SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D. C. 20549

                                   FORM 10-KSB


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

For the Fiscal Year Ended December 31, 2004                File Number 000-28037

                            FIRST SOUTH BANCORP, INC.
                 (Name of Small Business Issuer 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)

         Issuer'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)

         Check whether the issuer (1) has filed all reports required to be filed
by  Section  13 or 15(d) of the  Exchange  Act during the past 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 { }

         Check if there is no  disclosure  of  delinquent  filers in response to
Item 405 of  Regulation  S-B contained in this form,  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-KSB
or any amendment to this Form 10-KSB. { }

         The issuer's revenues for its most recent fiscal year were $16,500,536.

         The aggregate  market value of the Common Stock held by  non-affiliates
on February  10, 2005 was  approximately  $32,888,922.  As of February 10, 2005,
there were  1,682,490  shares of the  Registrant's  Common Stock,  no par value,
outstanding.  For purposes of the foregoing  calculation only, all directors and
executive officers of the Registrant have been deemed affiliates.

                       DOCUMENTS INCORPORATED BY REFERENCE

(1)  Portions of the Registrant's Proxy Statement for the 2005 Annual Meeting of
     Shareholders - Part III

Transitional Small Business Disclosure Format (check one): Yes {  }  No {X}




<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 one 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 Hilton
Head Island,  South  Carolina,  and a loan  production  office opened in 2003 in
Asheville, North 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 and
Buncombe  County in North  Carolina.  In  addition,  the Bank also  makes  other
authorized investments. As of December 31, 2004, the Bank employed 59 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, 2004. At
that time, in Spartanburg,  14 banks,  savings and loans, and savings banks with
46 branch  locations  competed for aggregate  deposits of  approximately  $2.020
billion.  The Bank has a city-wide  deposit  market  share of 6.92% and a market
share  rank of 5 out of the 14  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 1.27%,  and the Bluffton
branch has a market  share of 31.9%.  The Bank also  operates a loan  production
office located in Asheville, North Carolina.

         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
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.


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<PAGE>

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 subsidiaries are limited to banking, managing or controlling banks,
furnishing  services to or performing  services for its subsidiaries 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 of Financial  Institutions  (the "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  thereunder  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 either the
Savings  Association  Insurance Fund ("SAIF") or the Bank Insurance Fund ("BIF")
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 SAIF or the BIF or both.  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.


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<PAGE>

         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.

         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, 2004.

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
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

         Because the Bank's deposits are insured by the BIF, the Bank is subject
to insurance assessments imposed by the FDIC. Currently, the assessments imposed
on all FDIC deposits for deposit insurance have an effective rate ranging from 0
to 27 basis points per $100 of insured deposits,  depending on the institution's
capital position and other supervisory factors. However,  legislation enacted in
1996 requires that both  SAIF-insured  and  BIF-insured  deposits pay a pro rata
portion  of the  interest  due  on  the  obligations  issued  by  the  Financing
Corporation  ("FICO").  The FICO  assessment  is adjusted  quarterly  to reflect
changes in the assessment  bases of the respective funds based on quarterly Call
Report and Thrift Financial Report submissions.

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 thereunder,  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


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<PAGE>

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  thereunder,  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.

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;  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 case subject to certain  deposit  percentage 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 authority 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.



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Gramm-Leach-Bliley Act

          The  Gramm-Leach-Bliley  Act,  which makes it easier for  affiliations
between banks,  securities firms and insurance  companies to take place,  became
effective  in March,  2000.  The Act removes  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
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  creates  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  establishes  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 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.




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<PAGE>



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,  particularly  its fees for
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.

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 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  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, Hilton Head, South Carolina,
and 30  Hendersonville  Road,  Asheville,  North  Carolina.  All  properties are
believed to be well suited for the Bank's needs.



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<PAGE>


Item 3.  Legal Proceedings.

         On May 6, 2002, Lisa Lesavoy,  as successor trustee,  filed a complaint
in the United States  District Court for the District of South Carolina  against
the  Corporation  and an employee of the  Corporation's  subsidiary,  as well as
against eight other entities and individuals.  The complaint alleges that one of
the individual  defendants  (not the employee) was the  plaintiff's  predecessor
trustee and  breached  various  duties to the two trusts in question  all to the
financial  detriment  of the trusts.  The  complaint  further  alleges  that the
Corporation and the employee by lending to and arranging credit transactions for
the  trusts,  together  with the other  defendants,  aided and abetted the prior
trustee's   breaches  and  violated  the   Racketeer   Influenced   and  Corrupt
Organizations Act. The complaint seeks monetary damages and attorneys' fees. The
Corporation  plans to  vigorously  defend the action and is presently  unable to
reliably  estimate  the  amount  of  loss  it  may  suffer  as a  result  of the
litigation.

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 2004.

                                     PART II

Item 5.  Market for Common  Equity and  Related  Stockholder  Matters  and Small
         Business Issuer Purchases of Equity Securities.

Market for Common Stock, Stockholders and Dividends

         Although the common stock of the Company is traded from time to time on
an individual  basis,  no  established  trading market has developed and none is
expected to develop in the foreseeable future. The common stock is not traded on
any exchange or on the NASDAQ  National Market System.  During 2004,  management
was aware of a few  transactions in which the Company's common stock traded in a
range from $21.49 to $35.00 per share.  However,  management has not ascertained
that these transactions are the result of arm's length negotiations  between the
parties, and because of the limited number of shares involved,  these prices may
not be indicative of the market value of the common stock.

         As of February 10, 2005, there were approximately 529 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-B is set forth
in Item 11 of this Form 10-KSB.



                                       8
<PAGE>

Recent Sales of Unregistered Securities

         During 2004, the Company issued shares of Common Stock to the following
classes of person upon the exercise of options issued  pursuant to the Company's
stock option plan.  The  securities  were issued  pursuant to the exemption from
registration provided by Section 4 (2) of the Securities Act of 1933 because the
issuance did not involve a public offering.

                                                                    Aggregate
                                                                    Exercise
Date Issued         Class of Purchasers       Number of Shares        Price
-----------         -------------------       ----------------        -----

 11/1/2004          Bank officer                    450               3,300

 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 2004.  Accordingly,  no disclosure is
required pursuant to 17 C.F.R. 228.703.

Item 6.  Management's Discussion and Analysis or Plan of Operation.

         Statements  included in this Form 10-KSB  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.


    This  discussion  is  intended  to assist  in  understanding  the  financial
condition  and  results  of  operations  of the  Company,  and should be read in
conjunction with the financial  statements and related notes contained elsewhere


                                       9
<PAGE>

herein. Because the Bank is responsible for all of the Company's operations, the
discussion will refer to the results of operations of the Bank.

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.


         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 Bank had net income from operations for the year ended December 31,
2004,  of  $3,000,055,  or $1.87 per share,  compared to net income for the year
ended  December 31, 2003, of $2,104,267 or $1.52 per common share.  The Bank had
net interest income (the difference  between interest earned on interest earning
assets and interest paid on interest  bearing  liabilities)  of $10,102,590  for
2004,  as compared to  $8,474,452  for 2003.  The Bank also had other  operating
income (principally service charges, fees and commissions) of $1,189,247 in 2004
and $1,254,286 in 2003. The Bank provided $705,522 and $949,302 to its allowance
for loan losses in 2004 and 2003, respectively, and had other operating expenses
(principally  salaries and benefits and  occupancy  and  equipment  expenses) of
$5,930,260 in 2004, and $5,549,169 in 2003.

Net Interest Income

         Net  interest  income is the  amount  of  interest  earned on  interest
earning assets (loans,  investment securities,  time 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 Bank'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,  2004,  net  interest  income  was
$10,102,590.  During the year ended December 31, 2003,  net interest  income was
$8,474,452.  The  19.2%  increase  in net  interest  income  during  2004 can be
primarily  attributed to the increased growth in average earning assets by $49.6
million  from  2003  to  2004  compared  to  the  increased  growth  in  average
interest-bearing  liabilities  by $38.3  million  during the same period,  which
resulted in an increase of average interest free funds supporting earning assets
by $11.3 million from $22,797  million in 2003 to $34,076  million in 2004. This
overall net  increase in volume of average  earning  assets  compared to average
interest bearing liabilities offset the overall decrease in interest margin from
3.93% in 2003 to 3.81% in 2004,  a reduction  of 12 basis  points or 3%. The net
interest  income  increase for the year ended  December 31, 2004 compared to the
year ended  December 31, 2003 was also  primarily  the result of the increase in
earning assets which was enhanced by an increase in net interest margin.


                                       10
<PAGE>

         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, 2004,
2003, and 2002.

<TABLE>
<CAPTION>
                                                                      Average Balances, Yields, and Rates
                                                                             (Dollars in Thousands)

                                                                            Year Ended December 31,
                                                                            -----------------------
                                                 2004                              2003                             2002
                                                 ----                              ----                             ----
                                                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>
Federal funds sold ................  $      -   $     -              $      -     $     -               $      -   $     -
Due From banks - Interest-bearing .     9,266       137    1.48%        6,761          70    1.04%         9,993       157     1.57%
Investment securities .............    16,759       598    3.57%       13,666         533    3.90%        13,849       739     5.34%
Loans (2) (3) .....................   238,958    14,576    6.10%      194,944      12,282    6.30%       141,269     9,312     6.59%
                                                -------                           -------                          -------
Total interest earning assets .....   264,983   $ 15,311   5.78%      215,374     $12,884    5.98%       165,111   $10,208     6.18%
Cash and due from banks ...........     4,715                           4,663                              3,074
Valuation reserve for investment
  securities ......................        27                             100                                156
Allowance for loan losses .........   (2,694)                         (2,144)                            (1,553)
Premises and equipment ............     5,369                           4,217                              2,817
Investment in Trust ...............       142                               -                                  -
Other assets ......................     3,780                           3,630                              2,683
                                     --------                        --------                           --------
Total assets ......................  $276,322                        $225,840                           $172,288
                                     ========                        ========                           ========
Liabilities and shareholders'
  equity
Interest bearing transaction
  accounts ........................  $ 33,917   $   586    1.73%     $ 33,729     $   579    1.72%      $ 31,447   $   735     2.34%
Savings ...........................    47,889       845    1.76%       34,094         613    1.80%         8,838       175     1.98%
Time deposits $100,000 and over ...    35,525       850    2.39%       28,312         699    2.47%        18,168       588     3.24%
Other time deposits ...............    93,294     2,218    2.38%       80,867       2,035    2.52%        69,892     2,334     3.34%
                                     --------   -------              --------     -------               --------   -------
Total interest bearing deposits ...  $210,625   $ 4,499    2.14%     $177,002     $ 3,926    2.22%      $128,345   $ 3,832     2.99%
Retail repurchase agreements ......     5,156        47    0.91%        4,903          25    0.51%         5,887        65     1.10%
Subordinated debt .................     4,583       201    4.39%            -           -    0.00%             -         -     0.00%
Other Borrowed Funds ..............    10,543       461    4.37%       10,672         460    4.31%        10,276       456     4.44%
                                     --------   -------              --------     -------               --------   -------
Total interest bearing liabilities   $230,907   $ 5,208    2.26%     $192,577     $ 4,411    2.29%      $144,508   $ 4,353     3.01%
Non-interest bearing demand
  deposits ........................    20,837                          16,046                             12,951
Other liabilities .................     2,088                           1,854                              1,115
Shareholders' equity ..............    22,490                          15,363                             13,714
                                     --------                        --------                           --------
Total liabilities and
  shareholders' equity ............  $276,322                        $225,840                           $172,288
                                     ========                        ========                           ========
Interest rate spread (4) ..........                        3.52%                             3.69%                             3.17%
Net interest income and net yield .
  on earning  assets (5) ..........             $10,103    3.81%                  $ 8,473    3.93%                  $5,855     3.55%
Interest free funds supporting
  earning assets (6) ..............  $ 34,076                        $ 22,797                           $ 20,603
</TABLE>

(1)  Average balances are computed on a daily basis.
(2)  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.
(3)  Interest income on loans for 2004, 2003, and 2002, included total loan fees
     of $993, $893, and $731, respectively.
(4)  Total  interest  earning  assets  yield  less the  total  interest  bearing
     liabilities rate.
(5)  Net interest income divided by total interest  earning assets (net interest
     margin).
(6)  Total interest earning assets less total interest bearing liabilities.

                                       11
<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.


                                                        Year Ended
                                                       December 31,
                                                    2004 compared to 2003
                                                 Increase (Decrease) Due to
                                                 --------------------------
                                                   (Dollars in thousands)
                                            Volume          Rate         Total
                                            ------          ----         -----
Interest earned on:
  Due from banks-interest-bearing ..       $    26        $    40        $    66
  Invesments .......................           121            (55)            66
  Net Loans ........................         2,773           (478)         2,295
                                           -------        -------        -------

Total Interest Income ..............       $ 2,920        $  (493)       $ 2,427
                                           -------        -------        -------

Interest paid on
  Interest Checking ................       $     3        $     4        $     7
  Savings Deposits .................           250            (18)           232
  Time Deposits 100,000 and over ...           178            (27)           151
  Other time deposits ..............           313           (130)           183
  Retail Repurchase Agreements .....             1             21             22
  Subordinated debt ................           201              -            201
  Other Borrowed Funds .............            (5)             6              1
                                           -------        -------        -------

Total Interest Expense .............       $   941        $  (144)       $   797
                                           -------        -------        -------

Change in Net Interest Income ......       $ 1,979        $  (349)       $ 1,630
                                           =======        =======        =======

         During  the year 2005  management  expects  that  interest  rates  will
continue to rise.  Improvements  in net interest income for 2004 are expected to
be the  result of  increases  in the volume  and  rates.  Management  expects to
continue following the market strategies which it has employed to date.

Interest Rate Sensitivity

         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  assets  exceeded rate
sensitive liabilities,  resulting in an asset sensitive position at December 31,
2004 of  $82.6  million  for a  cumulative  gap  ratio of  147%.  When  interest
sensitive  liabilities exceed interest sensitive assets for a specific repricing
"horizon", a negative interest sensitivity gap results. The gap is positive when
interest sensitive assets exceed interest sensitive liabilities, as was the case
at December 31, 2004, with respect to the one year time horizon. For a bank with
a positive gap,  such as the Bank,  rising  interest  rates would be expected to
have a  positive  effect on net  interest  income  and  falling  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'


                                       12
<PAGE>

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.


<TABLE>
<CAPTION>
                                                                               Interest Sensitivity Analysis
                                                                         Repricing Schedule as of December 31, 2004
                                                                                   (Amounts in thousands)


                                                               Within         4-12        Over One Year      Over
                                                              3 Months       Months       to Five Years     Five Years        Total
                                                              --------       ------       -------------     ----------        -----
Interest Earning Assets

<S>                                                          <C>            <C>             <C>             <C>             <C>
Interest-bearing deposits in other banks ..............      $  9,200       $      -        $      -        $      -        $  9,200
Other investments (Book Value)* .......................         2,454          3,441          12,986           2,983          21,864
Loans**
  Fixed rate ..........................................         2,423          5,463          10,293           1,130          19,309
  Variable rate .......................................       235,090              -               -               -         235,090
                                                             --------       --------        --------        --------        --------

Total interest earning assets .........................      $249,167       $  8,904        $ 23,279        $  4,113        $285,463
                                                             ========       ========        ========        ========        ========

Interest Bearing
Liabilities
  Interest bearing deposits
    Interest bearing transaction accounts .............      $ 32,298       $      -        $      -        $      -        $ 32,298
    Savings & MMIA ....................................        53,781              -               -               -          53,781
    Time deposits $100,000 and over ...................        11,704         10,851          17,437               -          39,992
    Other time deposits ...............................        25,870         30,874          46,427               -         103,171
                                                             --------       --------        --------        --------        --------
      Total interest bearing deposits .................      $123,653       $ 41,725        $ 63,864        $      -        $229,242
    Repurchase agreements .............................         4,700              -               -               -           4,700
    Subordinated debt .................................         5,000              -               -               -           5,000
    Other borrowed funds ..............................           417              -               -          10,000          10,417
                                                             --------       --------        --------        --------        --------
Total interest bearing liabilities ....................      $133,770       $ 41,725        $ 63,864        $ 10,000        $249,359
                                                             ========       ========        ========        ========        ========

Interest Sensitivity Gap ..............................      $115,397       $(32,821)       $(40,585)       $ (5,887)       $ 36,104
Cumulative interest sensitivity gap ...................      $115,397       $ 82,576        $ 41,991        $ 36,104
Gap ratio .............................................        186.27%         21.34%          36.45%          41.13%
Cumulative gap ratio ..................................        186.27%        147.05%         117.54%         114.48%
</TABLE>


*includes restricted FHLB stock $954
** excludes loans in non-accrual status totaling $350

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


                                       13
<PAGE>

$705,522,  $949,302,  and  $674,830  to the  allowance  during  the years  ended
December 31, 2004, 2003, and 2002 respectively. The decrease of $243,780 in 2004
and  increase of $234,472  in 2003 were was  primarily  due to changes in slower
growth in loans from a net increase in the loan  portfolio of $68 million during
2003 to $27.5 million loan growth during 2004.

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,  decreased by 5.19% to  $1,189,247  in 2004 from  $1,254,286 in
2003. Service charges, fees, and commissions increased by $239,176 or 52.6% from
2003 to 2004. Much of this increase was directly attributable to the increase in
brokerage  service  commissions  from  $77,804 in 2003 to  $300,036  in 2004,  a
$222,232  or  285%  increase.   The  increase  in  service  charges,  fees,  and
commissions was primarily offset, though, by the decreases in mortgage loan fees
of $105,446  or 45.2% and in loan  brokerage  fees of  $214,097 or 47.1%.  Other
income  increased by 45.8% to  $1,254,286  in 2003 from $860,419 in 2002. Of the
total $393,867  increase in  non-interest  income,  mortgage  banking loan fees,
which were  favorably  influenced by homeowner  refinancing to take advantage of
low long term rates,  accounted for $96,963,  or 24.6% of the increase from year
end 2002 to 2003.


Other Expenses

         Other  expenses,  which are those  non-interest  expenses most commonly
referred to as other  operating  expenses,  increased by $381,091,  or 6.9%,  in
2004. The most  significant  dollar increases were in the categories of salaries
and employee benefits,  which increased from $3,190,603 in 2003 to $3,564,689 in
2004,  an  increase  of $374,086 or 11.7% and  occupancy  and  equipment,  which
increased  from  $635,843 to  $823,475,  an increase of $187,632 or 29.51%.  The
increase in salaries and benefits can be  attributed to an increase in full time
equivalent  employees  from 52 at 2003  year  end to 59 at 2004  year  end.  The
increase  in  occupancy  and  equipment  was  primarily  due to the  increase in
depreciation  from the first full year of  operation  of the Hilton Head office,
which opened in July of 2003, and the First South Financial  Services  building,
which opened in December 2003. Other expenses  increased by $1,722,903,  or 45%,
from year end 2002 to 2003.  Principal  factors in the increase were the opening
of new offices and legal expenses for litigation.

Income Taxes

         During the year ended  December 31, 2003,  the Bank accrued  $1,386,000
for current income taxes.  The Bank accrued  $1,700,000 for current income taxes
during 2004. The Bank 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.  These
accounting  timing  differences  resulted  in a deferred  income tax  benefit of
$44,000 being recognized in 2004, and $260,000 being recognized in 2003.

Investment Portfolio

         As of December  31, 2004,  the Bank's  investment  portfolio  comprised
approximately  7.1 % of its total assets.  The following  table  summarizes  the
carrying  value  amounts of  securities  held by the Bank at December  31, 2004,
2003, and 2002.

                                       14
<PAGE>

Securities Portfolio Composition
(dollars in thousands)


<TABLE>
<CAPTION>
                                           December 31, 2004                December 31, 2003              December 31, 2002
                                           -----------------                -----------------              -----------------
                                           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 ..................   $ 16,499    $    (18)   $ 16,481   $  9,498   $     47   $  9,545   $ 13,996   $    132   $ 14,128
State and local obligations ...        123           4         127        123          5        128        123          4        127
Mortgage-backed securities ....        961         (16)        944          -          -          -          -          -          -
Restricted FHLB Stock .........        954           -         954        700          -        700        600          -        600
                                  --------    --------    --------   --------   --------   --------   --------   --------   --------
                                  $ 18,536    $    (30)   $ 18,506   $ 10,321   $     52   $ 10,373   $ 14,719   $    136   $ 14,855
                                  ========    ========    ========   ========   ========   ========   ========   ========   ========
Held for investment:
U.S. Government Agency
 obligations ..................   $  1,004    $     (1)   $  1,003   $  1,011   $     13   $  1,024   $  1,517   $     31   $  1,548
Trust Preferred securities ....        479         133         613        478        127        605        476         73        549
State and local obligations ...        375          10         385        375         12        387        375         12        387
Mortgage-backed securities ....      1,500          39       1,539      2,010          7      2,017          -          -          -
                                  --------    --------    --------   --------   --------   --------   --------   --------   --------
                                  $  3,358    $    181    $  3,539   $  3,874   $    159   $  4,033   $  2,368   $    116   $  2,484
                                  ========    ========    ========   ========   ========   ========   ========   ========   ========
</TABLE>


         On an ongoing basis,  management  assigns securities upon purchase into
one of two  categories  (available-for-sale  or  held-to-maturity)  based on the


                                       15
<PAGE>

intent,  taking into  consideration  factors such as expectations for changes in
market interest rates, liquidity needs,  asset/liability  management strategies,
and  capital  requirements.  The Bank does not  maintain  a  securities  trading
account.

         The following table presents scheduled maturities of debt securities at
December 31, 2004.  Available-for-sale  securities  are stated at estimated fair
value and held-for-investment securities are stated at amortized cost.

                         Securities Portfolio Maturities


<TABLE>
<CAPTION>
                                                    Analysis of Investment Securities
                                                            December 31, 2004
                                                          (dollars in thousands)

                                                                       Available-for-Sale                     Held-for-Investment
                                                                       ------------------                     -------------------
                                                                 Amortized       Estimated Fair       Amortized      Estimated Fair
                                                                    Cost              Value              Cost             Value
                                                                    ----              -----              ----             -----
U.S. Government Agency Oligations
<S>                                                               <C>               <C>                <C>               <C>
    Due in one year or less ................................      $ 1,499           $ 1,494            $1,004            $1,003
    Due from one to five years .............................       13,000            12,985                 -                 -
    Due from five to ten years .............................        1,000             1,001                 -                 -
    Due after ten years ....................................        1,000             1,000                 -                 -

State and local obligations(1)
    Due after ten years ....................................          123               127               375               385

Trust Preferred securities
    Due after ten years ....................................            -                 -               479               613

Mortgage Backed securities
    Due after ten years ....................................          961               944             1,500             1,539

Equity Securities ..........................................          954               954                 -                 -

Total(2)(3)

    Due in one year or less ................................      $ 1,499           $ 1,494            $1,004            $1,003
    Due from one to five years .............................       13,000            12,985                 -                 -
    Due from five to ten years .............................        1,000             1,001                 -                 -
    Due after ten years ....................................          961               944             1,500             1,539
</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
     2.57%,  3.46%,  3.96% and 4.54%,  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, 2004,  and are
     likely to change.

  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.

                                       16
<PAGE>

         The amount of loans outstanding at December 31, 2004, 2003, 2002, 2001,
and 2000 are shown in the following table according to type of loan.

 Loan Portfolio Composition

<TABLE>
<CAPTION>
                                                                                        December 31,
                                                                                        ------------
                                                        2004             2003             2002             2001           2000
                                                        ----             ----             ----             ----           ----

<S>                                               <C>              <C>              <C>              <C>              <C>
Commercial, financial and agricultural ........   $  46,728,921    $  51,523,910    $  47,099,954    $  36,270,381    $  23,755,686
Real estate - construction ....................      17,223,132       14,345,975       14,211,986       13,097,957       11,349,351
Real estate mortgage ..........................     190,325,765      160,813,718       96,495,309       76,168,473       47,272,549
Consumer ......................................         470,787          554,999        1,053,596          629,235          460,842
                                                  -------------    -------------    -------------    -------------    -------------
    Total loans ...............................     254,748,605      227,238,602      158,860,845      126,166,046       82,838,428

Less allowance for loan losses ................      (2,900,000)      (2,600,000)      (1,750,000)      (1,450,000)      (1,055,000)
                                                  -------------    -------------    -------------    -------------    -------------

Total Loans, net of allowance for loan losses .   $ 251,848,605    $ 224,638,602    $ 157,110,845    $ 124,716,046    $  81,783,428
                                                  =============    =============    =============    =============    =============
</TABLE>



Maturity Distribution of Loans

         The following table sets forth the maturity  distribution of the Bank's
loans, by type, as of December 31, 2004.

                         Maturity Distribution on Loans

                                                December 31, 2004
                                                -----------------
                                             (Dollars in Thousands)
                                      1 Year       1-5       5 Years
                                     or Less      Years      or More      Total

Commercial and industrial ......    $ 29,416    $ 16,675    $    638    $ 46,729
Real Estate-construction .......       8,096       7,098       2,029      17,223
Real Estate-mortgage ...........      61,647     108,348      20,332     190,327
Consumer installment ...........          86         384           -         470
              Total(1) .........    $ 99,245    $132,505    $ 22,999    $254,749
                                    ========    ========    ========    ========

 (1) Of all loans due after one year, $11,423 have predetermined  interest rates
and $144,081 have floating or adjustable interest rates.

         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


                                       17
<PAGE>

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 81% of the
Bank's loan  portfolio  at December  31,  2004.  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
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,  2004,  the Bank had three loans  totaling
$350,167 on non-accrual  status. Net income for 2004 includes no interest income
on these loans.  Had these loans been current in accordance  with their original
terms, $4,993 of additional interest income would have been recorded in 2004. At
December  31, 2003,  the Bank had four loans  totaling  $295,000 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                                                   2004          2003           2002         2001        2000
                                                                        ----          ----           ----         ----        ----

Non-performing loans:
<S>                                                                  <C>           <C>          <C>               <C>       <C>
  Non-accrual loans ...........................................      $   350       $   295      $    112          $  -      $   288
  Past due 90 days or more ....................................            -             -             -             -            -
  Other restructured loans ....................................            -             -             -             -            -
                                                                     -------       -------      --------          ----      -------
Total non-performing loans ....................................      $   350       $   295      $    112          $  -      $   288
Real estate acquired in settlement of loans ...................          520             -           625             -          200
                                                                     -------       -------      --------          ----      -------
Total non-performing assets ...................................      $   870       $   295      $    737          $  -      $   488
                                                                     =======       =======      ========          ====      =======
Non-performing assets as a
  Percentage of loans and other real estate ...................         0.34%         0.13%         0.46%         0.00%        0.59%
Allowance for loan losses as
  a percentage of non-performing loans ........................       828.57%       881.36%      1562.50%           NA       366.32%
</TABLE>



                                       18
<PAGE>

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  borrowers to comply with the current loan repayment  terms.  On
December  31, 2004 the total  amount of loans  determined  by  management  to be
potential  problem  loans was $735,000.  This amount  consisted of loans made to
eight borrowers.

Real Estate Owned

         The Bank  foreclosed on assets 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.


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 Bank,  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, 2004.

         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 First South 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.

         Management  also performs  periodic  reviews of the Bank'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,  2004,  as well as those
performed  throughout the 2004 year, did not identify an off-balance  sheet risk
upon which a reserve should be established.


                                       19
<PAGE>

<TABLE>
<CAPTION>
                                                                                    Summary of Loan Loss Experience
                                                                                          (Dollars in thousands)
                                                                                         Year Ended December 31,
                                                                                         -----------------------
                                                                       2004         2003         2002         2001           2000
                                                                       ----         ----         ----         ----           ----

<S>                                                                  <C>          <C>          <C>          <C>             <C>
Total loans outstanding at end of period ........................    $254,749     $227,239     $158,861     $102,333        $82,838
Average amount of loans outstanding .............................     238,958      194,944      141,269      126,166         70,980

Balance of allowance for loan losses - beginning ................       2,600        1,750        1,450        1,055            800
                                                                     --------     --------     --------     --------        -------
Loans charged off

Commercial & industrial .........................................          10          114          375           49              -
Real estate-mortgage ............................................         409           20           18            -              -
Other ...........................................................           2
Consumer installment * ..........................................           -        1,674            -            2              -
                                                                     --------     --------     --------     --------        -------
Total charge-offs ...............................................         421        1,808          393           51              -

Recoveries of loans previously charged-off

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

Net charge-offs .................................................         405           99          375           50              -

Additions to allowance charged to expense .......................         705          949          675          445            255
                                                                     --------     --------     --------     --------        -------

Balance of allowance for loan losses - ending ...................    $  2,900     $  2,600     $  1,750     $  1,450        $ 1,055
                                                                     --------     --------     --------     --------        -------
</TABLE>

<TABLE>
<CAPTION>
Ratios
                                                                         2004         2003         2002         2001           2000
                                                                         ----         ----         ----         ----           ----
Net charge-offs during period to
<S>                                                                     <C>          <C>          <C>          <C>            <C>
 average loans outstanding during period ........................        0.17%        0.05%        0.27%        0.05%          0.00%
Net charge-offs to loans at end of period .......................        0.16%        0.04%        0.24%        0.04%          0.00%
Allowance for loan losses to average loans ......................        1.21%        1.33%        1.10%        1.21%          1.49%
Allowance for loan losses to loans at end of period .............        1.14%        1.14%        1.10%        1.15%          1.27%
Nonperforming loans to allowance
 for loan losses at end of period ...............................       12.07%       11.35%        6.40%       27.31%         27.30%
Net charge-offs to allowance for loan losses ....................       13.98%        3.81%       21.43%        3.45%          0.00%
Net charge-offs to provision for loan losses ....................       57.48%       10.43%       55.56%       11.23%          0.00%
</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.

     The  following  table  presents the  allocation  of the  allowance for loan
losses at the end of the years ended December 31, 2004,  2003,  2002,  2001, and
2000  compared with the percent of loans in the  applicable  categories to total
loans.


                                       20
<PAGE>

<TABLE>
<CAPTION>
                     Allocation of Allowance for Loan Losses

                                                                        Period Ended December 31,
                                                                        -------------------------
                                                                          (Dollars in thousands)
                                               2004              2003               2002               2001              2000
                                               ----              ----               ----               ----              ----
                                                    % 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 ...........   $  965     33.28%  $1,017     39.10%  $  858     49.00%  $  703     48.50%  $  506    48.00%
Real estate - construction ..........      321     11.07%     290     11.20%     210     12.00%     174     12.00%     127    12.00%
Real estate - mortgage ..............    1,594     54.97%   1,272     48.90%     656     37.50%     551     38.00%     406    38.50%
Consumer installment ................       20      0.69%      21      0.80%      26      1.50%      22      1.50%      16     1.50%
                                        ------    ------   ------    ------   ------    ------   ------    ------   ------   ------

Total ...............................   $2,900    100.00%  $2,600    100.00%  $1,750    100.00%  $1,450    100.00%  $1,055   100.00%
                                        ======    ======   ======    ======   ======    ======   ======    ======   ======   ======
</TABLE>

Deposits

         The average  amounts and average rate paid on deposits held by the Bank
for the years ended December 31, 2004, 2003, and 2002 are summarized below:

                                Average Deposits

<TABLE>
<CAPTION>
                                                                                        December 31,
                                                                                        ------------
                                                                       2004                 2003                   2002
                                                                       ----                 ----                   ----
                                                                Amount     Rate       Amount     Rate        Amount     Rate
                                                                ------     ----       ------     ----        ------     ----
                                                                                    (Dollars in thousands)
<S>                                                           <C>          <C>      <C>          <C>       <C>          <C>
Noninterest bearing demand ..............................     $ 20,837              $ 16,046               $ 12,951
Interest bearing transaction accounts ...................       33,917     1.73%      33,729     1.72%       31,447     2.34%
Savings & MMIA ..........................................       47,889     1.77%      34,094     1.80%        8,838     1.98%
Time deposits - $100,000 and over .......................       35,525     2.39%      28,312     2.47%       18,168     3.24%
Other time deposits .....................................       93,294     2.38%      80,867     2.52%       69,892     3.34%
                                                              --------     -----    --------     -----     --------     -----
Total interest bearing deposits .........................     $210,625     2.14%    $177,002     2.22%     $128,345     2.99%
                                                              ========     =====    ========     =====     ========     =====

</TABLE>

         As of December 31, 2004, the Bank held  $39,992,000 in time deposits of
$100,000 or more, with  approximately  $11,704,000 with maturities  within three
months,  $10,851,000  with  maturities  over three through  twelve  months,  and
$17,437,000  with  maturities  over  twelve  months.   Wholesale  time  deposits
generated through corporations,  banks, credit unions, etc., on a national level
totaled  approximately  $31,398,000  as of  December  31,  2004.  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 2004 and 2003,  other than deposits,
were retail repurchase agreements and Federal Home Loan Bank advances.

         Retail repurchase  agreements are short-term borrowings from commercial
customers  collateralized  by  government or government  agency  securities  and
repayable  with  interest.  At December 31, 2004 and 2003,  First South Bank had
$4,700,237 and $6,088,913 in retail  repurchase  agreements,  respectively.  The
weighted average interest rates for retail repurchase agreements  outstanding at
December  31,  2004 and 2003  were  1.73%  and  .38%,  respectively,  and  those
repurchase agreements all had next day maturities.  The maximum amount of retail
repurchase  agreements  at the end of any  month  was  $7,031,903  in  2004  and
$7,058,835  in 2003.  The  approximate  average  amount  of  outstanding  retail
repurchase  agreements  was  $5,155,915  in 2004  and  $4,903,000  in  2003  and
approximate weighted interest rates in 2003 were .91% in 2004 and .51% in 2003.

         At  December  31,  2004 and 2003,  First  South had two  advances of $5
million  each  outstanding  from the  Federal  Home  Loan Bank of  Atlanta.  The
advances are  collateralized  by a lien on qualifying first mortgage loans in an

                                       21
<PAGE>

amount necessary to satisfy outstanding  indebtedness plus accrued interest. The
borrowings  carried fixed interest rates of 4.3% and 4.6% and mature in February
and March 2011. One of the advances  became callable during February 2003 and is
callable until maturity.  The other advance became callable in March 2004 and is
callable until its maturity.  The approximate  average amount of such borrowings
outstanding in 2004 and 2003 was $10 million.  The approximate weighted interest
rate  for  2004  and  2003  was  4.45%.  The  maximum  amount  of such  advances
outstanding at the end of any month in 2004 and 2003 was $10 million.

         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 approximate  average amount outstanding in 2004 was 4,583,000
and the approximate  weighted average interest rate was 4.39% (see Note 8 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,
                                2004        2003        2002
                                ----        ----        ----

Return on average assets       1.09%       0.93%       0.82%
Return on average equity      13.42%      13.70%      10.35%
Dividend payout ratio          0.00%       0.00%       0.00%
Equity to assets ratio         8.15%       6.80%       7.96%


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
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 73 % of total assets at December 31, 2004.  Asset liquidity is provided
from several sources,  including  amounts due from banks and federal funds sold,
and funds from maturing loans.  The Bank is a member of the FHLB of Atlanta and,
as such,  has the  ability  to borrow  against  the  security  of its 1-4 family
residential  mortgage loans. The Bank currently has two ten year $5,000,000 loan
advances  from  the  FHLB of  Atlanta.  Both of  these  advances  are  presently
callable.  The Bank 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 Bank'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  $2,059,397 during 2003 and
by  $10,434,729  in 2004.  The  increase  in 2004  resulted  from an increase in
retained earnings of $3,000,055,  a reduction in other  comprehensive  income of
$50,693, additional paid-in capital of $3,300 from the exercise of stock options
and the proceeds of $7,482,067 from private issuance of 300,000 shares of common
stock.


         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
deterioration  of the capital  position of a bank. If the capital position of an
affected institution were to fall below certain levels,  increasingly  stringent
regulatory corrective actions are mandated.

         At  December  31,  2004,  both the  Company and the Bank met all of the
requirements  to be  well  capitalized.  Capital  ratios  are  presented  in the
following table,  compared with the "well  capitalized" and minimum ratios under
the FDIC regulatory definitions and guidelines:


                                       22
<PAGE>

<TABLE>
<CAPTION>
The Bank                                                                                                           To Be Well
                                                                                                                Capitalized Under
                                                                                  For Capital                   Prompt Corrective
                                                           Actual                Adequacy Purposes              Action Provisions
                                                           ------                -----------------              -----------------
                                                 Amount              Ratio      Amount         Ratio          Amount          Ratio
                                                 ------              -----      ------         -----          ------          -----
December 31, 2004
Total Capital
<S>                                            <C>                  <C>       <C>               <C>         <C>               <C>
(To Risk Weighted Assets) ..............       $34,140,000          13.77%    $19,840,000       >8.0%       $24,800,000       >10.0%
Tier I Capital
(To Risk Weighted Assets) ..............       $26,340,000          10.62%     $9,920,000       >4.0%       $14,880,000       >6.0%
Tier I Capital
(To Average Assets) ....................       $26,340,000           8.90%    $11,839,000       >4.0%       $14,800,000       >5.0%
</TABLE>

<TABLE>
<CAPTION>

The Holding Company                                                                                                To Be Well
                                                                                                                Capitalized Under
                                                                                  For Capital                   Prompt Corrective
                                                           Actual                Adequacy Purposes              Action Provisions
                                                           ------                -----------------              -----------------
                                                 Amount              Ratio      Amount         Ratio          Amount          Ratio
                                                 ------              -----      ------         -----          ------          -----

December 31, 2004
   Total Capital
<S>                                            <C>                  <C>       <C>                <C>        <C>                <C>
   (To Risk Weighted Assets) ...........       $34,525,000          13.92%    $19,840,000       >8.0%       $24,800,000       >10.0%
   Tier I Capital
   (To Risk Weighted Assets) ...........       $31,625,000          12.75%     $9,920,000       >4.0%       $14,880,000       >6.0%
   Tier I Capital
   (To Average Assets) .................       $31,625,000          10.68%    $11,839,000       >4.0%       $14,800,000       >5.0%
</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, 2004,  the Bank had issued  commitments  to extend  credit of $36.2
million through  various types of lending  arrangements.  Of these  commitments,
65.8 %, or $23.8 million,  expire within one year, and 34.2 %, or $12.4 million,
expire in more than one year or more.  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.


                                       23
<PAGE>

Item 7. Financial Statements.





                    FIRST SOUTH BANCORP INC. AND SUBSIDIARY

                  REPORT ON CONSOLIDATED FINANCIAL STATEMENTS

              FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002






                                       24
<PAGE>




                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
                        CONSOLIDATED FINANCIAL STATEMENTS


                                TABLE OF CONTENTS

                                                                          Page

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM .............       1

FINANCIAL STATEMENTS
   Consolidated balance sheets ......................................       2
   Consolidated statements of income ................................       3
   Consolidated statements of changes in stockholders' equity .......       4
   Consolidated statements of cash flows ............................       5

NOTES TO FINANCIAL STATEMENTS .......................................  6 - 22






                                       25
<PAGE>











             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



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


           We have audited the accompanying consolidated balance sheets of First
South  Bancorp,  Inc. and  Subsidiary  (the Company) as of December 31, 2004 and
2003 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,
2004. 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, 2004 and 2003 and the results
of their operations and their cash flows for each of the years in the three year
period  ended  December  31,  2004  in  conformity  with  accounting  principles
generally accepted in the United States of America.




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




Charlotte, North Carolina
March 10, 2005




                                       26
<PAGE>


                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS



<TABLE>
<CAPTION>
                                                                                                              DECEMBER 31,
                                                                                                              ------------
                                                                                                        2004                 2003
                                                                                                        ----                 ----
                                                           ASSETS

<S>                                                                                                <C>                  <C>
CASH AND DUE FROM BANKS ...................................................................        $  4,092,178         $  4,492,767

INTEREST-BEARING DEPOSITS .................................................................           9,200,000               25,000

SECURITIES AVAILABLE-FOR-SALE .............................................................          18,506,440           10,372,164

SECURITIES HELD-FOR-INVESTMENT ............................................................           3,358,447            3,873,928

LOANS, net ................................................................................         251,155,171          224,169,439

PREMISES AND EQUIPMENT, net ...............................................................           5,333,819            5,455,891

INVESTMENT IN FSBS CAPITAL TRUST ..........................................................             155,000                    -

OTHER ASSETS ..............................................................................           4,629,282            3,331,774
                                                                                                   ------------         ------------

        Total assets ......................................................................        $296,430,337         $251,720,963
                                                                                                   ============         ============

                                            LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
     Noninterest - bearing demand .........................................................        $ 18,632,817         $ 19,028,127
     Interest bearing demand and savings ..................................................          86,078,673           80,063,488
     Time deposits ........................................................................         143,163,587          116,364,574
                                                                                                   ------------         ------------

        Total deposits ....................................................................         247,875,077          215,456,189

Retail repurchase agreements ..............................................................           4,700,237            6,088,913
Other borrowed funds ......................................................................          10,416,656           12,235,553
Subordinated debt .........................................................................           5,155,000                    -
Other accrued expenses and liabilities ....................................................           1,439,510            1,531,180
                                                                                                   ------------         ------------

        Total liabilities .................................................................         269,586,480          235,311,835

COMMITMENTS AND CONTINGENCIES - Notes 11 and 13 ...........................................                   -                    -

STOCKHOLDERS' EQUITY
     Common stock, no par value, 30,000,000 shares authorized, 1,682,490 and
       1,382,040 issued and outstanding at December 31, 2004 and 2003, respectively .......                   -                    -
     Paid-in capital ......................................................................          18,637,856           11,152,489
     Retained earnings ....................................................................           8,224,862            5,224,807
     Accumulated other comprehensive income ...............................................             (18,861)              31,832
                                                                                                   ------------         ------------

        Total stockholders' equity ........................................................          26,843,857           16,409,128
                                                                                                   ------------         ------------

        Total liabilities and stockholders' equity ........................................        $296,430,337         $251,720,963
                                                                                                   ============         ============
</TABLE>


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


                                       27
<PAGE>



                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
                        CONSOLIDATED STATEMENTS OF INCOME


<TABLE>
<CAPTION>
                                                                                        For the years ended December 31,
                                                                                        --------------------------------
                                                                                  2004                 2003                2002
                                                                                  ----                 ----                ----
 INTEREST INCOME
<S>                                                                            <C>                 <C>                 <C>
     Loans .............................................................       $14,575,623         $12,282,117         $ 9,312,105
     Securities
        U. S. Government and agency obligations ........................           450,766             431,568             631,322
        State and local obligations ....................................            25,998              26,016              25,995
        Mortgage backed securities .....................................            48,791                   -                   -
        Other securities ...............................................            72,745              74,993              81,446
     Deposits with banks ...............................................           137,366              70,064             156,644
                                                                               -----------         -----------         -----------

        Total interest income ..........................................        15,311,289          12,884,758          10,207,512
                                                                               -----------         -----------         -----------

INTEREST EXPENSE
     Deposits
        Time ...........................................................         3,068,349           2,734,418           2,921,920
        Interest-bearing demand and savings ............................         1,431,436           1,191,777             910,346
     Borrowed funds ....................................................           458,431             457,528             452,021
     Other .............................................................           250,483              26,583              68,522
                                                                               -----------         -----------         -----------

        Total interest expense .........................................         5,208,699           4,410,306           4,352,809
                                                                               -----------         -----------         -----------

        Net interest income ............................................        10,102,590           8,474,452           5,854,703

PROVISION FOR LOAN LOSSES ..............................................           705,522             949,302             674,830
                                                                               -----------         -----------         -----------

        Net interest income after provision for  loan losses ...........         9,397,068           7,525,150           5,179,873
                                                                               -----------         -----------         -----------

NONINTEREST INCOME
     Service charges, fees, and commissions ............................           693,755             454,579             357,714
     Loan brokerage fees ...............................................           240,248             454,344             302,342
     Mortgage banking loan fees ........................................           127,859             233,305             136,342
     Other .............................................................           127,385             112,058              64,021
                                                                               -----------         -----------         -----------

                                                                                 1,189,247           1,254,286             860,419
                                                                               -----------         -----------         -----------
NONINTEREST EXPENSES
     Salaries and employee benefits ....................................         3,564,689           3,190,603           2,391,337
     Occupancy and equipment ...........................................           823,475             635,843             479,388
     Legal expenses ....................................................           172,056             263,765              83,200
     Data processing ...................................................           201,843             329,269             163,272
     Other outside services ............................................           128,497             262,986              68,386
     Other .............................................................         1,039,700             866,703             640,683
                                                                               -----------         -----------         -----------

        Total other operating expenses .................................         5,930,260           5,549,169           3,826,266

        Income before income taxes .....................................         4,656,055           3,230,267           2,214,026

CURRENT INCOME TAX EXPENSE .............................................         1,700,000           1,386,000           1,003,262

DEFERRED INCOME TAX BENEFIT ............................................           (44,000)           (260,000)           (208,000)
                                                                               -----------         -----------         -----------

        Net income .....................................................        $3,000,055         $ 2,104,267         $ 1,418,764
                                                                                ==========         ===========         ===========

EARNINGS PER COMMON SHARE ..............................................             $1.87         $      1.52         $      1.03
                                                                                ==========         ===========         ===========

DILUTED EARNINGS PER COMMON SHARE ......................................             $1.76         $      1.46         $       .99
                                                                                ==========         ===========         ===========
</TABLE>


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


                                       28
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              For the years ended December 31, 2004, 2003, and 2002


<TABLE>
<CAPTION>
                                                                Common                                  Accumulated
                                                                stock                                      other           Total
                                                              in number      Paid-in       Retained    comprehensive   stockholders'
                                                              of shares      capital       earnings    income (loss)       equity
                                                              ---------      -------       --------    -------------       ------

<S>                                                           <C>          <C>            <C>               <C>          <C>
Balance, December 31, 2001 .............................        917,780    $11,096,989    $ 1,701,776       $110,188     $12,908,953

    Exercised stock options ............................          3,000         48,000              -              -          48,000
    Comprehensive income:
       Net income ......................................              -              -      1,418,764              -
       Net change in unrealized gain on
         securities available for sale net of ..........              -              -              -        (25,986)
         tax of $16,614
       Comprehensive income ............................              -              -              -              -       1,392,778
                                                              ---------    -----------    -----------       --------     -----------

Balance, December 31, 2002 .............................        920,780     11,144,989      3,120,540         84,202      14,349,731
                                                              ---------    -----------    -----------       --------     -----------

    Exercised stock options ............................            600          7,500              -              -           7,500
    Comprehensive income:
       Net income ......................................              -              -      2,104,267              -
       Net change in unrealized gain on
         securities available for sale net of tax
         benefit of $32,098 ............................              -              -              -        (52,370)
       Comprehensive income ............................              -              -              -              -       2,051,897
       Three-for-two common stock
          split ........................................        460,660              -              -              -               -
                                                              ---------    -----------    -----------       --------     -----------

Balance, December 31, 2003 .............................      1,382,040     11,152,489      5,224,807         31,832      16,409,128
                                                              ---------    -----------    -----------       --------     -----------

    Exercised stock options ............................            450          3,300              -              -           3,300

    Issuance of Common Stock (300,000 shares @
      $25 per share) net of expense of $17,933 .........        300,000      7,482,067              -              -       7,482,067

    Comprehensive income:
       Net income ......................................                                    3,000,055
       Net change in unrealized gain on
         securities available for sale net of tax
         benefit of $31,070 ............................              -              -              -        (50,693)              -
       Comprehensive income ............................              -              -              -                      2,949,362
                                                              ---------    -----------    -----------       --------     -----------

Balance, December 31, 2004 .............................      1,682,490    $18,637,856    $ 8,224,862       $(18,861)    $26,843,857
                                                              =========    ===========    ===========       ========     ===========
</TABLE>












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


                                       29
<PAGE>


                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                            For the years ended December 31,
                                                                                            --------------------------------
                                                                                      2004               2003                2002
                                                                                      ----               ----                ----
OPERATING ACTIVITIES
<S>                                                                              <C>                <C>                <C>
     Net income ...........................................................      $  3,000,055       $  2,104,267       $  1,418,764
     Adjustments to reconcile net income to net cash provided by
        operating activities
        Depreciation and amortization .....................................           432,071            243,468            189,003
        Provision for loan losses .........................................           705,522            949,302            674,830
        Gain on disposal of premises and equipment ........................                 -             (6,453)                 -
        (Gain) loss on sale of other real estate owned ....................                 -             (3,549)             2,851
        (Gain) loss on sale of loans ......................................           (78,783)                 -                  -
        Increase in cash surrender value of life insurance ................           (30,344)           (37,090)           (41,110)
        Deferred tax provision ............................................           (44,000)          (260,000)          (208,000)
        Decrease (increase) in interest receivable ........................          (177,899)          (195,401)          (150,497)
        Decrease (increase) in other assets ...............................          (829,848)           204,610           (495,309)
        Increase in accrued expenses and other
           Liabilities ....................................................            38,559            331,106            806,024
                                                                                 ------------       ------------       ------------

           Net cash provided by operating activities ......................         3,015,333          3,330,260          2,196,556
                                                                                 ------------       ------------       ------------

INVESTING ACTIVITIES
     Origination of loans, net of principal collected .....................       (28,199,269)       (67,880,945)       (33,812,549)
     Proceeds from matured/called securities available-for-sale ...........         5,000,000         10,998,714         11,000,000
     Proceeds from matured/called securities held-for-investment ..........                 -            518,503                  -
     Proceeds from sale of securities available-for-sale ..................         1,000,000                  -                  -
     Purchase of securities available-for-sale ............................       (14,001,975)        (6,600,000)       (16,998,552)
     Purchase of securities held-for-investment ...........................                 -         (2,023,848)        (1,017,363)
     Proceeds from MBS principal paydowns .................................           510,545                  -                  -
     Proceeds from sale of other real estate owned ........................                 -            337,457            147,149
     Proceeds from disposal of premises and equipment .....................                 -             20,487                  -
     Purchases of premises and equipment ..................................          (246,905)        (2,880,721)          (145,446)
     Investment in trust ..................................................          (155,000)                 -                  -
                                                                                 ------------       ------------       ------------

           Netcashusedforinvestingactivities ..............................       (36,092,604)       (67,510,353)       (40,826,761)
                                                                                 ------------       ------------       ------------

FINANCING ACTIVITIES
     Increase in deposits, net ............................................        32,418,888         59,758,242         38,414,871
     Proceeds from exercise of stock options ..............................             3,300              7,500             48,000
     Net (decrease) increase in retail repurchase agreements ..............        (1,388,676)         2,859,176         (2,393,657)
     Net (decrease) increase in other borrowings ..........................           181,103           (219,138)           414,024
     Proceeds of advances from FHLB .......................................        16,200,000          6,000,000                  -
     Repayment of advances from FHLB ......................................       (18,200,000)        (4,000,000)                 -
     Proceeds from issuance of subordinated debt ..........................         5,155,000                  -                  -
     Proceeds from stock issuance .........................................         7,482,067                  -                  -
                                                                                 ------------       ------------       ------------

           Net cash provided by financing activities ......................        41,851,682         64,405,780         36,483,238
                                                                                 ------------       ------------       ------------

           Net increase (decrease) in cash and cash equivalents ...........         8,774,411            225,687         (2,146,967)

CASH AND CASH EQUIVALENTS, BEGINNING
     OF YEAR ..............................................................         4,517,767          4,292,080          6,439,047
                                                                                 ------------       ------------       ------------

CASH AND CASH EQUIVALENTS, END OF YEAR ....................................      $ 13,292,178       $  4,517,767       $  4,292,080
                                                                                 ============       ============       ============

CASH PAID FOR
     Interest .............................................................      $  5,208,699       $  4,347,578       $  4,626,160
                                                                                 ============       ============       ============

     Income taxes .........................................................      $  1,524,449       $  1,132,904       $  1,063,007
                                                                                 ============       ============       ============
</TABLE>

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


                                       30
<PAGE>

                    FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


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 Hilton Head, South Carolina,
and a loan production office in Asheville, North 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
300,000 shares of stock at $25 per share, with net proceeds totaling $7,482,067.


NOTE 2- SUMMARY OF SIGNFICANT 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.

     (a)  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.

     (b)  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.

     (c)  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:

          -    securities  held-for-investment are held-to-maturity and reported
               at amortized cost,

          -    trading  securities  are  reported at fair value with  unrealized
               gains and losses included in earnings, or;

          -    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).


                                       31
<PAGE>


NOTE 2- SUMMARY OF SIGNFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

         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, 2004 and 2003.

     (d) 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  expected  losses in the loan  portfolio.  In
         determining the provision  amount,  management  gives  consideration to
         current and anticipated 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.

     (e) 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.


                                                                     (Continued)


                                       32
<PAGE>

NOTE 2- SUMMARY OF SIGNFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

  (f) 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.

     (g)  Loan Origination Fees

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

     (h) 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.


     (i)  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.

      (j) 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.

     (k)  Stock Options

         Financial   Accounting   Standards  Board  (FASB)   Statement  No  148,
         Accounting for  Stock-Based  Compensation - Transition and Disclosure -
         An Amendment of FASB Statement No. 123, was issued in December 2002 and
         provides  alternative  methods of transition for a voluntary  change to
         the fair value based  method of  accounting  for  stock-based  employee
         compensation.   In  addition,   SFAS  No.  148  amends  the  disclosure
         requirements of SFAS No. 123 to require  prominent  disclosures in both
         annual and interim financial  statements about the method of accounting
         for stock-based employee compensation and the effect of the method used
         on reported results. The disclosure  requirements of this statement are
         effective  for fiscal  years  ending  after  December  15, 2002 and are
         included in these financial statements.

         The  Company  has  elected to  continue  using the  measurement  method
         prescribed  in  Accounting   Principles   Board  Opinion  No.  25  and,
         accordingly,  FASB  Statement  No.  123 has no effect on the  Company's
         financial   position  or  results  of  operations.   As  a  result,  no
         compensation  cost has been  recognized  for the stock option plan. Had
         compensation  cost for the Company's  stock option plan been determined
         based on the fair value at the grant date of the awards consistent with
         the  provisions  of FASB  Statement No. 123, the Company's net earnings
         and  earnings per share would have  decreased to the pro forma  amounts
         indicated below:
                                                                     (Continued)



                                       33
<PAGE>


NOTE 2- SUMMARY OF SIGNFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

<TABLE>
<CAPTION>
                                                                                2004                   2003                  2002
                                                                                ----                   ----                  ----
<S>                                                                           <C>                   <C>                   <C>
Net income - as reported .........................................            $3,000,055            $2,104,267            $1,418,764
Net income - pro forma ...........................................             2,829,657             1,953,093             1,289,861
Earnings per common share - as reported ..........................                  1.87                  1.52                  1.03
Earnings per common share - pro forma ............................                  1.76                  1.41                  0.93
Diluted earnings per common share - as reported ..................                  1.76                  1.46                  0.99
Diluted earnings per common share - pro forma ....................                  1.66                  1.35                  0.90
</TABLE>


(l) Fair value of financial instruments

     FASB  Statement  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.



                                                                     (Continued)



                                       34
<PAGE>

NOTE 2- SUMMARY OF SIGNFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

   (m) Recent accounting pronouncements

In December  2004,  the FASB issued SFAS No. 123  (revised  2004),  "Share-Based
Payment" ("SFAS No. 123(R)").  SFAS No. 123(R) will require companies to measure
all  employee  stock-based  compensation  awards  using a fair value  method and
record such expense in its financial  statements.  In addition,  the adoption of
SFAS No. 123(R)  requires  additional  accounting and disclosure  related to the
income  tax  and  cash  flow  effects   resulting   from   share-based   payment
arrangements.  SFAS No. 123(R) is effective beginning as of the first interim or
annual  reporting  period  beginning  after  December 15,  2005.  The Company is
currently  evaluating  the impact that the adoption of SFAS No. 123(R) will have
on its financial position,  results of operations and cash flows. The cumulative
effect of adoption,  if any, will be measured and recognized in the statement of
operations on the date of adoption.

In  December  2003,  the FASB  issued FIN No. 46  (revised),  "Consolidation  of
Variable Interest Entities" ("FIN No. 46(R)"), which addresses  consolidation by
business  enterprises of variable  interest  entities.  FIN No. 46(R) requires a
variable  interest  entity to be  consolidated  by a company if that  company is
subject to a majority of the risk of loss from the  variable  interest  entity's
activities or entitled to receive a majority of the entity's  residual  returns,
or both.  FIN No.  46(R)  also  requires  disclosures  about  variable  interest
entities  that a company is not required to  consolidate,  but in which it has a
significant  variable interest.  FIN No. 46(R) provides guidance for determining
whether an entity qualifies as a variable interest entity by considering,  among
other  considerations,  whether the entity lacks sufficient equity or its equity
holders lack adequate decision-making ability. The consolidation requirements of
FIN No. 46(R) applied  immediately to variable  interest  entities created after
January  31,  2003.  The  consolidation  requirements  applied to the  Company's
existing  variable  interest entities in the first reporting period ending after
December  15,  2004.  Certain  of the  disclosure  requirements  applied  to all
financial  statements  issued after  December 31, 2003,  regardless  of when the
variable interest entity was established.  The adoption of FIN No. 46(R) did not
have any impact on the Company's  financial  position or results of  operations.
Subsequent  to December 31, 2003,  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.  In accordance with the provisions
of this  Interpretation,  the Company has not  consolidated its interest in FSBS
Capital Trust.

In November  2003, the Emerging  Issues Task Force ("EITF")  reached a consensus
that certain  quantitative  and qualitative  disclosures  should be required for
debt and  marketable  equity  securities  classified  as  available-for-sale  or
held-to-maturity  under SFAS No. 115 and SFAS No. 124 that are  impaired  at the
balance sheet date but for which  other-than-temporary  impairment  has not been
recognized.  Accordingly  the  EITF  issued  EITF  No.  03-1,  "The  Meaning  of
Other-Than-Temporary  Impairment and Its  Application  to Certain  Investments."
This issue  addresses  the meaning of  other-than-temporary  impairment  and its
application  to   investments   classified  as  either   available-for-sale   or
held-to-maturity  under SFAS No. 115 and provides  guidance on quantitative  and
qualitative  disclosures.  The  disclosure  requirements  of EITF  No.  03-1 are
effective for annual financial statements for fiscal years ending after June 15,
2004. The effective date for the measurement  and  recognition  guidance of EITF
No. 03-1 has been delayed.  The FASB staff has issued a proposed  Board-directed
FASB Staff Position ("FSP"), FSP EITF 03-1-a,  "Implementation  Guidance for the
Application  of Paragraph 16 of Issue No.  03-1." The proposed FSP would provide
implementation guidance with respect to debt securities that are impaired solely
due   to   interest    rates   and/or   sector    spreads   and   analyzed   for
other-than-temporary   impairment   under  the   measurement   and   recognition
requirements  of  EITF  No.  03-1.  The  delay  of the  effective  date  for the
measurement  and  recognition  requirements  of EITF No. 03-1 will be superseded
concurrent  with the final issuance of FSP EITF 03-1-a.  Adopting the disclosure
provisions of EITF No. 03-1 did not have any impact on the  Company's  financial
position or results of operations.





                                                                     (Continued)


                                       35
<PAGE>


NOTE 2- SUMMARY OF SIGNFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued

In March 2004,  the  Securities  and Exchange  Commission  ("SEC")  issued Staff
Accounting  Bulletin ("SAB") No. 105,  "Application of Accounting  Principles to
Loan commitments," to inform registrants of the Staff's view that the fair value
of the recorded loan  commitments  should not consider the expected  future cash
flows related to the associated  servicing of the future loan. The provisions of
SAB No. 105 must be applied to loan  commitments  accounted  for as  derivatives
that are  entered  into after March 31,  2004.  The Staff will not object to the
application of existing accounting  practices to loan commitments  accounted for
as  derivatives  that  are  entered  into on or  before  March  31,  2004,  with
appropriate  disclosures.  The Company  adopted the provisions of SAB No. 105 on
April 1, 2004. The adoption of SAB No. 105 did not have a material impact on the
Company's financial condition or results of operations.

Other  accounting  standards  that have been  issued or  proposed by the FASB or
other standards-setting  bodies that do not require adoption until a future date
are not  expected  to  have a  material  impact  on the  consolidated  financial
statements upon adoption.

 (n)  Operating Segments

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

  (o) Financial statement 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

Available-for-sale

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

<TABLE>
<CAPTION>
                                                                                                   2004
                                                                                                   ----
                                                                    Amortized               Gross unrealized             Estimated
                                                                      cost              gains             losses         fair value
                                                                      ----              -----             ------         ----------

<S>                                                                <C>               <C>               <C>               <C>
U.S. Government agency obligations .........................       $16,498,891       $         -       $    18,311       $16,480,580
State and local obligations ................................           123,153             4,239                 -           127,392
Mortgage backed securities .................................           960,618                 -            16,350           944,268
Restricted FHLB stock ......................................           954,200                 -                 -           954,200
                                                                   -----------       -----------       -----------       -----------

        Total securities - available-for-sale ..............       $18,536,862       $    4,239        $   34,661        $18,506,440
                                                                   ===========       ===========       ===========       ===========
<CAPTION>
                                                                                                   2003
                                                                                                   ----
                                                                    Amortized               Gross unrealized             Estimated
                                                                      cost              gains             losses         fair value
                                                                      ----              -----             ------         ----------

<S>                                                                <C>               <C>               <C>               <C>
U.S. Government agency obligations .........................       $ 9,497,730       $    68,805       $    22,190       $ 9,544,345
State and local obligations ................................           123,093             4,726                 -           127,819
Restricted FHLB stock ......................................           700,000                 -                 -           700,000
                                                                   -----------       -----------       -----------       -----------

        Total securities - available-for-sale ..............       $10,320,823           $73,531       $    22,190       $10,372,164
                                                                   ===========       ===========       ===========       ===========
</TABLE>

There was one sale of a  security  available-for-sale  in 2004 in the  amount of
1,000,000 and none in 2003.
                                                                     (Continued)


                                       36
<PAGE>


NOTE 3 - SECURITIES, Continued


 The Company has nine  securities in an unrealized loss position at December 31,
2004.  The eight  securities,  with a fair value of $9,418,868 and an unrealized
loss of $40,641 at December 31, 2004, have been in a continuous  unrealized loss
position for less than twelve months.  The other security,  with a fair value of
$974,380 and an unrealized  loss of $25,620 at December 31, 2004,  has been in a
continuous  unrealized  loss  position for more than 12 months.  The Company had
only one  security in an  unrealized  loss  position at December 31, 2003 with a
fair value of $977,810 and an  unrealized  loss of $22,910 at December 31, 2003.
This security had been in a continuous unrealized loss position for less than 12
months.  These  securities  are not  considered  to be  other  than  temporarily
impaired due to management's intent to hold these securities until maturity.


Held-for-investment

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

<TABLE>
<CAPTION>
                                                                                                    2004
                                                                                                    ----
                                                                       Amortized               Gross unrealized          Estimated
                                                                         cost              gains          losses         fair value
                                                                         ----              -----          ------         ----------

<S>                                                                    <C>              <C>              <C>              <C>
U.S. Government agency obligations .............................       $1,004,235       $        -       $    1,105       $1,003,130
Trust Preferred securities .....................................          479,274          133,404                -          612,678
Mortgage backed securities .....................................        1,499,938           38,623                -        1,538,561
State and local obligations ....................................          375,000            9,701                -          384,701
                                                                       ----------       ----------       ----------       ----------

        Total securities - held-for-investment .................       $3,358,447       $  181,728       $    1,105       $3,539,070
                                                                       ==========       ==========       ==========       ==========
</TABLE>


<TABLE>
<CAPTION>
                                                                                                    2003
                                                                                                    ----
                                                                       Amortized             Gross unrealized           Estimated
                                                                          cost              gains         losses        fair value
                                                                          ----              -----         ------        ----------

<S>                                                                    <C>                <C>            <C>            <C>
U.S. Government agency obligations .............................       $1,010,927         $   12,823     $    -         $1,023,750
Trust Preferred securities .....................................          477,862            127,592          -            605,454
Mortgage backed securities .....................................        2,010,139              7,496          -          2,017,635
State and local obligations ....................................          375,000             11,592          -            386,592
                                                                       ----------         ----------     ------         ----------

        Total securities-held-for-investment ...................       $3,873,928         $  159,503     $    -         $4,033,431
                                                                       ==========         ==========     ======         ==========
</TABLE>

The    scheduled    maturities    of    securities    held-for-investment    and
available-for-sale at December 31, 2004 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 ....................           $ 1,498,891           $ 1,494,410           $ 1,004,235           $ 1,003,130
Due from one to five years .................            13,000,000            12,985,170                     -                     -
Due from five to ten years .................             1,000,000             1,001,250                     -                     -
Due after ten years ........................             1,123,153             1,127,142               854,274               997,379
Mortgage backed securities .................               960,618               944,268             1,499,938             1,538,561
Equity securities ..........................               954,200               954,200                     -                     -
                                                       -----------           -----------           -----------           -----------
                                                       $18,536,862           $18,506,440           $ 3,358,447           $ 3,539,070
                                                       ===========           ===========           ===========           ===========
</TABLE>

At  December  31,  2004,  securities  with a  carrying  value  of  approximately
$11,465,545  were pledged to secure retail  repurchase  agreements and Treasury,
tax and loan deposits.


                                       37
<PAGE>

NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES

          Loans at December 31, 2004 and 2003 are summarized as follows:

                                                           December 31,
                                                           ------------
                                                       2004             2003
                                                       ----             ----

Construction and land development ............   $  17,223,132    $  14,345,975
1-4 Family residential properties ............      70,445,101       55,948,902
Multifamily residential properties ...........       1,648,521        1,274,998
Non-farm nonresidential properties ...........     117,031,288      101,938,822
Other real estate loans ......................       1,200,855        1,650,997
Commercial and industrial, non-real estate ...      46,728,921       51,523,910
Consumer .....................................         470,787          554,999
                                                 -------------    -------------
Total loans ..................................     254,748,605      227,238,603
Less allowance for loan losses ...............      (2,900,000)      (2,600,000)
Net deferred loan fees .......................        (693,434)        (469,164)
                                                 -------------    -------------
                                                 $ 251,155,171    $ 224,169,439
                                                 =============    =============

The  activity  in the  allowance  for loan  losses for 2004,  2003,  and 2002 is
summarized as follows:

                                          2004          2003            2002
                                          ----          ----            ----
Balance, beginning of year ........   $ 2,600,000    $ 1,750,000    $ 1,450,000
Provision charged at operations ...       705,522        949,302        674,830
Loan  charge-offs .................      (421,448)    (1,808,203)      (392,450)
Loan recoveries ...................        15,926      1,708,901         17,620
                                      -----------    -----------    -----------
Balance, end of year ..............   $ 2,900,000    $ 2,600,000    $ 1,750,000
                                      ===========    ===========    ===========

At  December  31, 2004 and 2003,  nonaccrual  loans  amounted  to  $350,167  and
$295,039,  respectively. The Company evaluates impairment of commercial loans on
an individual  loan basis.  As of December 31, 2004 and 2003 loans  individually
evaluated and considered  impaired  under FASB Statement No. 114,  Accounting by
Creditors for Impairment of a Loan were immaterial.

At December 31, 2004, the Company had loans outstanding to officers,  directors,
and their related interests of $4,045,317. During 2004, directors, officers, and
their related interests borrowed  $2,325,398 and repaid $1,730,554.  At December
31, 2003, the Company had loans  outstanding to officers,  directors,  and their
related interests of $3,450,473.  During 2003,  directors,  officers,  and their
related interests borrowed $2,835,278 and repaid $5,823,220.

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, 2004 and 2003,  pre-approved  but unused lines of credit for loans
totaled approximately  $36,240,245 and $38,169,647,  respectively.  In addition,
the Company had issued  standby  letters of credit  amounting  to  approximately
$2,816,000  and  $2,539,000  at December  31, 2004 and 2003,  respectively.  The
Company  also had  $1,921,000  in  outstanding  variable  rate  commercial  loan
commitments at December 31, 2004. 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.


                                                                     (Continued)


                                       38
<PAGE>

NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES, Continued

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.

NOTE 5 - PREMISES AND EQUIPMENT

Premises and equipment at December 31, 2004 and 2003 are summarized as follows:

                                                            December 31,
                                                            ------------
                                                      2004               2003
                                                      ----               ----

Land .....................................       $   431,412        $   431,412
Buildings ................................         4,718,620          4,715,267
Leasehold improvements ...................            93,590             93,590
Furniture and equipment ..................         1,682,443          1,439,200
                                                 -----------        -----------

                                                   6,926,065          6,679,469
Less accumulated depreciation ............        (1,592,246)        (1,223,578)
                                                 -----------        -----------

                                                 $ 5,333,819        $ 5,455,891
                                                 ===========        ===========

Depreciation  expense  for the years ended 2004,  2003,  and 2002 was  $368,667,
$243,468 and $189,003, respectively.

NOTE 6 - DEPOSITS

           A summary of deposit accounts at December 31, 2004 and 2003 follows:

                                                           December 31,
                                                           ------------
                                                    2004                 2003
                                                    ----                 ----
Demand
    Non-interest bearing ...............        $ 18,632,817        $ 19,028,127
    Interest bearing ...................          32,297,557          36,531,572
Savings ................................          53,781,116          43,531,916
Time, $100,000 and over ................          39,992,374          32,784,468
Other Time .............................         103,171,213          83,580,106
                                                ------------        ------------
                                                $247,875,077        $215,456,189
                                                ============        ============

At December 31, 2004, the scheduled maturities of time deposits are as follows:

                 2005                                       $ 79,300,002
                 2006                                         61,945,991
                 2007                                          1,719,594
                 2008                                            198,000
                 2009 and thereafter                                   -
                                                            -------------
                                                            $143,163,587
                                                            =============

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  $1,180,733 and $4,913,801 at December 31,
2004 and 2003, respectively.


                                       39
<PAGE>

NOTE 7 - OTHER BORROWED FUNDS

At December 31, 2004 and 2003, the Bank had two $5,000,000  fixed-rate  advances
outstanding from the FHLB that are  collateralized by a lien on qualifying first
mortgage and  commercial  loans in an amount  necessary  to satisfy  outstanding
indebtedness plus accrued interest. The borrowings carried interest rates of 4.6
percent and 4.3 percent and mature in March, 2011 and February 2011. Both of the
$5,000,000  advances are callable until maturity.  At December 31, 2003 the Bank
also had a $2,000,000  variable-rate  advance from the FHLB  collateralized by a
lien on  qualifying  first  mortgage  loans in an amount  necessary  to  satisfy
outstanding  indebtedness  plus  accrued  interest.  The  borrowing  carried  an
interest rate of 1.15 percent and matured in January 2004. The unused portion of
the line of credit with the FHLB was  approximately  $21,887,000 at December 31,
2004.

Treasury,  tax and loan  accounts  with  balances  of $416,656  and  $235,553 at
December 31, 2004 and 2003,  respectively  are also  included in other  borrowed
funds.  These  borrowings  bear interest at the federal funds rate less 25 basis
points.

At December  31,  2004,  the Bank had  $12,000,000  of unused lines of credit to
purchase federal funds from banks.


NOTE 8 - 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.

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 FSBS Capital Trust I,
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 9 - 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.



                                                                     (Continued)


                                       40
<PAGE>

NOTE 9 - REGULATORY CAPITAL REQUIREMENTS, Continued

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 I  capital  (as  defined  in the
regulations)  to  risk-weighted  assets (as defined),  and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2004  and  2003,  that  the  Company  and  the  Bank  met all  capital  adequacy
requirements to which it is subject.

As of December 31, 2004, 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 I risk-based, and Tier I 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, 2004
and 2003 are also presented in the tables below.

The Company

<TABLE>
<CAPTION>
                                                                                                         To be well capitalized
                                                                                        For capital      under prompt corrective
                                                                  Actual             adequacy purposes      action provisions
                                                                  ------             -----------------      -----------------
                                                            Amount      Ratio       Amount      Ratio      Amount         Ratio
                                                            ------      -----       ------      -----      ------         -----
As of December 31, 2004
<S>                                                      <C>            <C>       <C>            <C>      <C>            <C>
    Total Capital (to risk weighted assets) ..........   $34,525,000    13.92%    $19,840,000    >8.0%    $24,800,000    >10.0%
    Tier 1 Capital (to risk weighted assets) .........    31,625,000    12.75%      9,920,000    >4.0%     14,880,000    >6.0%
    Tier 1 Capital (to average assets) ...............    31,625,000    10.68%     11,839,000    >4.0%     14,800,000    >5.0%


As of December 31, 2003
    Total Capital (to risk weighted assets) ..........   $18,921,000     8.49%    $17,819,000    >8.0%    $22,274,000    >10.0%
    Tier 1 Capital (to risk weighted assets) .........    16,321,000     7.33%      8,910,000    >4.0%     13,365,000    >6.0%
    Tier 1 Capital (to average assets) ...............    16,321,000     6.47%     10,088,000    >4.0%     12,610,000    >5.0%

</TABLE>


The Bank
<TABLE>
<CAPTION>
                                                                                                         To be well capitalized
                                                                                        For capital      under prompt corrective
                                                                  Actual             adequacy purposes      action provisions
                                                                  ------             -----------------      -----------------
                                                            Amount      Ratio       Amount      Ratio      Amount         Ratio
                                                            ------      -----       ------      -----      ------         -----
As of December 31, 2004
<S>                                                      <C>            <C>       <C>             <C>     <C>             <C>
    Total Capital (to risk weighted assets) ..........   $34,140,000    13.77%    $19,840,000     >8.0%    $24,800,000    >10.0%
    Tier 1 Capital (to risk weighted assets) .........    26,340,000    10.62%      9,920,000     >4.0%     14,880,000     >6.0%
    Tier 1 Capital (to average assets) ...............    26,340,000     8.90%     11,839,000     >4.0%     14,800,000     >5.0%

As of December 31, 2003
    Total Capital (to risk weighted assets) ..........   $18,921,000     8.49%    $17,819,000     >8.0%     $22,274,000   >10.0%
    Tier 1 Capital (to risk weighted assets) .........    16,321,000     7.33%      8,910,000     >4.0%      13,365,000    >6.0%
    Tier 1 Capital (to average assets) ...............    16,321,000     6.47%     10,088,000     >4.0%      12,610,000    >5.0%

</TABLE>



                                       41
<PAGE>

NOTE 10 - INCOME TAXES

The provision for income taxes is summarized below:

                                          2004           2003           2002
                                          ----           ----           ----
Currently payable
     Federal ......................    $1,556,000     $1,284,325     $  945,312
     State ........................       144,000        101,675         57,950
                                       ----------     ----------     ----------
                                        1,700,000      1,386,000      1,003,262
Deferred
     Federal ......................      (122,928)      (240,927)      (195,986)
     State ........................        78,928        (19,073)       (12,014)
                                       ----------     ----------     ----------
                                          (44,000)      (260,000)      (208,000)
                                       ----------     ----------     ----------
           Total income taxes .....    $1,656,000     $1,126,000     $  795,262
                                       ==========     ==========     ==========

The reasons for the  difference  between the statutory  federal income tax rates
and the effective tax rates are summarized as follows for:

                                                          2004    2003     2002
                                                          ----    ----     ----

Statutory rates .....................................    34.0%    34.0%    34.0%
     Increase (decrease) resulting from:
       State taxes, net of federal benefit ..........     2.0      2.1      2.0
       Effect of tax exempt interest and dividends ..    (0.6)    (0.5)    (0.6)
       Life insurance ...............................    (0.7)    (0.7)    (1.5)
       Other, net ...................................     0.9      0.0      2.0
                                                         ----     ----     ----
                                                         35.6%    34.9%    35.9%

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

                                                             December 31,
                                                             ------------
                                                       2004              2003
                                                       ----              ----

Deferred tax assets
     Allowance for loan losses .............      $   902,000       $   825,000
     Available-for-sale securities .........           12,000                 -
     Other .................................           51,000           267,000
                                                  -----------       -----------

         Gross deferred tax assets .........          965,000         1,092,000
     Less valuation allowance ..............                -                 -
                                                  -----------       -----------

         Net deferred tax assets ...........          965,000         1,092,000

Deferred tax liabilities
     Depreciation ..........................         (158,000)         (137,000)
   . Loan Origination Fees .................         (230,000)                -
     Other .................................          (23,000)                -
     Available-for-sale securities .........                -           (10,000)
                                                  -----------       -----------
      Gross deferred liabilities ...........         (411,000)         (147,000)
                                                  -----------       -----------
         Net ...............................      $   554,000       $   945,000
                                                  ===========       ===========

The change in the valuation  allowance was $-0- for the year ending December 31,
2004.


                                       42
<PAGE>


NOTE 11 - COMMITMENTS AND CONTINGENCY

The  Company  leases the land and  building  for its  branches  under  operating
leases. Future minimum lease payments at December 31, 2004, are as follows:

                 2005                                    $158,916
                 2006                                     112,701
                 2007                                      88,809
                 2008                                      90,262
                 2009                                      92,841
                 2010 and thereafter                      189,507
                                                         --------

                                                         $733,036
                                                         ========

Total lease expense was $177,672, $171,176 and $134,755 for 2004, 2003 and 2002,
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.


NOTE 12 - 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.

In 2003, the Bank's regulators  required the Bank's Board of Directors to sign a
memorandum of understanding  in connection with the Bank's deferred  presentment
lending program which was in the process of being terminated.  The memorandum of
understanding  restricted  the payment of  dividends  without  prior  regulatory
approval, among other things. It was terminated in January 2004.


NOTE 13 - 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 $117,509, $93,770 and $81,937 in 2004, 2003 and
2002, 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 $141,422 and $114,050 at December 31, 2004 and
2003, respectively.



                                       43
<PAGE>

NOTE 14 - STOCK OPTIONS

The  Company  has  issued  incentive  stock  options  to  certain  officers  and
employees.  As permitted by FASB Statement No. 123,  Accounting for  Stock-Based
Compensation,  the Company has elected to continue using the measurement  method
prescribed in Accounting Principles Board Opinion No. 25 and, accordingly,  FASB
Statement No. 123 has no effect on the Company's  financial  position or results
of operations.

The following is a summary of stock option activity and related  information for
the years ended December 31, 2004, 2003 and 2002:

<TABLE>
<CAPTION>
                                                            2004                       2003                        2002
                                                            ----                       ----                        ----
                                                                   Weighted                    Weighted                    Weighted
                                                                   Average                     Average                      Average
                                                                   Exercise                    Exercise                    Exercise
                                                     Options        Price      Options          Price       Options          Price
                                                     -------        -----      -------          -----       -------          -----
Outstanding - Beginning of
<S>                                                  <C>            <C>        <C>               <C>        <C>               <C>
   Period ...................................        177,633         12.68     157,890           $11.61     141,173           $10.41
   Granted ..................................          8,295         34.55      20,654            20,65      21,218            19.37
   Exercised ................................           (450)         7.33        (911)            8.33      (4,500)           10.67
                                                     -------        ------     -------           ------     -------           ------
Outstanding - end of period .................        185,478        $13.67     177,633           $12.68     157,891           $11.61
                                                     =======        ======     =======           ======     =======           ======
Exercisable - end of period .................        140,859        $11.25     118,001           $10.41      96,048           $ 9.64
                                                     =======        ======     =======           ======     =======           ======
Weighted average fair value
         of options granted .................                       $22.71                       $13.41                       $12.65
                                                                    ======                       ======                       ======
</TABLE>

Exercise prices for options  outstanding as of December 31, 2004 and 2003 ranged
from $7.33 to $35.00.  The weighted average remaining  contractual life of those
options  is  approximately  5.8  years at  December  31,  2004 and 6.5  years at
December 31, 2003.

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 2004,  2003 and 2002;  dividend  yield of 0.00
percent,  expected  volatility of 50 percent in 2004,  2003 and 2002,  risk-free
interest  rates of 4.24 percent in 2004,  3.77 percent in 2003, and 4.00 percent
in 2002, and expected lives of 10 years for the options.


NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of financial instruments are as follows:

<TABLE>
<CAPTION>
                                                                                2004                               2003
                                                                                ----                               ----
                                                                   Carrying            Estimated         Carrying          Estimated
                                                                     Amount           Fair Value          Amount          Fair Value
                                                                     ------           ----------          ------          ----------
                                                                           (in thousands)                     (in thousands)
Financial assets
<S>                                                                <C>                <C>               <C>                 <C>
Cash and cash equivalents ..............................           $ 13,292           $ 13,292          $   4,518           $  4,518
Securities
      Available-for-sale ...............................             18,506             18,506             10,372             10,372
      Held-for-investment ..............................              3,358              3,539              3,874              4,033
Loans ..................................................            251,155            251,116            224,169            231,008

Financial liabilities
      Deposits .........................................            247,875            248,020            215,456            216,247
      Retail repurchase agreements .....................              4,700              4,700              6,089              6,089
      Other borrowed funds .............................             10,417             10,488             12,235             15,089
</TABLE>

                                                                     (Continued)

                                       44
<PAGE>


NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS, Continued

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.


NOTE 16 - EARNINGS PER COMMON SHARE (EPS)

The reconciliation of the numerators and denominators of the earnings per common
share and diluted EPS computation follows:

<TABLE>
<CAPTION>
                                                                                   Income                 Shares          Per share
December 31, 2004                                                                (numerator)           (denominator)        Amount
                                                                                 -----------           -------------        ------
Earnings per common share:
<S>                                                                               <C>                    <C>                 <C>
   Income available to common stockholders ...........................            $3,000,055             1,607,525           $1.87
   Dilutive effect of stock options ..................................                     -                98,047           (0.11)
                                                                                  ----------            ----------           -----
Diluted EPS:
   Income available to common stockholders
      and assumed conversions ........................................            $3,000,055             1,705,572           $1.76
                                                                                  ==========             =========           =====
</TABLE>

Options to purchase 100 shares of common  stock at $30.50 per share,  options to
purchase  400 shares of common  stock at $29.75 per share,  100 shares at $29.50
and 7,595  shares at $35.00  were not  included  in the  computation  of diluted
earnings per share for 2004 because the options' exercise price was greater than
the average market price of the common shares.

<TABLE>
<CAPTION>
December 31, 2003                                                                 (numerator)           (denominator)        Amount
                                                                                 -----------           -------------        ------
Earnings per common share:
<S>                                                                               <C>                    <C>                  <C>
   Income available to common stockholders ...........................            $2,104,267             1,381,722            $1.52
   Dilutive effect of stock options ..................................                     -                62,844            (0.06)
                                                                                  ----------            ----------            -----
Diluted EPS:
   Income available to common stockholders
      and assumed conversions ........................................            $2,104,267             1,444,566            $1.46
                                                                                  ==========            ==========            =====
</TABLE>


Options  to  purchase  14,204  shares  of common  stock at $21.00  per share and
options  to  purchase  450  shares of common  stock at $20.33 per share were not
included in the  computation of diluted  earnings per share for 2003 because the
options'  exercise price was greater than the average market price of the common
shares.

<TABLE>
<CAPTION>
December 31, 2002                                                                (numerator)           (denominator)        Amount
                                                                                 -----------           -------------        ------
Earnings per common share:
<S>                                                                               <C>                    <C>                  <C>
   Income available to common stockholders ...........................            $1,418,764             1,380,863            $1.03
   Dilutive effect of stock options ..................................                     -                45,525            (0.04)
                                                                                  ----------            ----------            -----
Diluted EPS:
   Income available to common stockholders
      and assumed conversions ........................................            $1,418,764             1,426,388            $0.99
                                                                                  ==========            ==========            =====
</TABLE>


                                                                     (Continued)


                                       45
<PAGE>

NOTE 16 - EARNINGS PER COMMON SHARE (EPS), Continued

Options to purchase 3,750 shares of common stock at $17.33 per share and options
to  purchase  150  shares of common  stock at $18.11  per share and  options  to
purchase  16,718  shares of  common  stock at $20.00  were not  included  in the
computation of diluted earnings per share for 2002 because the options' exercise
price was greater than the average market price of the common shares.


NOTE 17 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY

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

Balance Sheets
<TABLE>
<CAPTION>
                                                                                     2004                 2003                2002
                                                                                     ----                 ----                ----
Assets
<S>                                                                              <C>                 <C>                 <C>
   Cash ................................................................         $   540,866         $    55,500         $    48,000
   Investment in Trust .................................................             155,000                   -                   -
   Investment in common stock of First South Bank ......................          26,321,326          16,353,628          14,301,731
   Due from Bank .......................................................           4,900,000                   -                   -
   Debt Issuance Costs .................................................              81,665                   -                   -
                                                                                 -----------         -----------         -----------
         Total assets ..................................................         $31,998,857         $16,409,128         $14,349,731
                                                                                 ===========         ===========         ===========

Liabilities
   Subordinated Debt ...................................................          $5,155,000         $         -         $         -
                                                                                 -----------         -----------         -----------

Stockholders' equity ...................................................          26,843,857          16,409,128          14,349,731
                                                                                 -----------         -----------         -----------

             Total Liabilities and Stockholders Equity .................         $31,998,857         $16,409,128         $14,349,731
                                                                                 ===========         ===========         ===========
</TABLE>


Statements of operations
<TABLE>
<CAPTION>
                                                                                               For the years ended
                                                                                               -------------------
                                                                                  2004                 2003                   2002
                                                                                  ----                 ----                   ----

<S>                                                                           <C>                   <C>                  <C>
   Operating income ................................................          $   201,211           $         -          $         -
Expense
   Other expense ...................................................              219,544                     -                    -
                                                                              -----------           -----------          -----------
Loss before equity in undistributed net income
   of First South Bank .............................................              (18,333)                    -                    -
Equity in undistributed net income of First
   South Bank ......................................................            3,018,388             2,104,267            1,418,764
                                                                              -----------           -----------          -----------

         Net income ................................................          $ 3,000,055           $ 2,104,267          $ 1,418,764
                                                                              ===========           ===========          ===========
</TABLE>








                                                                     (Continued)




                                       46
<PAGE>


NOTE 17 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY, Continued


Statements of cash flows

<TABLE>
<CAPTION>
                                                                                             For the years ended
                                                                                             -------------------
                                                                                2004                   2003                  2002
                                                                                ----                   ----                  ----
Operating activities
<S>                                                                         <C>                   <C>                   <C>
  Net income .....................................................          $ 3,000,055           $ 2,104,267           $ 1,418,764
  Equity in undistributed income of
    First South Bank .............................................           (3,018,388)           (2,104,267)           (1,418,764)
  Net change in other assets .....................................              (81,668)                    -                     -
                                                                            -----------           -----------           -----------
      Net cash used in operating activities ......................             (100,001)                    -                     -
                                                                            -----------           -----------           -----------
Investing activities
  Investment in Trust ............................................             (155,000)                    -                     -
  Advances  to subsidiaries ......................................           (4,900,000)                    -                     -
                                                                            -----------           -----------           -----------
      Net cash used in investing activities ......................           (5,055,000)                    -                     -
                                                                            -----------           -----------           -----------

Financing activities
   Contributed capital to bank subsidiary ........................           (7,000,000)                    -                     -
   Proceeds from stock option exercise ...........................                3,300                 7,500                48,000
   Proceeds from issuance of subordinated debt ...................            5,155,000                     -                     -
   Proceeds from issuance of common stock ........................            7,482,067                     -                     -
                                                                            -----------           -----------           -----------
      Net cash provided by financing activities ..................            5,640,367                 7,500                48,000
                                                                            -----------           -----------           -----------

      Net increase in cash and cash equivalents ..................              485,366                 7,500                48,000

Cash and cash equivalents, beginning of year .....................               55,500                48,000                     -
                                                                            -----------           -----------           -----------

Cash and cash equivalents, end of year ...........................          $   540,866           $    55,500           $    48,000
                                                                            ===========           ===========           ===========
</TABLE>

                                       47
<PAGE>


NOTE 18 - NONCASH TRANSACTIONS

The Company  foreclosed  on assets  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.

Item 8.  Changes  In  and  Disagreements  With  Accountants  on  Accounting  and
         Financial Disclosure.

         Not Applicable

Item 8A. 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 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 8B. Other Information

         No information was required to be disclosed by the Registrant in a Form
8-K during the fourth quarter of 2004 that was not so disclosed.


                                    PART III

Item 9. 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" and "Section
16(a)  Beneficial  Ownership  Reporting  Compliance" in registrant's  definitive
proxy  statement  filed  with the  Commission  for the 2005  Annual  Meeting  of
Shareholders (the "2005 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
401(e) of Regulation S-B 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 10. Executive Compensation.

         The information set forth under the caption "Management  Compensation,"
in the 2005 Proxy Statement is incorporated herein by reference.



                                       48
<PAGE>


Item 11.  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 2005  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

<S>                                             <C>                       <C>                      <C>
Equity compensation plans
approved by security holders                    185,478                   $13.67                   33,822

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

Total                                           185,478                   $13.67                   33,822
</TABLE>



Item 12. Certain Relationships and Related Transactions.

         The information set forth under the caption "Certain  Relationships and
Related  Transactions"  in the 2005 Proxy  Statement is  incorporated  herein by
reference.



                                       49
<PAGE>



Item 13. Exhibits

(a) 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)
21             Subsidiaries of Registrant (3)
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.

Item 14.   Principal Accountant Fees and Services

           The  information  set forth  under the  caption  "Independent  Public
Accountants-Fees Paid to Independent Auditors" and "Audit Committee Pre-Approval
of Audit and Permissible Non-Audit Services of Independent Auditors" in the 2005
Proxy Statement is incorporated herein by reference.

                                       50
<PAGE>

                                   SIGNATURES

         In  accordance  with  Section  13 or 15(d)  of the  Exchange  Act,  the
registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereunto duly authorized.

                                   First South Bancorp, Inc.

March 24, 2005                     By: s/Barry L. Slider
                                      ------------------------------------------
                                         Barry L. Slider
                                         President and Chief Executive Officer


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

         In accordance  with the Exchange Act, 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 24, 2005
Richard H. Brooks

s/ Harold E. Fleming, M.D.
-------------------------               Director                                           March 24, 2005
Harold E. Fleming, M.D.


--------------------------               Director                                           March 24, 2005
Joel C. Griffin

s/ Roger A. F. Habisreutinger
--------------------------               Chairman, Director                                 March 24, 2005
Roger A. F. Habisreutinger


--------------------------               Director                                           March 24, 2005
Ashley F. Houser

s/ Herman E. Ratchford
--------------------------               Director                                           March 24, 2005
Herman E. Ratchford


--------------------------               Director                                           March 24, 2005
Chandrakant V. Shanbhag

s/ Barry L. Slider
--------------------------               President, Chief Executive Officer, Director       March 24, 2005
Barry L. Slider

s/ David G. White
--------------------------               Director                                           March 24, 2005
David G. White
</TABLE>



                                       51
<PAGE>


                                  Exhibit Index


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)
21             Subsidiaries of Registrant (3)
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.


                                       52