                      THREE MONTHS ENDED                       THREE MONTHS ENDED
                                                       DECEMBER 31, 2002                        DECEMBER 31, 2001
                                                                           DOLLARS IN THOUSANDS
                                                 AVERAGE                   AVERAGE       AVERAGE                 AVERAGE
                                                 BALANCE      INTEREST    YIELD/COST     BALANCE    INTEREST    YIELD/COST
<S>                                                <C>         <C>          <C>          <C>         <C>          <C>
Assets:
Loans receivable (1)                               $226,969    $3,372        5.94%       $224,268    $3,905        6.96%
Investment securities (2)                            84,869     1,152        5.43          85,387     1,222        5.72
Interest-bearing overnight deposits                  12,928        43        1.33          17,288        90        2.08
                                                   --------    ------       -----        --------    ------       -----
  Total interest-earning assets (4)                 324,766     4,567        5.63         326,943     5,217        6.38
Non interest-earning assets                          19,192                                21,785
                                                   --------                              --------
  Total assets                                     $343,958                              $348,728
                                                   ========                              ========
Liabilities and stockholders' equity
Interest bearing checking                            33,712        39        0.46          30,839        40        0.52
Money market investment accounts                     21,595        58        1.08          28,732       119        1.65
Passbook and statement savings                       29,208        81        1.11          26,218       111        1.69
Certificates of deposit                             156,527     1,113        2.84         158,868     1,824        4.59
FHLB advances                                        20,272       276        5.46          20,054       276        5.50
                                                   --------    ------       -----        --------    ------       -----
  Total interest-bearing liabilities                261,314     1,567        2.40         264,711     2,370        3.58
Non interest-bearing liabilities                     20,770                                20,101
                                                   --------                              --------
  Total liabilities                                 282,084                               284,812
Stockholders' equity                                 61,874                                63,916
                                                   --------                              --------
  Total liabilities and stockholders' equity       $343,958                              $348,728
                                                   ========                              ========

Net interest income                                             3,000                                 2,847
Interest rate spread                                                        3.23%                                 2.80%
Net interest margin (3)                                                     3.69%                                 3.48%
Ratio of average interest-earning assets
to average interest-bearing liabilities                                   124.28%                               123.51%
<FN>
 ________
(1)  Includes  nonaccrual  loans and loans held for sale,  net of discounts  and
     allowance for loan losses.
(2)  Includes FHLB of Atlanta stock.
(3)  Represents  net  interest   income  divided  by  the  average   balance  of
     interest-earning assets.
(4)  Due to immateriality, the interest income and yields related to certain tax
     exempt assets have not been adjusted to reflect a fully taxable  equivalent
     yield.
</FN>
</TABLE>

                                       10
<PAGE>

     Provision for Loan Losses. We charge provisions for loan losses to earnings
to maintain the total allowance for loan losses at a level we consider  adequate
to provide for probable loan losses,  based on existing loan levels and types of
loans outstanding,  nonperforming loans, prior loss experience, general economic
conditions and other factors.  We estimate the allowance  using an allowance for
loan losses  model which takes into  considerations  all of these  factors.  Our
policies  require  the review of assets on a regular  basis,  and we assign risk
grades to loans  based on the  relative  risk of the  credit,  considering  such
factors as  repayment  experience,  value of  collateral,  guarantors,  etc. Our
credit management systems have resulted in low loss experience;  however,  there
can be no assurances that such  experience will continue.  We believe we use the
best information available to make a determination with respect to the allowance
for loan losses,  recognizing that future adjustments may be necessary depending
upon a change in economic conditions.  The provision for loan losses was $60,000
and net charge-offs  were $2,000 for the year quarter December 31, 2002 compared
with a provision  of  $60,000,  and net  charge-offs  of $84,000 for the quarter
ended December 31, 2001. Nonperforming assets at December 31, 2002 and September
30, 2002 were $4.8 million and $4.4 million,  respectively.  The majority of the
non-performing  loans resulted from two unrelated,  unique credits which are not
necessarily indicative of the credit quality of the entire portfolio.  There was
no  significant  impact on the  provision  as these  loans are well  secured  by
property and  equipment.  The provision for the quarter ended  December 31, 2002
was positively  impacted by the decrease in charge-offs  which was offset by the
shift in the loan portfolio to commercial loans which receive higher allocations
in the allowance for loan losses model. The Company made no significant  changes
to the allowance for loan losses  methodology  during the period which  impacted
the provision for loan losses.

     During the quarter ended  December 31, 2002  commercial,  construction  and
home equity  loans  continued  to increase as well as the  percentages  of these
loans to the total  portfolio.  Although  these loans normally have a relatively
short maturity  management believes that there is greater risk inherent in these
loans than the typical one-to-four family residential mortgage loan.  Therefore,
management  assigns these types of loans a higher risk weighting in the analysis
of the loan loss reserve.  The  commercial  loans that have been  originated are
loans made to businesses to either produce a product,  sell a product or provide
a service.  Many of these  loans are  asset-based  loans  which are loans  where
repayment is based  primarily on the cash flow from  operations and  secondarily
on, the liquidation of assets such as inventory and accounts receivable.

     Other Income.  Other income decreased  $50,000,  or 5.9%, from $843,000 for
the quarter ended  December 31, 2001 to $793,000 for the quarter ended  December
31, 2002.  Customer service fees decreased  $32,000,  or 12.9% from $249,000 for
the quarter ended  December 31, 2001 to $217,000 for the quarter ended  December
31, 2002. This decrease results from a shift of accounts into products that have
lower service charges.  As a result of the mortgage loan  refinancing  activity,
the heavy  loan  prepayments  caused  the  Company's  amortization  of  mortgage
servicing  rights to exceed the loan  servicing  fees  received  for the quarter
ended December 31, 2002 by $15,000 which  compares with mortgage  servicing fees
of $6,000 for the quarter ended December 31, 2001.

     Operating  Expenses.  Total  operating  expenses  were $2.2 million for the
quarter  ended  December 31, 2002, a decrease of $78,000,  or 3.5% over the $2.3
million recorded for the three months ended December 31, 2001.  Compensation and
related  benefits expense  decreased  $187,000 from $1.6 million for the quarter
ended December 31, 2001 to $1.4 million for the quarter ended December 31, 2002.
Of this decrease,  $260,000 resulted from lower MRP expense in the quarter ended
December 31, 2002.  Compensation  and related  benefits  expense for the quarter
ended  December 31, 2001 included  $260,000 of MRP expense which was not present
in 2002 as the  final  vesting  date for the MRPs  was June 6,  2002.  Partially
offsetting  this decrease was increased  personnel  expense related to increased
number of  employees  and  increased  salary and benefit  costs.  Occupancy  and
equipment  expense  increased  $48,000,  or 15.8% from  $303,000 for the quarter
ended  December  31, 2001 to $351,000 for the quarter  ended  December 31, 2002.
This increase was primarily the result of increased  depreciation  and increased
property  taxes.  Expenses  incurred in operating real estate owned were $18,000
for the three months ended  December 31, 2001 compared to expenses of $6,000 for
the quarter  ended  December 31, 2002.  Other  expenses  increased  $73,000 from
$372,000  reported in the quarter  ended  December  31, 2001 to $445,000 for the
quarter  ended   December  31,  2002.   This  increase  was  related  to  larger
expenditures  for marketing  and  advertising  expenses and expenses  related to
operating a public company.

     Income Tax Expense.  Income tax expense  increased $44,000 from tax expense
of $527,000 for the quarter ended  December 31, 2001 to $571,000 for the quarter
ended  December 31, 2002.  The  effective tax rates were 36.7% and 38.4% for the
quarters  ended  December 31, 2002 and 2001,  respectively.  The decrease in the
effective rate was primarily due to a decrease in  non-deductible  expenses over
the prior period.

COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK

     The Company is a party to financial instruments with off-balance sheet risk
including  commitments  to extend  credit  under  existing  lines of credit  and
commitments  to sell  loans.  These  instruments  involve,  to varying  degrees,
elements of credit and interest rate risk in excess of the amount  recognized in
the consolidated balance sheets.

                                       11
<PAGE>

     Off-balance  sheet financial  instruments  whose contract amounts represent
credit and interest rate risk are summarized as follows:
<TABLE>
<CAPTION>
                                                                       December 31, 2002     September 30, 2002
                                                                       -----------------     ------------------
                                                                                 (dollars in thousands)
         <S>                                                             <C>                        <C>
         Commitments to originate new loans                                3,769                      1,435
         Unfunded commitments to extend credit under existing
              equity line and commercial lines of credit                  70,316                     56,200
         Commercial letters of credit                                        300                        266
         Commitments to sell loans held for sale                          12,319                      2,157
</TABLE>

     The Company  does not have any special  purpose  entities or other  similar
forms of off-balance sheet financing arrangements.

     Commitments  to originate new loans or to extend  credit are  agreements to
lend to a customer as long as there is no violation of any condition established
in the contract.  Loan  commitments  generally expire within 30 to 45 days. Most
equity line  commitments  are for a term of 15 years,  and  commercial  lines of
credit are generally  renewable on an annual basis.  Commitments  generally have
fixed expiration dates or other termination clauses and may require payment of a
fee.  Since many of the  commitments  are expected to expire without being drawn
upon, the total  commitment  amounts do not  necessarily  represent  future cash
requirements.  The  Company  evaluates  each  customer's  creditworthiness  on a
case-by-case basis. The amounts of collateral  obtained,  if deemed necessary by
the Company upon extension of credit, is based on management's credit evaluation
of the borrower.

     Commitments  to sell loans held for sale are  agreements to sell loans to a
third party at an agreed upon price.  At December 31, 2002,  the aggregate  fair
value of these commitments exceeded the book value of the loans to be sold.


CONTRACTUAL OBLIGATIONS

As of December 31, 2002

                                          Payments due by period
                                          ----------------------
                                          (Dollars in thousands)
                         Less than
<TABLE>
<CAPTION>
                           1 year    1-3 years    4-5 years    Over 5 years    Total
                         --------    ---------    ---------    ------------   -------
<S>                      <C>          <C>            <C>         <C>          <C>
Deposits                 $214,890     26,415         9,929           --       251,234
Advances from FHLB          5,000         --            --       20,000        25,000
Lease obligations              19         38            42           47           146
                         --------     ------         -----       ------       -------
Total contractual cash
    obligations          $219,909     26,453         9,971       20,047       276,380
                         ========     ======         =====       ======       =======
</TABLE>

ASSET QUALITY

     At  December  31,  2002,  the  Company had  approximately  $4.8  million in
non-performing assets (nonaccrual loans and real estate owned) or 1.40% of total
assets. At September 30, 2002,  non-performing assets were $4.4 million or 1.25%
of total assets.  At both  December 31, 2002 and  September  30, 2002,  impaired
loans  totaled $3.7  million,  as defined by  Statement of Financial  Accounting
Standards  No. 114,  "Accounting  by Creditors  for  Impairment  of a Loan." The
impaired  loans at  December  31,  2002 and  September  30, 2002 result from two
unrelated  commercial  loan  customers,  both of which  have  loans  secured  by
commercial real estate and business assets in Alamance County.  At both December
31, 2002 and September 30, 2002,  the entire $3.7 million of the impaired  loans
are on  non-accrual  status,  and their related  reserve for loan losses totaled
$160,000.  The average  carrying value of impaired loans was $3.7 million during
the three months ended  December 31, 2002.  Interest  income of $40,000 has been
recorded on impaired  loans in the three  months ended  December  31, 2002.  The
Bank's net  chargeoffs for the three months ended December 31, 2002 were $2,000.
The Bank's  allowance  for loan losses was $3.8 million at December 31, 2002 and
$3.7 million at September 30, 2002.  As a result of our  continued  shift toward
commercial, construction, consumer and home equity loans, the recent decrease in
residential mortgage loans, the increase in non-performing loans as a percentage
of total  loans as well as the  continued  decline  in the  local  and  regional
economy, the ratio of the allowance for loan losses to total loans, net of loans
in process  and  deferred  loan fees  increased  to 1.69% at  December  31, 2002
compared to 1.67% at September 30, 2002.

                                       12
<PAGE>

     The following table presents an analysis of our nonperforming assets:
<TABLE>
<CAPTION>
                                                           At                      At                      At
                                                      December 31,            September 30,           December 31,
                                                          2002                    2002                    2001
                                                       ---------               ---------               --------
<S>                                                    <C>                     <C>                      <C>
Nonperforming loans:
Nonaccrual loans                                       $   4,659               $   4,204                $   380
Loans 90 days past due and accruing                           --                      --                      -
Restructured loans                                            --                      --                      -
                                                       ---------               ---------               --------
Total nonperforming loans                                  4,659                   4,204                    380
Other real estate                                            183                     183                  2,328
                                                       ---------               ---------               --------
Total nonperforming assets                             $   4,842               $   4,387               $  2,708
                                                       =========               =========               ========

Nonperforming loans to loans receivable, net                2.12%                   1.91%                  0.18%
Nonperforming assets as a percentage
 of loans and other real estate owned                       2.20%                   1.99%                  1.25%
Nonperforming assets to total assets                        1.40%                   1.25%                  0.77%
</TABLE>

     Regulations  require that we classify our assets on a regular basis.  There
are three classifications for problem assets: substandard, doubtful and loss. We
regularly   review  our  assets  to   determine   whether  any  assets   require
classification or  re-classification.  At December 31, 2002, we had $5.4 million
in classified  assets  consisting of $5.2 million in substandard  and loss loans
and $183,000 in real estate owned. At September 30, 2002, we had $5.1 million in
substandard  assets  consisting  of $4.9  million in loans and  $183,000 in real
estate owned.

     In addition to  regulatory  classifications,  we also  classify as "special
mention" and "watch"  assets that are currently  performing  in accordance  with
their contractual terms but may become classified or nonperforming assets in the
future. At December 31, 2002, we have identified  approximately  $1.2 million in
assets classified as special mention and $30.6 million as watch.

LIQUIDITY AND CAPITAL RESOURCES

     The Bank must meet certain liquidity requirements  established by the State
of North Carolina Office of the Commissioner of Banks (the  "Commissioner").  At
December  31, 2002,  the Bank's  liquidity  ratio  exceeded  such  requirements.
Liquidity generally refers to the Bank's ability to generate adequate amounts of
funds to meet its cash needs.  Adequate  liquidity  guarantees  that  sufficient
funds are available to meet deposit withdrawals, fund loan commitments, maintain
adequate reserve  requirements,  pay operating expenses,  provide funds for debt
service, pay dividends to stockholders and meet other general commitments.

     Our primary sources of funds are deposits,  principal and interest payments
on loans, proceeds from the sale of loans, and to a lesser extent, advances from
the FHLB of Atlanta.  While  maturities and scheduled  amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions and local competition.

     Our most liquid assets are cash and cash  equivalents.  The levels of these
assets  are  dependent  on  our  operating,  financing,  lending  and  investing
activities  during  any  given  period.  At  December  31,  2002,  cash and cash
equivalents  totaled $15.3 million. We have other sources of liquidity should we
need additional funds.  During the three months ended December 31, 2002, we sold
loans  totaling  $24.8  million.  Additional  sources of funds  include  FHLB of
Atlanta  advances.  Other  sources of  liquidity  include  loans and  investment
securities  designated  as available  for sale,  which  totaled $84.7 million at
December 31, 2002.

     We  anticipate  that we will have  sufficient  funds  available to meet our
current commitments. At December 31, 2002, we had $3.8 million in commitments to
originate  new loans,  $70.3  million in unfunded  commitments  to extend credit
under  existing  equity  lines and  commercial  lines of credit and  $300,000 in
standby letters of credit. At December 31, 2002,  certificates of deposit, which
are scheduled to mature within one year, totaled $114.0 million. We believe that
a significant portion of such deposits will remain with us.

     The FDIC requires the Bank to meet a minimum leverage  capital  requirement
of Tier I capital to assets ratio of 4%. The FDIC also requires the Bank to meet
a ratio of total capital to  risk-weighted  assets of 8%, of which 4% must be in
the form of Tier

                                       13
<PAGE>

I capital.  The Commissioner  requires the Bank at all times to maintain certain
minimum capital levels. The Bank was in compliance with all capital requirements
of the FDIC and the  Commissioner at December 31, 2002 and is deemed to be "well
capitalized."

     The Federal Reserve also mandates capital  requirements on all bank holding
companies,  including 1st State  Bancorp,  Inc. These capital  requirements  are
similar to those  imposed by the FDIC on the Bank.  At December  31,  2002,  the
Company was in compliance with the capital requirements of the Federal Reserve.

     On October 2, 2000, the Company paid a one-time  special cash  distribution
of $5.17 to its stockholders.  The distribution was made to manage the Company's
capital and enhance  shareholder  value.  Returning  capital to the stockholders
reduced the Company's  equity to asset ratio from 21.2% to 17.2%.  The Company's
equity to asset ratio at  December  31, 2002 was 18.0%.  The  Company's  capital
level is sufficient to support future growth.

     The Company has declared  cash  dividends per common share of $0.08 for the
first  quarter in fiscal  2003 and fiscal  2002.  The  Company's  ability to pay
dividends is dependent upon earnings.  The Company's  dividend  payout ratio for
the three months ended  December 31, 2002,  September  30, 2002 and December 31,
2001 was 24.2%, 26.4% and 29.6%, respectively.

ACCOUNTING ISSUES

     In July 2001, the FASB issued Statement of Financial  Accounting  Standards
No. 141 (SFAS No.  141),  "Business  Combinations",  and  Statement of Financial
Accounting  Standards  No. 142 (SFAS No. 142),  "Goodwill  and Other  Intangible
Assets".  SFAS No. 141 requires  that the purchase  method of accounting be used
for all business  combinations  initiated after June 30, 2001. SFAS No. 141 also
specifies  criteria  which  must  be met for  intangible  assets  acquired  in a
purchase  method  business  combination to be recognized and reported apart from
goodwill.  SFAS No. 142  requires  that  goodwill  and  intangible  assets  with
indefinite  useful  lives  no  longer  be  amortized,  but  instead  tested  for
impairment at least annually in accordance  with the provisions of SFAS No. 142.
SFAS No. 142 also requires  that  identifiable  intangible  assets with definite
useful lives be amortized over their respective  estimated useful lives to their
estimated  residual  values,  and reviewed for  impairment  in  accordance  with
Statement  121,  "Accounting  for the  Impairment of  Long-Lived  Assets and for
Long-Lived  Assets to Be Disposed Of". The adoption of SFAS No. 141 and SFAS No.
142 did not have a  material  effect  on the  Company's  consolidated  financial
statements  other than providing  enhanced  disclosures  for mortgage  servicing
rights. For the periods presented herein, the Company had no goodwill and had no
intangible assets related to deposit and branch purchase acquisitions.

     On October 3, 2001,  the FASB  issued  Statement  of  Financial  Accounting
Standards  No. 144,  "Accounting  for the  Impairment  or Disposal of Long-Lived
Assets" (SFAS No. 144), which addresses  financial  accounting and reporting for
the impairment or disposal of long-lived  assets.  While SFAS No. 144 supercedes
SFAS No.  121  (Accounting  for the  Impairment  of  Long-Lived  Assets  and for
Long-Lived  Assets  to Be  Disposed  Of),  it  retains  many of the  fundamental
provisions  of SFAS No. 121. SFAS No. 144 also  supersedes  the  accounting  and
reporting provisions of FASB Opinion No. 30 (Reporting the Results of Operations
-  Reporting  the  Effects  of  Disposal  of  a  Segment  of  a  Business,   and
Extraordinary,  Unusual and Infrequently  Occurring Events and Transactions) for
the disposal of a segment of a business.  However, it retains the requirement in
Opinion  No. 30 to report  separately  discontinued  operations  and extends the
reporting to a component of an entity that either has been disposed of (by sale,
abandonment,  or in a distribution to owners) or is classified as held for sale.
By  broadening  the  presentation  of  discontinued  operations  to include more
disposal  transactions,  the FASB has enhanced  management's  ability to provide
information  that  helps  financial  statement  users to assess  the  effects of
disposal  transactions on the ongoing operations of an entity. The provisions of
SFAS No. 144 are  effective  for  financial  statements  issued for fiscal years
beginning  after  December 15,  2001,  and interim  periods  within those fiscal
years.  Adoption of SFAS No. 144 did not have a material impact on the Company's
consolidated financial statements.

     In June 2002, the FASB issued Statement of Financial  Accounting  Standards
No. 146 (SFAS No. 146),  "Accounting for Costs  Associated with Exit or Disposal
Activities,"  which  addresses  financial  accounting  and  reporting  for costs
associated with exit or disposal  activities and nullifies  Emerging Issues Task
Force  (EITF)  Issue No.  94-3,  "Liability  Recognition  for  Certain  Employee
Termination  Benefits  and Other  Costs to Exit an Activity  (including  Certain
Costs Incurred in a Restructuring)."  This Statement applies to costs associated
with an exit  activity  that does not  involve  an entity  newly  acquired  in a
business  combination  or with a  disposal  activity  covered  by SFAS No.  144,
"Accounting  for the  Impairment or Disposal of Long-Lived  Assets." Those costs
include, but are not limited to, the following: a) termination benefits provided
to current  employees  that are  involuntarily  terminated  under the terms of a
benefit arrangement that, in substance, is not an ongoing benefit arrangement or
an  individual  deferred  compensation  contract  (hereinafter  referred  to  as
one-time termination  benefits),  b) costs to terminate a contract that is not a
capital lease and c) costs to consolidate facilities or relocate employees. This
Statement does not apply to costs associated with the retirement of a long-lived
asset  covered by FASB  Statement  No.  143,  "Accounting  for Asset  Retirement
Obligations."  A  liability  for a cost  associated  with an  exit  or  disposal
activity  shall be  recognized  and measured  initially at its fair value in the
period in which the  liability is incurred.  A liability  for a cost  associated
with an exit or disposal activity is incurred when the

                                       14
<PAGE>

definition of a liability is met. The provisions of this Statement are effective
for exit or disposal activities that are initiated after December 31, 2002, with
early  application  encouraged.  This  statement  will impact the Company to the
extent it engages in exit or disposal activities in future periods.

     In  September  2002,  the FASB issued  Statement  of  Financial  Accounting
Standards   No.  147  (SFAS  No.  147),   "Accounting   for  Certain   Financial
Institutions",  which  brings  all  business  combinations  involving  financial
institutions,  except mutual financial institutions, into the scope of Statement
141,  "Business  Combinations".  SFAS No. 147 requires that all  acquisitions of
financial  institutions  that  meet  the  definition  of a  business,  including
acquisitions  of part of a financial  institution  that meet the definition of a
business,  must be accounted for in accordance with SFAS No. 141 and the related
intangibles  accounted for in accordance with SFAS No. 142. SFAS No. 147 removes
such acquisitions  from the scope of Statement 72 (SFAS No. 72,  "Accounting for
Certain  Acquisitions of Banking or Thrift  Institutions",  which was adopted in
February 1983 to address  financial  institutions  acquisitions  during a period
when many of such acquisitions  involved "troubled"  institutions.  SFAS No. 147
also amends SFAS No. 144 to include in its scope long-term customer relationship
intangibles  of  financial  institutions.  SFAS No. 147 is  generally  effective
immediately and provides guidance with respect to amortization and impairment of
intangibles  recognized in connection with  acquisitions  previously  within the
scope of SFAS No. 72. Adoption of SFAS No. 147 did not impact the Company as the
Company has no goodwill and no intangible  assets  related to deposit and branch
acquisitions.

     In  November  2002,  the  FASB  issued  Interpretation  No.  45  (FIN  45),
"Guarantor's  Accounting and Disclosure  Requirements for Guarantees,  Including
Indirect  Guarantees of Indebtedness of Others",  which addresses the disclosure
to be made by a guarantor in its interim and annual  financial  statements about
its obligations under  guarantees.  FIN 45 requires the guarantor to recognize a
liability  for  the  non-contingent  component  of the  guarantee,  such  as the
obligation  to stand  ready to perform in the event  that  specified  triggering
events or conditions  occur.  The initial  measurement  of this liability is the
fair value of the guarantee at inception.  The  recognition  of the liability is
required even if it is not probable  that  payments  will be required  under the
guarantee or if the guarantee was issued with a premium  payment or as part of a
transaction with multiple events. The disclosure  requirements are effective for
interim and annual  financial  statements  ending after  December 15, 2002.  The
initial recognition and measurement  provisions are effective for all guarantees
within the scope of FIN 45 issued or  modified  after  December  31,  2002.  The
Company  issues  standby  letters  of  credit  whereby  the  Company  guarantees
performance  if a specified  triggering  event or  condition  occurs  (primarily
nonperformance  under  construction   contracts  entered  into  by  construction
customers.)  The  guarantees  generally  expire  within  one  year  and  may  be
automatically  renewed  depending  on the terms of the  guarantee.  The  maximum
potential  amount of undiscounted  future payments related to standby letters of
credit at December 31, 2002 is $300,000.  At December 31, 2002,  the Company has
recorded no  liability  for the current  carrying  amount of the  obligation  to
perform as a guarantor and no contingent liability is considered  necessary,  as
such amounts are deemed immaterial.  Substantially all standby letters of credit
are secured by real estate  and/or  guaranteed by third parties in the event the
Company had to advance funds to fulfill the guarantee.

     In December 2002, the Financial Accounting Standards Board issued Statement
of  Financial   Accounting   Standards  No.  148,   Accounting  for  Stock-Based
Compensation  -  Transition  and  Disclosure'  (SFAS 148) an  amendment  of FASB
Statement No. 123,  Accounting for Stock-Based  Compensation  (SFAS 123),  which
provides  alternative  methods of transition for a voluntary  change to the fair
value based method of  accounting  for  stock-based  employee  compensation.  In
addition,  SFAS 148 amends the  disclosure  requirements  of SFAS 123 to require
prominent  disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition  provisions of the statement are
effective for financial  statements  for fiscal years ending after  December 15,
2002  while the  disclosure  requirements  are  effective  for  interim  periods
beginning  after  December  15, 2002,  with early  application  encouraged.  The
adoption  of SFAS  148  will  require  enhanced  disclosures  for the  Company's
stock-based employee compensation plan effective January 1, 2003.

                                       15
<PAGE>
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Company  monitors whether material changes in market risk have occurred
since September 30, 2002. The Company does not believe that any material adverse
changes in market risk exposures occurred since September 30, 2002.


ITEM 4.  CONTROLS AND PROCEDURES

     (a) Within 90 days  prior to the date of this  report,  we  carried  out an
evaluation,  under the supervision and with the  participation  of our principal
executive officer and principal  financial officer,  of the effectiveness of the
design and operation of our disclosure  controls and  procedures.  Based on this
evaluation,  our principal  executive  officer and principal  financial  officer
concluded  that our  disclosure  controls and procedures are effective in timely
alerting  them to material  information  required to be included in our periodic
SEC reports.

     (b) In  addition,  there have been no  significant  changes in our internal
controls or in other  factors that could  significantly  affect  those  controls
subsequent to the date of their last evaluation.

                                       16
<PAGE>

                           PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a.) Exhibits

     99 Certification


(b.) Reports on Form 8-K.  During the  quarter  ended  December  31,  2002,  the
     registrant did not file any current reports on Form 8-K.


                                       17
<PAGE>

                                   SIGNATURES



     Pursuant to the  requirements  of the Exchange Act, the  registrant  caused
this  report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.

                                       1ST STATE BANCORP, INC.



Date:  February 14, 2003            /s/ James C. McGill
                                    --------------------------------------------
                                    James C. McGill
                                    President and Chief Executive Officer
                                    (Principal Executive Officer)



Date:  February 14, 2003            /s/ A. Christine Baker
                                    --------------------------------------------
                                    A. Christine Baker
                                    Executive Vice President
                                    Treasurer and Secretary
                                    (Principal Financial and Accounting Officer)

                                       18
<PAGE>
                                  CERTIFICATION


I, James C. McGill,  President and Chief Executive Officer of 1st State Bancorp,
Inc., certify that:

1.   I have reviewed this  quarterly  report on Form 10-Q of 1st State  Bancorp,
     Inc.;

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

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

4.   The  registrant's  other  certifying  officers  and I are  responsible  for
     establishing and maintaining disclosure controls and procedures (as defined
     in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

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

     b)   Evaluated the  effectiveness of the registrant's  disclosure  controls
          and procedures as of a date within 90 days prior to the filing date of
          this quarterly report (the "Evaluation Date"); and

     c)   Presented  in  this  quarterly   report  our  conclusions   about  the
          effectiveness  of the disclosure  controls and procedures based on our
          evaluation as of the Evaluation Date;

5.   The registrant's other certifying  officers and I have disclosed,  based on
     our most recent  evaluation,  to the  registrant's  auditors  and the audit
     committee of  registrant's  board of directors (or persons  performing  the
     equivalent function):

     a)   All  significant  deficiencies  in the design or operation of internal
          controls  which could  adversely  affect the  registrant's  ability to
          record,  process,   summarize  and  report  financial  data  and  have
          identified for the  registrant's  auditors any material  weaknesses in
          internal controls; and

     b)   Any fraud, whether or not material,  that involves management or other
          employees who have a  significant  role in the  registrant's  internal
          controls; and

6.   The  registrant's  other  certifying  officers and I have indicated in this
     quarterly report whether or not there were significant  changes in internal
     controls  or in other  factors  that could  significantly  affect  internal
     controls  subsequent to the date of our most recent  evaluation,  including
     any corrective actions with regard to significant deficiencies and material
     weaknesses.

Date:   February 14, 2003

                               By:  /s/ James C. McGill
                                    --------------------------------------------
                                    Name:  James C. McGill
                                    Title: President and Chief Executive Officer
<PAGE>
                                  CERTIFICATION


I, A. Christine Baker,  Secretary,  Treasurer and Chief Financial Officer of 1st
State Bancorp, Inc,, certify that:

1.   I have reviewed this  quarterly  report on Form 10-Q of 1st State  Bancorp,
     Inc.;

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

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

4.   The  registrant's  other  certifying  officers  and I are  responsible  for
     establishing and maintaining disclosure controls and procedures (as defined
     in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

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

     b)   Evaluated the  effectiveness of the registrant's  disclosure  controls
          and procedures as of a date within 90 days prior to the filing date of
          this quarterly report (the "Evaluation Date"); and

     c)   Presented  in  this  quarterly   report  our  conclusions   about  the
          effectiveness  of the disclosure  controls and procedures based on our
          evaluation as of the Evaluation Date;

5.   The registrant's other certifying  officers and I have disclosed,  based on
     our most recent  evaluation,  to the  registrant's  auditors  and the audit
     committee of  registrant's  board of directors (or persons  performing  the
     equivalent function):

     a)   All  significant  deficiencies  in the design or operation of internal
          controls  which could  adversely  affect the  registrant's  ability to
          record,  process,   summarize  and  report  financial  data  and  have
          identified for the  registrant's  auditors any material  weaknesses in
          internal controls; and

     b)   Any fraud, whether or not material,  that involves management or other
          employees who have a  significant  role in the  registrant's  internal
          controls; and

6.   The  registrant's  other  certifying  officers and I have indicated in this
     quarterly report whether or not there were significant  changes in internal
     controls  or in other  factors  that could  significantly  affect  internal
     controls  subsequent to the date of our most recent  evaluation,  including
     any corrective actions with regard to significant deficiencies and material
     weaknesses.

Date:   February 14, 2003

                                       By: /s/ A. Christine Baker
                                           -------------------------------------
                                           Name:  A. Christine Baker
                                           Title: Secretary, Treasurer and
                                                    Chief Financial Officer