UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D. C. 20549

                                    FORM 10-K

                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006                File Number 000-28037

                            FIRST SOUTH BANCORP, INC.
             (Exact name of Registrant as specified in its Charter)

          South Carolina                                57-1086258
(State or Other Jurisdiction of             (IRS Employer Identification Number)
 Incorporation or Organization)

        1450 John B. White, Sr., Blvd., Spartanburg, South Carolina 29306
                (Address of Principal Executive Office, Zip Code)

       Registrant's Telephone Number, Including Area Code: (864) 595-0455

        Securities Registered Pursuant to Section 12(b) of the Act: None

           Securities Registered Pursuant to Section 12(g) of the Act:
                           Common Stock, No Par Value
                                (Title of Class)

         Indicate  by check  mark if the  registrant  is a  well-known  seasoned
issuer, as defined in Rule 405 of the Securities Act. [ ] Yes   [X] No

         Indicate  by  check  mark if the  registrant  is not  required  to file
reports pursuant to Section 13 or Section 15(d) of the Act. [ ] Yes  [X] No

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
Registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days.

         Yes [X]  No [ ]

          Indicate by check mark if there is no disclosure of delinquent  filers
pursuant to Item 405 of Regulation S-K contained herein,  and no disclosure will
be contained,  to the best of  registrant's  knowledge,  in definitive  proxy or
information  statements  incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.[ ]

         Indicate by check mark whether the  registrant  is a large  accelerated
filer,  an accelerated  filer,  or a  non-accelerated  filer.  See definition of
"accelerated  filer and large  accelerated  filer" in Rule 12b-2 of the Exchange
Act. (Check one):

Large accelerated filer [ ]   Accelerated filer [ ]    Non-accelerated filer [X]

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

         The  aggregate  market value of the  Registrant's  Common Stock held by
non-affiliates  on June 30, 2006, the last business day of the Registrant's most
recently  completed second fiscal quarter,  was approximately  $35,150,089.  The
Registrant  has no  non-voting  common equity  outstanding.  For purposes of the
foregoing  calculation  only,  all  directors  and  executive  officers  of  the
Registrant have been deemed affiliates.

         As  of  February  28,  2007,   there  were  2,155,538   shares  of  the
Registrant's Common Stock, no par value, outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

(1) Portions of the Proxy  Statement for the 2007 Annual Meeting of Shareholders
to be held  June  27,  2007,  to be  filed  with  the  Securities  and  Exchange
Commission are  incorporated by reference into Part III of this Annual Report on
Form 10-K.

<PAGE>


                                Table of Contents


                                 Filing Sections
<TABLE>
<CAPTION>

<S>                                                                                                             <C>
Document.........................................................................................................1
Base.............................................................................................................1
Cover Page.......................................................................................................1

Part I
------------------------------------------------------------------------------------------------------------------
Item 1.     Business.............................................................................................4
Item 1A.    Risk Factors........................................................................................10
Item 1B.    Unresolved Staff Comments...........................................................................14
Item 2.     Properties..........................................................................................14
Item 3.     Legal Proceedings...................................................................................14
Item 4.     Submission of Matters to Vote of Security Holders...................................................14

Part II
------------------------------------------------------------------------------------------------------------------
Item 5      Market for Common Equity and Related Stockholder Matters............................................14
Item 6      Selected Consolidated Financial Data................................................................15
Item 7      Management Discussion and Analysis of Financial Condition and Results of Operations.................18
Item 7A     Quantitative and Qualitative Disclosures About Market Risk..........................................36
Item 8      Financial Statements and Supplementary Data.........................................................37
Item 9      Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................65
Item 9A.    Controls and Procedures.............................................................................65
Item 9B     Other Information...................................................................................65

Part III
------------------------------------------------------------------------------------------------------------------
Item 10      Directors and Executive Officers and Corporate Governance..........................................65
Item 11      Executive Compensation.............................................................................65
Item 12      Security Ownership of Certain Beneficial Owners and Management.....................................66
Item 13      Certain Relationships and Related Transactions and Director Deposits...............................66
Item 14      Principal Accountant Fees and Services.............................................................66
Item 15      Exhibits and Financial Statement Schedules.........................................................66
Signatures......................................................................................................68
Exhibit Index   ................................................................................................69


</TABLE>


                                       2
<PAGE>

Forward-Looking Statements

Statements  included  in this  report  which are not  historical  in nature  are
intended to be, and are hereby  identified as  "forward-looking  statements" for
purposes  of the safe  harbor  provided  by section  21E of the  Securities  and
Exchange Act of 1934, as amended. Words such as "estimate", "project", "intend",
"expect",  "believe",  "anticipate",  "plan", and similar  expressions  identify
forward looking  statements.  The Company  cautions readers that forward looking
statements,  including without  limitation,  those relating to the Company's new
offices,  future  business  prospects,  revenues,  working  capital,  liquidity,
capital  needs,  adequacy of allowance  for loan  losses,  interest  costs,  and
income,  are subject to certain risks and uncertainties  that could cause actual
results to differ from those  indicated in forward  looking  statements,  due to
several important factors herein  identified,  among others, and other risks and
factors  identified  from time to time in the  Company's  reports filed with the
Securities and Exchange Commission.  These forward-looking  statements are based
on  current   expectations,   estimates  and  projections  about  our  industry,
management's  beliefs,  and  assumptions  made by management.  Such  information
includes,  without  limitation,   discussions  as  to  estimates,  expectations,
beliefs,  plans,  strategies,  and objectives  concerning  the Company's  future
financial and operating  performance.  These  statements  are not  guarantees of
future performance and are subject to risks,  uncertainties and assumptions that
are difficult to predict,  particularly in light of the fact that the Company is
a relatively  new company  with limited  operating  history.  Therefore,  actual
results may differ from those  expressed or forecasted  in such  forward-looking
statements. The risks and uncertainties include, but are not limited to:

     o    The Company's growth and ability to maintain growth:

     o    government  monetary and fiscal  policies,  as well as legislative and
          regulatory changes:

     o    the effect of interest  rate changes on our level and  composition  of
          deposits,  loan  demand  and the  value  of our  loan  collateral  and
          securities:

     o    the effects of competition from other financial institutions operating
          in the Company's  market areas and elsewhere,  including  institutions
          operating locally, regionally, nationally and internationally:

     o    failure of assumptions  underlying the  establishment of the allowance
          for loan losses, including the value of collateral securing loans; and

     o    loss of consumer  confidence and economic  disruptions  resulting from
          terrorist activities.

     The Company undertakes no obligation to publicly update or revise any
forward-looking  statements,  whether  as a result  of new  information,  future
events or otherwise.  In light of these risks,  uncertainties,  and assumptions,
the forward-looking events discussed in this report might not occur.


                                       3
<PAGE>

Part 1

Item 1.  Description of Business.

General

         First South Bancorp,  Inc.,  (the  "Company") is a bank holding company
with no operations other than those carried on by its  wholly-owned  subsidiary,
First South Bank (the "Bank").  The Company was organized in 1999 under the laws
of South  Carolina  for the purpose of becoming a holding  company for the Bank.
The Bank conducts a general banking  business under a state charter  approved by
the South Carolina State Board of Financial Institutions (the "State Board") and
granted by the Secretary of State of South  Carolina.  The Bank was organized in
1996. The Bank conducts its activities from its main office and a branch office,
opened in 1997, in Spartanburg,  South Carolina,  a branch opened in March, 2000
in Columbia,  South Carolina,  a branch opened in July, 2003 in Bluffton,  South
Carolina,  and a loan  production  office  opened in 2006 in  Greenville,  South
Carolina.

         The Bank's business primarily consists of accepting deposits and making
loans.  The Bank seeks deposit  accounts from  households  and businesses in its
primary  market areas by offering a full range of savings  accounts,  retirement
accounts (including Individual Retirement  Accounts),  checking accounts,  money
market accounts,  and time  certificates of deposit.  It also makes  commercial,
real estate and installment loans, primarily on a secured basis, to borrowers in
and around Spartanburg,  Richland,  and Beaufort Counties in South Carolina.  In
addition, the Bank also makes other authorized  investments.  As of December 31,
2006, the Bank employed 65 persons on a full time equivalent basis.

Competition

         The Bank competes  primarily in the South Carolina city of Spartanburg,
for which the most recent market share data available is as of June 30, 2006. At
that time, in Spartanburg,  13 banks,  savings and loans, and savings banks with
43 branch  locations  competed for aggregate  deposits of  approximately  $2.245
billion.  The Bank has a city-wide  deposit  market  share of 6.82% and a market
share  rank of 8 out of the 13  competitors.  The Bank  also has a  full-service
branch  located in the city of  Columbia,  South  Carolina and  Bluffton,  South
Carolina.  The  Columbia  branch has a market  share of 1.10%,  and the Bluffton
branch has a market share of 9.51%.

         Banks generally compete with other financial  institutions  through the
savings  products and services  offered,  the pricing of services,  the level of
service provided,  the convenience and availability of services,  and the degree
of expertise  and  personal  concern  with which  services  are offered.  In the
conduct of certain  areas of its business,  the Bank  competes  with  commercial
banks, credit unions,  consumer finance companies,  insurance  companies,  money
market  mutual  funds and other  financial  institutions,  some of which are not
subject to the same degree of regulation and restriction  imposed upon the Bank.
Many of these  competitors  have  substantially  greater  resources  and lending
limits than the Bank and offer certain services,  such as international  banking
services and trust services, which the Bank does not provide.

Moreover,  most of these  competitors  have more numerous branch offices located
throughout  their market areas,  a competitive  advantage that the Bank does not
have to the same degree.

         The banking industry is significantly  affected by prevailing  economic
conditions as well as by government policies and regulations  concerning,  among
other things,  monetary and fiscal affairs,  the housing  industry and financial
institutions.  Deposits at banks are influenced by a number of economic factors,
including interest rates, competing  instruments,  levels of personal income and
savings and the extent to which interest on retirement  savings  accounts is tax
deferred.  Lending  activities  are  also  influenced  by a number  of  economic


                                       4
<PAGE>

factors,  including  demand  for  and  supply  of  housing,  conditions  in  the
construction  industry and  availability of funds.  Primary sources of funds for
lending  activities  include savings  deposits,  income from  investments,  loan
principal  repayments,   and  proceeds  from  sales  of  loans  to  conventional
participating lenders.

Employees

         As of December  31,  2006,  we had a total of 65  full-time  equivalent
employees. The employees are not represented by a collective bargaining unit. We
consider the relations with employees good.


Effect of Government Regulation

         Bank  holding  companies  and banks  are  extensively  regulated  under
federal and state law. To the extent that the  following  information  describes
statutory  and  regulatory  provisions,  it is  qualified  in  its  entirety  by
reference to such  statutes and  regulations.  Any change in  applicable  law or
regulation  may have a material  effect on the  business  of the Company and the
Bank.


General

         As a bank holding  company under the Bank Holding Company Act ("BHCA"),
the  Company  obtained  the  approval of the Board of  Governors  of the Federal
Reserve System (the "Federal Reserve") to acquire the Bank and is subject to the
regulations of the Federal Reserve. Under the BHCA, the Company's activities and
those of its subsidiary are limited to banking,  managing or controlling  banks,
furnishing  services to or performing services for its subsidiary or engaging in
any other activity which the Federal Reserve determines to be so closely related
to banking or managing or controlling  banks as to be a proper incident thereto.
The  Company  may  engage  in a  broader  range of  activities  if it  becomes a
"financial  holding company"  pursuant to the  Gramm-Leach-Bliley  Act, which is
described below under the caption  "Gramm-Leach-Bliley  Act." The BHCA prohibits
the Company  from  acquiring  direct or indirect  control of more than 5% of the
outstanding  voting stock or substantially all of the assets of any bank or from
merging or  consolidating  with  another  bank  holding  company  without  prior
approval of the Federal  Reserve.  Additionally,  the BHCA prohibits the Company
from engaging in or from  acquiring  ownership or control of more than 5% of the
outstanding voting stock of any company engaged in a non-banking business unless
such business is determined by the Federal  Reserve to be so closely  related to
banking as to be properly  incident  thereto.  The BHCA generally does not place
territorial   restrictions  on  the  activities  of  such  non-banking   related
activities.

         The Company is also subject to regulation and  supervision by the South
Carolina  State Board.  A South  Carolina bank holding  company must provide the
State  Board  with  information   with  respect  to  the  financial   condition,
operations,  management and  inter-company  relationships of the holding company
and its subsidiaries. The State Board also may require such other information as
is necessary  to keep itself  informed  about  whether the  provisions  of South
Carolina  law and the  regulations  and orders  issued  there under by the State
Board have been complied  with, and the State Board may examine any bank holding
company and its subsidiaries.

Obligations of the Company to its Subsidiary Bank

         A number of obligations  and  restrictions  are imposed on bank holding
companies  and their  depository  institution  subsidiaries  by Federal  law and
regulatory  policy that are designed to reduce  potential  loss  exposure to the
depositors of such  depository  institutions  and to the FDIC insurance funds in
the event the depository  institution  is in danger of becoming  insolvent or is
insolvent.  For example, under the policy of the Federal Reserve, a bank holding
company is required to serve as a source of financial strength to its subsidiary
depository  institutions and to commit resources to support such institutions in
circumstances  where it might not do so absent such  policy.  In  addition,  the
"cross-guarantee"  provisions of the Federal  Deposit  Insurance Act, as amended
("FDIA"),  require  insured  depository  institutions  under  common  control to
reimburse  the FDIC for any  loss  suffered  or  reasonably  anticipated  by the


                                       5
<PAGE>

Deposit  Insurance  Fund of the FDIC as a result of the  default  of a  commonly
controlled insured depository  institution or for any assistance provided by the
FDIC to a  commonly  controlled  insured  depository  institution  in  danger of
default.  The FDIC may decline to enforce the  cross-guarantee  provisions if it
determines that a waiver is in the best interest of the Deposit  Insurance Fund.
The  FDIC's  claim for  damages is  superior  to claims of  shareholders  of the
insured  depository  institution  or its holding  company but is  subordinate to
claims of depositors,  secured creditors and holders of subordinated debt (other
than affiliates) of the commonly controlled insured depository institutions.

         The FDIA also provides that amounts  received from the  liquidation  or
other resolution of any insured  depository  institution by any receiver must be
distributed (after payment of secured claims) to pay the deposit  liabilities of
the  institution  prior to payment  of any other  general  or  unsecured  senior
liability,   subordinated  liability,  general  creditor  or  shareholder.  This
provision gives depositors a preference over general and subordinated  creditors
and  shareholders  in the event a receiver is appointed to distribute the assets
of the Bank.

         Any capital  loans by a bank holding  company to any of its  subsidiary
banks are  subordinate  in right of payment  to  deposits  and to certain  other
indebtedness of such subsidiary  bank. In the event of a bank holding  company's
bankruptcy,  any  commitment  by the bank  holding  company  to a  federal  bank
regulatory  agency to maintain the capital of a subsidiary  bank will be assumed
by the bankruptcy trustee and entitled to a priority of payment.

Capital Adequacy Guidelines for Bank Holding Companies and State Banks

         The various federal bank regulators,  including the Federal Reserve and
the FDIC have adopted  risk-based and leverage capital  adequacy  guidelines for
assessing bank holding company and bank capital adequacy. These standards define
what qualifies as capital and establish minimum capital standards in relation to
assets and off-balance sheet exposures, as adjusted for credit risks.

         Failure to meet capital  guidelines could subject the Bank to a variety
of enforcement  remedies,  including the termination of deposit insurance by the
FDIC and a prohibition on the taking of brokered deposits. See "Other Safety and
Soundness Regulations - Prompt Corrective Action" below.

         The risk-based  capital standards of both the Federal Reserve Board and
the FDIC explicitly identify  concentrations of credit risk and the risk arising
from non-traditional  activities,  as well as an institution's ability to manage
these risks,  as  important  factors to be taken into account by the agencies in
assessing an institution's overall capital adequacy. The capital guidelines also
provide that an institution's exposure to a decline in the economic value of its
capital  due to changes in interest  rates be  considered  by the  agencies as a
factor in evaluating a bank's capital  adequacy.  The Federal Reserve Board also
has issued additional  capital guidelines for bank holding companies that engage
in certain trading activities.

         The Company and the Bank met all requirements to be well capitalized at
December 31, 2006.

Payment of Dividends

         The  Company is a legal  entity  separate  and  distinct  from its bank
subsidiary.  Most of the  revenues of the  Company  are  expected to result from
dividends  paid to the Company by the Bank.  There are statutory and  regulatory


                                       6
<PAGE>

requirements  applicable to the payment of dividends by the  subsidiary  bank as
well as by the  Company  to its  shareholders.  It is not  anticipated  that the
Company will pay cash dividends in the near future.

Certain Transactions by the Company with its Affiliates

         Federal  law   regulates   transactions   among  the  Company  and  its
affiliates,  including  the  amount of the  Bank's  loans to or  investments  in
non-bank  affiliates and the amount of advances to third parties  collateralized
by  securities  of an  affiliate.  Further,  a  bank  holding  company  and  its
affiliates  are  prohibited  from  engaging in certain  tie-in  arrangements  in
connection with any extension of credit, lease or sale of property or furnishing
of services.

FDIC Insurance Assessments

         The FDIC merged the Bank  Insurance  Fund and the  Savings  Association
Insurance  Fund to form the Deposit  Insurance Fund ("DIF") on March 31, 2006 in
accordance  with the  Federal  Deposit  Insurance  Reform Act of 2005.  The FDIC
maintains the DIF by assessing depository institutions an insurance premium. The
amount each institution is assessed is based upon statutory factors that include
the balance of insured  deposits  as well as the degree of risk the  institution
poses to the  insurance  fund.  The FDIC uses a risk-based  premium  system that
assesses higher rates on those  institutions that pose greater risks to the DIF.
Under the rule adopted by the FDIC in November 2006,  beginning January 1, 2007,
the FDIC will  place each  institution  in one of four risk  categories  using a
two-step  process based first on capital  ratios (the capital group  assignment)
and then on other  relevant  information  (the  supervisory  group  assignment).
Beginning  January 1, 2007,  rates will range between 5 and 43 cents per $100 in
assessable deposits.

Regulation of the Bank

         The Bank is subject to regulation  and  examination by the FDIC and the
State Board. In addition, the Bank is subject to various other state and federal
laws and regulations,  including state usury laws, laws relating to fiduciaries,
consumer  credit  laws and laws  relating  to branch  banking.  The Bank's  loan
operations  are  also  subject  to  certain  federal  consumer  credit  laws and
regulations promulgated there under, including,  but not limited to: the federal
Truth-In-Lending   Act,  governing  disclosures  of  credit  terms  to  consumer
borrowers; the Home Mortgage Disclosure Act, requiring financial institutions to
provide certain information  concerning their mortgage lending; the Equal Credit
Opportunity  Act and the Fair Housing  Act,  prohibiting  discrimination  on the
basis of  certain  prohibited  factors  in  extending  credit;  the Fair  Credit
Reporting  Act,  governing  the use  and  provision  of  information  to  credit
reporting agencies;  the Bank Secrecy Act, dealing with, among other things, the
reporting of certain  currency  transactions;  and the Fair Debt Collection Act,
governing  the manner in which  consumer  debts may be collected  by  collection
agencies.  The deposit  operations  of the Bank are also subject to the Truth in
Savings Act, requiring certain disclosures about rates paid on savings accounts;
the  Expedited  Funds  Availability  Act,  which  deals with  disclosure  of the
availability  of funds  deposited in accounts and the  collection  and return of
checks by banks;  the Right to Financial  Privacy Act,  which  imposes a duty to
maintain  certain   confidentiality   of  consumer  financial  records  and  the
Electronic  Funds Transfer Act and regulations  promulgated  there under,  which
govern  automatic   deposits  to  and  withdrawals  from  deposit  accounts  and
customers'  rights and  liabilities  arising  from the use of  automated  teller
machines and other electronic banking services.

         The  Bank  is  also  subject  to  the  requirements  of  the  Community
Reinvestment  Act (the  "CRA").  The CRA imposes on  financial  institutions  an
affirmative  and  ongoing  obligation  to meet the credit  needs of their  local
communities,  including low- and moderate-income neighborhoods,  consistent with
the safe and sound operation of those institutions. Each financial institution's
actual performance in meeting community credit needs is evaluated as part of the
examination process, and also is considered in evaluating mergers,  acquisitions
and applications to open a branch or facility.


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<PAGE>

Other Safety and Soundness Regulations

         Prompt  Corrective  Action.  The federal  banking  agencies  have broad
powers under  current  federal law to take prompt  corrective  action to resolve
problems of insured depository institutions.  The extent of these powers depends
upon whether the  institutions in question are "well  capitalized,"  "adequately
capitalized,"    "undercapitalized,"    "significantly    undercapitalized"   or
"critically undercapitalized."

         A bank that is "undercapitalized"  becomes subject to provisions of the
FDIA:   restricting  payment  of  capital  distributions  and  management  fees;
requiring the FDIC to monitor the condition of the bank; requiring submission by
the bank of a capital  restoration plan;  prohibiting the acceptance of employee
benefit plan deposits; restricting the growth of the bank's assets and requiring
prior approval of certain  expansion  proposals.  A bank that is  "significantly
undercapitalized" is also subject to restrictions on compensation paid to senior
management  of the bank,  and a bank that is  "critically  undercapitalized"  is
further subject to  restrictions on the activities of the bank and  restrictions
on payments of subordinated debt of the bank. The purpose of these provisions is
to require banks with less than adequate capital to act quickly to restore their
capital and to have the FDIC move promptly to take over banks that are unwilling
or unable to take such steps.

         Brokered Deposits.  Under current FDIC regulations,  "well capitalized"
banks may accept brokered deposits without restriction, "adequately capitalized"
banks may accept  brokered  deposits  with a waiver  from the FDIC  (subject  to
certain  restrictions on payment of rates), while  "undercapitalized"  banks may
not accept brokered  deposits.  The regulations  provide that the definitions of
"well capitalized", "adequately capitalized" and "undercapitalized" are the same
as the  definitions  adopted by the agencies to implement the prompt  corrective
action  provisions  described in the  previous  paragraph.  Management  does not
believe  that  these  regulations  will have a  material  adverse  effect on the
operations of the Bank.

Interstate Banking

         Under the Riegle-Neal  Interstate Banking and Branching  Efficiency Act
of 1994 the Company and any other  adequately  capitalized  bank holding company
located in South  Carolina can acquire a bank located in any other state,  and a
bank  holding  company  located  outside  South  Carolina  can acquire any South
Carolina-based  bank. In either  acquisition  scenario,  such  acquisitions  are
subject  to  certain deposit  percentage  limitations  and  other  restrictions.
Unless prohibited by state law, adequately  capitalized and managed bank holding
companies are permitted to consolidate  their  multistate bank operations into a
single bank subsidiary and to branch interstate  through  acquisitions.  De novo
branching  by an  out-of-state  bank is  permitted  only if the laws of the host
state  expressly  permit it. The  authorities of a bank to establish and operate
branches  within a state  continue to be subject to applicable  state  branching
laws.  South  Carolina law was amended,  effective  July 1, 1996, to permit such
interstate branching but not de novo branching by an out-of-state bank.

Gramm-Leach-Bliley Act

          The  Gramm-Leach-Bliley  Act,(the  "Act")which  makes  it  easier  for
affiliations  between banks,  securities  firms and insurance  companies to take
place,  became  effective  in  March  of 2000.  The Act  removed  Depression-era
barriers that had separated banks and securities firms, and seeks to protect the
privacy of consumers' financial information.

         Under  provisions of the  legislation  and  regulations  adopted by the
appropriate regulators, banks, securities firms and insurance companies are able
to structure new affiliations  through a holding company  structure or through a
financial subsidiary. The legislation creates a new type of bank holding company
called a "financial  holding  company" which has powers much more extensive than
those of standard holding companies.  These expanded powers include authority to
engage in "financial activities," which are activities that are (1) financial in
nature;  (2)  incidental  to  activities  that are  financial in nature;  or (3)
complementary  to a  financial  activity  and that do not  impose  a safety  and


                                       8
<PAGE>

soundness risk. Significantly,  the permitted financial activities for financial
holding  companies include authority to engage in merchant banking and insurance
activities,  including insurance portfolio investing. A bank holding company can
qualify as a financial holding company and expand the services it offers only if
all of its subsidiary depository institutions are well-managed, well-capitalized
and  have  received  a  rating  of   "satisfactory"   on  their  last  Community
Reinvestment Act examination.

         The  legislation  also  created  another  new type of  entity  called a
"financial subsidiary." A financial subsidiary may be used by a national bank or
a group of national banks to engage in many of the same activities permitted for
a financial holding company, though several of these activities,  including real
estate development or investment,  insurance or annuity underwriting,  insurance
portfolio  investing and merchant  banking,  are reserved for financial  holding
companies.  A bank's  investment  in a financial  subsidiary  affects the way in
which the bank calculates its regulatory capital, and the assets and liabilities
of financial  subsidiaries  may not be consolidated  with those of the bank. The
bank must also be certain that its risk  management  procedures  are adequate to
protect it from  financial and  operational  risks created both by itself and by
any financial subsidiary.  Further, the bank must establish policies to maintain
the separate corporate  identities of the bank and its financial  subsidiary and
to prevent each from becoming liable for the obligations of the other.

         The Act also  established  the  concept  of  "functional  supervision,"
meaning that  similar  activities  should be  regulated  by the same  regulator.
Accordingly,  the Act spells out the regulatory authority of the bank regulatory
agencies,  the  Securities  and Exchange  Commission  (SEC) and state  insurance
regulators  so that each type of activity  is  supervised  by a  regulator  with
corresponding expertise. The Federal Reserve Board is intended to be an umbrella
supervisor  with the  authority to require a bank  holding  company or financial
holding  company or any subsidiary of either to file reports as to its financial
condition,  risk management  systems,  transactions with depository  institution
subsidiaries  and  affiliates,  and compliance  with any federal law that it has
authority to enforce.

         Although the Act reaffirms that states are the regulators for insurance
activities  of  all  persons,  including   federally-chartered  banks,  the  Act
prohibits  states from preventing  depository  institutions and their affiliates
from conducting insurance activities.

         The Act also  establishes  a minimum  federal  standard  of  privacy to
protect the confidentiality of a consumer's  personal financial  information and
gives the consumer the power to choose how personal financial information may be
used by  financial  institutions.  The privacy  provisions  of the Act have been
implemented by adoption of regulations by various federal agencies.

         The Act and the  regulations  adopted  pursuant  to the Act  create new
opportunities  for the Company to offer  expanded  services to  customers in the
future,  though  the  Company  has not yet  determined  what the  nature  of the
expanded  services  might be or when the Company might find it feasible to offer
them. The Act has increased competition from larger financial  institutions that
are  currently  more  capable  than  the  Company  of  taking  advantage  of the
opportunity  to  provide a  broader  range of  services.  However,  the  Company
continues to believe that its commitment to providing high quality, personalized
service to customers will permit it to remain competitive in its market area.

Sarbanes-Oxley Act

         The  Sarbanes-Oxley  Act was  signed  into  law on July 30,  2002,  and
mandated  extensive reforms and requirements for public  companies.  The SEC has
adopted   extensive  new  regulations   pursuant  to  the  requirements  of  the
Sarbanes-Oxley  Act. The  Sarbanes-Oxley  Act and the SEC's new regulations have
increased the  Company's  cost of doing  business,  and will impact its fees for


                                       9
<PAGE>

internal  and  external  audit  services  and  legal  services,  and the law and
regulations  are  expected to continue to do so.  However,  the Company does not
believe that it will be affected by  Sarbanes-Oxley  and the new SEC regulations
in ways that are materially different or more onerous than those of other public
companies of similar size and in similar businesses.

USA Patriot Act

            In 2001, the USA Patriot Act was enacted. The Act requires financial
institutions  to  help  prevent,   detect,  and  prosecute  international  money
laundering  and  financing  of  terrorism.  The  effectiveness  of  a  financial
institution  in  combating  money  laundering  activities  is  a  factor  to  be
considered in any application submitted by a financial institution with the bank
regulatory  agencies.  Our Bank has adopted  systems and procedures  designed to
comply  with the USA  Patriot  Act and  regulations  adopted  thereunder  by the
Secretary of the Treasury.

Legislative Proposals

         Proposed  legislation which could significantly  affect the business of
banking is  introduced  in Congress  from time to time.  Management  of the Bank
cannot predict the future course of such  legislative  proposals or their impact
on the Company and the Bank should they be adopted.

Fiscal and Monetary Policy

         Banking is a business  which depends to a large extent on interest rate
differentials. In general, the difference between the interest paid by a bank on
its deposits and its other  borrowings,  and the interest  received by a bank on
its loans and  securities  holdings,  constitutes  the major portion of a bank's
earnings.  Thus, the earnings and growth of the Company and the Bank are subject
to the influence of economic  conditions  generally,  both domestic and foreign,
and also to the  monetary  and  fiscal  policies  of the  United  States and its
agencies,  particularly the Federal Reserve.  The Federal Reserve  regulates the
supply of money through various means,  including open market dealings in United
States government  securities,  the discount rate at which banks may borrow from
the Federal Reserve,  and the reserve  requirements on deposits.  The nature and
timing of any changes in such  policies  and their impact on the Company and the
Bank cannot be predicted.

Further Information

         Further  information  about the business of the Company and the Bank is
set forth in Item 6 - Management's Discussion and Analysis or Plan of Operation.

Item 1A.  Risk Factors

                                  RISK FACTORS

                          Risks Related to Our Business

         Our growth  strategy will require  future  increases in capital that we
may not be able to accomplish.

         We are required by banking  regulators  to maintain  various  ratios of
capital to assets.  As our assets grow we expect our  capital  ratios to decline
unless we can increase our earnings or raise sufficient new capital to keep pace
with asset growth.  Our ability to raise  additional  capital,  if needed,  will
depend,  among other things,  on conditions in the capital markets at that time,
which are outside our control,  and on our financial  condition and performance.


                                       10
<PAGE>

If we are unable to limit a capital ratio decline by increasing our capital,  we
will have to  restrict  our asset  growth as we approach  the  minimum  required
capital to asset ratios.

         We may be unable to successfully manage our sustained growth.

         Our future  profitability  will depend in part on our ability to manage
growth  successfully.  Our ability to manage growth  successfully will depend on
our  ability to  maintain  cost  controls  and asset  quality  while  attracting
additional loans and deposits, as well as on factors beyond our control, such as
economic conditions and interest rate trends. If we grow too quickly and are not
able to control  costs and  maintain  asset  quality,  growth  could  materially
adversely affect our financial performance.

         We depend on the services of a number of key  personnel,  and a loss of
any of those  personnel  could  disrupt  our  operations  and  result in reduced
revenues.

         We are a relationship-driven  organization.  Our growth and development
to date have  depended  in large part on the  efforts  of our senior  management
team.  These senior  officers  have primary  contact with our  customers and are
extremely important in maintaining personalized  relationships with our customer
base,  which are key aspects of our business  strategy,  and in  increasing  our
market  presence.  The  unexpected  loss of services of one or more of these key
employees  could have a material  adverse  effect on our operations and possibly
result in  reduced  revenues  if we were  unable to find  suitable  replacements
promptly.

         If our loan customers do not pay us as they have  contracted to, we may
experience losses.

         Our  principal  revenue  producing  business  is making  loans.  If our
customers do not repay the loans, we will suffer losses. Even though we maintain
an allowance for loan losses, the amount of the allowance may not be adequate to
cover the losses we  experience.  We attempt to mitigate this risk by a thorough
review of the  creditworthiness of loan customers.  Nevertheless,  there is risk
that  our  credit  evaluations  will  prove  to be  inaccurate  due  to  changed
circumstances or otherwise.

         Our business is concentrated in the Upstate area of South Carolina, and
a downturn in the economy of the area,  a decline in area real estate  values or
other events in our market area may adversely affect our business.

         Although  we have  branches  in the  center  of the state and a coastal
area, most of our business is located in the Upstate area of South Carolina.  As
a result,  our financial  condition and results of operations may be affected by
changes in the Upstate  economy.  A prolonged  period of economic  recession,  a
general  decline  in real  estate  values in our  market  area or other  adverse
economic conditions in the Upstate and South Carolina may result in decreases in
demand for our  services,  increases in nonpayment of loans and decreases in the
value of collateral  securing loans,  which could have a material adverse effect
on our business, future prospects, financial condition or results of operations.

         We face strong  competition from larger,  more established  competitors
which may adversely affect our ability to operate profitably.

         We encounter strong competition from financial  institutions  operating
in our market areas of South Carolina.  In the conduct of our business,  we also
compete with credit unions,  insurance companies,  money market mutual funds and
other financial  institutions,  some of which are not subject to the same degree
of regulation as we are. Many of these  competitors have  substantially  greater
resources  and  lending  abilities  than we have  and  offer  services,  such as
investment  banking,  trust and  international  banking  services that we do not
provide.  We believe that we have been able to, and will continue to be able to,
compete  effectively with these institutions  because of our experienced bankers
and  personalized  service,  as well as through  loan  participations  and other


                                       11
<PAGE>

strategies and techniques. However, we cannot promise that we are correct in our
belief.  If we are wrong,  our ability to operate  profitably  may be negatively
affected.

         Technological  changes  affect  our  business,  and we may  have  fewer
resources than many of our competitors to invest in technological improvements.

         The   financial   services   industry   continues   to  undergo   rapid
technological  changes  with  frequent  introductions  of new  technology-driven
products and services.  In addition to enabling financial  institutions to serve
clients better, the effective use of technology may increase  efficiency and may
enable financial institutions to reduce costs. Our future success may depend, in
part,  upon our ability to use technology to provide  products and services that
provide  convenience to customers and to create  additional  efficiencies in our
operations.  We may need to make significant  additional capital  investments in
technology in the future,  and we may not be able to  effectively  implement new
technology-driven   products  and  services.   Many  of  our  competitors   have
substantially greater resources to invest in technological improvements.

         Our  profitability and liquidity may be affected by changes in interest
rates and economic conditions.

         Our  profitability  depends upon our net interest income,  which is the
difference between interest earned on our interest-bearing assets, such as loans
and investment securities, and interest expense on interest-bearing liabilities,
such as deposits  and  borrowings.  Our net  interest  income will be  adversely
affected  if market  interest  rates  change  such that the  interest  we pay on
deposits and borrowings  increases  faster than the interest earned on loans and
investments.  Interest rates, and  consequently  our results of operations,  are
affected by general  economic  conditions  (domestic and foreign) and fiscal and
monetary policies.  Monetary and fiscal policies may materially affect the level
and direction of interest  rates.  Beginning in June 2004 through June 2006, the
Federal  Reserve  has  raised  rates 17 times  for a total  increase  of  4.25%.
Although the Federal Reserve has not increased rates since June, 2006, it may do
so again at any time.  Increases in interest rates generally decrease the market
values  of  interest-bearing  investments  and  loans  held  and  therefore  may
adversely  affect our  liquidity  and earnings.  Increased  interest  rates also
generally affect the volume of mortgage loan  originations,  the resale value of
mortgage loans  originated  for resale,  and the ability of borrowers to perform
under existing loans of all types.

                        Risks Related to Our Common Stock

         Our  common  stock has a  limited  trading  market,  which may make the
prompt execution of sale transactions difficult.

         Although  our  common  stock  may be  traded  from  time  to time on an
individual basis, no active trading market has developed and none may develop in
the  foreseeable  future.  Our  common  stock  is not  traded  on any  exchange.
Accordingly,  if you wish to sell shares you may  experience  a delay or have to
sell them at a lower price in order to sell them promptly, if at all.

         We may issue additional securities, which could affect the market price
of our common stock and dilute your ownership.

         We may issue  additional  securities to raise  additional  capital,  to
support growth, or to make acquisitions. Sales of a substantial number of shares
of our common  stock,  or the  perception  by the market  that those sales could
occur, could cause the market price of our common stock to decline or could make
it more difficult for us to raise capital through the sale of common stock or to
use our common stock in future acquisitions.

         We do not plan to pay cash dividends in the foreseeable future.

         We have never paid cash dividends and do not plan to pay cash dividends
in the  foreseeable  future.  We plan to use the funds that might  otherwise  be


                                       12
<PAGE>

available to pay  dividends to expand our business.  Declaration  and payment of
dividends are within the discretion of our board of directors.  Our bank will be
our most  likely  source of funds with which to pay cash  dividends.  Our bank's
declaration  and payment of future  dividends to us are within the discretion of
the bank's board of directors,  and are dependent  upon its earnings,  financial
condition,  its need to retain  earnings  for use in the  business and any other
pertinent  factors.  The bank's  payment of dividends is also subject to various
regulatory requirements.

         Provisions in our articles of incorporation  and South Carolina law may
discourage  or prevent  takeover  attempts,  and these  provisions  may have the
effect of reducing the market price for our stock.

         Our articles of incorporation  include several provisions that may have
the  effect  of  discouraging  or  preventing  hostile  takeover  attempts,  and
therefore  of  making  the  removal  of  incumbent  management  difficult.   The
provisions  include  staggered terms for our board of directors and requirements
that make it difficult to remove our directors. In addition,  South Carolina law
contains several provisions that may make it more difficult for a third party to
acquire  control of us without the approval of our board of  directors,  and may
make it more  difficult or expensive  for a third party to acquire a majority of
our outstanding  common stock. To the extent that these provisions are effective
in discouraging  or preventing  takeover  attempts,  they may tend to reduce the
market price for our stock.

         Our directors have significant voting power.

         Our present directors beneficially own almost 40% of our stock. Because
they own over 33 1/3%, if they vote  together,  they will be able to prevent any
merger, consolidation,  share exchange, sale of substantial assets, dissolution,
removal of directors or amendment to the articles of  incorporation  they do not
want.

         Our  common  stock  is  not  insured,  so you  could  lose  your  total
investment.

         Our  common  stock is not a  deposit  or  savings  account,  and is not
insured by the Federal  Deposit  Insurance  Corporation or any other  government
agency. Should our business fail you could lose your total investment.

                          Risks Related to Our Industry

         We are  subject  to  governmental  regulation  which  could  change and
increase our cost of doing business or have an adverse affect on our business.

         We  operate  in  a  highly  regulated   industry  and  are  subject  to
examination,  supervision  and  comprehensive  regulation by various federal and
state agencies. Our compliance with the requirements of these agencies is costly
and may limit our  growth and  restrict  certain  of our  activities,  including
payment of dividends, mergers and acquisitions,  investments, loans and interest
rates charged,  and locations of offices.  We are also subject to capitalization
guidelines  established  by federal  authorities  and our  failure to meet those
guidelines  could  result,  in an extreme  case,  in our bank's  being placed in
receivership.  We have also recently been subjected to some of the extensive and
expensive  requirements imposed on public companies by the Sarbanes-Oxley Act of
2002 and related regulations.

         The laws and  regulations  applicable  to the  banking  industry  could
change at any time,  and we cannot  predict  the impact of these  changes on our
business or profitability.  Because  government  regulation  greatly affects the
business  and  financial  results  of all  commercial  banks  and  bank  holding
companies,  our cost of compliance could adversely affect our ability to operate
profitably.

         We are  susceptible  to changes in monetary  policy and other  economic
factors which may adversely affect our ability to operate profitably.

                                       13
<PAGE>

         Changes in governmental,  economic and monetary policies may affect the
ability of our bank to attract  deposits  and make loans.  The rates of interest
payable  on  deposits  and  chargeable  on loans are  affected  by  governmental
regulation  and fiscal policy as well as by national,  state and local  economic
conditions.  All of these  matters  are  outside of our  control  and affect our
ability to operate profitably.

Item 1B. Unresolved Staff Comments

         None

Item 2.  Description of Property.

         The Bank owns the real  property  at 1450 John B.  White,  Sr.,  Blvd.,
Spartanburg,  South Carolina,  where its main offices are located. The Bank also
owns the real  property  adjacent to its main office at 1460 John B. White,  Sr.
Blvd,  Spartanburg,  South  Carolina.  A portion of this facility houses deposit
operations and the financial  services division of the Bank. The remaining space
is used for  several  tenants  and would  allow  further  expansion  of the main
office.  The  Bank  leases  the  properties  at  1035  Fernwood  Glendale  Road,
Spartanburg, South Carolina, 1333 Main Street, Columbia, South Carolina, 7 Arley
Way, Bluffton, South Carolina, and 3441 Pelham Road, Greenville, South Carolina.
All properties are believed to be well suited for the Bank's needs.

Item 3.  Legal Proceedings.

         The  Company  may  from  time  to  time be a  party  to  various  legal
proceedings  arising in the ordinary  course of business,  but management of the
Company  is not aware of any  pending or  threatened  litigation  or  unasserted
claims or assessments that are expected to result in losses,  if any, that would
be material to the Company's business and operations.

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

         No matters  were  submitted  to a vote of security  holders  during the
fourth quarter of 2006.


                                     PART II

Item 5.  Market for Common Equity and Related Stockholder Matters.

Market for Common Stock, Stockholders and Dividends

         Our common  stock  trades from time to time over the counter and trades
are reported on the OTC Bulletin  Board under the symbol  "FSBS".  The following
table shows the reported high and low bid prices of our common stock reported by
the OTC  Bulletin  Board for the  periods  shown.  The prices  reported  reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions.  The prices have been adjusted to reflect a 6 for
5 stock split declared in May 2006.

                                     Year Ended                 Year Ended
                                     December 31,              December 31,
                                        2006                      2005
                                        ----                      ----
                                   Low         High         Low          High
                                   ---         ----         ---          ----
First Quarter ..............   $   25.92    $   29.17    $   25.83    $   27.92
Second Quarter .............       25.50        27.92        22.50        29.58
Third Quarter ..............       26.05        28.75        25.83        28.33
Fourth Quarter .............       27.00        28.40        25.83        27.50


                                       14
<PAGE>

         As of  February  28,  2007,  there  were 501  holders  of record of the
Company's common stock,  excluding individual  participants in security position
listings.

         The  Company  has never paid any cash  dividends,  and to  support  its
continued  capital  growth,  does not expect to pay cash  dividends  in the near
future.  The dividend  policy of the Company is subject to the discretion of the
Board of  Directors  and depends upon a number of factors,  including  earnings,
financial  condition,  cash needs and general  business  conditions,  as well as
applicable regulatory  considerations.  At present, the Company's only source of
funds with which it could pay  dividends  is  dividend  payments  from the Bank.
South Carolina  banking  regulations  restrict the amount of cash dividends that
can  be  paid  to  shareholders,  and  all  of  the  Bank's  cash  dividends  to
shareholders   are  subject  to  the  prior   approval  of  the  South  Carolina
Commissioner of Banking.

Securities Authorized for Issuance under Equity Compensation Plans

         The information  required by Item 201(d) of Regulation S-K is set forth
in Item 12 of this Form 10-K.

Recent Sales of Unregistered Securities

         During  2006,  the  Company  did not issue any  unregistered  shares of
common stock pursuant to the Company's stock option plan.

 Purchases of Equity Securities by the Company and Affiliated Purchasers

         Neither  the Company nor any  "affiliated  purchaser"  as defined in 17
C.F.R.  240.10b-18(a)(3)  purchased  any  shares  or units  of any  class of the
Company's  equity  securities  that is registered  pursuant to Section 12 of the
Exchange Act during the fourth  quarter of 2005.  Accordingly,  no disclosure is
required pursuant to 17 C.F.R. 228.703.

Item 6. Selected Consolidated Financial Data.

         The selected consolidated financial data presented below should be read
in conjunction with management's  discussion and analysis of financial condition
and  results  of  operations,  and the  consolidated  financial  statements  and
footnotes  thereto,  of the Company at December 31, 2006 and 2005, and the three
year period ended December 31, 2006, presented elsewhere herein.

                                       15
<PAGE>

                Selected Consolidated Financial Data

                            December 31

<TABLE>
<CAPTION>
(Dollars in thousands except for per share data)                 2006          2005            2004           2003           2002
                                                                 ----          ----            ----           ----           ----
SUMMARY OF OPERATIONS:
<S>                                                         <C>            <C>            <C>            <C>            <C>
Total interest income ...................................   $    27,784    $    20,810    $    15,311    $    12,884    $    10,208
Total interest expense ..................................       (13,133)        (8,141)        (5,208)        (4,410)        (4,353)
                                                            -----------    -----------    -----------    -----------    -----------
Net interest income .....................................        14,651         12,669         10,103          8,474          5,855
Provision for loan losses ...............................          (950)          (561)          (706)          (949)          (675)
                                                            -----------    -----------    -----------    -----------    -----------
Net interest income after provision for loan losses .....        13,701         12,108          9,397          7,525          5,180
Noninterest income ......................................         1,203            915          1,189          1,254            860
Noninterest expenses ....................................        (7,716)        (7,701)        (5,930)        (5,549)        (3,826)
                                                            -----------    -----------    -----------    -----------    -----------
Income before income taxes ..............................         7,188          5,322          4,656          3,230          2,214
Income taxes ............................................        (2,607)        (1,922)        (1,656)        (1,126)          (795)
                                                            -----------    -----------    -----------    -----------    -----------
Net income ..............................................   $     4,581    $     3,400    $     3,000    $     2,104    $     1,419
                                                            ===========    ===========    ===========    ===========    ===========
PER COMMON SHARE DATA:*
Earnings per share ......................................   $      2.16    $      1.64    $      1.56    $      1.27    $      0.86
Diluted earnings per share ..............................   $      2.11    $      1.58    $      1.47    $      1.21    $      0.83
Book value per share ....................................   $     16.68    $     14.70    $     13.30    $      9.89    $      8.66
Actual shares outstanding ...............................     2,155,538      2,100,497      2,018,952      1,658,412      1,657,692
Weighted average shares outstanding .....................     2,120,320      2,071,014      1,929,030      1,658,066      1,657,035
Diluted weighted average shares outstanding .............     2,172,756      2,156,662      2,046,686      1,733,478      1,711,665

BALANCE SHEET DATA:
Assets ..................................................   $   353,423    $   324,732    $   296,430    $   251,721    $   184,964
Total loans, net ........................................       293,190        265,033        251,155        224,169        156,978
Total deposits ..........................................       308,057        265,725        247,875        215,456        155,698
Retail repurchase agreements ............................         2,171          5,740          4,700          6,089          3,230
Other borrowed funds ....................................           287         15,298         10,417         12,236         10,455
Subordinated debt .......................................         5,155          5,155          5,155              -              -
Capital .................................................        35,955         30,871         26,844         16,409         14,350
Average total assets ....................................       346,922        310,537        276,322        225,840        172,288
Average loans, net ......................................       284,649        254,914        236,264        192,800        139,716
Average interest earning assets .........................       334,271        298,052        264,983        215,374        165,111
Average deposits ........................................       295,595        259,124        231,462        193,048        141,296
Average interest bearing deposits .......................       280,738        241,674        210,625        177,002        128,345
Average interest bearing liabilities ....................       295,688        261,618        231,450        192,577        144,508
Average shareholders' equity ............................        33,684         28,961         22,490         15,363         13,714
</TABLE>

* Adjusted for stock splits

                                       16
<PAGE>

           Selected Consolidated Financial Data - continued

                             December 31
<TABLE>
<CAPTION>

(Dollars in thousands except per share data)                                        2006      2005      2004      2003       2002
                                                                                    ----      ----      ----      ----       ----
SELECTED FINANCIAL RATIOS:
<S>                                                                               <C>       <C>       <C>       <C>       <C>
Return on average assets ........................................................   1.32%     1.09%     1.08%     0.93%      0.82%
Return on average equity ........................................................  13.60%    11.73%    13.33%    13.70%     10.35%
Dividend payout .................................................................   0.00%     0.00%     0.00%     0.00%      0.00%
Efficiency (1) ..................................................................  48.67%    56.69%    52.52%    57.04%     56.98%
Net interest margin (2) .........................................................   4.38%     4.25%     3.81%     3.93%      3.55%
Net interest spread (3) .........................................................   3.87%     3.87%     3.52%     3.69%      3.17%

CAPITAL RATIOS:
Tier 1 leverage ratio ...........................................................  11.73%    11.13%    10.68%     6.47%      7.57%
Risk-based capital ratios:
     Tier 1 .....................................................................  13.72%    11.49%    12.75%     7.33%      8.94%
     Total ......................................................................  14.79%    14.72%    13.92%     8.49%     10.04%
Average equity to average assets ................................................   9.71%     9.32%     8.14%     6.80%      7.96%

ASSET QUALITY RATIOS:
Net charge-offs during period to average loans outstanding during period ........   0.23%     0.17%     0.16%     0.05%      0.27%
Allowance for loan losses to loans at end of period .............................   1.10%     1.11%     1.14%     1.14%      1.10%
Allowance for loan losses as a percentage of non-performing loans ............... 176.64%   153.80%   828.57%   881.36%   1562.50%
Non-performing assets to total assets ...........................................   0.80%     0.76%     0.29%     0.12%      0.40%

OTHER DATA:
Banking locations ...............................................................      5         4         4         4          3
Full-time equivalent employees ..................................................     65        58        59        52         41
</TABLE>
(1)  Efficiency ratio is non-interest expense divided by the sum of net interest
     income before the provision for loan losses plus non-interest income.
(2)  Net interest margin is net interest income divided by total average earning
     assets.
(3)  Net interest spread is the difference  between the average yield on earning
     assets and the average yield on average interest bearing liabilities.

Quarterly Financial Information

         The  following  table sets forth,  for the periods  indicated,  certain
consolidated quarterly financial  information.  This information is derived from
our unaudited financial  statements which include, in the opinion of management,
all normal recurring adjustments which management considers necessary for a fair
presentation  of the results for such  periods.  The sum of the four quarters of
earnings  per share  might not equal the total  earnings  per share for the full
year due to rounding.  This  information  should be read in conjunction with our
consolidated  financial  statements and the notes thereto included  elsewhere in
this  document.  The results for any quarter are not  necessarily  indicative of
results  for  future  periods.  Historical  earnings  per  share  data have been
adjusted to reflect the Company's 2006 six for five stock split.


                                       17
<PAGE>

                             Selected Quarterly Data

<TABLE>
<CAPTION>
                                                                 2006                                        2005
                                                                 ----                                        ----
                                                  4Q        3Q          2Q        1Q          4Q         3Q          2Q         1Q
                                               -------    -------    -------    -------    -------    -------    -------    -------
(Dollars in thousands except
 for per share data)
<S>                                            <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>
Interest income ............................   $ 7,180    $ 7,081    $ 6,914    $ 6,609    $ 5,824    $ 5,317    $ 4,994    $ 4,675
Interest expense ...........................    (3,639)    (3,490)    (3,210)    (2,794)    (2,399)    (2,069)    (1,943)    (1,730)
                                               -------    -------    -------    -------    -------    -------    -------    -------
Net interest income ........................     3,541      3,591      3,704      3,815      3,425      3,248      3,051      2,945
Provision for loan losses ..................      (379)       (29)      (227)      (315)      (143)         5       (136)      (287)
                                               -------    -------    -------    -------    -------    -------    -------    -------
Net interest income after provision
 for loan losses ...........................     3,162      3,562      3,477      3,500      3,282      3,253      2,915      2,658
Noninterest income .........................       171        322        546        164        305        172        221        217
Noninterest expense ........................    (1,957)    (1,990)    (2,004)    (1,765)    (1,519)    (1,503)    (3,177)    (1,502)
                                               -------    -------    -------    -------    -------    -------    -------    -------
Income before income taxes .................     1,376      1,894      2,019      1,899      2,068      1,922        (41)     1,373
Income taxe expense ........................      (511)      (682)      (729)      (685)      (773)      (677)        27       (499)
                                               -------    -------    -------    -------    -------    -------    -------    -------
Net income .................................   $   865    $ 1,212    $ 1,290    $ 1,214    $ 1,295    $ 1,245    $   (14)   $   874
                                               -------    -------    -------    -------    -------    -------    -------    -------
Basic per share earnings ...................   $  0.41    $  0.57    $  0.61    $  0.58    $  0.62    $  0.62    $ (0.01)   $  0.43
Diluted earnings per share .................   $  0.40    $  0.56    $  0.59    $  0.56    $  0.60    $  0.60    $ (0.01)   $  0.41
</TABLE>

Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

            Some of the  statements  in this report  constitute  forward-looking
statements,  within the meaning of the Private Securities  Litigation Reform Act
of 1995 and the Securities Exchange Act of 1934. These statements are related to
future events, other future financial  performance or business  strategies,  and
include  statements  containing  terminology  such as "may",  "will",  "should",
"expects",   "scheduled",    "plans",   "intends",   "believes",    "estimates",
"potential",  "continue",  or the  negative  of such  terms or other  comparable
terminology.  Actual  events or results may differ  materially  from the results
anticipated  in these  forward-looking  statements  due to a variety of factors,
including,  without  limitation:  the  effects  of future  economic  conditions,
governmental monetary and fiscal policies, as well as legislative and regulatory
changes, the risks of changes in interest rates and the level and composition of
deposits,  loan demand,  and the values of loan  collateral,  and the effects of
competition from other commercial banks,  thrifts,  consumer finance  companies,
and other financial institutions operating in our market area and elsewhere. All
forward-looking  statements  attributable to our Company are expressly qualified
in their  entirety by these  cautionary  statements.  We disclaim  any intent or
obligation to update these  forward-looking  statements,  whether as a result of
new information,  future events, or otherwise. There is no assurance that future
results, levels of activity, performance, or goals will be achieved.

            Our discussion  and analysis of earnings and related  financial data
are  presented  herein  to  assist  investors  in  understanding  the  financial
condition  of our  Company at  December  31,  2006 and 2005,  and the results of
operations for the years ended December 31, 2006, 2005 and 2004. This discussion
should be read in conjunction with consolidated financial statements and related
footnotes of our Company presented  elsewhere herein.  Historical per share data
has been adjusted to reflect our May 2006 six for five stock split.

Critical Accounting Policies

         The Company has adopted  various  accounting  policies which govern the
application of accounting  principles generally accepted in the United States of
America  in  the  preparation  of  the  Company's  financial   statements.   The
significant accounting policies of the Company are described in the footnotes to
the consolidated financial statements.


                                       18
<PAGE>

         Certain   accounting   policies  involve   significant   judgments  and
assumptions by management, which have a material impact on the carrying value of
certain assets and liabilities. Management considers such accounting policies to
be  critical  accounting  policies.   The  judgments  and  assumptions  used  by
management  are based on  historical  experience  and other  factors,  which are
believed to be reasonable under the circumstances.  Because of the nature of the
judgments and assumptions  made by management,  actual results could differ from
those  judgments  and  estimates,  which  could  have a  material  impact on the
carrying  values of assets and  liabilities and the results of operations of the
Company.

         The  Company  believes  the  allowance  for loan  losses is a  critical
accounting  policy that  requires the most  significant  judgments and estimates
used in  preparation  of its  consolidated  financial  statements.  Refer to the
section  "Allowance  for  Loan  Losses"  for  a  description  of  the  Company's
estimation and methodology related to the allowance for loan losses.

Earnings Performance

         The Company had net income from  operations for the year ended December
31, 2006, of $4,580,804, or $2.16 per share, compared to net income for the year
ended December 31, 2005, of $3,400,004,  or $1.64 per common share.  The Company
had net interest  income (the  difference  between  interest  earned on interest
earning assets and interest paid on interest bearing liabilities) of $14,651,358
for 2006,  as  compared to  $12,669,012  for 2005.  The  Company  also had other
operating  income  (principally  service  charges,   fees  and  commissions)  of
$1,202,378  in 2006 and  $915,445 in 2005.  The Company  provided  $949,930  and
$561,086 to its  allowance for loan losses in 2006 and 2005,  respectively,  and
had other ordinary  operating  expenses  (principally  salaries and benefits and
occupancy and equipment expenses) of $7,716,002 in 2006, and $7,701,067 in 2005.
The Company also recorded in 2005 an  out-of-the-ordinary  expense of $1,677,155
resulting from the mediated settlement of a legal complaint filed in May 2002.

         The Company had net income from  operations for the year ended December
31, 2005, of $3,400,004, or $1.64 per share, compared to net income for the year
ended December 31, 2004, of $3,000,055,  or $1.56 per share. The Company had net
interest income (the  difference  between  interest  earned on interest  earning
assets and interest paid on interest  bearing  liabilities)  of $12,669,012  for
2005, as compared to $10,102,590  for 2004. The Company also had other operating
income (principally  service charges,  fees and commissions) of $915,445 in 2005
and  $1,189,247  in 2004.  The Company  provided  $561,086  and  $705,522 to its
allowance for loan losses in 2005 and 2004,  respectively.  In 2005, the Company
had other ordinary  operating  expenses  (principally  salaries and benefits and
occupancy  and  equipment  expenses) of  $6,023,912,  excluding  the  $1,677,155
mediated  settlement  expense  of the legal  complaint  filed in May  2002,  and
$5,930,260 in 2004.

Net Interest Income

         Net  interest  income is the  amount  of  interest  earned on  interest
earning assets (loans, investment securities, interest-bearing deposits in other
banks and federal funds sold),  less the interest  expenses incurred on interest
bearing  liabilities  (interest bearing deposits and borrowed money), and is the
principal source of the Company's  earnings.  Net interest income is affected by
the level of  interest  rates,  volume and mix of  interest  earning  assets and
interest bearing liabilities, and the relative funding of these assets.

         For  the  year  ended  December  31,  2006,  net  interest  income  was
$14,651,358.  During the year ended December 31, 2005,  net interest  income was
$12,669,012.  The 15.6% increase in net interest income in 2006 can be primarily
attributed to the 177 basis point  increase in the average prime rate during the
year. The extent of the Company's asset sensitivity (a balance sheet position in
which earning assets reprice more frequently than interest-bearing  liabilities)
in the rising interest rate environment of 2006 contributed significantly to the
increase in net interest income.  The increase in average earning assets in 2006
of   $36,219,000,   especially   as   compared   to  the   increase  in  average


                                       19
<PAGE>

interest-bearing  liabilities during the same period of $34,070,000,  was also a
significant contributor to the increase in net interest income. The net interest
margin  increased 13 basis points to 4.38% in 2006 from 4.25% in 2005, while the
changes in the mix of earning  assets and  interest-bearing  liabilities in 2006
resulted in the interest rate spread  recorded in 2006 being the same as that of
2005, 3.87%.

         For  the  year  ended  December  31,  2005,  net  interest  income  was
$12,669,012.  During the year ended December 31, 2004,  net interest  income was
$10,102,590.  The 25.4% increase in net interest income in 2005 can be primarily
attributed to the 200 basis point  increase in the average prime rate during the
year. The extent of the Company's asset sensitivity (a balance sheet position in
which earning assets reprice more frequently than interest-bearing  liabilities)
in the rising interest rate environment of 2005 contributed significantly to the
increase in net interest income.  The increase in average earning assets in 2005
of  $33.1   million,   especially   as  compared  to  the  increase  in  average
interest-bearing liabilities during the same period of $30.7 million, was also a
significant  contributor  to the  increase  in net  interest  income.  Those two
factors served as the primary basis for the  improvement of the interest  spread
between the earning assets yield and the interest -bearing  liabilities  funding
cost of 35 basis points,  from 3.52% in 2004 to 3.87% in 2005,  and the increase
in the net interest  margin of 44 basis  points,  from 3.81% in 2004 to 4.25% in
2005.

           The table "Average  Balances,  Yields and Rates," provides a detailed
analysis of the effective yields and rates on the categories of interest earning
assets and interest  bearing  liabilities for the years ended December 31, 2006,
2005, and 2004.


                                       20
<PAGE>

                       Average Balances, Yields, and Rates
                             (Dollars in Thousands)
                             Year Ended December 31,

<TABLE>
<CAPTION>
                                                             2006                         2005                        2004
                                                             ----                         ----                        ----
                                                           Interest                     Interest                    Interest
                                               Average     Income/  Yields/ Average     Income/ Yields/ Average     Income/  Yields/
                                               Balances(1) Expense  Rates   Balances(1) Expense Rates   Balances(1) Expense  Rates
                                               ----------- -------  -----   ----------- ------- -----   ----------- -------  -----
Assets

<S>                                             <C>        <C>       <C>    <C>         <C>        <C>     <C>        <C>      <C>
Due From banks - Interest-bearing ............  $ 12,320   $   606   4.92%  $ 15,705    $   506    3.22%   $  9,266   $   137  1.48%
Investment securities (2) ....................    34,064     1,607   4.72%    24,398        932    3.82%     16,759       598  3.57%
Loans (3) (4) ................................   287,887    25,571   8.88%   257,949     19,372    7.51%    238,958    14,576  6.10%
                                                --------   -------          --------    -------            --------   -------
Total interest earning assets ................  $334,271   $27,784   8.31%  $298,052    $20,810    6.98%   $264,983   $15,311  5.78%
Cash and due from banks ......................     5,282                       5,555                          4,715
Valuation reserve for investment securities ..      (325)                       (150)                            27
Allowance for loan losses ....................    (3,238)                     (3,035)                        (2,694)
Premises and equipment .......................     5,381                       5,268                          5,369
Investment in Trust ..........................       155                         155                            142
Other assets .................................     5,396                       4,692                          3,780
                                                --------                    --------                       --------
Total assets .................................  $346,922                    $310,537                       $276,322
                                                ========                    ========                       ========
Liabilities and shareholders' equity
Interest bearing transaction accounts ........  $ 31,047   $ 1,096   3.53%  $ 38,481    $   976    2.54%   $  33,917      586  1.73%
Savings ......................................    54,225     2,392   4.41%    49,612      1,276    2.57%      47,889      845  1.76%
Time deposits $100,000 and over ..............    67,998     3,108   4.57%    44,868      1,505    3.35%      35,525      850  2.39%
Other time deposits ..........................   127,468     5,684   4.46%   108,713      3,487    3.21%      93,294    2,218  2.38%
                                                --------   -------          --------    -------            --------   -------
Total interest bearing deposits ..............  $280,738   $12,280   4.37%  $241,674    $ 7,244    3.00%   $ 210,625    4,499  2.14%
Retail repurchase agreements .................     4,120       173   4.20%     4,706        127    2.70%       5,156       47  0.91%
Subordinated debt ............................     5,000       402   8.04%     5,000        311    6.22%       4,583      201  4.39%
Other Borrowed Funds - Long Term .............     4,178       190   4.55%    10,000        452    4.52%      10,000      461  4.61%
Other Borrowed Funds - Short Term ............     1,652        88   5.33%       238          7    2.94%         543        9  1.66%
                                                --------   -------          --------    -------            --------   -------
Total interest bearing liabilities ...........  $295,688   $13,133   4.44%  $261,618    $ 8,141    3.11%   $ 230,907    5,217  2.26%
                                                           -------                      -------                       -------
Non-interest bearing demand deposits .........    14,857                      17,450                          20,837
Other liabilities ............................     2,693                       2,508                           2,088
Shareholders' equity .........................    33,684                      28,961                          22,490
                                                --------                    --------                       ---------
Total liabilities and  shareholders' equity ..  $346,922                    $310,537                       $ 276,322
                                                ========                    ========                       =========
Interest rate spread (5) .....................                       3.87%                         3.87%                       3.53%
Net interest income and net yield
 on earning  assets (6) ......................             $14,651   4.38%              $12,669    4.25%              $10,094  3.81%
                                                           =======                      =======                       =======
Interest free funds supporting
 earning assets (7) ..........................  $ 38,583                    $ 36,434                       $  34,076

</TABLE>
(1)  Average balances are computed on a daily basis.
(2)  Average investment securities include $123 Tax Exempt Securities
(3)  Nonaccruing  loans are included in the average loan  balances and income on
     such loans is  recognized  on a cash basis and excludes  impact of deferred
     loan origination fees.
(4)  Interest income on loans for 2006, 2005, and 2004, included total loan fees
     of $1,073, $1,039, and $993, respectively.
(5)  Total  interest  earning  assets  yield  less the  total  interest  bearing
     liabilities rate.
(6)  Net interest income divided by total interest  earning assets (net interest
     margin).
(7)  Total interest earning assets less total interest bearing liabilities.


                                       21
<PAGE>

Rate/Volume Analysis of Net Interest Income

         The  effect  of  changes  in  average  balances  (volume)  and rates on
interest  income,  interest  expense and net  interest  income,  for the periods
indicated,  is shown below.  The effect of a change in average  balance has been
determined  by applying the average rate in the earlier  period to the change in
average balance in the later period,  as compared with the earlier  period.  The
effect of a change in the  average  rate has been  determined  by  applying  the
average  balance in the later  period to the change in the  average  rate in the
later  period,  as compared  with the earlier  period.  Changes  resulting  from
average balance/rate variances are included in changes resulting from volume.

<TABLE>
<CAPTION>
                                                         Year Ended December 31,                     Year Ended December 31,
                                                          2006 compared to 2005                       2005 compared to 2004
                                                  Increase (Decrease) Due to Volume/Rate      Increase (Decrease) Due to Volume/Rate
                                                          (Dollars in thousands)                     (Dollars in thousands)

                                                    Volume          Rate          Total         Volume          Rate          Total
                                                    ------          ----          -----         ------          ----          -----
Interest earned on:
<S>                                                <C>            <C>           <C>            <C>            <C>           <C>
  Due from banks-interest-bearing ..........       $  (109)       $   209       $   100        $    95        $   274       $   369
  Investments ..............................           369            306           675            272             62           334
  Net Loans ................................         2,249          3,950         6,199          1,159          3,637         4,796
                                                   -------        -------       -------        -------        -------       -------

Total Interest Income ......................       $ 2,509        $ 4,465       $ 6,974        $ 1,526        $ 3,973       $ 5,499
                                                   -------        -------       -------        -------        -------       -------

Interest paid on:
  Interest Checking ........................       $  (188)       $   308       $   120        $    79        $   311       $   390
  Savings Deposits .........................           998            118         1,116             30            401           431
  Time Deposits $100,000 and over ..........           774            829         1,603            224            431           655
  Other time deposits ......................         1,594            603         2,197            366            903         1,269
  Retail Repurchase Agreements .............           (16)            62            46             (4)            84            80
  Investment in Trust ......................             -             91            91             18             92           110
  Other Borrowed Funds .....................          (198)            17          (181)           (13)             2           (11)
                                                   -------        -------       -------        -------        -------       -------

Total Interest Expense .....................       $ 2,964        $ 2,028       $ 4,992        $   700        $ 2,224       $ 2,924
                                                   -------        -------       -------        -------        -------       -------

Change in Net Interest Income ..............       $  (455)       $ 2,437       $ 1,982        $   826        $ 1,749       $ 2,575
                                                   =======        =======       =======        =======        =======       =======
</TABLE>


                                       22
<PAGE>

During the year 2007  management  expects that interest rates will remain fairly
stable for the first half of the year with moderate declines in the second half.
If interest rate  projections  are accurate,  little,  if any improvement in net
interest income is expected in 2007.

Market Risk - Interest Rate Sensitivity

         Market risk is the risk of loss from adverse  changes in market  prices
and rates.  Our market risk arises  principally from interest rate risk inherent
in our lending,  deposit and borrowing activities.  Management actively monitors
and manages its  interest  rate risk  exposure.  Although we manage other risks,
such as credit  quality and  liquidity  risk in the normal  course of  business,
management  considers  interest rate risk to be our most significant market risk
and  this  risk  could  potentially  have the  largest  material  effect  on our
financial  condition and results of operations.  Other types of market risk such
as foreign  currency  exchange  risk and  commodity  price risk do not affect us
directly.

         Achieving  consistent growth in net interest income is the primary goal
of our asset/liability function. We attempt to control the mix and maturities of
assets and  liabilities  to achieve  consistent  growth in net  interest  income
despite  changes in market interest rates. We seek to accomplish this goal while
maintaining   adequate  liquidity  and  capital.   Our  asset/liability  mix  is
sufficiently  balanced  so that the effect of  interest  rates  moving in either
direction is not expected to be material over time.

         Interest rate  sensitivity  management is concerned with the timing and
magnitude of repricing  assets  compared to liabilities and is an important part
of asset/liability  management. It is the objective of interest rate sensitivity
management to generate stable growth in net interest income,  and to control the
risks  associated  with interest rate movement.  Management  constantly  reviews
interest rate risk exposure and the expected  interest rate  environment so that
timely adjustments in interest rate sensitivity can be made.

         The  table,  "Interest  Sensitivity  Analysis",  indicates  that,  on a
cumulative basis through twelve months,  rate sensitive  liabilities exceed rate
sensitive assets,  resulting in a liability  sensitive  position at December 31,
2006 of $21.8  million  for a  cumulative  gap  ratio of  92.3%.  When  interest
sensitive assets exceed interest sensitive  liabilities for a specific repricing
"horizon", a positive interest sensitivity gap results. The gap is negative when
interest sensitive liabilities exceed interest sensitive assets, as was the case
at December 31, 2006, with respect to the one year time horizon. For a bank with
a negative gap, such as the Bank,  falling  interest  rates would be expected to
have a positive effect on net interest income and rising rates would be expected
to have the opposite effect.

         The table below  reflects the balances of interest  earning  assets and
interest  bearing  liabilities  at the  earlier of their  repricing  or maturity
dates.  Amounts  of fixed  rate  loans are  reflected  at the  earlier  of their
contractual  maturity  date or the  date at  which  the  loans  may be  repriced
contractually.  Time  deposits in other  banks are  reflected  in the  deposits'
maturity dates.  Repurchase agreements and other borrowed funds are reflected in
the earliest  contractual  repricing  interval due to the immediately  available
nature  of  these  funds.  Interest  bearing  liabilities  with  no  contractual
maturity,  such as interest bearing  transaction  accounts and savings deposits,
are reflected in the earliest repricing interval due to contractual arrangements
which give  management the  opportunity to vary the rates paid on these deposits
within a thirty day or shorter period.  However, the Bank is under no obligation
to vary the rates paid on those  deposits  within any given  period.  Fixed rate
time  deposits are reflected at their  contractual  maturity  dates.  Fixed rate
advances are reflected at their  contractual  maturity dates,  and variable rate
advances  are  reflected  in the  earliest  repricing  interval  since they were
borrowed under the daily rate credit option, and reprice daily.


                                       23
<PAGE>

                          Interest Sensitivity Analysis
                   Repricing Schedule as of December 31, 2006
                             (Amounts in thousands)

<TABLE>
<CAPTION>
                                                              Within     After 3 to 12    After One Year      After
Interest Earning Assets                                      3 Months       Months        to Five Years     Five Years        Total
-----------------------                                      --------       ------        -------------     ----------        -----

<S>                                                        <C>             <C>              <C>             <C>            <C>
Interest-bearing deposits in other banks ............      $  10,688       $       -        $       -       $       -      $  10,688
Other investments (Book Value)* .....................          1,162           5,597           10,493          16,104         33,356
Loans**
  Fixed rate ........................................          5,642           7,541           48,027             670         61,880
  Variable rate .....................................        233,343               -                -               -        233,343
                                                           ---------       ---------        ---------       --------       ---------

Total interest earning assets .......................      $ 250,835       $  13,138        $  58,520       $  16,774      $ 339,267
                                                           =========       =========        =========       =========      =========

Interest Bearing Liabilities
----------------------------
  Interest bearing deposits
    Interest bearing transaction accounts ...........      $  28,764       $       -        $       -       $       -      $  28,764
    Savings .........................................         62,129               -                -               -         62,129
    Time deposits $100,000 and over .................         33,333          36,600            4,546               -         74,479
    Other time deposits .............................         46,854          70,614            9,204               -        126,672
                                                           ---------       ---------        ---------       --------       ---------
      Total interest bearing deposits ...............        171,080         107,214           13,750               -        292,044
    Retail repurchase agreements ....................          2,171               -                -               -          2,171
    Subordinated debt ...............................          5,000               -                -               -          5,000
    Other borrowed funds ............................            287               -                -               -            287
                                                           ---------       ---------        ---------       --------       ---------

Total interest bearing liabilities ..................      $ 178,538       $ 107,214        $  13,750       $       -      $ 299,502
                                                           =========       =========        =========       ========       =========


Interest Sensitivity Gap ............................      $  72,297       ($ 94,076)       $  44,770       $  16,774      $  39,765
Cumulative interest sensitivity gap .................      $  72,297       ($ 21,779)       $  22,991       $  39,765
Gap ratio ...........................................        140.05%           12.20%          425.60%              -
Cumulative gap ratio ................................        140.05%           92.30%          107.70%          113.3%
</TABLE>

*includes restricted FHLB stock $741
** excludes loans in non-accrual status totaling $1,757

Provision for Loan Losses

         The allowance for loan losses,  established  through charges to expense
in the form of a provision for loan losses,  allows for loan losses  inherent in
the Bank's loan  portfolio.  Loan losses or  recoveries  are charged or credited
directly to the  allowance.  The level of the  allowance  for loan losses at any
given reportable  period is the result of applying the methodology  discussed in
the section  under the heading  "Allowance  for Loan  Losses." The Bank provided
$949,930,  $561,086,  and  $705,522  to the  allowance  during  the years  ended
December 31, 2006, 2005, and 2004 respectively. The increase of $388,844 in 2006
was  due to loan  growth,  primarily  the  result  of  establishing  a new  loan
production office and buying back participated  loans. Total loans grew by $28.4
million in 2006 and $13.8 million in 2005.

                                       24
<PAGE>

Other Income

         Other income,  which consists  primarily of mortgage banking loan fees,
loan brokerage fees, service charges on deposit accounts,  and other commissions
and fees income,  increased by $286,933,  or 31.3%,  to  $1,202,378 in 2006 from
$915,445 in 2005.  The overall  increase  resulted from an increase in all Other
Income  categories.  Service  charges,  commissions and fees income increased by
$87,796, or 13.5%, loan brokerage fees increased by $120,117, or 73.9%, mortgage
loan fees  increased  by $962,  or 1.9%.  The  remainder  of the total  $286,933
increase,  $78,058,  was due  primarily  to the  difference  between the amounts
received in 2006 and 2005 from the sale of bank owned assets.

         Other income decreased by $273,802,  or 23.0%, in 2005 to $915,445 from
$1,189,247  in 2004.  The overall  decline  resulted from a decline in all Other
Income  categories.  Service  charges,  commissions  and fees income declined by
$42,241,  or 6.1%,  loan  brokerage  fees  declined  by $77,722,  or 32.2%,  and
mortgage  loan fees  declined by $76,697,  or 60.0%.  The remainder of the total
$273,802 decline,  $77,142, was due almost exclusively to the difference between
the amounts received in 2005 and 2004 from the sale of bank owned assets.

Other Expenses

         Excluding the impact of the out-of-the ordinary  litigation  settlement
expense in 2005 of $1,677,155,  other expense,  those non-interest expenses most
commonly  referred to as other  operating  expenses,  increased  $1,692,090,  or
28.1%. With several  categories of non-interest  expense  experiencing  either a
decline or minimal  increase in 2006 compared to 2005,  most of the increase can
be  attributed  to  increases  in the  categories  of salaries  and benefits and
occupancy  expense.  Salaries and benefits  increased to $4,771,114 in 2006 from
$3,747,308 in 2005, a $1,023,806, or 27.3%, increase. Annual salary increases in
2006 for 2005 employees, the addition of seven new employees in 2006, and a 7.5%
overall  increase in benefits expense in 2006 accounted for the increase in 2006
personnel expense. The $187,304, or 24.6%, increase in occupancy expense in 2006
compared to that of 2005, to $947,556 from $760,252, can be primarily attributed
to a $63,129, or 41.3%,  increase in lease expense resulting mainly from opening
a loan production office in 2006, a $37,879,  or 9.9%,  increase in depreciation
expense,  and  a  $42,433,  or  186.0%,   increase  in  premises  and  equipment
maintenance costs.

         Other  expenses in 2005, as compared to 2004,  increased by $1,770,807,
or 29.9%.  However,  most of the net  increase  in other  expenses  for the year
resulted  from  a  $1,677,155  litigation  settlement  expense.   Excluding  the
litigation settlement expense, the total of other expenses increased by $93,652,
or 1.6%, from 2004 to 2005, with some categories of other expenses  declining in
2005.  Most  notable of the  categories  with a declining  annual  expense  were
occupancy and equipment,  down $63,223, or 7.7%, and expenses related to the use
of  outside or  third-party  service  providers,  exclusive  of data  processing
services. The categories of other expenses having the largest dollar increase in
2005  were  salaries  and  benefits  expense,  up  $182,619,  or 5.1%,  and data
processing expense, up $21,553, or 1.1%.

Income Taxes

         During the year ended December 31, 2006, the Company accrued $2,713,154
for current  income taxes.  The Company  accrued  $1,946,300  for current income
taxes  during  2005.  The Company  accounts for income taxes under SFAS No. 109,
"Accounting for Income Taxes." Certain items of income and expense  (principally
provision for loan losses and depreciation) are included in one reporting period
for  financial  accounting  purposes  and another for income tax  purposes.  The
income  taxes  accrued  in 2006  amounted  to 37.7% of pretax  income,  the same
percentage as in 2005.

         During the year ended December 31, 2005, the Company accrued $1,946,300
for current income taxes,  as compared to $1,700,000 in 2004. The current income
tax expense for each of these  years,  net of the amount of deferred  income tax
benefit recorded,  was 36.1% of pretax income in 2005 and 35.6% of pretax income
in 2004.


                                       25
<PAGE>

Investment Portfolio

         As of December 31,  2006,  the book value of the  Company's  investment
portfolio comprised approximately 9.4 % of its total assets. The following table
summarizes  the  carrying  value  amounts of  securities  held by the Company at
December 31, 2006,  2005,  and 2004. In the table and the following  table,  the
caption "U.S.  Government  agency  obligations" also includes the obligations of
government sponsored enterprises (GSEs).

Securities Portfolio Composition
(dollars in thousands)

<TABLE>
<CAPTION>
                                            December 31, 2006            December 31, 2005                 December 31, 2004
                                             Net Unrealized               Net Unrealized                     Net Unrealized
                                             --------------               --------------                     --------------
                                       Book     Holding      Fair     Book    Holding     Fair        Book       Holding      Fair
                                       Value  Gain/(Loss)   Value     Value  Gain/(Loss)  Value      Value     Gain/(Loss)    Value
                                       -----  -----------   -----     -----  -----------  -----      -----     -----------    -----
Available for sale:
<S>                                   <C>        <C>      <C>        <C>        <C>       <C>         <C>           <C>      <C>
U. S. Government agency obligations   $21,993    $(151)   $ 21,842   $21,490    $(264)    $21,226     $16,499       $(18)    $16,481
State and local obligations .......       123        5         128       123        6         129         123          4         127
Mortgage-backed securities ........       597      (14)        583       766      (24)        742         961        (16)        944
Restricted FHLB Stock .............       741        -         741     1,269        -       1,269         954          -         954
                                      -------    -----    --------   -------    -----     -------     -------       ----     -------
                                      $23,454    $(160)   $ 23,294   $23,648    $(282)    $23,366     $18,536       $(30)    $18,506
                                      =======    =====    ========   =======    =====     =======     =======       ====     =======

Held for investment:
U.S. Government Agency obligations    $ 8,998    $  17    $  9,015   $ 6,000    $  (2)    $ 5,998     $ 1,004       $ (1)    $ 1,003
Trust Preferred securities ........       482      150         632       481      153         634         479        133         613
State and local obligations .......         -        -           -         -        -           -         375         10         385
Mortgage-backed securities ........       421        3         425       783       12         795       1,500         39       1,539
                                      -------    -----    --------   -------    -----     -------     -------       ----     -------
                                      $ 9,901    $ 170    $ 10,072   $ 7,264    $ 163     $ 7,427     $ 3,358       $181     $ 3,539
                                      =======    =====    ========   =======    =====     =======     =======       ====     =======

</TABLE>

         On an ongoing basis,  management  assigns securities upon purchase into
one of two categories  (available-for-sale or held-to-maturity) based on whether
it has the intent to hold the securities to maturity,  taking into consideration
factors such as expectations  for changes in market  interest  rates,  liquidity
needs,  asset/liability  management  strategies,  and capital requirements.  The
Company does not maintain a securities trading account.

         The following table presents scheduled maturities of debt securities at
December 31, 2006.  Available-for-sale  securities  are stated at estimated fair
value and held-for-investment securities are stated at amortized cost.


                                       26
<PAGE>

Securities Portfolio Maturities


                        Analysis of Investment Securities
                                December 31, 2006
                             (dollars in thousands)

<TABLE>
<CAPTION>
                                                                         Available-for-Sale                Held-for-Investment
                                                                         ------------------                -------------------

                                                                                      Estimated                        Estimated
                                                                Amortized Cost        Fair Value        Amortized Cost    Fair Value
                                                                --------------        ----------        --------------    ----------

U.S. Government Agency Oligations
<S>                                                                  <C>                <C>                <C>                <C>
    Due in one year or less ............................             $5,000             $4,961             $                  $    -
    Due from one to five years .........................              6,493              6,427              4,000              3,978
    Due from five to ten years .........................              6,500              6,485              4,998              5,037
    Due after ten years ................................              4,000              3,969                  -                  -

State and local obligations (1)
    Due after ten years ................................                123                128                  -                  -

Trust Preferred securities
    Due after ten years ................................                  -                  -                482                632

Mortgage Backed securities
    Due after ten years ................................                597                583                421                425

Equity Securities ......................................                741                741                  -                  -

Total (2) (3)

    Due in one year or less ............................             $5,000             $4,961             $    -             $    -
    Due from one to five years .........................              6,493              6,427              4,000              3,978
    Due from five to ten years .........................              6,500              6,485              4,998              5,037
    Due after ten years ................................              4,123              4,097                421                425
</TABLE>
(1)  Not adjusted for tax equivalency
(2)  Excludes equity securities
(3)  Weighted average yields on debt securities scheduled to mature in less than
     one year,  one to five  years,  five to ten years,  and after ten years are
     3.36%,  4.80%,  5.64% and 6.11%,  respectively.  Due to call  features (the
     ability of the  issuing  entity to redeem a security  on a  specified  date
     prior to  maturity),  the  yields  shown for the four  maturity  ranges are
     disclosed for  information  purposes only as of December 31, 2006,  and are
     likely to change.


                                       27
<PAGE>

Loan Portfolio

         Management believes the loan portfolio is adequately diversified. There
are no  significant  concentrations  of loans in any  particular  individuals or
industry or group of related individuals or industries, or any foreign loans.

         The amount of loans outstanding at December 31, 2006, 2005, 2004, 2003,
and 2002 are shown in the following table according to type of loan.


Loan Portfolio Composition

<TABLE>
<CAPTION>
                                                                                      December 31,
                                                                                      ------------
                                                       2006              2005             2004             2003              2002
                                                       ----              ----             ----             ----              ----
<S>                                               <C>              <C>              <C>              <C>              <C>
Commercial, financial and agricultural ........   $  50,556,004    $  45,229,728    $  46,728,921    $  51,523,910    $  47,099,954
Real estate - construction ....................      29,634,235       14,041,295       17,223,132       14,345,975       14,211,986
Real estate mortgage ..........................     216,395,114      208,851,125      190,325,765      160,813,719       96,495,309
Consumer ......................................         394,754          409,653          470,787          554,999        1,053,596
                                                  -------------    -------------    -------------    -------------    -------------
    Total loans ...............................     296,980,107      268,531,801      254,748,605      227,238,603      158,860,845

Less deferred fees ............................        (514,958)        (498,388)        (693,454)        (469,164)        (133,049)
Less allowance for loan losses ................      (3,275,000)      (3,000,000)      (2,900,000)      (2,600,000)      (1,750,000)
                                                  -------------    -------------    -------------    -------------    -------------

Total Loans, net of allowance for loan losses .   $ 293,190,149    $ 265,033,413    $ 251,155,151    $ 224,169,439    $ 156,977,796
                                                  =============    =============    =============    =============    =============
</TABLE>

         At  December  31,  2006,  $32,155,601  of  commercial,   financial  and
agricultural loans were due in one year or less,  $17,672,323 were due after one
year through five years, and $728,080 were due after five years. At December 31,
2006,  $21,841,220 of real estate -  construction  loans were due in one year or
less,  $7,535,015 were due after one year through five years,  and $258,000 were
due after five years.

         A certain degree of risk taking is inherent in the extension of credit.
Management has established loan and credit policies designed to control both the
types and  amounts of risks  assumed and to  ultimately  minimize  losses.  Such
policies include limitations on  loan-to-collateral  values for various types of
collateral,  requirements for appraisals of real estate collateral, problem loan
management  practices and collection  procedures,  and nonaccrual and charge-off
guidelines.

         Commercial loans primarily represent loans made to businesses,  and may
be made on either a secured or an  unsecured  basis.  Collateral  is  ordinarily
taken unless the borrower has strong cash flows,  low debt to worth ratios,  and
the loan is of short duration.  When taken, collateral usually consists of liens
on  receivables,  equipment,  inventories,  furniture  and  fixtures.  Unsecured
business loans are generally short-term with emphasis on repayment strengths and
low debt to worth ratios.  Commercial lending involves  significant risk because
repayment usually depends on the cash flows generated by a borrower's  business,
and the debt service capacity of a business can deteriorate because of downturns
in  national  and local  economic  conditions.  To  control  risk,  initial  and
continuing financial analysis of a borrower's financial information is required.

         Real estate  construction  loans  generally  consist of  financing  the
construction  of 1-4 family  dwellings  and some  nonfarm,  nonresidential  real
estate.  Usually, loan to cost ratios are limited to 75% and permanent financing
commitments are required prior to the advancement of loan proceeds.

         Loans  secured by real  estate  mortgages  comprised  nearly 73% of the
Bank's loan  portfolio  at December  31,  2006.  Residential  real estate  loans
consist mainly of first and second  mortgages on single family homes,  with some
multifamily  loans.  Loan-to-value  ratios for these  instruments  are generally
limited  to 90%.  Nonfarm,  nonresidential  loans are  secured by  business  and
commercial  properties with  loan-to-value  ratios generally limited to 80%. The


                                       28
<PAGE>

repayment  of both  residential  and  business  real estate  loans is  dependent
primarily  on the income and cash flows of the  borrowers,  with the real estate
serving as a secondary or liquidation source of repayment.

         Consumer loans generally involve more risks than other loans because of
the type and nature of the underlying  collateral,  or because of the absence of
collateral.  Consumer loan repayments are dependent on the borrower's continuing
financial stability and are likely to be adversely affected by job loss, divorce
and illness.  Furthermore,  the  application of various  federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be  recovered  on such loans in the case of a default.  In most cases,
any  repossessed  collateral will not provide an adequate source of repayment of
the outstanding loan balance.

Nonperforming Loans; Other Problem Assets

         When a loan is 90 days past due as to interest or principal or there is
serious doubt as to collectibility,  the accrual of interest income is generally
discontinued  unless  the  estimated  net  realizable  value  of  collateral  is
sufficient to assure  collection of the principal  balance and accrued interest.
When the  collectibility  of a  significant  amount of  principal  is in serious
doubt,  the  principal  balance  is  reduced  to the  estimated  fair  value  of
collateral by  charge-off  to the  allowance for loan losses and any  subsequent
collections  are credited first to the remaining  principal  balance and then to
the  allowance  for loan  losses as a  recovery  of the  amount  charged  off. A
nonaccrual loan is not returned to accrual status unless  principal and interest
are current and the borrower  has  demonstrated  the ability to continue  making
payments as agreed.  At December 31, 2006,  the Company had eight loans totaling
$1,756,803  on  non-accrual  status.  Net income for 2006  includes  no interest
income on these  loans.  Had these loans been current in  accordance  with their
original terms,  $137,140 of additional interest income would have been recorded
in 2006. At December 31, 2005, the Company had twelve loans totaling  $1,892,763
on non-accrual status.

The following table presents information on non-performing loans and real estate
acquired in settlement of loans:

<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                             ------------
                                                                                       (dollars in thousands)
Non-performing Assets                                              2006           2005           2004           2003           2002
                                                                   ----           ----           ----           ----           ----

<S>                                                              <C>            <C>            <C>            <C>            <C>
Non-performing loans:
  Non-accrual loans .....................................        $1,757         $1,893         $  350         $  295         $  112
  Past due 90 days or more ..............................            97             57              -              -              -
                                                                 ------         ------         ------         ------         ------
Total non-performing loans ..............................        $1,854         $1,950         $  350         $  295         $  112
Real estate acquired in settlement of loans .............           965            520            520              -            625
                                                                 ------         ------         ------         ------         ------
Total non-performing assets .............................        $2,819         $2,470         $  870         $  295         $  737
                                                                 ======         ======         ======         ======         ======
Non-performing assets as a
  Percentage of loans and
  other real estate .....................................          0.95%          0.90%          0.34%          0.13%          0.46%

Allowance for loan losses as
  a percentage of non-performing loans ..................        176.64%        153.80%        828.57%        881.36%      1,562.50%
</TABLE>

Potential Problem Loans

Management has identified and maintains a list of potential problem loans. These
are loans that are neither  included in non-accrual  status,  nor loans that are
past due 90 days or more and still  accruing.  A loan is added to the  potential
problem list when management  becomes aware of information about possible credit
problems  of  borrowers  that  causes  serious  doubts as to the ability of such


                                       29
<PAGE>

borrowers to comply with the current loan repayment  terms. On December 31, 2006
the total amount of loans determined by management to be potential problem loans
was $1,970,776. This amount consisted of loans made to ten borrowers.

Real Estate Owned

         The Company  foreclosed on real estate collateral during the year ended
December 31, 2004 and transferred the loans and accrued interest balances at the
time of foreclosure to other real estate owned in the amount of $520,234. During
the year ending December 31, 2005, there was no activity  regarding  foreclosure
on real estate collateral. However during the year ending December 31, 2006, the
net affect of foreclosure on real estate collateral  totaled $444,419  resulting
in an ending  balance for other real estate  owned for  December  31,  2006,  of
$964,653.

Allowance for Loan Losses

         The  allowance  for loan  losses  is  increased  by direct  charges  to
operating  expense.  Losses on loans are charged  against the  allowance  in the
period in which  management has determined  that it is more likely than not such
amounts have become  uncollectible.  Recoveries of previously  charged off loans
are credited to the  allowance.  The table,  "Summary of Loan Loss  Experience,"
summarizes loan balances at the end of each period indicated,  averages for each
period, changes in the allowance arising from charge-offs and recoveries by loan
category, and additions to the allowance which have been charged to expense.

       In reviewing  the adequacy of the  allowance for loan losses at each year
end,  management took into  consideration the historical loan losses experienced
by the Company,  current economic conditions affecting the borrowers' ability to
repay,  the volume of loans,  and the  trends in  delinquent,  nonaccruing,  and
potential  problem loans, and the quality of collateral  securing  nonperforming
and problem loans. After charging off all known losses, management considers the
allowance for loan losses adequate to cover its estimate of loan losses inherent
in the loan portfolio as of December 31, 2006.

         In  calculating  the amount  required in the allowance for loan losses,
management  applies a  consistent  methodology  that is updated  quarterly.  The
methodology  utilizes a loan risk grading  system and  detailed  loan reviews to
assess credit risks and the overall  quality of the loan  portfolio.  Also,  the
calculation provides for management's assessment of trends in national and local
economic conditions that might affect the general quality of the loan portfolio.
For  outstanding  loans,  the risk rating system is the major factor employed to
quantify the probable  losses in the loan  portfolio.  Predetermined  percentage
factors for dollars outstanding in each loan grade are applied and then totaled.
For loans specifically identified by management during loan reviews,  management
separates these loans from the general pool of loans and assigns a separate risk
rating for these  loans based on the  likelihood  of  collectibility,  financial
condition of the borrower, value of collateral,  and other relevant factors. Two
additional  calculations are based on FDIC  classifications  and daily statement
loan type total using  factors as noted below.  The four  methods for  measuring
probable losses are performed  monthly and their results  averaged to provide an
amount to be established as a reserve  against loan losses.  The monthly reserve
provisions,  and  the  details  supporting  the  calculations  utilized  in  the
computation,  are  reviewed  by the  Board's  Loan  Committee  and the  Board of
Directors.  The factors used in these  calculations  were initially derived from
prior  experience with similar systems at other banks.  These factors have been,
and  will  continue  to  be,  modified  as the  Bank's  actual  historical  loss
experience in different  economic  environments can be fully incorporated into a
predictive model.  Regulators also review the adequacy of the allowance for loan
losses as part of their  examination of the Bank and may require  adjustments to
the  allowance  based  upon  information  available  to them at the  time of the
examination.

                                       30
<PAGE>

         Management also performs periodic reviews of the Company's  off-balance
sheet credit risks,  such as unfunded loan  commitments  and standby  letters of
credit.  When these reviews identify a probable loss, a separate loss reserve is
established.  The  review  performed  at  December  31,  2006,  as well as those
performed  throughout the 2006 year, did not identify an off-balance  sheet risk
upon which a reserve should be established.

<TABLE>
<CAPTION>
                                                                                     Summary of Loan Loss Experience
                                                                                          (Dollars in thousands)
                                                                                          Year Ended December 31,
                                                                                          -----------------------
                                                                          2006         2005         2004        2003         2002
                                                                          ----         ----         ----        ----         ----
<S>                                                                    <C>          <C>          <C>          <C>          <C>
Total loans outstanding at end of period ..........................    $296,980     $268,532     $254,749     $227,239     $158,861
Average amount of loans outstanding ...............................     287,887      257,949      238,958      194,944      141,269

Balance of allowance for loan losses - beginning ..................       3,000        2,900        2,600        1,750        1,450
                                                                       --------     --------     --------     --------     --------
Loans charged off

Commercial & industrial ...........................................         265          112           10          114          375
Real estate-mortgage ..............................................         513          365          409           20           18
Other .............................................................           -            -            2
Consumer installment * ............................................           -            3            -        1,674            -
                                                                       --------     --------     --------     --------     --------
Total charge-offs .................................................         778          480          421        1,808          393

Recoveries of loans previously charged-off

Commercial & industrial ...........................................          88            3            6           35            -
Real estate-mortgage ..............................................          15           16           10            -           17
Consumer installment * ............................................           -            -            -        1,674            1
                                                                       --------     --------     --------     --------     --------
Total recoveries ..................................................         103           19           16        1,709           18

Net charge-offs ...................................................         675          461          405           99          375

Additions to allowance charged to expense .........................         950          561          705          949          675
                                                                       --------     --------     --------     --------     --------

Balance of allowance for loan losses - ending .....................    $  3,275     $  3,000     $  2,900     $  2,600     $  1,750
                                                                       --------     --------     --------     --------     --------


Ratios
                                                                           2006         2005         2004         2003         2002
Net charge-offs during period to average loans outstanding
during period .....................................................        0.23%        0.17%        0.16%        0.05%        0.27%
Net charge-offs to loans at end of period .........................        0.23%        0.17%        0.15%        0.04%        0.24%
Allowance for loan losses to average loans ........................        1.14%        1.16%        1.21%        1.33%        1.10%
Allowance for loan losses to loans at end of period ...............        1.10%        1.11%        1.14%        1.14%        1.10%
Nonperforming loans to allowance for loan losses at end of
period ............................................................       56.61%       65.00%       12.06%       11.35%        6.40%
Net charge-offs to allowance for loan losses ......................       20.61%       15.36%       13.98%        3.81%       21.43%
Net charge-offs to provision for loan losses ......................       71.05%       82.17%       57.48%       10.43%       55.56%
</TABLE>

*The amount of consumer loan losses in 2003, which was matched dollar-for-dollar
by the  amount  of  consumer  loan  recoveries,  consisted  solely  of  deferred
presentment  loans.  The Bank  ceased to make  this  type of loan in the  fourth
quarter of 2003.

                                       31
<PAGE>

     The  following  table  presents the  allocation  of the  allowance for loan
losses at the end of the years ended December 31, 2006,  2005,  2004,  2003, and
2002  compared with the percent of loans in the  applicable  categories to total
loans.

<TABLE>
<CAPTION>
                                                              Allocation of Allowance for Loan Losses
                                                                     Period Ended December 31,
                                                                     -------------------------
                                                                      (Dollars in thousands)
                                       2006                2005                2004                 2003                 2002
                                       ----                ----                ----                 ----                 ----
                                           % of                 % of                % of                 % of                  % of
                                 Amount    Loans    Amount     Loans    Amount      Loans    Amount      Loans    Amount      Loans
                                 ------    -----    ------     -----    ------      -----    ------      -----    ------      -----
<S>                              <C>      <C>       <C>       <C>       <C>        <C>       <C>        <C>       <C>       <C>
Commercial and industrial .....  $1,081    33.00%   $  990     33.00%   $  965      33.27%   $1,017      39.10%   $  858     49.00%
Real estate - construction ....     361    11.02%      330     11.00%      321      11.07%      290      11.20%      210     12.00%
Real estate - mortgage ........   1,813    55.36%    1,660     55.33%    1,594      54.97%    1,272      48.90%      656     37.50%
Consumer installment ..........      20     0.62%       20      0.67%       20       0.69%       21        .80%       26      1.50%
                                 ------   ------    ------    ------    ------     ------    ------     ------    ------    ------
Total .........................  $3,275   100.00%   $3,000    100.00%   $2,900     100.00%   $2,600     100.00%   $1,750    100.00%
                                 ======   ======    ======    ======    ======     ======    ======     ======    ======    ======

</TABLE>

Deposits

         The average  amounts and average rate paid on deposits held by the Bank
for the years ended December 31, 2006, 2005, and 2004 are summarized below:

<TABLE>
<CAPTION>
                                                                           Average Deposits

                                                                             December 31,
                                                                             ------------
                                                             2006                2005               2004
                                                             ----                ----               ----
                                                       Amount    Rate     Amount     Rate    Amount     Rate
                                                       ------    ----     ------     ----    ------     ----
                                                                     (Dollars in thousands)

<S>                                                   <C>                <C>                <C>
Noninterest bearing demand ........................   $14,857            $17,450            $20,837
Interest bearing transaction accounts .............    31,047   3.53%     38,481    2.54%    33,917    1.73%
Savings ...........................................    54,225   4.41%     49,612    2.57%    47,889    1.77%
Time deposits - $100,000 and over .................    67,998   4.57%     44,868    3.35%    35,525    2.39%
Other time deposits ...............................   127,468   4.46%    108,713    3.21%    93,294    2.38%

Total interest bearing deposits ...................  $280,738   4.37%   $241,674    3.00%  $210,625    2.14%

</TABLE>

         As of December 31, 2006, the Company held approximately  $74,479,000 in
time  deposits in amounts of $100,000 or more,  with  approximately  $33,333,000
with  maturities  within three months,  $36,600,000  with  maturities over three
through  twelve  months,  and  $4,546,000  with  maturities  over twelve months.
Wholesale time deposits generated through  corporations,  banks,  credit unions,
etc., on a national level totaled  approximately  $11,588,000 as of December 31,
2006. It is a common  industry  practice not to consider these types of deposits
as  core  deposits  because  their  retention  can  be  expected  to be  heavily
influenced by rates  offered,  and therefore  they have the  characteristics  of
shorter-term purchased funds. Wholesale time deposits involve the maintenance of
an  appropriate  matching  of maturity  distribution  and a  diversification  of
sources  to  achieve  an  appropriate  level of  liquidity.  Such  deposits  are
generally more volatile and interest rate sensitive than other deposits.

Borrowed Funds

       Major sources of borrowed  funds in 2006 and 2005,  other than  deposits,
were retail repurchase agreements and Federal Home Loan Bank advances.

                                       32
<PAGE>

         Retail repurchase  agreements are short-term borrowings from commercial
customers  collateralized  by  government or government  agency  securities  and
repayable  with  interest.  At  December  31,  2006 and 2005,  the  Company  had
$2,171,379 and $5,470,153 in retail  repurchase  agreements,  respectively.  The
weighted average interest rates for retail repurchase agreements  outstanding at
December  31,  2006 and 2005  were  4.36%  and  3.40%,  respectively,  and those
repurchase agreements all had next day maturities.  The maximum amount of retail
repurchase  agreements  at the end of any  month  was  $5,611,994  in  2006  and
$6,413,256  in 2005.  The  approximate  average  amount  of  outstanding  retail
repurchase  agreements  was  $4,120,000  in 2006  and  $4,706,000  in  2005  and
approximate weighted interest rates were 4.21% in 2006 and 2.66% in 2005.

      Though the Company had no outstanding  advances from the Federal Home Loan
Bank of Atlanta at December 31, 2006, as compared to the $15,000,000 outstanding
on  December  31,  2005,  advances   outstanding  for  the  2006  year  averaged
$5,641,096.  The average loan advance  outstanding amount for 2006 was comprised
of one  $5,000,000  fixed rate  advance at rate of 4.46% called on May 15, 2006,
one  $5,000,000  fixed rate  advance at a rate of 4.62% called on June 21, 2006,
and three daily rate credit  advances of various  amounts  outstanding for short
periods of time with interest  rates which  averaged  4.44%.  Growth in deposits
during the year in excess of loan growth provided sufficient liquidity to payoff
all borrowings from the Federal Home Loan Bank by year-end.  By comparison,  the
approximate annual average amount of outstanding Federal Home Loan Bank advances
in 2005 was $10,000,000  with a weighted  average rate of 4.45%,  with a maximum
amount  of  advances  outstanding  at  the  end  of  any  month  in  2005  being
$15,000,000.

         In  2004  the  Company  issued  subordinated  debt  in  the  amount  of
$5,155,000  to FSBS Capital Trust I. The  subordinated  debt matures in 2034 and
has a  variable  interest  rate.  The  average  amount  outstanding  in 2006 was
$5,155,000 and had an approximate  weighted  average rate of 8.04%.  In 2005 the
average amount  outstanding was $5,155,000 and the approximate  weighted average
interest rate was 6.22% (see Note 9 to the Consolidated Financial Statements).

Return on Equity and Assets

         The following  table shows the return on assets (net income  divided by
average total assets),  return on equity (net income divided by average equity),
dividend  payout ratio  (dividends  declared per share divided by net income per
share),  and equity to assets ratio  (average  equity  divided by average  total
assets) for each period indicated.

                                                 Year ended December 31,
                                                 -----------------------
                                           2006           2005           2004
                                           ----           ----           ----

       Return on average assets ........   1.32%          1.09%          1.08%
       Return on average equity ........  13.60%         11.73%         13.33%
       Dividend payout ratio ...........   0.00%          0.00%          0.00%
       Equity to assets ratio ..........   9.71%          9.32%          8.13%

Liquidity

         Liquidity is the ability to meet current and future obligations through
liquidation  or maturity of existing  assets or the  acquisition  of  additional
liabilities.  Adequate  liquidity  is  necessary  to meet  the  requirements  of
customers for loans and deposit  withdrawals  in the most timely and  economical
manner. Some liquidity is ensured by maintaining assets which may be immediately
converted  into cash at minimal cost  (amounts due from banks and federal  funds
sold).  However,  the most  manageable  sources of  liquidity  are  composed  of


                                       33
<PAGE>

liabilities, with the primary focus on liquidity management being on the ability
to obtain deposits within the Bank's service area. Core deposits (total deposits
less wholesale time deposits) provide a relatively stable funding base, and were
equal to 66.1 % of total  assets  at  December  31,  2006.  Asset  liquidity  is
provided from several sources,  including amounts due from banks, and funds from
maturing  investments and loans.  The Bank is a member of the FHLB and, as such,
has the ability to borrow against the security of its First Mortgage Residential
and  Commercial  loans.  At December  31, 2006,  the Company had no  outstanding
advances drawn on its  $34,286,200  available  credit from the Federal Home Loan
Bank.  The Company also has  additional  lines of credit with other banks in the
form of federal  funds  lines in the amount of  $12,000,000.  The Bank has never
drawn  on any of  these  federal  funds  lines.  Management  believes  that  the
Company's  overall liquidity sources are adequate to meet its operating needs in
the ordinary course of its business.

Capital Resources

         The equity capital of the Company increased  $5,083,467 during 2006 and
by  $4,027,348  in 2005.  The  increase  in 2006  resulted  from net  income  of
$4,580,804, an increase in other comprehensive income of $75,421, and additional
paid-in capital of $427,242 from the exercise of stock options.  The increase in
2005 resulted from an increase in retained  earnings of $3,400,304,  a reduction
in other  comprehensive  income  of  $156,434,  additional  paid-in  capital  of
$783,778 from the exercise of stock options.

Both the  Company  and the Bank  are  subject  to  regulatory  capital  adequacy
standards.  Under  these  standards,  financial  institutions  are  required  to
maintain certain minimum ratios of capital to  risk-weighted  assets and average
total assets. Under the provisions of the Federal Deposit Insurance  Corporation
Improvements Act of 1991, federal financial institution  regulatory  authorities
are  required to  implement  prescribed  "prompt  corrective  actions"  upon the
decline in the capital  position of a bank below  certain  levels.  Increasingly
stringent regulatory corrective actions are mandated.

At  December  31,  2006,  both the  Company  and the Bank met all of the minimum
capital  adequacy  standards  and  the  Bank  met  the  requirements  to be well
capitalized  under the prompt correction action provision of the Federal Deposit
Insurance Act.  Capital  ratios are presented in the table below,  compared with
the minimum  ratios and amounts  necessary to be "well  capitalized"  under FDIC
regulatory definitions and guidelines.

                                       34
<PAGE>

<TABLE>
<CAPTION>
                                                                                                               To Be Well
                                                                                                            Capitalized Under
                                                                                    For Capital             Prompt Corrective
The Bank                                                                         Adequacy Purposes          Action Provisions
As of December 31, 2006                                   Actual                      Minimum                    Minimum
                                                          ------                      -------                    -------
                                                  Amount          Ratio       Amount          Ratio       Amount            Ratio
                                                  ------          -----       ------          -----       ------            -----
Total Capital
<S>                                              <C>              <C>         <C>              <C>        <C>              <C>
(To Risk Weighted Assets) ..............         $42,536          14.22%      $23,930          8.00%      $29,913          10.00%
Tier 1 Capital
(To Risk Weighted Assets) ..............         $34,361          11.49%      $11,965          4.00%      $14,956           6.00%
Tier 1 Capital
(To Average Assets) ....................         $34,361           9.82%      $14,003          4.00%      $17,503           5.00%
</TABLE>
<TABLE>
<CAPTION>

The Holding Company
As of December 31, 2006                                   Actual                      Minimum
                                                          ------                      -------
                                                  Amount          Ratio       Amount          Ratio
                                                  ------          -----       ------          -----
Total Capital
<S>                                              <C>              <C>         <C>             <C>
(To Risk Weighted Assets) ..............         $44,230          14.79%      $23,930         8.00%
Tier 1 Capital
(To Risk Weighted Assets) ..............         $41,055          13.72%      $11,965         4.00%
Tier 1 Capital
(To Average Assets) ....................         $41,055          11.73%      $14,003         4.00%
</TABLE>

Inflation

        Since the assets and  liabilities  of a bank are  primarily  monetary in
nature (payable in fixed,  determinable  amounts),  the performance of a bank is
affected  more by changes in interest  rates than by inflation.  Interest  rates
generally increase as the rate of inflation increases,  but the magnitude of the
change in rates may not be the same.

         While the effect of inflation  on banks is normally not as  significant
as is its influence on those  businesses  which have large  investments in plant
and inventories, it does have an effect. During periods of high inflation, there
are  normally  corresponding  increases  in the money  supply,  and  banks  will
normally experience  above-average  growth in assets,  loans and deposits.  Also
general  increases  in the  prices  of goods  and  services  usually  result  in
increased operating expenses.

Off-Balance Sheet Arrangements

         The Company,  through the  operations  of the Bank,  makes  contractual
commitments to extend credit in the ordinary course of its business  activities.
These  commitments are legally binding  agreements to lend money to customers of
the Bank at  predetermined  interest  rates for a  specific  period of time.  At
December 31, 2006,  the Bank had issued  commitments  to extend  credit of $57.0
million through  various types of lending  arrangements.  Of these  commitments,
65.8 %, or $37.5 million,  expire within one year, and 34.2%,  or $19.5 million,
expire in more  than one  year.  Past  experience  indicates  that many of these
commitments to extend credit will expire unused.

         The  Company   evaluates   each   customer's   creditworthiness   on  a
case-by-case  basis. The amount of collateral  obtained,  if deemed necessary by
the Company upon extension of credit,  is based of the credit  evaluation of the
borrower.  Collateral  varies, but may include accounts  receivable,  inventory,
property, plant and equipment, commercial and residential real estate.

                                       35
<PAGE>

Contractual Obligations & Other Commitments

         The following  table  presents,  as of December 31, 2006, the Company's
significant  fixed and determinable  contractual  obligations by payment period.
The payment  amounts  represent those amounts  contractually  due to recipients.
Annual lease  amounts for the next five years are shown in Note 12  "Commitments
and  Contingencies" in the "Notes to Consolidated  Financial  Statements" of the
Company's audited financial statement for the year ended December 31, 2006.

                                December 31, 2006

Contractual Cash Obligations              (Dollars in Thousands)
                                             Less Than   1 to 2  3 to 5  After 5
                                      Total   1 Year     Years    Years   Years
                                      -----   ------     -----    -----   -----
Operating Leases (1) ............... $  673   $  197   $  172    $ 210    $ 94
Purchase Contract (2) ..............  1,102
                                      -----    -----    -----    -----   -----
Total Contract Cash Obligations .... $1,775   $  197   $  172    $ 210    $ 94
                                      =====    =====    =====    =====   =====

(1)  The Company leases the land and buildings for its branches under  operating
     leases. The amounts shown in this table are minimum lease payments,  and do
     not reflect  additional  charges for common area maintenance  expense which
     will be determined in futur
(2)  The Company has entered  into a contract to purchase  the land and building
     for its Greenville,  SC. branch office. It is estimated that the settlement
     on this purchase will be prior to April 1, 2007.


Item 7A. Quantitative and Qualitative Disclosures about Market Risk

            The information  required by Item 305 of Regulation S-K is set forth
in Item 7 of this Form 10-K under captions "Management's Discussion and Analysis
of Financial  Condition  and Results of Operations - Market Risk - Interest Rate
Sensitivity" and - "Off-Balance Sheet Arrangements."


                                       36
<PAGE>



Item 8.  Financial Statements and Supplementary Data





                     FIRST SOUTH BANCORP INC. AND SUBSIDIARY

                   REPORT ON CONSOLIDATED FINANCIAL STATEMENTS

                               FOR THE YEARS ENDED
                        DECEMBER 31, 2006, 2005 AND 2004






                                       37
<PAGE>


                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
                        CONSOLIDATED FINANCIAL STATEMENTS



                                TABLE OF CONTENTS

                                                                         Page

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM .............       39

FINANCIAL STATEMENTS
   Consolidated balance sheets ......................................       40
   Consolidated statements of income ................................       41
   Consolidated statements of changes in stockholders' equity .......       42
   Consolidated statements of cash flows ............................       43

NOTES TO FINANCIAL STATEMENTS .......................................  44 - 64






                                       38
<PAGE>





             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Stockholders
First South Bancorp, Inc. and Subsidiary
Spartanburg, South Carolina

We have  audited the  accompanying  consolidated  balance  sheets of First South
Bancorp, Inc. and Subsidiary (the Company) as of December 31, 2006 and 2005, and
the related  consolidated  statements of income,  stockholders'  equity and cash
flows for each of the years in the three year period  ended  December  31, 2006.
These consolidated  financial statements are the responsibility of the Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audits.

We conducted  our audits in  accordance  with  standards  of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and  perform  the  audit  to  obtain  reasonable  assurance  about  whether  the
consolidated financial statements are free of material  misstatements.  An audit
includes  examining,  on a test  basis,  evidence  supporting  the  amounts  and
disclosures in the  consolidated  financial  statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects, the financial position of First South Bancorp,
Inc.  and  Subsidiary  at  December  31,  2006 and 2005 and the results of their
operations  and their cash flows for each of the years in the three year  period
ended  December 31, 2006, in conformity  with  accounting  principles  generally
accepted in the United States of America.



/s/ Cherry Bekaert & Holland, L.L.P.




Charlotte, North Carolina
March 27, 2007











                                       39
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                                            December 31,
                                                                                                            ------------
                                                                                                    2006                     2005
                                                                                                    ----                     ----
Assets:
<S>                                                                                          <C>                      <C>
   Cash and due from banks .......................................................           $   5,032,116            $   5,022,070
   Interest-bearing deposits .....................................................              10,650,000               13,510,000
   Securities available-for-sale .................................................              23,293,132               23,365,835
   Securities held-for-investment ................................................               9,901,638                7,264,070
   Loans, net ....................................................................             293,190,149              265,033,413
   Premises and equipment, net ...................................................               5,290,165                5,288,478
   Investment in FSBS Capital Trust I ............................................                 155,000                  155,000
   Other assets ..................................................................               5,910,992                5,093,214
                                                                                             -------------            -------------
         Total assets ............................................................           $ 353,423,192            $ 324,732,080
                                                                                             =============            =============
Liabilities and Stockholders' Equity
Liabilities
Deposits
   Noninterest-bearing demand ....................................................           $  16,037,824            $  13,820,544
   Interest bearing demand and savings ...........................................              90,867,730               80,280,670
   Time deposits .................................................................             201,151,385              171,623,759
                                                                                             -------------            -------------
         Total deposits ..........................................................             308,056,939              265,724,973
Retail repurchase agreements .....................................................               2,171,379                5,740,153
Other borrowed funds .............................................................                 286,710               15,297,615
Subordinated debt ................................................................               5,155,000                5,155,000
Other accrued expenses and liabilities ...........................................               1,798,492                1,943,134
         Total liabilities .......................................................             317,468,520              293,860,875
                                                                                             -------------            -------------
Commitments and contingencies
Stockholders' equity
   Common stock, no par value;  30,000,000 shares authorized
     2,155,538 and 2,100,497 issued and outstanding at
     December 31, 2006 and 2005, respectively ....................................                       -                        -
   Paid-in capital ...............................................................              19,848,876               19,421,634
   Retained earnings .............................................................              16,205,670               11,624,866
   Accumulated other comprehensive loss ..........................................                 (99,874)                (175,295)
                                                                                             -------------            -------------
         Total stockholders' equity ..............................................              35,954,672               30,871,205
                                                                                             -------------            -------------
         Total liabilities and stockholders' equity ..............................           $ 353,423,192            $ 324,732,080
                                                                                             =============            =============
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       40
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

                        CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                                           For the years ended December 31,
                                                                                           --------------------------------
                                                                                2006                  2005                  2004
                                                                                ----                  ----                  ----
Interest income
<S>                                                                        <C>                   <C>                   <C>
   Loans .........................................................         $ 25,570,894          $ 19,371,996          $ 14,575,623
   Securities
      U. S. Government agency and government
           sponsored enterprise obligations ......................            1,446,881               749,803               450,766
      State and local obligations ................................                6,303                 9,583                25,998
      Mortgage backed securities .................................               51,022                80,085                48,791
      Other securities ...........................................              102,623                92,569                72,745
   Deposits with banks ...........................................              606,248               506,063               137,366
                                                                           ------------          ------------          ------------
         Total interest income ...................................           27,783,971            20,810,099            15,311,289
                                                                           ------------          ------------          ------------
Interest expense
   Deposits
      Time .......................................................            8,791,795             4,991,986             3,068,349
      Interest-bearing demand and savings ........................            3,487,133             2,252,043             1,431,436
   Borrowed funds ................................................              269,848               452,943               458,431
   Other .........................................................              583,837               444,115               250,483
                                                                           ------------          ------------          ------------
         Total interest expense ..................................           13,132,613             8,141,087             5,208,699
                                                                           ------------          ------------          ------------
         Net interest income .....................................           14,651,358            12,669,012            10,102,590
Provision for loan losses ........................................              949,930               561,086               705,522
                                                                           ------------          ------------          ------------
         Net interest income after provision for
           loan losses ...........................................           13,701,428            12,107,926             9,397,068
                                                                           ------------          ------------          ------------
Noninterest income
   Service charges, fees, and commissions ........................              739,310               651,514               693,755
   Loan brokerage fees ...........................................              282,643               162,526               240,248
   Mortgage banking loan fees ....................................               52,124                51,162               127,859
   Other .........................................................              128,301                50,243               127,385
                                                                           ------------          ------------          ------------
         Total noninterest income ................................            1,202,378               915,445             1,189,247
                                                                           ------------          ------------          ------------
Noninterest expenses
   Salaries and employee benefits ................................            4,771,114             3,747,308             3,564,689
   Occupancy and equipment .......................................              947,556               760,252               823,475
   Legal expenses ................................................               36,747               170,288               172,056
   Data processing ...............................................              231,867               223,396               201,843
   Other outside services ........................................              102,157                84,149               128,497
   Litigation settlement .........................................                    -             1,677,155                     -
   Other .........................................................            1,626,561             1,038,519             1,039,700
                                                                           ------------          ------------          ------------
         Total other operating expenses ..........................            7,716,002             7,701,067             5,930,260
         Income before income taxes ..............................            7,187,804             5,322,304             4,656,055
Current income tax expense .......................................            2,713,154             1,946,300             1,700,000
Deferred income tax benefit ......................................             (106,154)              (24,000)              (44,000)
                                                                           ------------          ------------          ------------
         Net income ..............................................         $  4,580,804          $  3,400,004          $  3,000,055
                                                                           ============          ============          ============
Earnings per common share ........................................         $       2.16          $       1.64          $       1.56
                                                                           ============          ============          ============
Diluted earnings per common share ................................         $       2.11          $       1.58          $       1.47
                                                                           ============          ============          ============
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       41
<PAGE>

                    FIRST SOUTH BANCORP INC., AND SUBISIDIARY
                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
             For the years ended December 31, 2006, 2005, and 2004

<TABLE>
<CAPTION>
                                                                                                                           Total
                                                                                                                        Accumulated
                                                           Common Stock                                                    other
                                                            in number      Paid-in         Retained     comprehensive  Stockholders'
                                                            of Shares      Capital         Earnings     income (loss)      equity
                                                            ---------      -------         --------     -------------      ------
<S>                                                         <C>          <C>             <C>            <C>            <C>
Balance at January 1, 2004 ...........................      1,658,412    $ 11,152,489    $  5,224,807   $     31,832   $ 16,409,128

Exercised stock options ..............................            540           3,300                                         3,300

Issuance of common stock .............................        360,000       7,482,067                                     7,482,067
   (360,000 shares at $20.83 per share net of
   expense of $17,933)

Comprehensive income:
   Net Income ........................................                                      3,000,055                     3,000,055

Net change in
unrealized gain on
available for sale
securities, net of tax benefit of $31,070 ............                                                       (50,693)       (50,693)
                                                                                                                       -------------

Comprehensive income .................................                                                                    2,949,362
                                                         ------------    ------------    ------------   ------------   ------------


Balance at December 31, 2004 .........................      2,018,952      18,637,856       8,224,862        (18,861)    26,843,857

Exercised stock options ..............................         81,545         783,778                                       783,778

Comprehensive income:
   Net Income ........................................                                      3,400,004                     3,400,004

Net change in
unrealized gain on
available for sale
securities, net of tax benefit of $95,876 ............                                                      (156,434)      (156,434)
                                                                                                                       ------------

Comprehensive income .................................                                                                    3,243,570
                                                         ------------    ------------    ------------   ------------   ------------

Balance December 31, 2005 ............................      2,100,497      19,421,634      11,624,866       (175,295)    30,871,205


Exercised Stock Options ..............................         55,041         427,242                                       427,242

Comprehensive income:
   Net Income ........................................                                      4,580,804                     4,580,804

Net change in
unrealized gain on
available for sale
securities, net of tax benefit $46,224 ...............                                                        75,421         75,421
                                                                                                                       ------------

Comprehensive Income .................................                                                                    4,656,225
                                                         ------------    ------------    ------------   ------------   ------------

Balance at December 31, 2006 .........................      2,155,538    $ 19,848,876    $ 16,205,670   $    (99,874)  $ 35,954,672
                                                            =========    ============    ============   ============   ============
</TABLE>


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       42
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                           For the years ended December 31,
                                                                                           --------------------------------
                                                                                        2006             2005              2004
                                                                                        ----             ----              ----
OPERATING ACTIVITIES
<S>                                                                              <C>                <C>                <C>
   Net income .............................................................      $  4,580,804       $  3,400,004       $  3,000,055
   Adjustments to reconcile net income to net cash
      provided by operating activities
       Depreciation .......................................................           419,335            381,456            432,071
       Provision for loan losses ..........................................           949,930            561,086            705,522
       Write downs on other real estate owned .............................            75,129                  -                  -
       Loss on sale of other real estate owned ............................            57,342                  -                  -
       Gain on sale of loans ..............................................                 -             (8,151)           (78,783)
       Increase in cash surrender value of life insurance .................           (31,712)           (30,325)           (30,344)
       Deferred tax provision .............................................                 -            (24,000)           (44,000)
       Increase in interest receivable ....................................          (405,114)          (571,235)          (177,899)
       Decrease (increase) in other assets ................................            17,373            257,507           (829,848)
       Increase (decrease) in accrued expenses
          and other liabilities ...........................................          (144,642)           503,624             38,559
                                                                                 ------------       ------------       ------------
           Net cash provided by operating activities ......................         5,518,445          4,469,966          3,015,333
                                                                                 ------------       ------------       ------------
INVESTING ACTIVITIES
   Origination of loans, net of principal collected .......................       (30,473,750)       (14,431,177)       (28,199,269)
   Proceeds from matured/called securities available-for-sale .............         9,528,300          4,497,818          5,000,000
   Proceeds from matured/called securities held-for-investment ............                 -          1,377,868                  -
   Proceeds from sale of securities available-for-sale ....................                 -                  -          1,000,000
   Purchase of securities available-for-sale ..............................        (9,500,000)        (9,804,288)       (14,001,975)
   Purchase of securities held-for-investment .............................        (2,998,150)        (6,000,000)                 -
   Proceeds from MBS principal paydowns ...................................           526,632            911,272            510,545
   Proceeds from sale of other real estate owned ..........................           790,062                  -                  -
   Proceeds from disposal of premises and equipment .......................            42,850                  -                  -
   Purchases of premises and equipment ....................................          (463,872)          (336,116)          (246,905)
   Investment in trust ....................................................                 -                  -           (155,000)
                                                                                 ------------       ------------       ------------
           Net cash used in investing activities ..........................       (32,547,928)       (23,784,623)       (36,092,604)
                                                                                 ------------       ------------       ------------
FINANCING ACTIVITIES
   Increase in deposits, net ..............................................        42,331,966         17,849,896         32,418,888
   Proceeds from exercise of stock options ................................           427,242            783,778              3,300
   Net increase(decrease) in retail repurchase agreements .................        (3,568,774)         1,039,916         (1,388,676)
   Net (decrease) increase in other borrowings ............................           (10,905)          (119,041)           181,103
   Proceeds of advances from FHLB .........................................                 -          5,000,000         16,200,000
   Repayment of advances from FHLB ........................................       (15,000,000)                 -        (18,200,000)
   Proceeds from issuance of subordinated debt ............................                 -                  -          5,155,000
   Proceeds from stock issuance ...........................................                 -                  -          7,482,067
                                                                                 ------------       ------------       ------------
           Net cash provided by financing activities ......................        24,179,529         24,554,549         41,851,682
                                                                                 ------------       ------------       ------------
           Net increase (decrease) in cash and cash equivalents ...........        (2,849,954)         5,239,892          8,774,411
CASH AND CASH EQUIVALENTS,
   BEGINNING OF YEAR ......................................................        18,532,070         13,292,178          4,517,767
                                                                                 ------------       ------------       ------------
CASH AND CASH EQUIVALENTS, END OF YEAR ....................................      $ 15,682,116       $ 18,532,070       $ 13,292,178
                                                                                 ============       ============       ============
CASH PAID FOR:
   Interest ...............................................................      $ 12,899,387       $  7,874,663       $  5,208,699
                                                                                 ============       ============       ============
   Income taxes ...........................................................      $  3,218,693       $  1,517,400       $  1,524,449
                                                                                 ============       ============       ============
</TABLE>


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.



                                       43
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 1 - ORGANIZATION

First South  Bancorp,  Inc.  (the  "Corporation"  or the  "Company")  is a South
Carolina  corporation  organized  in 1999 for the  purpose  of  being a  holding
company for First South Bank ("the Bank"). On September 30, 1999,  pursuant to a
plan  of  exchange  approved  by  the  shareholders  of  the  Bank,  all  of the
outstanding  shares of common  stock of the Bank were  exchanged  for  shares of
common  stock  of the  Corporation.  The  Corporation  presently  engages  in no
business  other than that of owning the Bank and has no employees.  The Bank was
incorporated on April 23, 1996, and began banking operations on August 19, 1996.
The Bank is a South Carolina chartered commercial bank and is engaged in lending
and deposit gathering  activities from two branches in Spartanburg  County,  one
branch in Columbia,  South Carolina, one branch in Bluffton, South Carolina, and
a loan production  office in Greenville,  South Carolina.  It operates under the
laws of South  Carolina  and the Rules and  Regulations  of the Federal  Deposit
Insurance   Corporation   and  the  South  Carolina  State  Board  of  Financial
Institutions.

On April 1, 2004,  the Company  completed a secondary  stock  offering  and sold
360,000  shares  of stock at  $20.83  per  share,  with  net  proceeds  totaling
$7,482,067.

NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES

The  following is a  description  of the  significant  accounting  and reporting
policies that First South Bancorp,  Inc. and Subsidiary follows in preparing and
presenting their financial statements.

Basis of Presentation and Consolidation - The consolidated  financial statements
include the accounts of the Corporation  and its  wholly-owned  subsidiary,  the
Bank.  All  significant   intercompany   balances  and  transactions  have  been
eliminated in consolidation.

Use of Estimates - The preparation of the consolidated  financial  statements in
conformity with accounting principles generally accepted in the United States of
America  requires  management  to make  estimates  and  assumptions  that affect
reported  amounts  of  assets  and  liabilities  and  disclosure  of  contingent
liabilities at the date of the financial  statements,  as well as the amounts of
income and expenses  during the Reporting  period.  Actual  results could differ
from those estimates.

Securities - Investments  in equity  securities  that have readily  determinable
fair values and all investments in debt securities are classified at acquisition
into one of three categories and accounted for as follows:

     o    securities  held-for-investment  are  held-to-maturity and reported at
          amortized cost,
     o    trading  securities are reported at fair value with  unrealized  gains
          and losses included in earnings, or;
     o    securities  available-for-sale  are reported at  estimated  fair value
          with unrealized  gains and losses reported as a separate  component of
          comprehensive income (net of tax effect).

The Company intends to hold the available-for-sale  securities for an indefinite
period of time but may sell them prior to maturity.  All other  securities  have
been classified as held-to-maturity securities because management has determined
that the  Company  has the  intent and the  ability to hold all such  securities
until maturity.

Gains and  losses on sales of  securities  are  recognized  when  realized  on a
specific identification,  trade date basis. Premiums and discounts are amortized
into interest income using a method that approximates the level yield method.

There were no investments  classified as trading securities at December 31, 2006
and 2005.

                                       44
<PAGE>

                   FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES - continued

Loans and  Allowance  for Loan  Losses - Loans are  carried  at their  principal
amount  outstanding.  Interest income is recorded as earned on an accrual basis.
The accrual of interest is  discontinued  when,  in  management's  opinion,  the
borrower may be unable to meet payments as they become due,  generally  when the
loan is 90 days delinquent.  All interest  accrued,  but not collected for loans
that are placed on nonaccrual, is reversed against interest income. A commercial
loan is considered  past due when a payment is not received by the next business
day after the due date. A consumer loan is considered past due when a payment is
not received within 30 days after the due date.

The  Company  uses the  allowance  method  in  providing  for loan  losses.  The
provision  for loan  losses is based upon  management's  estimate  of the amount
needed to maintain the allowance  for loan losses at an adequate  level to cover
known and probable  losses in the loan  portfolio.  In determining the provision
amount,  management  gives  consideration to current  economic  conditions,  the
growth and composition of the loan portfolio,  the relationship of the allowance
for loan losses to outstanding loans and other factors. Management believes that
the  allowance  for loan  losses is  adequate.  While  management  uses the best
information  available to make evaluations,  future adjustments may be necessary
if economic and other conditions differ substantially from the assumptions used.

Management considers loans to be impaired when, based on current information and
events,  it is probable  that the Company  will be unable to collect all amounts
due  according  to the  contractual  terms of the loan  agreement.  Factors that
influence  management's  judgments include, but are not limited to, loan payment
pattern,  source of  repayment,  and value of  collateral.  A loan  would not be
considered  impaired  if an  insignificant  delay  in loan  payment  occurs  and
management   expects  to  collect  all  amounts  due.  The  major   sources  for
identification  of loans to be  evaluated  for  impairment  include past due and
nonaccrual  reports,  internally  generated  lists of loans  with  certain  risk
grades, and regulatory reports of examination. Impaired loans are measured using
either  the  discounted  expected  cash flow  method or the value of  collateral
method.  When the ultimate  collectibility of an impaired loan's principal is in
doubt, wholly or partially, all cash receipts are applied to principal.

Other Real Estate Owned - Other real estate owned (OREO)  represents  properties
acquired through foreclosure or other proceedings.  OREO is held for sale and is
recorded  at the lower of the  recorded  amount of the loan or fair value of the
properties  less  estimated  costs of  disposal.  Fair  value is  determined  by
appraisal.  Any  write-down  to fair  value at the time of  transfer  to OREO is
charged to the  allowance  for loan losses.  Property is evaluated  regularly to
ensure the  carrying  amount is  supported  by its current  fair value.  OREO is
reported net of allowance for losses in the Company's financial statements.

Premises  and   Equipment  -  Premises  and   equipment,   including   leasehold
improvements, are stated at cost less accumulated depreciation.  Depreciation is
provided over the estimated useful lives which includes the remaining lease term
and probable  renewal  periods.  Expenditures for major renewals and betterments
are  capitalized  and those for maintenance and repairs are charged to operating
expense as incurred.

Loan  Origination Fees - Origination fees received and direct costs incurred are
amortized to interest income over the contractual lives of the loans.

Cash and Cash Equivalents - Cash and cash equivalents  include cash and due from
banks,  federal  funds  sold and  interest-bearing  deposits.  During the normal
course of business,  the Company may have cash  deposits  with banks that are in
excess of federally insured limits.


                                       45
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES - continued

Income Taxes - Deferred tax assets and liabilities are recognized for the future
tax  consequences  attributable to differences  between the financial  statement
carrying  amount of existing  assets and  liabilities  and their  respective tax
bases.  Deferred tax assets and liabilities are measured using enacted tax rates
expected  to apply to  taxable  income  in the  years in which  those  temporary
differences  are  expected to be  recovered  in income.  Deferred tax assets are
reduced by a  valuation  allowance  if it is more  likely  than not that the tax
benefits will not be realized.  Management  believes that no valuation allowance
is required at December 31, 2006, 2005, and 2004.

Earnings Per Common  Share - Earnings per common share is computed  based on the
weighted  average  number of common  shares  outstanding.  Diluted  earnings per
common share  includes the dilutive  effect of outstanding  stock  options.  All
share amounts have been  adjusted for the 6 for 5 stock split in 2006,  see Note
15.

Stock-Based  Compensation  - On January 1, 2006,  the  Company  adopted the fair
value recognition  provisions of Financial  Accounting  Standards Board ("FASB")
Statement of Financial  Accounting  Standards  ("SFAS") No. 123(R),  Share-Based
Payment,  to account for  compensation  costs under its stock option plans.  The
Company  previously   utilized  the  intrinsic  value  method  under  Accounting
Principles  Board  Opinion  ("APB")  No.  25,  Accounting  for  Stock  Issued to
Employees (as amended).  Under the intrinsic value method  prescribed by APB 25,
no  compensation  costs were  recognized for the Company's stock options because
the option  exercise  price in its plans  equals the market price on the date of
grant.  Prior to January 1,  2006,  the  Company  only  disclosed  the pro forma
effects on net income and  earnings  per share as if the fair value  recognition
provisions of SFAS No. 123 had been utilized.

In adopting SFAS No. 123(R), the Company elected to use the modified prospective
method to account for the transition from the intrinsic value method to the fair
value recognition method.  Under the modified  prospective method,  compensation
cost is  recognized  from the adoption  date  forward for all new stock  options
granted and for any outstanding  unvested awards as if the fair value method had
been  applied  to those  awards as of the date of  grant.  The  following  table
illustrates the effect on net income and earnings per share as if the fair value
based method had been  applied to all  outstanding  and unvested  awards in each
period.

<TABLE>
<CAPTION>
                                                                                 For the years ended December 31,
                                                                                 --------------------------------
                                                                                         2005              2004
                                                                                         ----              ----
<S>                                                                              <C>              <C>
     Net income - as reported ...............................................    $   3,400,004    $    3,000,055
     Deduct: Stock based compensation .......................................          398,628           170,398
     Net income - pro forma .................................................        3,001,376         2,829,657
     Earnings per common share - as reported ................................             1.64              1.56
     Earnings per common share - pro forma ..................................             1.45              1.47
     Diluted earnings per common share - as reported ........................             1.58              1.47
     Diluted earnings per common share - pro forma ..........................             1.39              1.38
</TABLE>

The fair value of each option  grant is estimated on the date of grant using the
Black-Scholes   option-pricing   model  with  the  following   weighted  average
assumptions  used for grants in 2005 and 2004;  dividend  yield of 0.00 percent,
expected volatility of 50 percent in 2005 and 2004,  risk-free interest rates of
4.33 percent in 2005,  and 4.24 percent in 2004,  and expected lives of 10 years
for the options.

On December 21, 2005, the board of directors  approved  accelerating the vesting
of 30,705 unvested stock options.  The  accelerated  vesting was effective as of
December  30,  2005.  All of the other terms and  conditions  applicable  to the
outstanding stock options remain unchanged.


                                       46
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES - continued

Stock Options  (continued) - The decision to accelerate vesting of these options
was to avoid the recognition of pre-tax compensation expense by the Company upon
the adoption of SFAS No. 123(R). In the Company's view, the future  compensation
expense would  outweigh the incentive and retention  value  associated  with the
stock options.  The future pre-tax compensation expense that was estimated to be
avoided,  based upon the effective  date of January 1, 2006,  was expected to be
approximately $138,000 and $134,000 in fiscal years 2006 and 2007, respectively.
The Company  believes  that the  acceleration  of vesting  stock options met the
criteria for variable accounting under FASB  Interpretation  (FIN) No. 44. Based
upon past  experience,  the Company believed the grantees of these stock options
would remain as a director or employee of the Company.

Fair Value of  Financial  Instruments  - SFAS No. 107,  "Disclosures  about Fair
Value of Financial  Instruments",  requires disclosure of fair value information
about  financial  instruments,  whether  or not  recognized  on the  face of the
balance  sheet,  for  which  it is  practicable  to  estimate  that  value.  The
assumptions used in the estimation of the fair value of the Company's  financial
instruments  are detailed  below.  Where quoted prices are not  available,  fair
values are based on estimates  using  discounted  cash flows and other valuation
techniques.  The use of discounted cash flows can be  significantly  affected by
the assumptions  used,  including the discount rate and estimates of future cash
flows. The following  disclosures  should not be considered an indication of the
liquidation value of the Company,  but rather represent a good-faith estimate of
the value of the financial instruments held by the Company.

The following  methods and assumptions  were used to estimate the fair value for
each class of financial instruments:

     Cash and Cash  Equivalents  - For cash on  hand,  amounts  due from  banks,
     federal  funds sold,  and  interest-bearing  deposits,  the carrying  value
     approximates fair value.

     Securities - The fair value of  investments  securities  is based on quoted
     market  prices,  if available.  If a quoted market price is not  available,
     fair value is estimated using quoted market prices for similar  securities.
     Restricted Federal Home Loan Bank (FHLB) stock is valued at cost.

     Loans - The fair value of fixed rate loans is estimated by discounting  the
     future cash flows using the current  rates at which  similar loans would be
     made to borrowers  with similar  credit  ratings and for the same remaining
     maturities.  The fair value of variable rate loans with frequent  repricing
     and no significant changes in credit risk approximates book value.

     Deposits  and  Borrowings  - The fair  value of fixed  rate time  deposits,
     borrowed funds and subordinated debt is estimated by discounting the future
     cash flows using the current rates at which similar deposits and borrowings
     would be accepted for the same remaining maturities.

     Other   Interest-Bearing   Liabilities  -  The  carrying  value  of  retail
     repurchase  agreements  and other borrowed  funds  approximates  fair value
     since these obligations have variable interest rates with daily repricings.
     At least an equal  amount of  securities,  at their  carrying  values,  are
     pledged as collateral for all repurchase agreements.

     Commitments  - The fair value of  commitments  to extend credit is based on
     fees currently  being charged for similar  instruments and is considered to
     approximate   carrying  value.  For  other  commitments,   generally  of  a
     short-term  nature,  the carrying  value is  considered  to be a reasonable
     estimate of fair value.


                                       47
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES - continued

Recent  Accounting  Pronouncements  -  The  following  is a  summary  of  recent
authoritative   pronouncements  that  may  affect  accounting,   reporting,  and
disclosure of financial information by the Company:

In February  2006,  the FASB issued SFAS No. 155,  Accounting for Certain Hybrid
Financial  Instruments - an amendment of FASB  Statements  No. 133 and 140. This
Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities,  and SFAS  No.  140,  Accounting  for  Transfers  and  Servicing  of
Financial Assets and  Extinguishments  of Liabilities.  This Statement  resolves
issues  addressed in SFAS No. 133  Implementation  Issue No. D1,  Application of
Statement 133 to Beneficial Interests in Securitized  Financial Assets. SFAS No.
155 permits fair value  re-measurement for any hybrid financial  instrument that
contains  an embedded  derivative  that  otherwise  would  require  bifurcation,
clarifies which interest  only-strips and principal-only  strips are not subject
to the  requirements  of SFAS No. 133,  establishes  a  requirement  to evaluate
interests  in  securitized  financial  assets  to  identify  interests  that are
freestanding  derivatives or that are hybrid financial  instruments that contain
an embedded derivative requiring  bifurcation,  clarifies that concentrations of
credit  risk in the form of  subordination  are not  embedded  derivatives,  and
amends SFAS No. 140 to eliminate the prohibition on a qualifying special purpose
entity  from  holding a  derivative  financial  instrument  that  pertains  to a
beneficial interest other than another derivative financial instrument. SFAS No.
155 is  effective  for all  financial  instruments  acquired or issued after the
beginning of an entity's first fiscal year that begins after September 15, 2006.
The  Company  does not  believe  that the  adoption  of SFAS No. 155 will have a
material impact on its financial position, results of operations and cash flows.

In March  2006,  the FASB  issued  SFAS No. 156,  Accounting  for  Servicing  of
Financial  Assets--an amendment of FASB Statement No. 140. This Statement amends
SFAS No. 140,  Accounting  for Transfers  and Servicing of Financial  Assets and
Extinguishments  of  Liabilities,  with respect to the accounting for separately
recognized servicing assets and servicing liabilities.  SFAS No. 156 requires an
entity to  recognize  a  servicing  asset or  servicing  liability  each time it
undertakes  an  obligation  to  service a  financial  asset by  entering  into a
servicing  contract;  requires all separately  recognized  servicing  assets and
servicing  liabilities to be initially  measured at fair value,  if practicable;
permits an entity to choose its subsequent measurement methods for each class of
separately recognized servicing assets and servicing liabilities; at its initial
adoption,  permits a one-time reclassification of available-for-sale  securities
to trading  securities by entities with  recognized  servicing  rights,  without
calling into question the treatment of other available-for-sale securities under
SFAS No. 115, provided that the available-for-sale  securities are identified in
some  manner as  offsetting  the  entity's  exposure to changes in fair value of
servicing assets or servicing liabilities that a servicer elects to subsequently
measure at fair value;  and requires  separate  presentation of servicing assets
and servicing  liabilities  subsequently measured at fair value in the statement
of financial position and additional  disclosures for all separately  recognized
servicing assets and servicing liabilities.  An entity should adopt SFAS No. 156
as of the  beginning of its first fiscal year that begins  after  September  15,
2006.  The Company  does not  believe  the  adoption of SFAS No. 156 will have a
material impact on its financial position, results of operations and cash flows.

In July 2006, the FASB issued FIN No. 48 ("FIN 48"),  Accounting for Uncertainty
in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in enterprises' financial statements in accordance with SFAS No. 109,
Accounting  for Income  Taxes.  FIN 48  prescribes a  recognition  threshold and
measurement attributable for the financial statement recognition and measurement
of a tax  position  taken or expected  to be taken in a tax return.  FIN 48 also
provides  guidance on  derecognition,  classification,  interest and  penalties,
accounting in interim periods,  disclosures and transitions. FIN 48 is effective
for fiscal years  beginning  after  December 15, 2006.  The Company is currently
analyzing the effects of FIN 48 on its financial position, results of operations
or cash flows.


                                       48
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES -


Recent  Accounting  Pronouncements  (continued)  - In September  2006,  the FASB
issued SFAS No. 157, Fair Value  Measurements.  SFAS No. 157 defines fair value,
establishes  a  framework  for  measuring  fair  value  in  generally   accepted
accounting  principles,  and expands  disclosures about fair value measurements.
This  standard  does not  require  any new fair value  measurements,  but rather
eliminates  inconsistencies found in various prior pronouncements.  SFAS No. 157
is  effective  for the Company on January 1, 2008 and is not  expected to have a
significant impact on the Company's financial statements.

In  September,  2006,  The FASB ratified the  consensuses  reached by the FASB's
Emerging  Issues Task Force ("EITF")  relating to EITF 06-4,  Accounting for the
Deferred   Compensation  and  Postretirement   Benefit  Aspects  of  Endorsement
Split-Dollar  Life  Insurance   Arrangements.   EITF  06-4  addresses   employer
accounting for endorsement split-dollar life insurance arrangements that provide
a benefit to an employee that extends to postretirement periods should recognize
a liability  for future  benefits in  accordance  with SFAS No. 106,  Employers'
Accounting for Postretirement  Benefits Other Than Pensions,  or Opinion No. 12,
Omnibus  Opinion - 1967. EITF 06-4 is effective for fiscal years beginning after
December 15, 2006.  Entities should recognize the effects of applying this Issue
through either (a) a change in accounting  principle through a cumulative-effect
adjustment to retained  earnings or to other  components of equity or net assets
in the  statement  of  financial  position  as of the  beginning  of the year of
adoption  or  (b)  a  change  in  accounting  principle  through   retrospective
application to all prior  periods.  The Company does not believe the adoption of
EITF 06-4 will have a  material  impact on its  financial  position,  results of
operations and cash flows.

In September 2006, the FASB ratified the consensus reached related to EITF 06-5,
Accounting for Purchases of Life  Insurance - Determining  the Amount That Could
Be Realized in Accordance with FASB Technical Bulletin No. 85-4,  Accounting for
Purchases  of Life  Insurance.  EITF  06-5  states  that a  policyholder  should
consider  any  additional  amounts  included  in the  contractual  terms  of the
insurance  policy other than the cash surrender  value in determining the amount
that could be realized under the insurance contract.  EITF 06-5 also states that
a policyholder should determine the amount that could be realized under the life
insurance   contract   assuming   the   surrender  of  an   individual-life   by
individual-life  policy (or certificate by certificate in a group policy).  EITF
06-5 is  effective  for fiscal years  beginning  after  December  15, 2006.  The
Company does not believe the  adoption of EITF 06-5 will have a material  impact
on its financial position, results of operations and cash flows.

In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No. 108. SAB
108  provides  interpretive  guidance  on how the  effects of the  carryover  or
reversal of prior year  misstatements  should be  considered  in  quantifying  a
potential current year misstatement.  Prior to SAB 108, companies might evaluate
the  materiality of financial  statement  misstatements  using either the income
statement or balance sheet approach, with the income statement approach focusing
on new  misstatements  added in the current year, and the balance sheet approach
focusing on the cumulative amount of misstatement present in a company's balance
sheet.  Misstatements  that would be material under one approach could be viewed
as immaterial under another approach, and not be corrected. SAB 108 now requires
that companies view financial  statement  misstatements  as material if they are
material according to either the income statement or balance sheet approach. The
Company has analyzed SAB 108 and  determined  that upon adoption it will have no
impact on the reported results of operations or financial conditions.


                                       49
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES - continued

Recent Accounting Pronouncements (continued) - In December 2006, the FASB issued
a Staff Position ("FSP") on EITF 00-19-2,  Accounting for  Registration  Payment
Arrangements  ("FSP  EITF  00-19-2").  This FSP  specifies  that the  contingent
obligation to make future payments or otherwise transfer  consideration  under a
registration  payment  arrangement,  whether  issued as a separate  agreement or
included as a provision of a financial instrument or other agreement,  should be
separately recognized and measured in accordance with SFAS No. 5, Accounting for
Contingencies.  If the transfer of  consideration  under a registration  payment
arrangement  is probable  and can be  reasonably  estimated  at  inception,  the
contingent  liability under the registration  payment arrangement is included in
the allocation of proceeds from the related  financing  transaction (or recorded
subsequent  to  the  inception  of a  prior  financing  transaction)  using  the
measurement  guidance  in SFAS No.  5.  This FSP is  effective  immediately  for
registration payment arrangements and the financial instruments subject to those
arrangements that are entered into or modified subsequent to the issuance of the
FSP. For prior  arrangements,  the FSP is  effective  for  financial  statements
issued for fiscal years  beginning  after December 15, 2006 and interim  periods
within those  years.  The Company does not believe the adoption of this FSP will
have a material impact on its financial position, results of operations and cash
flows.

In  February  2007,  the FASB issued  SFAS No.  159,  The Fair Value  Option for
Financial  Assets and  Financial  Liabilities  - Including  an amendment of FASB
Statement No. 115. This  statement  permits,  but does not require,  entities to
measure many financial  instruments  at fair value.  The objective is to provide
entities with an opportunity to mitigate  volatility in reported earnings caused
by measuring related assets and liabilities  differently without having to apply
complex hedge accounting provisions. Entities electing this option will apply it
when the  entity  first  recognizes  an  eligible  instrument  and  will  report
unrealized  gains and  losses on such  instruments  in  current  earnings.  This
statement (1) applies to all entities, (2) specifies certain election dates, (3)
can be applied on an instrument-by-instrument basis with some exceptions, (4) is
irrevocable, and (5) applies only to entire instruments. One exception is demand
deposit  liabilities which are explicitly excluded as qualifying for fair value.
With respect to SFAS No. 115, available-for-sale and held-to-maturity securities
at the  effective  date are eligible for the fair value option at that date.  If
the fair value option is elected for those  securities  at the  effective  date,
cumulative  unrealized  gains and losses at that date shall be  included  in the
cumulative-effect  adjustment and thereafter,  such securities will be accounted
for as trading securities.  SFAS No. 159 is effective for the Company on January
1, 2008.  Earlier  adoption is  permitted  in 2007 if the Company also elects to
apply the  provisions  of SFAS No. 157, Fair Value  Measurement.  The Company is
currently analyzing the fair value option provided under SFAS No. 159.

Other  accounting  standards  that have been  issued or  proposed by the FASB or
other standards-setting bodies are not expected to have a material impact on the
Company's financial position, results of operations and cash flows.

Operating  Segments - The Company has  determined  that,  using the  definitions
contained in SFAS No. 131,  "Disclosures  about  Segments of an  Enterprise  and
Related  Information",  all of its  activities  constitute  only one  reportable
operating segment.

Concentrations of Credit Risk - Financial instruments, which potentially subject
the Company to  concentrations  of credit  risk,  consist  principally  of loans
receivable,  investment  securities,  federal  funds sold and  amounts  due from
banks.

The Company makes loans to individuals and small businesses for various personal
and  commercial  purposes  primarily in and around  Spartanburg,  Richland,  and
Beaufort  counties  in South  Carolina.  The  Company's  loan  portfolio  is not
concentrated  in loans to any single  borrower or a  relatively  small number of
borrowers. Additionally,  Management is not aware of any concentrations of loans
to classes of  borrowers  or  industries  that would be  similarly  affected  by
economic conditions.



                                       50
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES - continued

Concentrations of Credit Risk (continued) - In addition to monitoring  potential
concentrations  of  loans  to  particular  borrowers  or  groups  of  borrowers,
industries and geographic  regions,  Management monitors exposure to credit risk
from concentrations of lending products and practices such as loans that subject
borrowers to substantial  payment  increases (e.g.  principal  deferral periods,
loans  with  initial   interest-only   periods,   etc),   and  loans  with  high
loan-to-value  ratios.  Management has determined that there is no concentration
of credit risk associated with its lending policies or practices. However, there
are industry  practices that could subject the Company to increased  credit risk
should economic conditions change over the course of a loan's life. For example,
the Company makes variable rate loans and fixed rate principal-amortizing  loans
with maturities prior to the loan being fully paid (i.e. balloon payment loans).
These loans are  underwritten  and  monitored  to manage the  associated  risks.
Therefore,  management  believes that these particular  practices do not subject
the Company to unusual credit risk.

The Company's  investment  portfolio consists  principally of obligations of the
United States, its agencies or its corporations and general obligation municipal
securities.  In the opinion of Management,  there is no  concentration of credit
risk in its  investment  portfolio.  The Company places its  correspondent  bank
account  deposits  with high  quality  institutions,  and  sells  its  overnight
investments to the Federal Home Loan Bank of Atlanta. Management believes credit
risk associated with correspondent accounts is not significant.

Reclassification  - Certain of the prior year amounts have been  reclassified to
conform to current year presentation;  such  reclassifications are immaterial to
the financial statements.


NOTE 3 - SECURITIES

A  summary  of the  amortized  cost  and  estimated  fair  value  of  securities
available-for-sale follows:

<TABLE>
<CAPTION>
                                                                                           Gross Unrealized
                                                                   Amortized               ----------------              Estimated
                                                                     Cost             Gains              Losses          Fair Value
                                                                     ----             -----              ------          ----------
December 31, 2006
<S>                                                             <C>                <C>                <C>                <C>
   U.S. government agency obligations ..................        $ 4,000,000        $     9,380        $    17,490        $ 3,991,890
   Government sponsored enterprises ....................         17,993,247                  -            143,282         17,849,965
   State and local obligations .........................            123,258              4,566                  -            127,824
   Mortgage-backed securities ..........................            597,214                  -             14,261            582,953
   Restricted FHLB stock ...............................            740,500                  -                  -            740,500
                                                                -----------        -----------        -----------        -----------
      Total ............................................        $23,454,219        $    13,946        $   175,033        $23,293,132
                                                                ===========        ===========        ===========        ===========
December 31, 2005
   U.S. government agency obligations ..................        $ 3,000,000        $         -        $    55,930        $ 2,944,070
   Government sponsored enterprises ....................         18,490,708                  -            208,478         18,282,230
   State and local obligations .........................            123,204              5,670                  -            128,874
   Mortgage-backed securities ..........................            765,855                  -             23,994            741,861
   Restricted FHLB stock ...............................          1,268,800                  -                  -          1,268,800
                                                                -----------        -----------        -----------        -----------
      Total ............................................        $23,648,567        $     5,670        $   288,402        $23,365,835
                                                                ===========        ===========        ===========        ===========
</TABLE>

There were no sales of securities available-for-sale in 2006 or 2005.


                                       51
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 3 - SECURITIES - continued

The following table shows gross unrealized losses and fair value,  aggregated by
investment category,  and length of time that individual securities have been in
a continuous unrealized loss position, at December 31, 2006.

Securities Available-for-Sale

<TABLE>
<CAPTION>
                                                       Less Than                  Twelve Months
                                                     Twelve Months                   or More                        Total
                                                     -------------                   -------                        -----
                                                       Unrealized                   Unrealized                    Unrealized
                                               Fair Value       Losses       Fair Value       Losses       Fair Value       Losses
                                               ----------       ------       ----------       ------       ----------       ------
<S>                                           <C>            <C>            <C>            <C>            <C>            <C>
U.S. government agency obligations .......    $   999,380    $       620    $   983,130    $    16,870    $ 1,982,510    $    17,490
Government sponsored enterprises .........      5,975,600         24,400     11,374,365        118,882     17,349,965        143,282
Mortgage backed securities ...............              -              -        582,953         14,261        582,953         14,261
                                              -----------    -----------    -----------    -----------    -----------    -----------
     Total ...............................    $ 6,974,980    $    25,020    $12,940,448    $   150,013    $19,915,428    $   175,033
                                              ===========    ===========    ===========    ===========    ===========    ===========
</TABLE>

Securities classified as  available-for-sale  are recorded at fair market value.
Approximately  65.0% of the unrealized losses on securities  available-for-sale,
or eleven  individual  securities,  consisted of securities in a continuous loss
position  for twelve  months or more.  The Company has the ability and intent to
hold these  securities  until such time as the value  recovers or the securities
mature.  The  Company  believes,  based on industry  analyst  reports and credit
ratings,  that the  deterioration  in value is attributable to changes in market
interest  rates and is not in the credit  quality  of the issuer and  therefore,
these losses are not considered other-than-temporary.

A summary of the carrying  value and  estimated  fair market value of securities
held-for-investment follows:

<TABLE>
<CAPTION>
                                                                                            Gross Unrealized
                                                                    Amortized               ----------------             Estimated
                                                                       Cost             Gains             Losses         Fair Value
                                                                       ----             -----             ------         ----------
December 31, 2006
<S>                                                                <C>               <C>              <C>                <C>
   U.S. government agency obligations ......................       $ 2,000,000       $     2,500      $          -       $ 2,002,500
   Government sponsored enterprises ........................         6,998,283            36,357            22,000         7,012,640
   Trust preferred securities ..............................           482,154           149,502                 -           631,656
   Mortgage backed securities ..............................           421,201             3,428                 -           424,629
                                                                   -----------       -----------       -----------       -----------
      Total securities held for investment .................       $ 9,901,638       $   191,787       $    22,000       $10,071,425
                                                                   ===========       ===========       ===========       ===========
December 31, 2005
   U.S. government agency obligations ......................       $ 2,000,000       $     8,120      $          -       $ 2,008,120
   Government sponsored enterprises ........................         4,000,000             1,420            11,520         3,989,900
   Trust preferred securities ..............................           480,641           153,331                 -           633,972
   Mortgage backed securities ..............................           783,429            12,057                 -           795,486
                                                                   -----------       -----------       -----------       -----------
      Total securities held for investment .................       $ 7,264,070       $   174,928       $    11,520       $ 7,427,478
                                                                   ===========       ===========       ===========       ===========
</TABLE>



                                       52
<PAGE>


                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 3 - SECURITIES - continued

Securities Held-for-Investment

<TABLE>
<CAPTION>
                                                      Less Than                  Twelve Months
                                                    Twelve Months                   or More                        Total
                                                    -------------                   -------                        -----
                                                      Unrealized                  Unrealized                     Unrealized
                                              Fair Value       Losses    Fair Value       Losses        Fair Value           Losses
                                              ----------       ------    ----------       ------        ----------           ------

<S>                                           <C>           <C>           <C>           <C>           <C>                   <C>
Government sponsored enterprises .........    $1,992,420    $    7,580    $1,985,580    $   14,420    $    3,978,000        $ 22,000
                                              ----------    ----------    ----------    ----------    --------------        --------

     Total ...............................    $1,992,420    $    7,580    $1,985,580    $   14,420    $    3,978,000        $ 22,000
                                              ==========    ==========    ==========    ==========    ==============        ========
</TABLE>
Securities  classified as  held-for-investment  are recorded at amortized  cost.
Approximately 65.6% of the unrealized losses on securities  held-for-investment,
or one  individual  security,  consisted  of a  security  in a  continuous  loss
position  of twelve  months or more.  The  Company  believes,  based on industry
analyst  reports  and  credit  ratings,  that  the  deterioration  in  value  is
attributable  to  changes  in market  interest  rates  and is not in the  credit
quality  of  the  issuer,  and  therefore,   these  losses  are  not  considered
other-than-temporary.

The    scheduled    maturities    of    securities    held-for-investment    and
available-for-sale at December 31, 2006 were as follows:

<TABLE>
<CAPTION>
                                                                Available-For-Sale                         Held-For-Investment
                                                                ------------------                         -------------------
                                                         Amortized           Estimated               Amortized           Estimated
                                                            Cost             Fair Value                 Cost             Fair Value
                                                            ----             ----------                 ----             ----------
<S>                                                    <C>                   <C>                  <C>                  <C>
Due in one year or less ....................           $ 5,000,000           $ 4,960,910          $          -         $           -
Due from one to five years .................             6,493,247             6,427,245             4,000,000             3,978,000
Due from five to ten years .................             6,500,000             6,484,720             4,998,283             5,037,140
Due after ten years ........................             4,123,258             4,096,804                     -                     -
Mortgage backed securities .................               597,214               582,953               421,201               424,629
Equity securities ..........................               740,500               740,500               482,154               631,656
                                                       -----------           -----------           -----------           -----------
                                                       $23,454,219           $23,293,132           $ 9,901,638           $10,071,425
                                                       ===========           ===========           ===========           ===========
</TABLE>

At December 31, 2006, securities with a book value of approximately  $7,141,673,
and  market  value of  $7,054,956  were  pledged  to  secure  retail  repurchase
agreements, state funds, and Treasury, tax and loan deposits.

NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans at December 31, 2006 and 2005 are summarized as follows:

                                                          December 31,
                                                          ------------
                                                     2006              2005
                                                     ----              ----
Construction and land development ............   $  29,634,235    $  14,041,295
1-4 family residential properties ............      67,063,355       65,187,499
Multifamily residential properties ...........       6,986,855        3,761,194
Non-farm nonresidential properties ...........     139,267,286      136,691,677
Other real estate loans ......................       3,077,618        3,210,755
Commercial and industrial, non-real estate ...      50,556,004       45,229,728
Consumer .....................................         394,754          409,653
                                                 -------------    -------------
   Total loans ...............................     296,980,107      268,531,801
   Less allowance for loans losses ...........      (3,275,000)      (3,000,000)
   Net deferred loan fees ....................        (514,958)        (498,388)
                                                 -------------    -------------
                                                 $ 293,190,149    $ 265,033,413
                                                 =============    =============



                                       53
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES - continued

The  activity  in the  allowance  for loan  losses for 2006,  2005,  and 2004 is
summarized as follows:

                                                    December 31,
                                                    ------------
                                          2006          2005           2004
                                          ----          ----           ----
Balance, beginning of year ........   $ 3,000,000    $ 2,900,000    $ 2,600,000
Provision charged to operations ...       949,930        561,086        705,522
Loan charge-offs ..................      (778,107)      (479,789)      (421,448)
Loan recoveries ...................       103,177         18,703         15,926
                                      -----------    -----------    -----------
Balance, end of year ..............   $ 3,275,000    $ 3,000,000    $ 2,900,000
                                      ===========    ===========    ===========

At December  31, 2006 and 2005,  nonaccrual  loans  amounted to  $1,756,803  and
$1,892,763,  respectively.  The Company evaluates impairment of commercial loans
on an individual loan basis. As of December 31, 2006 and 2005 loans individually
evaluated and considered  impaired under SFAS No. 114,  "Accounting by Creditors
for Impairment of a Loan", were immaterial.

At December 31, 2006, the Company had loans outstanding to officers,  directors,
and their related interests of $4,686,954. During 2006, directors, officers, and
their related interests borrowed  $6,241,362 and repaid $4,672,432.  At December
31, 2005, the Company had loans  outstanding to officers,  directors,  and their
related interests of $3,118,024.  During 2005,  directors,  officers,  and their
related interests borrowed $1,391,840 and repaid $2,319,133.

In the normal  course of  business  there are  outstanding  commitments  for the
extension of credit,  which are not  reflected in the financial  statements.  At
December  31, 2006 and 2005,  pre-approved  but unused lines of credit for loans
totaled approximately  $50,964,000 and $40,616,000,  respectively.  In addition,
the Company had issued  standby  letters of credit  amounting  to  approximately
$6,104,000  and  $2,442,000  at December  31, 2006 and 2005,  respectively.  The
Company  also had  $4,702,415  in  outstanding  variable  rate  commercial  loan
commitments at December 31, 2006. These  commitments  represent no more than the
normal  lending  risk  that  the  Company  commits  to its  borrowers.  If these
commitments  are drawn,  the  Company  will  obtain  collateral  if it is deemed
necessary  based  on  management's   credit   evaluation  of  the  counterparty.
Management  believes  that  these  commitments  can  be  funded  through  normal
operations.  The fair value of these standby  letters of credit is based on fees
currently  charged for similar  instruments  and is  immaterial to the financial
statements taken as a whole.

The Company grants primarily  commercial,  real estate, and installment loans to
customers  throughout its market area,  which consists  primarily of Spartanburg
County,  Richland  County,  and  Hilton  Head  area in  South  Carolina  and the
Asheville area in North Carolina.  The real estate  portfolio can be affected by
the condition of the local real estate market.  The  commercial and  installment
loan portfolio can be affected by the local economic conditions.


                                       54
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 5 -  PREMISES AND EQUIPMENT

Premises and equipment at December 31, 2006 and 2005 are summarized as follows:

                                                            December 31,
                                                            ------------
                                                     2006                2005
                                                     ----                ----
Land .....................................       $   407,012        $   431,412
Buildings ................................         4,417,777          4,326,450
Leasehold improvements ...................           695,274            667,474
Furniture and equipment ..................         1,953,899          1,638,855
                                                 -----------        -----------
                                                   7,473,962          7,064,191
Less accumulated depreciation ............        (2,183,797)        (1,775,713)
                                                 -----------        -----------
                                                 $ 5,290,165        $ 5,288,478
                                                 ===========        ===========

Depreciation  expense  for the years ended 2006,  2005,  and 2004 was  $419,335,
$381,456 and $432,071, respectively.


NOTE 6 - DEPOSITS

A summary of deposit accounts at December 31, 2006 and 2005 follows:

                                                           December 31,
                                                           ------------
                                                    2006                  2005
                                                    ----                  ----
Demand
   Non-interest bearing ..............         $ 16,037,824         $ 13,820,544
   Interest bearing ..................           28,764,470           34,496,978
Savings ..............................           62,103,260           45,783,692
Time, $100,000 and over ..............           74,479,216           53,795,608
Other ................................          126,672,169          117,828,151
                                               ------------         ------------
                                               $308,056,939         $265,724,973
                                               ============         ============

At December 31, 2006, the scheduled maturities of time deposits are as follows:

     2007                                             $  187,243,870
     2008                                                  7,345,951
     2009                                                  6,379,354
     2010                                                    182,210
                                                      --------------
                                                      $  201,151,385
                                                      ==============

Directors and executive officers were customers of and had transactions with the
Bank in the  ordinary  course of  business.  Included in such  transactions  are
deposit  accounts,  all of which were made under  normal  terms.  The  aggregate
amount of these  deposit  accounts was  $1,308,545  and $906,178 at December 31,
2006 and 2005, respectively.


                                       55
<PAGE>


                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 7 - RETAIL REPURCHASE AGREEMENTS

Information   concerning  securities  sold  under  agreement  to  repurchase  is
summarized as follows for the year ended December 31, 2006 and 2005:

                                                         2006            2005
                                                         ----            ----
Average balance during the year .................     $4,120,047     $4,706,156
Average interest rate during the year ...........           4.21%          2.66%
Maximum month-end balance during the year .......      5,611,994      6,413,256

U.S. government agency and government  sponsored  enterprises  securities with a
book value of  $5,018,415  and a market value of $4,963,172 at December 31, 2006
are used as collateral for the agreement.


NOTE 8 - OTHER BORROWED FUNDS

Other borrowed  funds  consists of advances from the FHLB and treasury,  tax and
loan accounts.

Advances from the FHLB consisted of the following at December 31, 2006 and 2005:

                                         Interest      2006            2005
         Description                       Rate       Balance         Balance
                                           ----       -------         -------
    Fixed rate advances maturing:
       February 15, 2011 .............    4.46%      $      -      $ 5,000,000
       March 21, 2011 ................    4.62%             -        5,000,000
    Daily rate advances ..............    4.44%             -        5,000,000
                                                     --------      -----------
                                                     $      -      $15,000,000
                                                     ========      ===========


Scheduled  principal  reductions of FHLB fixed rate advances are all in 2011. In
2006, the FHLB exercised a call option on the borrowings, therefore retiring the
advances  without  penalty.  The Company  utilized  excess deposits to repay the
advances.

As collateral for all outstanding  advances,  the Company pledges its qualifying
first mortgage loans as well as FHLB stock held by the Company.

Treasury,  tax and loan  accounts  with  balances  of $286,710  and  $297,615 at
December 31, 2006 and 2005,  respectively  are also  included in other  borrowed
funds.  These  borrowings  bear interest at the federal funds rate less 25 basis
points.

At December  31,  2006,  the Bank had  $12,000,000  of unused lines of credit to
purchase federal funds from banks.


                                       56
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 9 - SUBORDINATED DEBT

In January 2004, the Company formed a wholly-owned  Delaware  statutory business
trust, FSBS Capital Trust I (the "Trust"), which issued $5,000,000 of guaranteed
preferred beneficial  interests in the Company's junior subordinated  deferrable
interest debentures (the "Trust Preferred Securities"). These debentures qualify
as Tier I capital.  All of the common  securities  of the Trust are owned by the
Company.  The proceeds from the issuance of the common  securities and the Trust
Preferred  Securities  were  used by the  Trust to  purchase  from  the  Company
$5,155,000  of junior  subordinated  debentures  of the  Company  which  carry a
variable  interest rate of 3 Month LIBOR plus 2.8 percent per annum.  The junior
subordinated  debentures  represent  the sole asset of the Trust.  In accordance
with FIN No. 46 R, the Trust is not consolidated  with the financial  statements
of the Company.

The Company has entered into contractual arrangements which, taken collectively,
fully guarantee payment of (i) accrued and unpaid  distributions  required to be
paid on the Trust Preferred  Securities;  (ii) the redemption price with respect
to any Trust Preferred Securities called for redemption by the Trust , and (iii)
payments  due  upon  a  voluntary  or  involuntary  dissolution,  winding  up or
liquidation of the Trust.

The Trust Preferred  Securities are mandatorily  redeemable upon maturity of the
debentures  in  January  2034 or upon  earlier  redemption  as  provided  in the
indenture.  The Company has the right to redeem the debentures  purchased by the
Trust in whole or in part, at any time,  however if they are redeemed before the
fifth  anniversary,  the  cost  would  be 105  percent  of the par  value of the
securities. The debentures may be redeemed after the fifth anniversary at par.


NOTE 10 - REGULATORY CAPITAL REQUIREMENTS

The Company and the Bank are subject to various regulatory capital  requirements
administered  by the federal banking  agencies.  Failure to meet minimum capital
requirements   can  initiate   certain   mandatory   and   possible   additional
discretionary  actions by regulators  that, if  undertaken,  could have a direct
material  effect on the  Company  and the  Bank's  financial  statements.  Under
capital adequacy  guidelines and the regulatory  framework for prompt corrective
action,  the Company and the Bank must meet  specific  capital  guidelines  that
involve  quantitative  measures  of  their  assets,  liabilities,   and  certain
off-balance-sheet items as calculated under regulatory accounting practices. The
capital amounts and classifications are also subject to qualitative judgments by
the regulators  about  components,  risk  weighting,  and other factors.  Prompt
corrective action provisions are not applicable to bank holding companies.

Quantitative  measures  established  by  regulation to ensure  capital  adequacy
require the Company  and the Bank to  maintain  minimum  amounts and ratios (set
forth in the  table  below)  of total  and Tier 1  capital  (as  defined  in the
regulations)  to  risk-weighted  assets (as defined),  and of Tier 1 capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2006  and  2005,  that  the  Company  and  the  Bank  met all  capital  adequacy
requirements to which it is subject.


                                       57
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 10 - REGULATORY CAPITAL REQUIREMENTS - continued

As of December 31, 2006, the most recent  notification from the FDIC categorized
the  Bank  as  well  capitalized  under  the  regulatory  framework  for  prompt
corrective  action.  To be categorized as adequately  capitalized  the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set  forth in the  table.  There  are no  conditions  or  events  since  that
notification  that  management  believes have changed the Bank's  category.  The
Company and the Bank's actual capital amounts and ratios as of December 31, 2006
and 2005 are also presented in the tables below.

<TABLE>
<CAPTION>
                                                                                                                To Be Well-
                                                                                                              Capitalized Under
                                                                              For Capital                     Prompt Corrective
The Company                                                  Actual         Adequacy Purposes                 Action Provisions
                                                             ------         -----------------                 -----------------
                                                     Amount           Ratio       Amount          Ratio      Amount        Ratio
                                                     ------           -----       ------          -----      ------        -----
December 31, 2006
<S>                                              <C>                  <C>        <C>              <C>    <C>             <C>
  Total capital (to risk-weighted assets) .....  $ 44,230,000         14.79%     $23,930,000      8.00%         N/A         N/A
  Tier 1 capital (to risk-weighted assets) ....    41,055,000         13.72%      11,965,000      4.00%         N/A         N/A
  Tier 1 capital (to average assets) ..........    41,055,000         11.73%      14,003,000      4.00%         N/A         N/A
December 31, 2005
  Total capital (to risk-weighted assets) .....  $ 38,985,000         14.46%     $21,563,000      8.00%         N/A         N/A
  Tier 1 capital (to risk-weighted assets) ....    35,985,000         13.35%      10,782,000      4.00%         N/A         N/A
  Tier 1 capital (to average assets) ..........    35,985,000         11.13%      12,928,000      4.00%         N/A         N/A

The Bank
December 31, 2006
  Total capital (to risk-weighted assets) .....  $ 42,536,000         14.22%     $23,930,000      8.00%  $29,913,000     10.00%
  Tier 1 capital (to risk-weighted assets) ....    34,361,000         11.49%      11,965,000      4.00%   14,956,000      6.00%
  Tier 1 capital (to average assets) ..........    34,361,000          9.82%      14,003,000      4.00%   17,503,000      5.00%
December 31, 2005
  Total capital (to risk-weighted assets) .....  $ 37,660,000         13.98%     $21,551,000      8.00%  $26,938,000     10.00%
  Tier 1 capital (to risk-weighted assets) ....    29,760,000         11.05%      10,775,000      4.00%   16,163,000      6.00%
  Tier 1 capital (to average assets) ..........    29,760,000          9.21%      12,924,000      4.00%   16,155,000      5.00%
</TABLE>


NOTE 11 - INCOME TAXES

The provision for income taxes is summarized below:
<TABLE>
<CAPTION>
                                                                                               December 31,
                                                                                               ------------
                                                                        2006                       2005                      2004
                                                                        ----                       ----                      ----
Currently payable
<S>                                                                 <C>                       <C>                       <C>
   Federal ...........................................              $ 2,497,810               $ 1,784,300               $ 1,556,000
   State .............................................                  215,344                   162,000                   144,000
                                                                    -----------               -----------               -----------
                                                                      2,713,154                 1,946,300                 1,700,000
Deferred
   Federal ...........................................                 (106,248)                  (22,798)                 (122,928)
   State .............................................                       94                    (1,202)                   78,928
                                                                    -----------               -----------               -----------
                                                                       (106,154)                  (24,000)                  (44,000)
                                                                    -----------               -----------               -----------
      Total income taxes .............................              $ 2,607,000               $ 1,922,300               $ 1,656,000
                                                                    ===========               ===========               ===========
</TABLE>



                                       58
<PAGE>


                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 11 - INCOME TAXES - continued

The reasons for the  difference  between the statutory  federal income tax rates
and the effective tax rates are summarized as follows for:
<TABLE>
<CAPTION>
                                                                                                       December 31,
                                                                                                       ------------
                                                                                       2006               2005               2004
                                                                                       ----               ----               ----
<S>                                                                                    <C>                <C>                <C>
Statutory rates ...........................................................            34.0%              34.0%              34.0%
Increase (decrease) resulting from:
   State taxes, net of federal benefit ....................................             2.0                3.1                2.0
   Effect of taxes exempt interest and dividends ..........................               -               (0.2)              (0.6)
   Life insurance .........................................................            (0.2)              (0.4)              (0.7)
   Other, net .............................................................            (0.5)              (0.4)               0.9
                                                                                       ----               ----               ----
                                                                                       36.3%              36.1%              35.6%
                                                                                       ====               ====               ====
</TABLE>

The tax  effects of  temporary  differences  result in  deferred  tax assets and
liabilities as presented below:

                                                           December 31,
                                                           ------------
                                                     2006                2005
                                                     ----                ----
Deferred tax assets
   Allowance for loan losses .............       $   960,697        $   910,861
   Available-for-sale securities .........            61,213            107,439
   Other .................................           142,156            118,031
                                                 -----------        -----------
      Gross deferred tax assets ..........         1,164,066          1,136,331
      Less valuation allowance ...........                 -                  -
                                                 -----------        -----------
      Net deferred tax assets ............         1,164,066          1,136,331
Deferred tax liabilities
   Depreciation ..........................          (118,959)          (144,172)
   Deferred loan cost ....................          (194,251)          (199,573)
   Prepaid expenses ......................           (18,839)           (20,591)
                                                 -----------        -----------
      Gross deferred liabilities .........          (332,049)          (364,336)
                                                 -----------        -----------
         Net .............................       $   832,017        $   771,995
                                                 ===========        ===========

NOTE 12 - COMMITMENTS AND CONTINGENCIES
The  Company  leases the land and  building  for its  branches  under  operating
leases. Future minimum lease payments at December 31, 2006, are as follows:

      2007                                               $     196,950
      2008                                                     171,921
      2009                                                     123,438
      2010                                                      47,804
      2011                                                      38,974
      2012 and thereafter                                       94,187
                                                         -------------
                                                         $     673,274
                                                         =============

Total lease expense was $215,972, $152,843 and $177,672 for 2006, 2005 and 2004,
respectively.
The  Company is  subject to legal  proceedings  and  claims  which  arise in the
ordinary  course of business.  In the opinion of management,  the disposition of
these claims will not have a material  adverse impact on the financial  position
or results of operations of the Company.


                                       59
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 13 - RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES

Federal and state banking  regulations  place certain  restrictions on dividends
paid and loans or advances made by the Bank to the Corporation. The total amount
of cash  dividends,  which  may be paid at any  date  without  prior  regulatory
consent,  is generally limited to the year's net income of the Bank provided the
Bank received a composite rating of one or two at the last examination conducted
by the federal or state regulatory authority,  and loans or advances are limited
to 10 percent of the Bank's common stock and surplus on a secured basis.

In  addition,  cash  dividends  paid by the  Bank to the  Corporation  would  be
prohibited  if the effect  would  cause the Bank's  capital to be reduced  below
applicable minimum regulatory capital requirements.

NOTE 14 - EMPLOYEE BENEFIT PLANS

401(k) Plan - All employees of the Company who meet certain eligibility criteria
are permitted to participate in a 401(k) plan. For each employee's  contribution
up to 6 percent  of  compensation,  the  Company  makes a 100  percent  matching
contribution.  Expense related to this plan was $164,350,  $124,479 and $117,509
in 2006, 2005 and 2004, respectively.

Salary  Continuation  Plan - During  1999,  the  Company  entered  into a salary
continuation  agreement with certain officers of the Company.  The plan provides
for a series of payments over a specified  number of periods to these  employees
upon  their  retirement  or  termination  as stated in the plan.  The  amount of
accrued benefit expense included in other  liabilities was $273,090 and $221,506
at December 31, 2006 and 2005, respectively.

NOTE 15 - STOCK OPTIONS

The  Company  has  issued  incentive  stock  options  to  certain  officers  and
employees.

The following is a summary of stock option activity and related  information for
the years ended December 31, 2006, 2005 and 2004:

<TABLE>
<CAPTION>
                                                                  2006                      2005                       2004
                                                                  ----                      ----                       ----
                                                                       Weighted                  Weighted                   Weighted
                                                                        Average                   Average                    Average
                                                                       Exercise                  Exercise                   Exercise
                                                         Options         Price      Options        Price       Options        Price
                                                         -------         -----      -------        -----       -------        -----
<S>                                                       <C>       <C>              <C>       <C>              <C>      <C>
Outstanding at beginning of year ....................     146,649   $     14.18      222,694   $     9.38       213,280  $     10.57
Granted .............................................           -             -       26,165        26.33         9,954        28.79
Forfeited ...........................................        (120)        26.25      (20,665)       17.56             -            -
Exercised ...........................................     (55,041)         7.76      (81,545)        9.61          (540)        6.11
                                                           ------   -----------      -------   ----------       -------  -----------
Outstanding at end of year ..........................      91,488   $     18.03      146,649   $    14.18       222,694  $     11.39
                                                           ======   ===========      =======   ==========       =======  ===========
Exercisable, end of period ..........................      91,488   $     18.03      146,649   $    14.18       168,995  $      9.38
                                                           ======   ===========      =======   ==========       =======  ===========
Weighted average fair value
   of options granted ...............................               $         -                $    17.35                $     18.93
                                                                    ===========                ==========                ===========
</TABLE>

Exercise prices for options  outstanding as of December 31, 2006 and 2005 ranged
from $6.11 to $29.17.  The weighted average remaining  contractual life of those
options  is  approximately  3.5  years at  December  31,  2006 and 4.7  years at
December 31, 2005.


                                       60
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 15 - STOCK OPTIONS - continued

The total fair value of shares vested during the years ended  December 31, 2006,
2005 and 2004 was $0, $862,895 and $206,945, respectively.

The total intrinsic value of options  exercised  during the years ended December
31, 2006, 2005 and 2004 was $1,091,134, $1,880,381 and $12,452, respectively.

As of December 31, 2006 all options outstanding were exercisable.  The aggregate
intrinsic value of these options was $842,977.

On May 5, 2006,  the Company  declared a six for five stock split for a total of
350,053 shares. All share and per share data has been retroactively  restated to
give effect to the common stock split.


NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of financial instruments are as follows:
<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                             ------------
(Dollars in thousands)                                                          2006                                2005
                                                                                ----                                ----
                                                                    Carrying         Estimated            Carrying        Estimated
                                                                     Amount          Fair Value            Amount         Fair Value
                                                                     ------          ----------            ------         ----------
Financial assets
<S>                                                                <C>                <C>                <C>                <C>
   Cash and cash equivalents ...........................           $ 15,682           $ 15,682           $ 18,532           $ 18,532
Securities
   Available-for-sale ..................................             23,293             23,293             23,366             23,366
   Held-for-investment .................................              9,902             10,701              7,264              7,427
   Loans ...............................................            293,190            293,842            265,033            264,792
Financial liabilities
   Deposits ............................................            308,057            308,157            265,725            266,283
   Retail repurchase agreements ........................              2,171              4,124              5,740              5,710
   Other borrowed funds ................................                287                287             15,298             14,740
   Subordinated debt ...................................              5,155              5,155              5,155              5,155
</TABLE>

The fair value  estimates are made at a specific point in time based on relevant
market and other information about the financial instruments.  Because no market
exists for a significant  portion of the Company's financial  instruments,  fair
value  estimates  are  based  on  judgments   regarding   future  expected  loss
experience,   current  economic  conditions,  risk  characteristics  of  various
financial instruments, and such other factors. These estimates are subjective in
nature and  involve  uncertainties  and  matters  of  significant  judgment  and
therefore  cannot be determined  with  precision.  Changes in assumptions  could
significantly affect the estimates.  In addition,  the tax ramifications related
to the  realization  of the  unrealized  gains and losses can have a significant
effect on fair value estimates and have not been considered in the estimates.


                                       61
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 17 - EARNINGS PER COMMON SHARE (EPS)

The reconciliation of the numerators and denominators of the earnings per common
share and diluted  EPS  computation  follows.  All share and per share data have
been retroactively restated for all common stock splits.

<TABLE>
<CAPTION>
                                                                                    Income             Shares              Per Share
December 31, 2006                                                                 (Numerator)        (Denominator)           Amount
                                                                                  -----------        -------------           ------
Earnings per common share:
<S>                                                                               <C>                    <C>                <C>
   Income available to common stockholders ...........................            $4,580,804             2,120,320          $  2.16
   Dilutive effect of stock options ..................................                     -                52,436            (0.05)
                                                                                  ----------             ---------          -------
Diluted EPS:
   Income available to common stockholders
      and assumed conversions ........................................            $4,580,804             2,172,756          $  2.11
                                                                                  ==========             =========          =======
December 31, 2005 Earnings per common share:
   Income available to common stockholders ...........................            $3,400,004             2,071,014          $  1.64
   Dilutive effect of stock options ..................................                     -                85,648            (0.06)
                                                                                  ----------             ---------          -------
Diluted EPS:
   Income available to common stockholders
      and assumed conversions ........................................            $3,400,004             2,156,662          $  1.58
                                                                                  ==========             =========          =======
December 31, 2004 Earnings per common share:
   Income available to common stockholders ...........................            $3,000,055             1,929,030          $  1.56
   Dilutive effect of stock options ..................................                     -               117,656            (0.09)
                                                                                  ----------             ---------          -------
Diluted EPS:
   Income available to common stockholders
      and assumed conversions ........................................            $3,000,055             2,046,686          $  1.47
                                                                                  ==========             =========          =======
</TABLE>

Options to purchase  5,690  shares of common  stock at $29.17 per share were not
included in the  computation of diluted  earnings per share for 2006 because the
options'  exercise  price was greater  than the average  market  price of common
shares.

Options to purchase 360 shares of common  stock at $27.08 per share,  options to
purchase  9,965 shares of common stock at $27.50 per share,  and 5,690 shares at
$29.17 were not included in the  computation  of diluted  earnings per share for
2005 because the  options'  exercise  price was greater than the average  market
price of common shares.


                                       62
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 18 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY

Financial information pertaining to First South Bancorp, Inc. is as follows:

                                 Balance Sheets

<TABLE>
<CAPTION>
                                                                                                   December 31,
                                                                                                   ------------
                                                                                    2006               2005                2004
                                                                                    ----               ----                ----
Assets
<S>                                                                            <C>                  <C>                  <C>
  Cash ..............................................................          $ 1,751,886          $ 1,324,644          $   540,866
  Investment in Trust (Note 9) ......................................              155,000              155,000              155,000
  Investment in common stock of the Bank ............................           34,261,118           29,584,893           26,321,326
  Due from the Bank .................................................            4,900,000            4,900,000            4,900,000
  Debt issuance costs ...............................................               41,667               61,668               81,665
                                                                               -----------          -----------          -----------
      Total assets ..................................................          $41,109,671          $36,026,205          $31,998,857
                                                                               ===========          ===========          ===========

Liabilities and Stockholders' Equity
  Due to Trust (Note 9) .............................................          $ 5,155,000          $ 5,155,000          $ 5,155,000
  Shareholders' equity ..............................................           35,954,671           30,871,205           26,843,857
                                                                               -----------          -----------          -----------
      Total liabilities and stockholders' equity ....................          $41,109,671          $36,026,205          $31,998,857
                                                                               ===========          ===========          ===========
</TABLE>


                            Statements of Operations

<TABLE>
<CAPTION>
                                                                                            For the years ended December 31,
                                                                                            --------------------------------
                                                                                     2006               2005                2004
                                                                                     ----               ----                ----

<S>                                                                             <C>                 <C>                 <C>
Operating income .......................................................        $   402,229         $   311,450         $   201,211
Expense ................................................................            422,229             331,493             219,544
                                                                                -----------         -----------         -----------
Loss before equity in undistributed net income of the Bank .............            (20,000)            (20,043)            (18,333)
Equity in undistributed net income of the Bank .........................          4,600,804           3,420,047           3,018,388
                                                                                -----------         -----------         -----------
      Net income .......................................................        $ 4,580,804         $ 3,400,004         $ 3,000,055
                                                                                ===========         ===========         ===========
</TABLE>




                                       63
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

NOTE 18 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY - continued

                            Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                         For the years ended December 31,
                                                                                         --------------------------------
                                                                                  2006                2005                  2004
                                                                                  ----                ----                  ----
Operating Activities
<S>                                                                        <C>                   <C>                   <C>
  Net income .....................................................         $  4,580,804          $  3,400,004          $  3,000,055
  Equity in undistributed income of
     the Bank ....................................................           (4,600,804)           (3,420,047)           (3,018,388)
  Net change in other assets .....................................               20,000                20,043               (81,668)
                                                                           ------------          ------------          ------------
       Net cash provided by operating activities .................                    -                     -              (100,001)
                                                                           ------------          ------------          ------------
Investing Activities
  Investment in Trust (Note 9) ...................................                    -                     -              (155,000)
  Advances to the Bank ...........................................                    -                     -            (4,900,000)
                                                                           ------------          ------------          ------------
       Net cash used in investing  activities ....................                    -                     -            (5,055,000)
                                                                           ------------          ------------          ------------
Financing Activities
  Proceeds from stock option exercise ............................              427,242               783,778                 3,300
  Proceeds from issuance of long-term debt .......................                    -                     -             5,155,000
  Proceeds from issuance of common stock .........................                    -                     -             7,482,067
                                                                           ------------          ------------          ------------
       Net cash provided by financing activities .................              427,242               783,778            12,640,367
                                                                           ------------          ------------          ------------
       Net increase in cash and cash equivalents .................              427,242               783,778               485,366
Cash and cash equivalents, beginning of year .....................            1,324,644               540,866                55,500
                                                                           ------------          ------------          ------------
Cash and cash equivalents, end of year ...........................         $  1,751,886          $  1,324,644          $    540,866
                                                                           ============          ============          ============
</TABLE>


NOTE 19 - SUBSEQUENT EVENTS

In November  2006,  the Bank entered  into an agreement to purchase  property to
serve as a future  branch site.  The purchase is expected to close in March 2007
for approximately $1.1 million.



                                       64
<PAGE>


                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY


Item 9.  Changes  In  and  Disagreements  With  Accountants  on  Accounting  and
         Financial Disclosure.

         Not Applicable

Item 9A. Controls and Procedures

         Based on the evaluation required by 17 C.F.R. Section  240.13a-15(b) or
240.15d-15(b) of the Company's disclosure controls and procedures (as defined in
17 C.F.R. Sections 240.13a-15(e) or 240.15d-15(e), the Company's chief executive
officer and chief financial officer concluded that such controls and procedures,
as of the end of the period covered by this annual report, were effective.

        No   disclosure   is   currently   required   under   17   C.F.R.Section
228.308(a)or(b).

         There  has  been no  change  in the  Company's  internal  control  over
financial  reporting  during the most recent fiscal  quarter that has materially
affected,  or is reasonably likely to materially  affect, the Company's internal
control over financial reporting.

Item 9B. Other Information

         On November 22, 2006, the Company entered into an agreement to purchase
a 7,650 square foot  building and .97 acre parcel of land in  Greenville,  South
Carolina for a branch office from Church and Hampton,  LLC for $1.1 million. The
transaction was closed on March 26, 2007.

                                    PART III

Item 10.  Directors,   Executive   Officers,   Promoters  and  Control  Persons;
          Compliance With Section 16(a) of the Exchange Act.

         The information set forth under the captions "Management of the Company
- Directors" and "Management of the Company - Executive  Officers",  "Committees
of the  Board of  Directors-Audit  Committee",  and  "Section  16(a)  Beneficial
Ownership Reporting Compliance" in registrant's definitive proxy statement filed
with the Commission for the 2007 Annual Meeting of Shareholders (the "2007 Proxy
Statement") is incorporated herein by reference.

         Audit Committee Financial Expert

         The Company's  board of directors has determined  that the Company does
not have an "audit committee  financial expert", as that term is defined by Item
407(d)(5)  of  Regulation  S-K   promulgated  by  the  Securities  and  Exchange
Commission,  serving on its audit committee.  The Company's audit committee is a
committee  of  directors  who  are  elected  by the  shareholders  and  who  are
independent of the Company and its  management.  After  reviewing the experience
and  training  of all of the  Company's  independent  directors,  the  board  of
directors  has  concluded  that no  independent  director  meets the SEC's  very
demanding  definition.  Therefore,  it would be  necessary  to find a  qualified
individual willing to serve as both a director and member of the audit committee
and have that  person  elected  by the  shareholders  in order to have an "audit
committee  financial  expert"  serving on the  Company's  audit  committee.  The
Company's audit committee is, however,  authorized to use consultants to provide
financial  accounting  expertise in any instance  where members of the committee
believe  such  assistance  would be useful.  Accordingly,  the Company  does not
believe that it needs to have an "audit committee financial expert" on its audit
committee.

         Code of Ethics

         The  Company  has  adopted a code of ethics  (as  defined  by 17 C.F.R.
228.406) that applies to its principal executive officer and principal financial
officer.  The Company will provide a copy of the code of ethics, free of charge,
to any person upon written request to V. Lewis Shuler, Executive Vice President,
First South Bancorp, 1450 John B. White, Sr. Blvd., Spartanburg, S.C. 29306.

Item 11. Executive Compensation.

         The information set forth under the caption "Management  Compensation,"
in the 2007 Proxy  Statement  is  incorporated  herein by  reference;  provided,
however, the "Compensation Committee Report" shall be deemed to be furnished and
not "filed" and will not be deemed  incorporated  by  reference  into any filing
under the  Securities  Act of 1933 or the  Securities  Exchange Act of 1934 as a
result of being so furnished.



                                       65
<PAGE>
                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

Item 12.  Security  Ownership of Certain  Beneficial  Owners and  Management and
          Related Stockholder Matters.

         The  information  set forth under the caption  "Security  Ownership  of
Certain  Beneficial  Owners  and  Management"  in the 2007  Proxy  Statement  is
incorporated herein by reference.

<TABLE>
<CAPTION>
                                                                         Equity Compensation Plan Information

                                                                 (a)                        (b)                     (c)
                                                                                                           Number of securities
                                                                                                           remaining available
                                                                                                           for future issuance
                                                                                                           under equity
                                                      Number of securities to     Weighted-average         compensation plans
                                                      be issued upon exercise     exercise price of        (excluding securities
                                                      of outstanding options,     outstanding options,     reflected in column
                                                      warrants, and rights        warrants, and rights     (a)
                                                      --------------------        --------------------     ----------------------

Plan category
---------------
Equity compensation plans
<S>                                                            <C>                         <C>                         <C>
approved by security holders ...........................       91,488                      $   18.03                   420,000

Equity compensation plans
not approved by security  holders ......................            -                           -                            -
                                                              -------                      ------                      -------


Total ..................................................       91,488                      $   18.03                   420,000

</TABLE>

Item 13. Certain  Relationships  and Related  Transactions.

         The  information  set forth under the  captions  "Governance  Matters -
Director  Independence" and "Certain  Relationships and Related Transactions" in
the 2007 Proxy  Statement is  incorporated  herein by reference.  Members of our
Audit  Committee and  Compensation  Committee are all  independent  under NASDAQ
Global Marketplace Rules. The entire Board serves as Nominating  Committee,  and
all Board members are not independent under such rules.

Item 14. Principal Accountant Fees and Services

         The  information  set  forth  under  the  caption  "Independent  Public
Accounts-Fees Paid to Independent Auditors" and Audit Committee  Pre-approval of
Audit and Permissible  Non-Audit  Services of Independent  Auditors" in the 2007
Proxy Statement is incorporated herein by reference.

                                       66
<PAGE>

Item 15. Exhibits and Financial Statement Schedules

(1)      Report of Independent  Registered  Public  Accounting Firm Consolidated
         Balance   Sheets   Consolidated   Statements  of  Income   Consolidated
         Statements of Changes in Stockholder' Equity Consolidated Statements of
         Cash Flows Notes to Financial Statements

(2)      Financial Statement Schedules - None

(3)      Description of Exhibits.

Exhibit No.                Description

3.1            Articles of Incorporation of Registrant (1)
3.2            Bylaws of Registrant (1)
4.1            Form of Common Stock Certificate(2)
10.1           First South Bank Stock Option Plan (3)
10.2           Form of  Option  Agreements  with  Barry L.  Slider,  dated as of
               December 31, 1998, December 31, 1997 and December 31, 1996. (3)
10.3           Option  Agreement  with  Barry L.  Slider,  dated as of April 17,
               1997(2)
10.4           Form of Salary  Continuation  Agreements with Barry L. Slider and
               V. Lewis Shuler dated November 19, 1999 (2)
10.5           Amended  and  Restated   Declaration   of  the  Trust  among  the
               Registrant, Wells Fargo Delaware Trust Company, Wells Fargo Bank,
               National Association,  Barry L. Slider and V. Lewis Shuler, dated
               as of January 30, 2004. (4)
10.6           Indenture  between  Registrant  and Wells  Fargo  Bank,  National
               Association, dated as of January 30, 2004. (4)
10.7           Guarantee  Agreement between the Registrant and Wells Fargo Bank,
               National Association, dated as of January 30, 2004. (4)
10.8           Registrant's Junior Subordinated Debt Security Due 2034. (4)
10.9           First South Bancorp, Inc., Incentive Stock Option Plan (5)
10.10          Contract between Church and Hampton, LLC and First South Bank for
               purchase of real property
21             Subsidiaries of Registrant (3)
23             Consent of Independent Registered Public Accounting Firm
31.1           Rule  13a-14(a) /  15d-14(a)  Certifications  of Chief  Executive
               Officer
31.2           Rule  13a-14(a) /  15d-14(a)  Certifications  of Chief  Financial
               Officer
32             Section 1350 Certifications
--------------
(1)  Incorporated by reference to Form 8-A filed November 12, 1999
(2)  Incorporated  by reference  to Form 10-KSB for the year ended  December 31,
     2000
(3)  Incorporated  by reference  to Form 10-KSB for the year ended  December 31,
     1999
(4)  Incorporated  by reference  to Form 10-QSB for the quarter  ended March 31,
     2004.
(5)  Incorporated  by  reference  to Exhibit  4.2 to  Registrant's  registration
     statement on Form S-8, Registration No. 333-128522


                                       67
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY

                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                   First South Bancorp, Inc.


March 30, 2007                     By: s/Barry L. Slider
                                      ------------------------------------------
                                         Barry L. Slider
                                         President and Chief Executive Officer


                                   By: s/V. Lewis Shuler
                                      ------------------------------------------
                                         V. Lewis Shuler
                                         Executive Vice President & Chief
                                            Financial Officer
                                         (Principal Financial and Principal
                                          Accounting Officer)

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities and on the dates indicated:


<TABLE>
<CAPTION>

Signature                                Title                                              Date
---------                                -----                                              ----

<S>                                      <C>                                                <C>
--------------------------               Director                                           March 21, 2007
Harold E. Fleming, M.D.


--------------------------               Director                                           March 21, 2007
Joel C. Griffin

s/Roger A. F. Habisreutinger
--------------------------               Chairman, Director                                 March 30, 2007
Roger A. F. Habisreutinger


--------------------------               Director                                           March 21, 2007
Herman E. Ratchford

s/Chandrakant V. Shanbhag
--------------------------               Director                                           March 30, 2007
Chandrakant V. Shanbhag

s/Barry L. Slider
--------------------------               President, Chief Executive Officer, Director       March 30, 2007
Barry L. Slider

s/David G. White
--------------------------               Director                                           March 30, 2007
David G. White
</TABLE>

                                       68

<PAGE>
                                 EXHIBIT INDEX


3.1            Articles of Incorporation of Registrant (1)
3.2            Bylaws of Registrant (1)
4.1            Form of Common Stock Certificate(2)
10.1           First South Bank Stock Option Plan (3)
10.2           Form of  Option  Agreements  with  Barry L.  Slider,  dated as of
               December 31, 1998, December 31, 1997 and December 31, 1996. (3)
10.3           Option  Agreement  with  Barry L.  Slider,  dated as of April 17,
               1997(2)
10.4           Form of Salary  Continuation  Agreements with Barry L. Slider and
               V. Lewis Shuler dated November 19, 1999 (2)
10.5           Amended  and  Restated   Declaration   of  the  Trust  among  the
               Registrant, Wells Fargo Delaware Trust Company, Wells Fargo Bank,
               National Association,  Barry L. Slider and V. Lewis Shuler, dated
               as of January 30, 2004. (4)
10.6           Indenture  between  Registrant  and Wells  Fargo  Bank,  National
               Association, dated as of January 30, 2004. (4)
10.7           Guarantee  Agreement between the Registrant and Wells Fargo Bank,
               National Association, dated as of January 30, 2004. (4)
10.8           Registrant's Junior Subordinated Debt Security Due 2034. (4)
10.9           First South Bancorp, Inc., Incentive Stock Option Plan (5)
10.10          Contract between Church and Hampton, LLC and First South Bank for
               purchase of real property
21             Subsidiaries of Registrant (3)
23             Consent of Independent Registered Public Accounting Firm
31.1           Rule  13a-14(a) /  15d-14(a)  Certifications  of Chief  Executive
               Officer
31.2           Rule  13a-14(a) /  15d-14(a)  Certifications  of Chief  Financial
               Officer
32             Section 1350 Certifications
--------------
(1)  Incorporated by reference to Form 8-A filed November 12, 1999
(2)  Incorporated  by reference  to Form 10-KSB for the year ended  December 31,
     2000
(3)  Incorporated  by reference  to Form 10-KSB for the year ended  December 31,
     1999
(4)  Incorporated  by reference  to Form 10-QSB for the quarter  ended March 31,
     2004.
(5)  Incorporated  by  reference  to Exhibit  4.2 to  Registrant's  registration
     statement on Form S-8, Registration No. 333-128522

                                       69