2002 Annual Report


-----------------------------------
100 YEARS  1902-2002
-----------------------------------


          First South Bancorp
          -------------------

<PAGE>

                                TABLE OF CONTENTS

Letter to Stockholders                                                         1

Stockholder Information                                                        3

Selected Consolidated Financial Information and Other Data                     4

Management's Discussion and Analysis of Financial Condition
   and Results of Operations                                                   5

Report of Independent Accountants                                             20

Consolidated Statements of Financial Condition                                21

Consolidated Statements of Operations                                         22

Consolidated Statements of Stockholders' Equity                               23

Consolidated Statements of Cash Flows                                         24

Notes to Consolidated Financial Statements                                    25

Board of Directors                                                            49

Executive Officers                                                            49

Area Executives                                                               49

First South Bank Office Locations                                             50

First South Bank ATM Locations                                                50

First South Bank Products and Services                                        51

                                MISSION STATEMENT

     "Our  mission  is to become the  premier  community  bank in eastern  North
     Carolina.  We will  enhance  shareholder  value by serving the personal and
     business  needs  of  our  markets,  providing  superior  customer  service,
     investing in the communities  that we serve, and enriching the lives of our
     employees."

<PAGE>

                             LETTER TO STOCKHOLDERS

To Our Stockholders:

I am pleased to report that First South Bancorp achieved the greatest  financial
performance in the history of our company during 2002.  These results  represent
the  completion  of 100 years of  operation  for First South  Bank,  our primary
subsidiary  that opened for business on September  19, 1902.  Since 1902 and the
subsequent formation of First South Bancorp in 1997, we have grown to become the
15th largest  commercial  bank holding company in North Carolina with 22 offices
providing financial services in more than 43 of North Carolina's 100 counties.

It is with a great  deal of  pleasure  that I report  the  total  return  to our
stockholders  increased dramatically in 2002. The market price of our stock grew
to $35.58 at December 31, 2002 from $22.25 split  adjusted at December 31, 2001,
and combined with increased cash dividends resulted in a total return of 63.0%.

For the year ended  2002,  we  reported  record  earnings  of $9.5  million,  an
increase of 184.2% over the $3.4  million,  net of a one-time  ESOP  termination
expense,  reported for 2001.  Diluted  earnings per share increased to $2.06 for
2002,  compared to $.75 for 2001,  an increase of 174.7%.  Our return on average
assets and return on average equity improved to 1.61% and 18.39%,  respectively,
for year end 2002, from .61% and 6.85% respectively for year end 2001.

During the year,  the Board of Directors  increased  the annual cash dividend to
$.68 per share from $.48 per share in 2001,  an increase of 41.7%.  As a result,
in 2002  we paid  out  $2.9  million  in  cash  dividends  to our  shareholders,
representing 31.0% of net income for the year.

The assets of the company grew by $79.2 million or 14.4% to $628.5 million, from
$549.3 million at year end 2001. In addition, total loans and leases were $490.9
million.  Total deposits were $526.3  million,  with  transaction  and statement
savings representing 41.5% of that amount at year end. While internal growth was
strong and the Bank successfully opened new banking and loan production offices,
the Bank's  efficiency  ratio was 49.8% for year end 2002. This is a significant
achievement.   The  ability  to  grow  the  Bank  while  sustaining  solid  core
performance  underscores the importance of planning,  our ability to execute our
plans and the strength of our people.

During 2002, we increased  noninterest income by 19.2% to $8.5 million from $7.1
million in 2001. This income  component,  which  represented  18.7% of our total
revenue in 2002 compared to 15.0% in 2001, is a major area of focus. Our goal is
to increase  noninterest  income to 20% of total  revenue over the coming years.
Mortgage  lending  will play a major role in meeting  our goal along with income
from our partnership with UVEST, a financial services company. In addition,  the
Bank will explore delivering insurance products to our customers.

The Bank has begun to move into new arenas. We have opened a new loan production
office in Raleigh,  NC and will follow with a full service  branch in 2003.  The
Bank was added to the Russell 2000 (R) Index,  helping raise our visibility with
the investment community. Our leasing subsidiary, First South Leasing, continues
to grow and  complement  the  company.  Our goal is to  continue  to improve the
results we have  achieved and we are committed to improving  shareholder  value.
Our future will depend on our  ability to stay  focused on customer  service and
delivering quality products.

                                        1
<PAGE>

We will invest in the  continuing  education and training of our staff to ensure
they are capable and qualified.

The past year resulted in the  culmination of 100 years of service to the people
of North  Carolina.  It is  important  to reflect on that  history  and what the
incorporators  and  employees  of the Bank  have  achieved.  It all  started  on
September  19, 1902 when the Home Building & Loan  Association  was organized in
Washington,  North Carolina, with the following  incorporators:  William Bragaw,
A.M. Dumay, W.B. Walling,  H.B. Mayo, George T. Leach,  Stephen C. Bragaw,  R.A.
Zoeller,  W.B. Morton,  B.G. Moss, W.E. Swindell,  Charles F. McWhoter,  John G.
Bragaw,  Jr., C.H. Sterling,  E.K. Willis, E.M. Brown, E.B. Moore, J.F. Buckman,
A. Mayo, C.F. Bland, Frank C. Kugler, Thomas P. Howard, M.M. Jones, R.T. Hodges,
J. Havens and E.R. Mixon.

For many years,  the Home Building & Loan Association was located in the offices
of Guaranty Bank & Trust  Company at the corner of Market and Main  Streets.  In
January 1946,  Harvey C. Elliott,  a native of Washington,  North Carolina,  was
employed as full-time  Secretary-Treasurer,  succeeding H.S.  Gurganus,  who had
been serving in a part-time capacity. The assets of the Association at that time
were $305,000. By 1956, assets of the Association had reached $1.0 million.

In January of 1960, the name of the Association was changed from Home Building &
Loan Association to Home Savings & Loan Association to more adequately designate
the primary functions of this type of financial  institution - that of promoting
thrift and encouraging homeownership. In 1979 the Association gained approval to
open its first  branch  office in Elizabeth  City,  North  Carolina.  Since that
initial branch the Bank now has 22 offices.

The decision to convert to a public company, form a holding company and become a
state chartered  commercial bank was realized in 1997. The Bank had a successful
public offering raising $43.6 million.

First South Bank is now 100 years old and I believe the  incorporators  would be
proud of what has been accomplished. The Bank has faithfully served the citizens
of Eastern North  Carolina and looks  forward to the future.  There will be many
challenges and opportunities as we travel down the next 100 years.

Each member of your Board of Directors  along with our  officers  and  employees
join me in thanking you for  supporting  First South  Bancorp.  As always,  your
comments or  suggestions  are  welcomed  and we look  forward to your  continued
support.

                                        Sincerely,


                                        Tom Vann
                                        President and
                                        Chief Executive Officer

                                        2
<PAGE>

                             STOCKHOLDER INFORMATION

CORPORATE HEADQUARTERS
     First South Bancorp, Inc.                  Telephone:  252-946-4178
     1311 Carolina Avenue                             Fax:  252-946-3873
     Washington, NC  27889                         E-mail: info@firstsouthnc.com
                                                  Website:  www.firstsouthnc.com

STOCK LISTING INFORMATION
The Company's common stock is listed and trades on the Nasdaq Stock Market under
the symbol FSBK.

STOCK PRICE INFORMATION
The  following  is the high and low  trading  price  information  and  dividends
declared per share for the periods indicated.

     Quarter Ended                       High           Low         Dividends
     -------------                       ----           ---         ---------
     March 31, 2001          (1)        $16.67        $15.37          $.12
     June 30, 2001           (1)         18.33         16.46           .12
     September 30, 2001      (1)         24.17         17.67           .12
     December 31, 2001       (1)         25.27         21.10           .12

     March 31, 2002          (1)         26.00         22.33           .17
     June 30, 2002                       40.00         25.60           .17
     September 30, 2002                  37.97         34.25           .17
     December 31, 2002                   36.51         33.35           .17
     ----------------
     (1)  Adjusted for three-for-two stock split on April 19, 2002.

REGISTRAR AND TRANSFER AGENT
Inquiries regarding stock transfer,  registration,  lost certificates or changes
in name and address  should be directed to the  Company's  stock  registrar  and
transfer agent: Registrar and Transfer Company, 10 Commerce Drive, Cranford, New
Jersey 07016; via the Internet at www.rtco.com; or toll-free at (800) 866-1340.

FORM 10-K
The Annual Report on Form 10-K of the Company as filed with the  Securities  and
Exchange  Commission is available  via the Internet on the Company's  website at
www.firstsouthnc.com  under the heading "Financial  Reports-EDGAR  Online here".
Shareholders  will be provided a copy without charge by writing to the Corporate
Secretary,  William  L.  Wall,  First  South  Bancorp,  Inc.,  P. O.  Box  2047,
Washington, NC 27889.

INVESTOR INFORMATION
Shareholders,  investors,  and analysts interested in additional information may
contact William L. Wall, Chief Financial Officer,  First South Bancorp, Inc., P.
O. Box 2047, Washington, NC 27889; or via email to bwall@firstsouthnc.com.

ANNUAL MEETING
The Annual Meeting of  Stockholders  of First South  Bancorp,  Inc. will be held
Thursday,  May 15, 2003 at 11:00  a.m.,  at the main office of First South Bank,
1311 Carolina Avenue, Washington, North Carolina.

GENERAL COUNSEL           SPECIAL COUNSEL          INDEPENDENT ACCOUNTANTS
Rodman, Holscher,         Stradley Ronon           PricewaterhouseCoopers LLP
 Francisco & Peck, P.A.    Stevens & Young, LLP    Suite 2300
320 North Market Street   Suite 600                150 Fayetteville Street Mall
Washington, NC  27889     1220 19th Street, N.W.   Raleigh, NC  27601
                          Washington, DC 20036

                                        3
<PAGE>

SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

<TABLE>
<CAPTION>
                                                                     At or For the Year Ended December 31, 2002,
                                                                      Three Months Ended December 31, 2002, and
                                                                 Years Ended September 30, 2001, 2000, 1999 and 1998
                                                      --------------------------------------------------------------------------
                                                      12/31/02     12/31/01      9/30/01      9/30/00      9/30/99      9/30/98
                                                      --------     --------      --------     --------     --------     --------
                                                                    (dollars in thousands, except per share data)
Selected Financial Condition Data
---------------------------------
<S>                                                   <C>          <C>           <C>          <C>          <C>          <C>
Total assets                                          $628,473     $549,318      $541,195     $559,719     $292,305     $281,479
Loans receivable, net                                  490,914      405,613       374,087      366,210      212,054      224,999
Cash and investment securities                          90,259       75,745        95,191       59,927       12,435       20,119
Mortgage-backed securities                              23,526       43,904        48,603      108,519       56,326       27,017
Deposits                                               526,327      475,589       471,939      471,942      234,618      204,635
Borrowings                                              38,195        5,441         4,909       30,388        1,318       11,933
Stockholders' equity                                    50,100       51,031        50,769       44,835       48,763       56,714

Selected Operations Data
------------------------
Interest income                                       $ 36,826     $  9,467      $ 42,159     $ 36,865     $ 23,129     $ 21,867
Interest expense                                        12,473        4,092        22,168       19,013        9,979        9,240
                                                      --------     --------      --------     --------     --------     --------
Net interest income                                     24,353        5,375        19,991       17,852       13,150       12,627
Provision for loan losses                                1,756            0           830          977          120          310
Noninterest income                                       8,462        1,625         6,776        3,432        2,874        2,646
Noninterest expenses                                    16,337        3,832        16,047       14,100       10,255        9,940
ESOP Termination                                             0        3,143             0            0            0            0
                                                      --------     --------      --------     --------     --------     --------
Income before income taxes                              14,722           25         9,890        6,207        5,649        5,023
Income taxes                                             5,210        1,165         4,060        2,658        2,453        1,900
                                                      --------     --------      --------     --------     --------     --------
Net income                                            $  9,512     $ (1,140)     $  5,830     $  3,549     $  3,196     $  3,123
                                                      ========     ========      ========     ========     ========     ========
Earnings per share - basic                  (1)       $   2.18     $  (0.26)     $   1.34     $   0.76     $   0.60     $   0.54
Earnings per share - diluted                (1)           2.06        (0.26)         1.30         0.76         0.60         0.54
Dividends per share                         (1)           0.68         0.12          0.45         0.31         0.21         0.18

Selected Financial Ratios and Other Data
----------------------------------------
Performance Ratios:
Return on average assets                    (2)           1.64%        1.46%         1.06%        0.76%        1.09%        1.19
Return on average equity                    (2)          18.39        15.70         12.31         7.71         6.03         5.40
Interest rate spread                                      4.43         4.05          3.67         3.73         3.95         4.03
Net interest margin                                       4.54         4.24          3.90         4.05         4.69         5.05
Average earning assets/average
  interest bearing liabilities                          116.03       116.27        114.06       115.51       131.01       127.57
Noninterest expense/average assets          (3)           2.81         2.80          2.92         3.03         3.50         3.80
Efficiency ratio                            (3)          49.79        54.74         59.95        66.25        63.99        65.08
Dividend payout ratio                       (2)          31.19        25.71         33.33        40.35        34.07        33.75

Quality Ratios:
Nonperforming assets/total assets                         0.30%        0.35%         0.29%        0.33%        0.40%        0.43
Nonperforming loans/total loans                           0.30         0.31          0.28         0.45         0.27         0.36
Loan loss reserves/total loans                            1.40         1.31          1.42         1.39         1.53         1.50
Provision for loan losses/total loans                     0.36         0.00          0.22         0.27         0.06         0.14

Capital Ratios and Other Data:
Equity/total assets, end of period                        8.00%        9.29%         9.38%        8.02%       16.69%       19.95
Average equity/average assets                             8.90         9.33          8.62         9.89        18.09        22.14
Full service offices                                        21           20            19           17            9            8
Loans serviced for others                             $261,823     $274,240      $295,216     $300,006     $275,255     $250,202
</TABLE>

--------------
(1)  Adjusted  for  three-for-two  stock splits on April 19, 2002 and August 19,
     1998.
(2)  Based on net income of  $2,003,494  earned before the  $3,143,467  one-time
     ESOP termination charge in 12/31/01 period.
(3)  Excludes  the  $3,143,476  one-time  ESOP  termination  charge in  12/31/01
     period.

                                        4
<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL. First South Bancorp, Inc. (the "Company") was formed for the purpose of
issuing common stock, owning 100% of First South Bank (the "Bank") and operating
through the Bank a commercial  banking  business.  The Company has engaged in no
activities   other  than  owning  the  Bank,   therefore,   this  discussion  of
consolidated  financial  condition and results of operations relates principally
to the  Bank.  The  business  of the Bank  consists  principally  of  attracting
deposits  from the  general  public  and using  them to  originate  secured  and
unsecured  commercial and consumer loans,  permanent  mortgage and  construction
loans secured by  single-family  residences and other loans. The Bank's earnings
depend  primarily on its net interest  income,  the difference  between interest
earned  on  interest  earning  assets  and  interest  paid  on  interest-bearing
liabilities.  The level of  noninterest  income and  expenses  also  affects the
Bank's earnings.

Prevailing economic conditions, as well as federal and state regulations, affect
the  operations of the Bank.  The Bank's cost of funds is influenced by interest
rates  paid on  competing  investments,  rates  offered  on  deposits  by  other
financial  institutions in the Bank's market area and by general market interest
rates.  Lending  activities  are  affected by the demand for  financing  of real
estate and various types of commercial and consumer loans, and by interest rates
at which such financing may be offered.

The Bank's business emphasis is to operate as a well-capitalized, profitable and
independent  community  oriented  financial  institution  dedicated to providing
quality  customer  service and meeting the financial needs of the communities it
serves.  Management  believes  the Bank can be more  effective  in  serving  its
customers than many larger competitors because of its ability to respond quickly
and  effectively to customer needs and inquiries.  The Bank's ability to provide
these  services is enhanced by the  stability  of the Bank's  senior  management
team.

The Company's common stock is listed and trades on the Nasdaq Stock Market under
the symbol  FSBK.  Effective  as of July 1, 2002,  the  Company was added to the
Russell  2000  (R)  Index,  helping  raise  the  Company's  visibility  with the
investment community.

CHANGE IN FISCAL YEAR END.  On January 4, 2002,  the Board of  Directors  of the
Company (the "Board")  approved a change in the  Company's  fiscal year end from
September 30 to December 31, effective December 31, 2001. Adopting a December 31
fiscal year end eliminated the duplication of work the Company previously did to
convert  information from a fiscal year to a calendar year and will simplify the
Company's  internal and external  communications.  It also brought the Company's
fiscal year end in  conformity  with the fiscal year end used by the majority of
banks in North Carolina and  throughout the United States.  The Bylaws have been
amended to reflect this change in fiscal year.

BASIS OF  PRESENTATION.  Based on the  change in the  Company's  fiscal  year to
December 31, the Management's Discussion and Analysis of Financial Condition and
Results of Operations will:

     o    Compare  the  Financial  Condition  as of  December  31,  2002  to the
          Financial  Condition  as of  December  31,  2001;  and the  Results of
          Operations  for the year ended  December  31,  2002 to the  Results of
          Operations for the year ended December 31, 2001 (unaudited);
     o    Compare  the  Financial  Condition  as of  December  31,  2001  to the
          Financial  Condition  as of  December  31, 2000  (unaudited);  and the
          Results of Operations  for the three months ended December 31, 2001 to
          the Results of Operations for the three months ended December 31, 2000
          (unaudited);
     o    Compare the Financial Condition and Results of Operations for the year
          ended  September  30, 2001 to the  Financial  Condition and Results of
          Operations for the year ended September 30, 2000; and
     o    Discuss the Company's liquidity and capital resources, asset/liability
          management, market risk, rate/volume analysis, and yield/cost analysis
          as of December 31, 2002, and where applicable, compare the years ended
          December 31, 2002 and 2001;  the three months ended  December 31, 2001
          and 2000; and the years ended September 30, 2001 and 2000.

STOCK SPLIT. On April 19, 2002 the Company paid a three-for-two  stock split, in
the form of a 50% stock dividend, to stockholders of record as of April 8, 2002.
Stockholders  received one additional share of common stock for every two shares
held on the record  date.  All prior  period  share and per share data have been
adjusted for the split.

                                        5
<PAGE>

SIGNIFICANT  ACTIVITIES  AND EVENTS.  Effective  as of December  31,  2001,  the
Company  terminated  its Employee  Stock  Ownership Plan ("ESOP") and incurred a
one-time  non-tax  deductible  charge  of  $3.1  million  related  to  the  ESOP
termination.  As a result of the ESOP termination,  the Company reduced its ESOP
expense to none for the year ended  December  31, 2002 from $4.2 million for the
year ended  December 31,  2001.  During the year ended  December  31, 2001,  the
Company  incurred  $1.1  million of ESOP  expense in  addition  to the  one-time
termination  charge.  For future  periods the Company will not incur any further
charges related to the ESOP. The Company  believes the benefits of the ESOP were
not sufficient to justify the ongoing annual expense incurred to maintain it and
the cost savings  achieved in future  periods will more than  compensate for the
one-time charge incurred to terminate it.

The Company  recorded net income of $9.5 million for the year ended December 31,
2002,  compared to $3.3 million for the year ended  December  31, 2001.  Diluted
earnings per share were $2.06 for the year ended December 31, 2002,  compared to
$.75 for the year ended  December  31,  2001.  Had the Company not  incurred the
one-time ESOP  termination  expense,  net income for the year ended December 31,
2001 would have been $6.5 million.

The Company  recorded a net loss for the three months ended December 31, 2001 of
$1.1 million, compared to net income of $1.3 for the three months ended December
31,  2000.  Diluted  earnings  per share were $(.26) for the three  months ended
December 31, 2001 compared to $.30 for the three months ended December 31, 2000.
Had the Company not incurred the one-time ESOP termination  expense,  net income
for the three months ended December 31, 2001 would have been $2.0 million.

On November 30, 1999, the Company  consummated  the  acquisition of Green Street
Financial  Corp ("Green  Street"),  the parent  holding  company of Home Federal
Savings and Loan Association of Fayetteville,  North Carolina, with full service
offices located in Fayetteville and Lumberton,  North Carolina.  The acquisition
was  accounted for using the purchase  method of accounting  for a cash purchase
price of $59.2  million,  representing  $15.25 per share of Green Street  common
stock. Summary financial  information related to Green Street acquisition was as
follows (unaudited): loans receivable - $125.4 million; premises and equipment -
$1.2 million; deposits - $101.6 million; and goodwill - $288,000.

On February  18, 2000,  the Bank  completed  the  purchase of six Triangle  Bank
("Triangle") branch offices located in Rocky Mount and Tarboro,  North Carolina.
This  acquisition  was accounted for using the purchase method of accounting and
the Bank assumed the deposits of the six Triangle  branch  offices for a premium
of approximately  4.0% of the assumed deposits.  Summary  financial  information
related to the Triangle  branches  purchase was as follows  (unaudited):  cash -
$113.8 million; loans receivable - $26.2 million;  premises and equipment - $2.4
million;  deposits  -  $144.1  million;  and  unidentifiable  intangible  - $4.9
million;

Concurrent with the Green Street acquisition, the Bank changed its name to First
South Bank. These acquisitions enabled the Company to leverage its capital base,
represent a significant  growth in the Bank's branch  office  network,  and have
benefited the Company's earnings.

LIQUIDITY AND CAPITAL RESOURCES.  As a state chartered commercial bank, the Bank
must meet liquidity requirements established by the North Carolina Office of the
Commissioner  of Banks (the  "Commissioner").  Savings  banks,  which convert to
commercial  banks,  are  required  to  maintain  15%  liquidity  pursuant to the
conversion  guidelines  adopted by the Commissioner.  The Bank's liquidity ratio
under these  guidelines was 18.6% at December 31, 2002 and 19.5% at December 31,
2001.

The  Bank's  primary  sources  of funds are  deposits,  principal  and  interest
payments on loans,  proceeds from loan and securities  sales,  and advances from
the  Federal  Home Loan Bank of  Atlanta  (the  "FHLB").  While  maturities  and
scheduled  amortization of loans are predictable sources of funds, deposit flows
and mortgage  prepayments are influenced by interest rates,  economic conditions
and local competition.  The Bank's primary investing activity is the origination
of  commercial,  consumer  and  mortgage  loans.  During  fiscal  2002 and 2001,
originations of loans held for sale and investment, net of principal repayments,
were  $176.5  million  and  $83.4  million,  respectively.  The  Bank's  primary
financing  activities  are the attraction of checking,  certificate  and savings
deposits, and obtaining FHLB advances.

The levels of cash and cash  equivalents  is dependent on the Bank's  operating,
financing, lending and investing activities during any given period. At December
31, 2002 and 2001,  cash and cash  equivalents  totaled  $34.5 million and $21.7
million,  respectively.  The Bank has other  sources of  liquidity if a need for
additional funds arises. During the years ended

                                        6
<PAGE>

December  31, 2002 and 2001,  real estate loans sold or  securitized  were $87.2
million and $52.6 million each.

Borrowings  consisting of FHLB advances and retail  repurchase  agreements  were
$38.2  million at December  31, 2002  compared to $5.4  million at December  31,
2001.  Other  sources  of  liquidity  include  investment  and   mortgage-backed
securities  designated  as available  for sale,  which  totaled $79.3 million at
December 31, 2002 and $98.0 million at December 31, 2001.

At December 31, 2002, stockholders' equity was $50.1 million,  compared to $51.0
million at  December  31,  2001.  Net income for fiscal  2002 was $9.5  million,
compared  to $3.3  million  for fiscal  2001.  At  December  31, 2002 there were
4,203,912 shares of common stock outstanding, net of 2,341,936 treasury shares.

As a North Carolina  chartered  commercial bank and a Federal Deposit  Insurance
Corporation  (the  "FDIC")  insured  institution,  the Bank is  required to meet
various state and federal regulatory  capital standards.  The Bank's stand-alone
equity was $50.0  million at December  31,  2002,  compared to $46.7  million at
December  31,  2001.  The  Commissioner  requires the Bank to maintain a capital
surplus of not less than 50% of common capital stock. The FDIC requires the Bank
to meet a minimum leverage capital  requirement of Tier I capital (consisting of
retained earnings and common  stockholders'  equity, less any intangible assets)
to assets  ratio of at least 4%,  and a total  capital to  risk-weighted  assets
ratio of 8%, of which 4% must be in the form of Tier I capital.  The Bank was in
compliance  with all regulatory  capital  requirements  at December 31, 2002 and
2001.

OFF-BALANCE  SHEET  ARRANGEMENTS.  The Bank is a party to financial  instruments
with  off-balance  sheet  risk in the  normal  course  of  business  To meet the
financing  needs  of  its  customers.   These  financial   instruments   include
commitments  to extend  credit and involve  elements of credit and interest rate
risk in excess  of the  amount  recognized  on the  balance  sheet.  The  Bank's
exposure  to credit  loss in the event of  non-performance  by the  customer  is
represented by the contractual  amount of those  commitments.  The Bank uses the
same credit policies in making  commitments  and  conditional  obligations as it
does for on-balance sheet instruments.

Commitments  to extend  credit are  agreements  to lend to a customer as long as
there is no violation of any condition established in the contract.  Commitments
generally  have fixed  expiration  dates or other  termination  clauses  and may
require payment of a fee. The Bank evaluates each customer's creditworthiness on
a case-by-case basis. The amount of collateral obtained,  if deemed necessary by
the Bank upon extension of credit, is based on management's credit evaluation of
the borrower.  A summary of the  contractual  amounts of the Bank's  exposure to
off-balance sheet risk as of December 31, 2002 and 2001 is as follows:

<TABLE>
<CAPTION>
                                                             December 31, 2002   December 31, 2001
                                                             -----------------   -----------------
                                                                     (Dollars in thousands)
<S>                                                             <C>                 <C>
Commitments to extend credit:
Commitments to originate loans                                  $     76,657        $     50,204
Undrawn balances on lines of credit and undrawn
  Balances on credit reserves (overdraft protection)                  48,483              48,627
                                                                ------------        ------------
     Total commitments to extend credit                         $    124,140        $     98,831
                                                                ------------        ------------
</TABLE>

Included in the  commitments to originate loans as of December 31, 2002 and 2001
are fixed  interest  rate loan  commitments  of $8.3 million and $11.7  million,
respectively.  The shorter duration of  interest-sensitive  liabilities,  to the
extent  they are used to fund  these  fixed-rate  loans,  indicates  the Bank is
exposed to interest rates because in a rising rate environment  liabilities will
be repricing  faster and at higher interest rates,  thereby  reducing the market
value of fixed-rate  long-term assets and net interest income. Since many of the
commitments  are  expected to expire  without  being drawn upon,  amounts do not
necessarily represent future cash requirements.

ASSET/LIABILITY MANAGEMENT. The Bank strives to maintain consistent net interest
income and reduce its exposure to adverse  changes in interest rates by matching
the terms to repricing of its interest-sensitive assets and liabilities. Factors
beyond the Bank's control,  such as market interest rates and  competition,  may
also impact interest income and interest expense. The Bank's net interest income
will  generally  increase  when interest  rates rise over an extended  period of
time, and  conversely,  will decrease when interest rates decline.  The Bank can
significantly influence its net interest income by controlling the increases and
decreases  in its  interest  income and  interest  expense,  which are caused by
changes in market interest rates.  See Table 1 below for additional  information
on the effects of net interest income caused by changes in interest rates.

                                        7
<PAGE>

The President of the Bank reports  interest rate risk and trends,  liquidity and
capital ratio  requirements  to the Board on a regular basis.  The Board reviews
the maturities of the Bank's assets and liabilities and establishes policies and
strategies designed to regulate the flow of funds and to coordinate the sources,
uses and pricing of such funds.  The first priority in  structuring  and pricing
assets and  liabilities is to maintain an acceptable  interest rate spread while
reducing the net effects of changes in interest rates. The Bank's  management is
responsible for administering the policies and  determinations of the Board with
respect to the Bank's asset and liability goals and strategies.

A  principal  strategy  in managing  the Bank's  interest  rate risk has been to
increase  interest  sensitive  assets such as commercial and consumer  loans. At
December 31, 2002,  the Bank had $295.0  million of  commercial  loans and $81.9
million  of  consumer  loans,  compared  to $200.6  million  and $77.8  million,
respectively, at December 31, 2001. The Bank had $38.7 million of loans held for
sale at December  31,  2002,  compared to $29.3  million at December  31,  2001.
Depending on conditions  existing at a given time, the Bank may sell  fixed-rate
residential mortgage loans in the secondary market. In managing its portfolio of
investment securities, all investment securities are held as available for sale,
allowing  the Bank to sell a security  in a timely  manner  should an  immediate
liquidity   need  arise.   The  Bank  had  $79.3  million  of   investment   and
mortgage-backed  securities  classified  as  available  for sale at December 31,
2002, compared to $98.0 million at December 31, 2001.

MARKET RISK.  Market risk  reflects  the risk of economic  loss  resulting  from
changes in market prices and interest  rates.  The risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods. Market risk arises primarily from interest rate risk inherent
in lending and deposit taking  activities.  The Bank does not maintain a trading
account for any class of  financial  instruments,  nor does it engage in hedging
activities or purchase high-risk derivative instruments.  Furthermore,  the Bank
is not subject to foreign currency exchange risk or commodity price risk.

The Bank  measures  interest  rate risk by  computing  estimated  changes in net
interest  income  and the net  portfolio  value  ("NPV")  of its cash flows from
assets,  liabilities  and  off-balance  sheet  items in the  event of a range of
assumed changes in market interest rates.  The Bank's exposure to interest rates
is  reviewed  on a  quarterly  basis by  management  and the Board.  Exposure to
interest  rate  risk is  measured  with  the use of  interest  rate  sensitivity
analysis to determine the change in NPV in the event of hypothetical  changes in
interest  rates,  while  interest  rate  sensitivity  gap  analysis  is  used to
determine the repricing characteristics of assets and liabilities.  If estimated
changes to NPV and net interest income are not within the limits  established by
the Board,  the Board may  direct  management  to adjust  the  Bank's  asset and
liability mix to bring interest rate risk within Board approved limits.

NPV represents  the market value of portfolio  equity and is equal to the market
value of assets minus the market value of liabilities, with adjustments made for
off-balance  sheet items.  This  analysis  assesses the  potential  loss in risk
sensitive  instruments  in the event of sudden and  sustained 1% to 3% increases
and decreases in market interest  rates.  The Board has adopted an interest rate
risk policy that  establishes  maximum  increases in NPV of 17%, 36% and 56% and
decreases in NPV of 15%, 36% and 61% in the event of sudden and  sustained 1% to
3% increases or decreases in market interest  rates.  Table 1 below presents the
Bank's  projected  changes in NPV and net interest income in the event of sudden
and sustained  increases or decreases in market  interest  rates for the various
rate shock  levels at December  31,  2002.  At  December  31,  2002,  the Bank's
estimated  changes  in NPV and net  interest  income  were  within  the  targets
established by the Board.

TABLE 1 - PROJECTED CHANGE IN NPV AND NET INTEREST INCOME

<TABLE>
<CAPTION>
 Change                  Net Portfolio Value                        Net Interest Income
                         -------------------                        -------------------
in Rates         $ Amount     $ Change      % Change        $ Amount     $ Change      % Change
--------         --------     --------      --------        --------     --------      --------
                                             (Dollars in thousands)

<S>        <C>    <C>         <C>            <C>             <C>         <C>             <C>
+ 300      bp     $76,284     $(2,834)       (3.6)%          $28,406     $ 2,383         9.2%
+ 200      bp      78,048      (1,070)       (1.4)            27,906       1,883         7.2
+ 100      bp      79,215          97          .1             27,033       1,010         3.9
Base               79,118          --          --             26,023          --          --
- 100      bp      78,423        (695)        (.9)            24,731      (1,292)       (5.0)
- 200      bp      78,168        (950)       (1.2)            22,661      (3,362)      (12.9)
- 300      bp      80,243       1,125         1.4             21,385      (4,368)      (17.8)
</TABLE>

                                        8
<PAGE>

Computations of prospective  effects of  hypothetical  interest rate changes are
based on numerous  assumptions,  including  relative  levels of market  interest
rates,  loan  prepayments and deposit decay rates, and should not be relied upon
as indicative of actual results.  Further,  the  computations do not contemplate
any actions the Bank may undertake in response to changes in interest rates. The
NPV  calculation  is based on the net  present  value of  discounted  cash flows
utilizing market prepayment assumptions.

Certain  shortcomings are inherent in the method of analysis  presented in Table
1. For  example,  although  certain  assets  and  liabilities  may have  similar
maturities  to  repricing,  they may react in  differing  degrees  to changes in
market  interest  rates.  The  interest  rates on  certain  types of assets  and
liabilities may fluctuate in advance of changes in market interest rates,  while
interest  rates on other types may lag behind  changes in market rates.  Certain
assets,  such as  adjustable-rate  loans, have features that restrict changes in
interest  rates  on a  short-term  basis  and over  the  life of the  asset.  In
addition,  the proportion of adjustable-rate loans in the Bank's portfolio could
decrease in future periods if market  interest rates remain at or decrease below
current levels due to refinance  activity.  Further, in the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate from
those assumed in the table.  Also,  the ability of many borrowers to repay their
adjustable-rate debt may decrease in the event of an increase in interest rates.

In  addition,  the Bank uses  interest  sensitivity  gap analysis to monitor the
relationship between the maturity and repricing of its  interest-earning  assets
and interest-bearing liabilities,  while maintaining an acceptable interest rate
spread. Interest sensitivity gap is defined as the difference between the amount
of  interest-earning  assets maturing or repricing within a specific time period
and the amount of interest-bearing liabilities maturing or repricing within that
time period. A gap is considered positive when the amount of  interest-sensitive
assets exceeds the amount of interest-sensitive  liabilities,  and is considered
negative  when the amount of  interest-rate-sensitive  liabilities  exceeds  the
amount of interest-rate-sensitive  assets. Generally,  during a period of rising
interest rates, a negative gap would adversely affect net interest income, while
a positive gap would result in an increase in net interest  income.  Conversely,
during a period of falling  interest  rates,  a negative  gap would result in an
increase in net interest income,  while a positive gap would  negatively  affect
net interest income. The Bank's goal is to maintain a reasonable balance between
exposure to interest rate fluctuations and earnings.

RATE/VOLUME  ANALYSIS.  Net interest income can also be analyzed in terms of the
impact of changing interest rates on average interest-earning assets and average
interest-bearing  liabilities, and the changing volume or amount of these assets
and  liabilities.  Table 2 below  represents  the  extent  to which  changes  in
interest rates and changes in the volume of average  interest-earning assets and
average  interest-bearing  liabilities  have affected the Bank's interest income
and interest expense during the periods indicated.  For each category of average
interest-earning asset and average  interest-bearing  liability,  information is
provided on changes  attributable  to: (i) changes in volume  (changes in volume
multiplied by old rate);  (ii) changes in rate (change in rate multiplied by old
volume); (iii) changes in rate-volume (changes in rate multiplied by the changes
in volume); and (iv) net change (total of the previous columns).

ANALYSIS OF NET INTEREST INCOME.  Net interest income  primarily  represents the
difference  between  income  derived from  interest-earning  assets and interest
expense on interest-bearing liabilities. Net interest income is affected by both
the difference between the yield on earning assets and the average cost of funds
("interest rate spread"),  and the relative volume of  interest-earning  assets,
interest-bearing liabilities and noninterest-bearing deposits.

Table 3 below sets forth certain  information  relating to the Bank's Statements
of Financial  Condition and Statements of Operations for the year ended December
31, 2002, the three months ended December 31, 2001, and the year ended September
30, 2001, reflecting the yield on average earning assets and the average cost of
funds for the periods  indicated.  Average  balances  are derived from month end
balances.  The Bank does not believe that using month end  balances  rather than
average daily  balances has caused any material  difference  in the  information
presented.

                                        9
<PAGE>

TABLE 2 - RATE/VOLUME ANALYSIS
<TABLE>
<CAPTION>
                                             Year Ended December 31,                 Three Months Ended December 31,
                                     ----------------------------------------    ----------------------------------------
                                                 2002  vs.  2001                             2001  vs.  2000
                                     ----------------------------------------    ----------------------------------------

                                            Increase (Decrease) Due to                  Increase (Decrease) Due to
                                     ----------------------------------------    ----------------------------------------
                                                                                  Rate/                 Rate/
                                     Volume      Rate      Volume      Total     Volume      Rate      Volume      Total
                                     -------    -------    -------    -------    -------    -------    -------    -------
                                                                        (In thousands)
Interest income:
<S>                                  <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>
Loans receivable                     $ 5,280    $(5,454)   $  (902)   $(1,076)   $   462    $(1,173)   $   (64)   $  (775)
Investment securities                     90        (97)        (3)       (10)       115        (93)       (12)        10
Mortgage-backed securities            (1,858)      (120)        54     (1,924)    (1,048)       (46)        25     (1,069)
Other interest-earning assets           (372)      (281)       133       (520)       200        (47)      (123)        30
                                     -------    -------    -------    -------    -------    -------    -------    -------
     Total earning assets              3,140     (5,952)      (718)    (3,530)      (271)    (1,359)      (174)    (1,804)
                                     -------    -------    -------    -------    -------    -------    -------    -------

Interest expense:
Deposits                                 366     (7,300)      (141)    (7,075)        25     (1,694)        (6)    (1,675)
FHLB advances                           (241)      (174)       137       (278)      (513)      (383)       380       (516)
Other interest-bearing liabilities       (21)       (83)        13        (91)       (13)       (57)        10        (60)
                                     -------    -------    -------    -------    -------    -------    -------    -------
Total interest-bearing liabilities       104     (7,557)         9     (7,444)      (501)    (2,134)       384     (2,251)
                                     -------    -------    -------    -------    -------    -------    -------    -------
Change in net interest income        $ 3,036    $ 1,605    $  (727)   $ 3,914    $   230    $   775    $  (558)   $   447
                                     =======    =======    =======    =======    =======    =======    =======    =======

                                             Year Ended September 30,
                                     ----------------------------------------
                                                 2001  vs.  2000
                                     ----------------------------------------
                                            Increase (Decrease) Due to
                                     ----------------------------------------
                                                            Rate/
                                     Volume      Rate      Volume      Total
                                     -------    -------    -------    -------
                                                  (In thousands)
Interest income:
Loans receivable                     $ 4,103    $   145    $    21    $ 4,269
Investment securities                  2,285        (39)       (69)     2,177
Mortgage-backed securities              (439)      (344)        24       (759)
Other interest-earning assets            (63)      (350)        20       (393)
                                     -------    -------    -------    -------
     Total earning assets              5,886       (588)        (4)     5,294
                                     -------    -------    -------    -------

Interest expense:
Deposits                               3,363       (437)       (81)     2,845
FHLB advances                            131        108         25        264
Other interest-bearing liabilities        82        (23)       (13)        46
                                     -------    -------    -------    -------
Total interest-bearing liabilities     3,576       (352)       (69)     3,155
                                     -------    -------    -------    -------
Change in net interest income        $ 2,310    $  (236)   $    65    $ 2,139
                                     =======    =======    =======    =======
</TABLE>

                                       10
<PAGE>

TABLE 3 - YIELD/COST ANALYSIS
<TABLE>
<CAPTION>
                                             Year Ended December 31,    Three Months Ended December 31,    Year Ended September 30,
                                           ---------------------------  -------------------------------  ---------------------------
                                                      2002                           2001                          2001
                                           ---------------------------  -------------------------------  ---------------------------
                                                                                (In thousands)
                                                               Average                       Average                        Average
                                           Average              Yield/    Average             Yield/    Average              Yield/
                                           Balance    Interest   Cost     Balance   Interest  Cost(2)   Balance    Interest   Cost
                                           -------    --------   ----     -------   --------  -------   -------    --------   ----
Interest earning assets:
<S>                                        <C>        <C>         <C>     <C>        <C>        <C>     <C>        <C>         <C>
Loans receivable (1)                       $438,148   $30,909     7.05%   $389,746   $7,715     7.92%   $369,735   $32,760     8.86%
Investment securities                        54,542     3,461     6.35      54,583      865     6.34      51,386     3,461     6.74
Mortgage-backed securities                   34,679     2,191     6.32      46,586      781     6.71      77,422     5,223     6.75
Other interest-earning assets                 8,812       265     3.01      16,501      106     2.57      14,547       715     4.92
                                           --------   -------   ------    --------   ------   ------    --------   -------   ------
     Total earning assets                   536,181    36,826     6.87     507,416    9,467     7.46     513,090    42,159     8.22
                                                      -------   ------               ------   ------               -------   ------

Nonearning assets                            44,896                         39,658                        36,225
                                           --------                       --------                      --------
     Total assets                          $581,077                       $547,074                      $549,315
                                           ========                       ========                      ========

Interest bearing liabilities:
Time deposits                              $306,636    10,261     3.35    $309,391    3,567     4.61    $323,037    18,496     5.72
Demand deposits                             130,245     2,001     1.54     102,827      465     1.81      87,309     2,396     2.74
Savings                                      19,431       142     0.73      19,126       48     1.00      20,450       262     1.28
FHLB advances                                 1,469        28     1.90         250        1     1.60      13,638       822     6.03
Repurchase agreements                         4,344        41     0.94       4,808       11     0.92       5,419       192     3.54
                                           --------   -------   ------    --------   ------   ------    --------   -------   ------
     Total interest-bearing liabilities     462,125    12,473     2.68     436,402    4,092     3.75     449,853    22,168     4.93

Noninterest bearing demand deposits          48,551         0     0.00      43,035        0     0.00      37,383         0     0.00
                                           --------   -------   ------    --------   ------   ------    --------   -------   ------
     Total sources of funds                 510,676    12,473     2.44     479,437    4,092     3.41     487,236    22,168     4.55
                                           --------                       --------                      --------

Other liabilities and
   stockholders'equity:
Other liabilities                            18,683                         16,584                        14,707
Stockholders' equity                         51,718                         51,053                        47,372
                                           --------                       --------                      --------
     Total liabilities and
       stockholders' equity                $581,077                       $547,074                      $549,315
                                           ========                       ========                      ========
Net interest income                                   $24,353                        $5,375                        $19,991
                                                      =======                        ======                        =======
Interest rate spread  (3)                                         4.43%                         4.05%                          3.67%
                                                                ======                        ======                         ======
Net yield on earning assets (4)                                   4.54%                         4.24%                          3.90%
                                                                ======                        ======                         ======

Ratio of earning assets to interest
     bearing liabilities                                        116.03%                       116.27%                        114.06%
                                                                ======                        ======                         ======
</TABLE>

     (1)  Includes classified loans.
     (2)  Ratio calculations have been annualized.
     (3)  Represents the difference  between the yield on earning assets and the
          average cost of funds.
     (4)  Represents the net interest income divided by average earning assets.

                                       11
<PAGE>

RESULTS OF OPERATIONS
---------------------

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2002 AND 2001

Total assets  increased 14.4% to $628.5 million at December 31, 2002 from $549.3
million at December 31, 2001.  Earning assets  increased 13.6% to $576.6 million
at December  31,  2002 from $507.7  million at  December  31,  2001,  reflecting
significant  growth in the  commercial  loan  portfolio,  opening  of a new full
service banking office and growth in the Bank's leasing division. Earning assets
were 91.7% of total assets at December  31, 2002,  compared to 92.4% at December
31, 2001.

Loans and lease  financing  receivable,  net of loan loss  reserves and deferred
loan fees,  increased  21.0% to $490.9  million at December 31, 2002 from $405.6
million at December 31, 2001. The Bank continues to emphasize the origination of
both  secured  and  unsecured  commercial  and  consumer  loans in order to take
advantage of generally higher yields as well as shorter terms to maturity.  From
time to time, the Bank sells selected  mortgage loans in the secondary market in
order to reduce  interest  rate and credit risk,  while  retaining  servicing to
generate  additional fee income. The years ended December 31, 2002 and 2001 were
both advantageous periods to execute such sales due to declining interest rates.

Commercial  loans  increased  47.0% to $295.0  million at December 31, 2002 from
$200.6  million at December 31, 2001.  Consumer  loans  increased  5.3% to $81.9
million at December  31,  2002 from $77.8  million at December  31,  2001.  This
growth  reflects  the Bank's  emphasis  of  structuring  itself as a  commercial
banking entity.  Commercial and consumer loan  originations  increased to $255.7
million during fiscal 2002, from $122.3 million during fiscal 2001.

Residential  real  estate  mortgage  loans  declined  8.6% to $122.0  million at
December 31, 2002 from $133.4 million at December 31, 2001, reflecting sales and
securitizations  of  loans,  net  of  origination   volume.  The  Bank  sold  or
securitized  $87.2  million of mortgage  loans during  fiscal 2002,  compared to
$52.6 million during fiscal 2001.  Loans serviced for others were $261.8 million
at December 31, 2002,  compared to $274.2  million at December 31, 2001.  During
fiscal 2002, the Bank originated  $153.4 million of residential  mortgage loans,
compared to $115.6 million during fiscal 2001.

Investment  securities and mortgage-backed  securities declined to $79.3 million
at  December  31,  2002,  from $98.0  million at  December  31,  2001.  The Bank
securitized  no  mortgage  loans held for sale into  mortgage-backed  securities
during fiscal 2002, compared to $12.3 million in fiscal 2001. The Bank sold $6.2
million of mortgage-backed securities during the 2002, compared to $63.2 million
during fiscal 2001. The mortgage-backed  securities  portfolio declined to $23.5
million at December 31, 2002 from $43.9 million at December 31, 2001.

In accordance  with adopting new  accounting  standards,  during fiscal 2002 the
Company  discontinued  the  amortization of its goodwill related to prior period
acquisitions. Goodwill related to prior period acquisitions were $4.2 million at
December  31,  2002 and 2001.  During  the year  ended  December  31,  2002,  no
amortization  expense was  recorded,  compared  to  $517,000  for the year ended
December 31, 2001. The remaining  unamortized  balance of the Company's goodwill
will be tested for impairment at least  annually.  The Company has performed its
annual  impairment  test and has determined that there has been no impairment of
goodwill as of December 31, 2002.

Deposits  increased  10.7% to $526.3  million at  December  31, 2002 from $475.6
million at  December  31,  2001.  Certificates  of deposit  increased  to $307.8
million at December 31, 2002 from $304.2  million at December 31, 2001. The Bank
continued to emphasize  attracting  lower cost core  deposits,  resulting in net
checking  account  growth of 30.8% to $199.6  million at December  31, 2002 from
$152.6  million at December 31, 2001.  The Bank has managed its cost of deposits
by  allowing   certain  high  rate   certificates  of  deposit  to  mature  amid
increasingly competitive market interest rates, offset by the growth in checking
accounts.  The Bank is also repricing higher costing certificates of deposits at
lower  rates,  and  combined  with the  growth of lower  costing  core  checking
accounts, has been an effective tool in managing its deposit cost.

Total  borrowings  were $38.2  million at  December  31,  2002  compared to $5.4
million  at  December  31,  2001.  FHLB  advances  used  primarily  to fund loan
originations were $34.0 million at December 31, 2002,  compared to $1,000,000 at
December 31, 2001.  Borrowings  in the form of repurchase  agreements  were $4.2
million at December  31,  2002,  compared to $4.4  million at December 31, 2001,
representing  funds held in cash  management  accounts  for  commercial  banking
customers.

                                       12
<PAGE>

Stockholders'  equity was $50.1 million at December 31, 2002,  compared to $51.0
million at December  31, 2001.  The equity to assets  ratio  declined to 8.0% at
December  31, 2002 from 9.3% at December 31, 2001,  due to the  Company's  14.4%
asset growth and 47.0% commercial loan growth during fiscal 2002, and the impact
of the stock repurchase program discussed below.

Accumulated  other  comprehensive  income was $3.8 million at December 31, 2002,
compared to $2.6 million at December 31, 2001, reflecting a significant increase
in  unrealized  gains on available  for sale  securities,  due  primarily to the
recent decline in market rates.

During the years ended  December 31, 2002 and 2001,  the Company  declared  four
quarterly cash dividends each,  totaling $0.68 and $0.48 per share respectively.
These cash dividend payments reflect dividend payout ratios on basic earnings of
31.2% for fiscal 2002 and 61.5% for fiscal 2001. Future quarterly dividends will
be determined at the  discretion of the Board of Directors  based upon earnings,
the  capital and  financial  condition  of the  Company,  and  general  economic
conditions.  These cash dividend payments, combined with the appreciation in the
market  price  of the  Company's  common  stock,  resulted  in total  return  to
shareholders of 63.0% for fiscal 2002, compared to 46.7% for fiscal 2001.

Pursuant to stock repurchase programs adopted by the Company during fiscal years
2002 and 2001,  the Company  acquired  260,450 and 239,846  shares of its common
stock, respectively,  through open market and private purchases. Shares acquired
under the  repurchase  program are being held as  treasury  stock,  at cost.  At
December  31, 2002,  treasury  shares were  2,341,936  totaling  $37.3  million,
compared to 2,099,561  shares  totaling  $28.7 million at December 31, 2001. The
Company  believes the repurchase of its  outstanding  common stock will increase
per share  earnings and return on average  equity,  and  decrease the  potential
dilutive effect caused by the exercise of stock options.  During fiscal 2002 and
2001, 18,075 and 37,725 shares,  respectively,  were issued upon the exercise of
stock options.

COMPARISON OF OPERATING  RESULTS FOR THE YEARS ENDED  DECEMBER 31, 2002 AND 2001
(UNAUDITED)

Net Income. Net income increased to $9.5 million for the year ended December 30,
2002 from $3.3 million for the year ended  December 31, 2001.  Diluted  earnings
per share increased to $2.06 per share for the year ended December 31, 2002 from
$.75 per share  for the year  ended  December  31,  2001.  Had the  Company  not
incurred the one-time ESOP  termination  expense,  net income for the year ended
December  31, 2001 would have been $6.5  million and diluted  earnings per share
would  have  been  $1.45  per  share.  The  average  number  of  diluted  shares
outstanding  (net of treasury  shares) was 4,628,434 and 4,472,062 for the years
ended December 31, 2002 and 2001. Return on average assets and return on average
equity were 1.6% and 18.4%  respectively  for fiscal  2002,  compared to .6% and
6.9% for fiscal 2001.  Return on average assets and return on average equity for
fiscal 2001,  excluding  the ESOP  termination,  would have been 1.2% and 13.3%,
respectively.  See  "Significant  Activities  and Events"  above for  additional
information.

Interest Income.  Interest income declined 8.7% to $36.8 million for fiscal 2002
from $40.3 million for fiscal 2001. The decline in interest  income on loans and
investments  during 2002 results from a lower yield on earning assets due to the
general  decline in  interest  rates.  The average  balance of  interest-earning
assets increased 5.3% to $536.2 million for fiscal 2002, from $509.1 million for
fiscal 2001. The yield on average  interest-earning  assets declined to 6.9% for
2002 from 7.9% for 2001.

Interest  Expense.  Interest  expense declined 37.4% to $12.5 million for fiscal
2002 from $19.9  million for fiscal  2001.  The  decline in interest  expense on
deposits  and  borrowings  reflects  a lower  cost of  average  interest-bearing
liabilities  due to the general  decline in interest  rates and the  significant
growth in lower  costing core checking  accounts  discussed  above.  The average
balance of  interest-bearing  liabilities  increased  4.6% to $462.1 million for
fiscal  2002 from  $441.9  million  for  fiscal  2001.  The  average  balance of
noninterest-bearing  deposits  increased  20.8% to $48.6 million for fiscal 2002
from $40.2  million  for  fiscal  2001.  The  average  cost of funds  (including
noninterest-bearing  deposits)  was 2.4% for  2002,  compared  to 4.1% for 2001,
reflecting the general decline in interest rates during 2002.

Net Interest  Income.  Net interest income  increased 19.2% to $24.4 million for
fiscal 2002 from $20.4  million for fiscal  2001.  The  increase in net interest
income is  primarily  due to the  decline in  interest  rates  during  2002,  an
increase in the volume of average  interest-earning  assets, and the increase in
noninterest-bearing  deposits.  The net yield on  interest-earning  assets  (net
interest income divided by average  interest-earning assets) was 4.5% for fiscal
2002,  compared to 4.0% for fiscal 2001.  The Bank's  interest  rate spread (the
difference  between the effective yield on average  interest-earning  assets and
the effective average cost of funds) was 4.4% for fiscal 2002,  compared to 3.8%
for 2001.

                                       13
<PAGE>

See Table 2 (Rate/Volume  Analysis) and Table 3 (Yield/Cost  Analysis) above for
additional  information  on interest  income,  interest  expense,  net  interest
income, average balances and yield/cost ratios.

Provision for Loan Losses.  The Bank  maintains an allowance for losses on loans
based upon  management's  evaluation of risk in the loan  portfolio,  the Bank's
past loan loss experience,  and current economic  conditions.  The Bank provided
$1.8 million for loan losses during fiscal 2002, compared to $590,000 for fiscal
2001.  These  provisions were necessary to support the risks associated with the
47.0% growth in the  commercial  loan  portfolio  during  fiscal  2002,  and the
overall  increase in the loan portfolio.  The allowance for loan losses was $7.0
million at December  31,  2002,  compared to $5.4  million at December 31, 2001,
which  the Bank  believes  is  adequate  to absorb  probable  losses in its loan
portfolio.  The ratio of the  allowance  for loan losses to total loans,  net of
loans-in-process  and deferred loan fees, was 1.4% at December 31, 2002 and 1.3%
at December 31, 2001.

The Bank uses an analytical  approach through a classification of assets program
to determine the adequacy of its loan loss allowance and the necessary provision
for loan  losses.  The loan  portfolio  is  reviewed  on a  quarterly  basis and
delinquent loans are individually  analyzed.  Consideration is given to the loan
status,  payment  history,  repayment  ability,  probability  of repayment,  and
loan-to-value  percentages.  Loans  are  classified  in  appropriate  categories
applicable to their circumstances as a result of this review and analysis. After
reviewing current economic conditions, changes in delinquency status, and actual
loan losses incurred by the Bank, management  establishes an appropriate reserve
percentage  applicable to each category of assets, and provision for loan losses
is recorded  when  necessary to bring the allowance to a level  consistent  with
this  analysis.  The  ratio of  non-performing  loans to total  loans was .3% at
December 31, 2002 and 2001.

Noninterest  Income.  Noninterest  income  increased  19.2% to $8.5  million for
fiscal 2002 from $7.1 million for fiscal 2001. Other income consists of fees and
service charges on loans, service charges on deposit accounts,  gains from sales
of loans and mortgage backed securities,  and other  miscellaneous  income. Loan
fees and service  charges  increased  24.7% to $4.6 million for fiscal 2002 from
$3.7  million  for fiscal  2001,  reflecting  the growth of the  commercial  and
consumer loan portfolios and the growth in checking accounts during fiscal 2002.
Gains from the sale of loans and  mortgage-backed  securities  increased to $2.2
million for fiscal 2002 from $1.8 million for fiscal  2001.  The volume of loans
and mortgage-backed  securities sold during 2002 was $92.9 million,  compared to
$115.5 million for 2001,  reflecting the sales  necessary to continue the Bank's
efforts  of  reducing  its  interest  rate  exposure.  Servicing  fee income was
$691,000 for 2002,  compared to $763,000 for 2001, as loans  serviced for others
declined to $261.8  million at December 31, 2002 from $274.2 million at December
31, 2001.

Noninterest  Expenses.  Noninterest expenses declined 15.4% to $16.3 million for
fiscal 2002 from $19.3 million in fiscal 2001.  The Company's  efficiency  ratio
(noninterest  expenses divided by net interest income plus  noninterest  income)
improved  to 49.8% for fiscal 2002 from 70.2% for fiscal  2001.  Had the Company
not incurred the one-time ESOP  termination  expense,  the efficiency  ratio for
fiscal 2001 would have been 58.7%.

The  largest  single  component  of these  expenses is  compensation  and fringe
benefits,  which was $9.7  million for both  fiscal 2002 and 2001  respectively.
During  fiscal  2001,  the  Company  incurred  $1.1  million of ESOP  expense in
addition to the one-time termination charge. For future periods the Company will
not  incur  any  further  charges  related  to the  ESOP.  Full-time  equivalent
employees  increased  to 228 at December 31, 2002 from 218 at December 31, 2001.
This  growth  is  due to  additional  personnel  resulting  from  opening  a new
full-service  branch office,  a new loan  production  office and  administrative
staff required to support the 14.3% growth in asset during fiscal 2002.

During fiscal 2002,  the Company  discontinued  the  amortization  of intangible
assets  related  to prior  period  acquisitions.  No  amortization  expense  was
recorded  during fiscal 2002,  compared to $517,000  during 2001.  The remaining
unamortized  balance of  intangible  assets of $4.2 million at December 31, 2002
will be tested for impairment at least annually.

Data processing  expense has grown  proportionately  with the growth in customer
accounts  and  transaction  activity  primarily  attributable  to the  growth in
earning assets and deposits from the prior year acquisitions.  Other noninterest
expenses  including  advertising,  deposit  insurance,  premises and  equipment,
repairs and  maintenance,  and office  expenses have also grown  proportionately
from period to period with the growth in earning assets and checking accounts.

                                       14
<PAGE>

Income  Taxes.  The  provision  for income  taxes  increased to $5.2 million for
fiscal 2002 from $4.3  million for fiscal 2001.  The  increase in provision  for
income taxes is the result of the increase of pretax  earnings to $14.7  million
for fiscal  2002 from $7.6  million for fiscal  2001,  which  included  the $3.1
million  one-time  ESOP  termination  charge which was not tax  deductible.  The
change in the amount of income tax  provisions  also  reflects  changes in other
pretax  income  and  expenses,   the  application  of  permanent  and  temporary
differences, and the income tax rates in effect during each period.

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2001 AND SEPTEMBER 30, 2001

Total  assets  increased  to $549.3  million at  December  31,  2001 from $541.2
million at September 30, 2001,  reflecting a 6.0% annualized  growth rate during
the three months ended December 31, 2001.

Earning assets grew at an annualized  rate of 4.7% to $507.7 million at December
31,  2001 from $501.8  million at  September  30,  2001,  reflecting  the Bank's
current  loan  demand.  Earning  assets  amounted  to 92.4% of total  assets  at
December 31, 2001,  compared to 92.7% at  September  30, 2001.  Interest-bearing
deposits in financial institutions declined to $1.4 million at December 31, 2001
from  $21.7  million  at  September  30,  2001,  reflecting  funding of the loan
portfolio growth discussed below.

The Bank has implemented various strategies to increase its regulatory liquidity
levels,  including the  securitization of certain mortgage loans previously held
for sale into mortgage-backed securities and the purchase of U.S. Government and
Agency  securities.   The  Bank's  mortgage-backed   securities  and  investment
securities  portfolio was $98.0 million at December 31, 2001, compared to $103.3
million at September 30, 2001.

Loans held for sale  increased to $29.3  million at December 31, 2001 from $20.5
million at  September  30,  2001,  while  loans and leases  held for  investment
increased  to $376.3  million  at  December  31,  2001 from  $353.6  million  at
September 30, 2001,  reflecting internal portfolio growth generated from current
loan demand.  To support the risk associated  with its loan portfolio,  the Bank
had reserves for potential  loan losses of $5.4 million at December 31, 2001 and
September 30, 2001, respectively. The ratio of reserves for loan losses to total
loans was 1.3% at December 31, 2001 and 1.4 % at September 30, 2001.

Total deposits and  borrowings  increased to $481.0 million at December 31, 2001
from $476.8 million at September 30, 2001.  Deposits increased to $475.6 million
at December  31, 2001 from $471.9  million at September  30, 2001,  reflecting a
3.1%  annualized  growth rate during the three months  ended  December 31, 2001.
Borrowings  primarily in the form of repurchase  agreements  representing  funds
held in cash management  accounts for commercial banking customers  increased to
$5.4 million at December 31, 2001 from $4.9 million at September 30, 2001.

Stockholders'  equity was $51.0 million at December 31, 2001,  compared to $50.8
million at  September  30, 2001.  At December  31, 2001,  the ratio of equity to
total assets was 9.3%, compared to 9.4% at September 30, 2001.

As a result of the ESOP termination,  the Company's $1.3 million note receivable
from  the ESOP was  repaid  in full via a  treasury  stock  purchase  of  59,677
unallocated  ESOP  shares,  resulting  in  the  release  of  all  the  remaining
unallocated   140,542  shares  to  ESOP  participants.   In  settlement  of  the
termination  expense of these  remaining  shares,  $3.2  million was recorded as
additional paid-in-capital as of December 31, 2001.

During the three  months  ended  December  31,  2001,  the Company  recognized a
decline in other  comprehensive  income  resulting  from a decline in unrealized
gains on available for sale securities due to a recent increase in market rates.
Accumulated other comprehensive  income declined to $2.6 million at December 31,
2001 from $3.5 million at September 30, 2001.

As a North  Carolina  chartered  commercial  bank,  the Bank must  meet  various
capital standards required by federal and state banking regulatory agencies. The
Bank's stand-alone capital was $47.9 million at December 31, 2001, substantially
in excess of all regulatory capital requirements.

Pursuant to a stock repurchase plan,  during the three months ended December 31,
2001 the Company  acquired 86,563 shares of its common stock through open market
and private  purchases,  totaling $1.9  million.  These shares are being held as
treasury stock at cost.  During the three months ended December 31, 2001,  8,250
shares of common  stock were issued  from  treasury  stock upon the  exercise of
stock options. At December 31, 2001, 2,099,561 shares totaling $28.7 million are
being held as  treasury  stock,  compared to  2,021,248  shares  totaling  $26.9
million at September 30, 2001.

                                       15
<PAGE>

On December 20, 2001,  the Company  declared a quarterly  cash dividend of $0.12
per share totaling $534,000,  payable January 18, 2002 to stockholders of record
as of  January 3, 2002.  This  dividend  payment  was the  Company's  nineteenth
consecutive quarterly cash dividend.

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND
2000 (UNAUDITED)

Net Income.  The Company recorded a net loss for the three months ended December
31, 2001 of $1.1  million,  compared to net income of $1.3 for the three  months
ended  December 31, 2000.  Diluted  earnings per share were $(.26) for the three
months  ended  December  31, 2001  compared to $.30 for the three  months  ended
December 31, 2000.  Had the Company not incurred the one-time  ESOP  termination
expense, net income for the three months ended December 31, 2001 would have been
$2.0 million and diluted  earnings per share would have been $.45 per share. The
average number of diluted shares outstanding was 4,308,369 and 4,521,189 for the
three months ended December 31, 2001 and 2000. See  "Significant  Activities and
Events" above for additional information.

Interest  Income.  Interest  income was $9.5  million for the three months ended
December 31, 2001, compared to $11.3 million for the three months ended December
31,  2000.  This  decline  in volume is  primarily  attributable  to a series of
interest rate reductions by the Federal Reserve since December 31, 2000. Average
interest-earning  assets were $507.4 million for the three months ended December
31, 2001,  compared to $529.8  million for the three  months ended  December 31,
2000. The yield on average interest-earning assets was 7.5% for the three months
ended  December 31, 2001,  compared to 8.5% for the three months ended  December
31, 2000.

Interest Expense.  Interest expense on deposits and borrowings  declined to $4.1
million for the three months  ended  December 31, 2001 from $6.3 million for the
three months  ended  December 31,  2000.  Average  interest-bearing  liabilities
declined to $436.4  million for the three  months  ended  December 31, 2000 from
$468.8 million for the three months ended December 31, 2000. The average cost of
funds  declined to 3.4% for the three months  ended  December 31, 2001 from 5.0%
for the  quarter  ended  December  31,  2000,  reflecting  a general  decline in
interest  rates since  December 31, 2000.  The Bank has  increased  its checking
account  base to $152.6  million at December  31,  2001 from  $115.0  million at
December 31, 2000, reflecting its continuing efforts of attracting lower costing
core deposits.

Net Interest Income. Net interest income increased to $5.4 million for the three
months  ended  December  31, 2001 from $4.9  million for the three  months ended
December 31, 2000. The Bank's net yield on interest-earning  assets was 4.2% for
the three months ended December 31, 2001,  compared to 3.7% for the three months
ended December 31, 2000. The Bank's interest rate spread (the difference between
the effective yield on average interest-earning assets and the effective average
cost of funds) was 4.2% for the three months ended  December 31, 2001,  compared
to 3.5% for the three months ended December 31, 2000.

See Table 2 (Rate/Volume  Analysis) and Table 3 (Yield/Cost  Analysis) above for
additional  information  on interest  income,  interest  expense,  net  interest
income, average balances and yield/cost ratios.

Provision for Loan Losses.  During the three months ended December 31, 2001, the
Bank recorded no provisions for loan losses,  compared to $240,000 for the three
months ended  December 31, 2000.  The Bank  believes  that level of reserves for
loan losses was adequate to provide for probable  future losses,  although there
were no  assurances  that  probable  future  losses,  if any,  would not  exceed
estimated amounts.

Noninterest  Income.  Noninterest income increased to $1.6 million for the three
months  ended  December  31, 2001 from $1.3  million for the three  months ended
December  31,  2000.  Noninterest  income  consists of fees and service  charges
earned on loans,  service charges on deposit  accounts,  and gains from sales of
loans  and  mortgage-backed  securities  and  other  miscellaneous  income.  The
increase  during the current  period is  attributable  to the growth in fees and
service  charges from a greater  volume of  commercial  and  consumer  loans and
checking accounts, and from the sale of loans and mortgage-backed securities.

During the three months ended  December 31, 2001 the Bank  recorded $1.1 million
of loan fees and  services  charges,  compared to $751,000  recorded  during the
three months ended December 31, 2000. In addition, during the three months ended
December  31,  2001,   the  Bank   recorded   gains  from  sales  of  loans  and
mortgage-backed securities of $192,000, compared to $164,000 recorded during the
three months ended December 31, 2000.

Noninterest Expense. Noninterest expenses were $6.9 million for the three months
ended  December  31,  2001,  compared to $3.7 million for the three months ended
December 31, 2000. The largest  single  component of these expenses was the $3.1
million one-time non-tax  deductible ESOP termination  charge.  See "Significant
Activities and Events" above for additional information.

                                       16
<PAGE>

Compensation  and fringe  benefits  were $2.2 million for the three months ended
December 31, 2001 and 2000, respectively.  Comparatively,  all other noninterest
expenses,  including premises and equipment,  advertising,  and office supplies,
were $1.6 million for the three months ended December 31, 2001, compared to $1.5
million for the three months ended  December  31,  2000,  reflecting  efforts to
control operating expenses.

Income  Taxes.  Income tax expense was $1.2  million for the three  months ended
December 31, 2001,  compared to $941,000 for the three months ended December 31,
2000. The changes in the amounts of income tax provisions  reflect the impact of
the non-tax deductible ESOP termination  charge,  changes in other pretax income
and expenses,  the application of permanent and temporary  differences,  and the
income tax rates in effect during each period.

COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2001 AND 2000

Total  assets were $541.2  million at  September  30,  2001,  compared to $559.7
million at September  30, 2000.  Earning  assets  declined to $501.7  million at
September  30, 2001 from $524.2  million at September 30, 2000,  reflecting  the
sales of certain mortgage loans and mortgage-backed  securities.  Earning assets
were 92.7% of total assets at September  30, 2001 compared to 93.8% at September
30, 2000.

Loans  receivable  increased to $374.1 million at September 30, 2001 from $366.2
million at  September  30,  2000.  Commercial  loans  increased  29.7% to $178.9
million at  September  30,  2001 from  $137.9  million at  September  30,  2000.
Consumer loans  increased 4.2% to $78.2 million at September 30, 2001 from $75.0
million at September  30,  2000.  This growth  reflects  the Bank's  emphasis on
commercial  banking.  Commercial  and consumer  loan  originations  increased to
$144.1 million for fiscal 2001 from $122.4 million for fiscal 2000.

Residential  real estate  mortgage  loans  declined  22.7% to $123.2  million at
September 30, 2001 from $159.3 million at September 30, 2000,  reflecting  sales
and exchanges of loans, net of origination volume.  During fiscal 2001, the Bank
originated  $60.4  million of real  estate  mortgage  loans,  compared  to $54.1
million  during  fiscal  2000.  The Bank sold or  securitized  $49.4  million of
mortgage loans during fiscal 2001, compared to $62.8 million during fiscal 2000.
Loans serviced for others were $295.2 million at September 30, 2001, compared to
$300.0 million at September 30, 2000.

Investment  securities and  mortgage-backed  securities declined 32.8% to $103.3
million at September 30, 2001 from $153.7 million at September 30, 2000.  During
the year ended September 30, 2001, the Bank increased its investment  securities
portfolio  (primarily U. S.  Government and Agency  securities) to $54.7 million
from $45.2 million at September 30, 2000.  During the years ended  September 30,
2001 and 2000, the Bank securitized  $12.3 million and $62.8 million of mortgage
loans previously held for sale into  mortgage-backed  securities.  The Bank sold
$63.2 million of mortgage-backed  securities during fiscal 2001,  compared to no
sales during fiscal 2000. The mortgage-backed  securities  portfolio declined to
$48.6 million at September 30, 2001 from $108.5 million at September 30, 2000.

Deposits  were $471.9  million at  September  30,  2001 and 2000,  respectively.
Certificates  of deposit  declined to $312.7 million at September 30, 2001, from
$339.3 million at September 30, 2000. The Bank emphasized  growing lower costing
core  deposits,  as  checking  accounts  increased  26.7% to $140.1  million  at
September  30, 2001 from $110.6  million at September  30, 2000.  During  fiscal
2001,  the Bank  managed  its cost of deposits  by  allowing  certain  high rate
certificates of deposit to mature amid increasingly  competitive market interest
rates, offset by the growth in checking accounts.  The Bank also repriced higher
costing  certificates of deposits at lower rates, and combined with the checking
account growth, was effectively able to manage its deposit cost.

Total  borrowings  declined  to $4.9  million at  September  30, 2001 from $30.4
million at September 30, 2000.  During fiscal 2001,  the Bank used proceeds from
the  mortgage-backed  securities  sales to repay $24.0 million of FHLB advances.
Borrowings in the form of repurchase  agreements  were $4.9 million at September
30, 2001, compared to $6.4 million at September 30, 2000.

Stockholders'  equity was $50.8 million at September 30, 2001, compared to $44.8
million at September 30, 2000. The ratio of equity to total assets  increased to
9.4% at September 30, 2001 from 8.0% at September 30, 2000,  reflecting  current
fiscal year earnings and a significant increase in unrealized gains on available
for sale  securities,  due  primarily  to the recent  decline  in market  rates.
Accumulated  other  comprehensive  income was $3.5 million at September 30, 2001
compared to other comprehensive loss of $1.3 million at September 30, 2000.

                                       17
<PAGE>

During the years ended  September 30, 2001 and 2000,  the Company  declared four
quarterly cash dividends  each,  totaling $.45 and $.31 per share  respectively.
These cash dividend payments reflect dividend payout ratios on basic earnings of
33.3% and 40.4%  respectively.  These cash dividend payments,  combined with the
appreciation  in the market price of the  Company's  common  stock,  resulted in
total return to shareholders of 41.2% for fiscal 2001 and 31.7% for fiscal 2000.

The  Company's  note  receivable  from  the ESOP  declined  to $1.4  million  at
September  30, 2001 from $1.8 million at  September  30,  2000,  reflecting  the
release of 68,898 shares to ESOP  participants.  At September 30, 2001,  203,889
unallocated  shares  remained in the ESOP,  compared to 272,787 at September 30,
2000.

Pursuant to stock repurchase programs adopted by the Company during fiscal years
2001 and 2000,  the Company  acquired  215,894 and 585,099  shares of its common
stock,  respectively,  which are  being  held as  treasury  stock,  at cost.  At
September 30, 2001,  treasury  shares were  2,021,248  totaling  $26.9  million,
compared to 1,805,354 shares totaling $23.0 million at September 30, 2000.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2001 AND 2000

Net Income.  Net income  increased to $5.8 million for the year ended  September
30,  2001 from $3.5  million  for the year ended  September  30,  2000.  Diluted
earnings per share increased to $1.30 per share for the year ended September 30,
2001 from $.76 per share for the year ended  September  30,  2000.  The  average
number of diluted shares  outstanding  was 4,478,139 and 4,690,308 for the years
ended September 30, 2001 and 2000.

Interest  Income.  Interest  income  increased 14.4% to $42.2 million for fiscal
2001 from $36.9  million for fiscal  2000.  The  increase in interest  income on
loans  and   investments   during  2001  results  from  the  growth  in  average
interest-earning  assets  attributable  to  the  completion  of two  prior  year
acquisitions.  Average interest-earning assets increased 16.5% to $513.1 million
for  fiscal  2001 from  $440.6  million  for fiscal  2000.  The yield on average
interest-earning assets was 8.2% for 2001, compared to 8.4% for 2000, reflecting
the decline in interest rates during 2001.

Interest  Expense.  Interest expense increased 14.4% to $22.2 million for fiscal
2001,  from $19.0  million for fiscal  2000.  Interest  expense on deposits  and
borrowings increased during 2001, resulting from the increased volume of average
interest-bearing  liabilities  from  internal  growth and the  completion of the
prior  year  acquisitions.  Average  balances  of  interest-bearing  liabilities
increased 17.9% to $449.9 million for fiscal 2001 from $381.5 million for fiscal
2000.  The average  cost of funds was 4.5% for 2001,  compared to 4.6% for 2000,
reflecting the decline in interest rates during 2001. Net Interest  Income.  Net
interest  income  increased  12.0% to $20.0  million  for fiscal 2001 from $17.9
million  for  fiscal  2000.  See  Table 2  (Rate/Volume  Analysis)  and  Table 3
(Yield/Cost  Analysis)  above for  additional  information  on interest  income,
interest expense, net interest income, average balances and yield/cost ratios.

Provision  for Loan Losses.  The Bank  provided  $830,000 for loan losses during
fiscal  2001,  compared to  $977,000  for fiscal  2000.  These  provisions  were
necessary to support the risks  associated with the growth of the commercial and
consumer  loan  portfolios  and the volume of loans  acquired  in the prior year
acquisitions.  The  allowance  for loan losses was $5.4 million at September 30,
2001, compared to $5.2 million at September 30, 2000. The ratio of the allowance
for loan losses to total  loans was 1.4% at  September  30,  2001 and 2000.  The
ratio of  non-performing  loans to total loans was .3% at September 30, 2001 and
..5% at September 30, 2000.

Noninterest  Income.  Noninterest  income  increased  97.4% to $6.8  million for
fiscal 2001 from $3.4  million for fiscal  2000.  Loan fees and service  charges
increased  78.3% to $3.4  million for fiscal  2001 from $1.9  million for fiscal
2000,  reflecting  the growth of the  commercial  and consumer loan  portfolios,
growth in  checking  accounts,  and the impact of the prior  year  acquisitions.
Gains  from  sales of loans and  mortgage-backed  securities  increased  to $1.8
million  for fiscal 2001 from  $2,000 for fiscal  2000.  The volume of loans and
mortgage-backed  securities sold or securitized  during 2001 was $112.6 million,
compared to $62.8  million  for 2000,  reflecting  increased  volume of sales or
securitizations  due to declining  interest rates and more favorable  pricing in
the secondary mortgage market. Servicing fee income on loans serviced for others
was $766,000  for 2001,  compared to $771,000  for 2000,  as loans  serviced for
others  declined to $295.2  million at September 30, 2001 from $300.0 million at
September 30, 2000.

                                       18
<PAGE>

Noninterest Expenses.  Noninterest expenses increased 13.8% to $16.0 million for
fiscal 2001 from $14.1 million in fiscal 2000.  The Company's  efficiency  ratio
improved to 59.9% for fiscal 2001 from 66.3% for fiscal 2000.  Compensation  and
fringe  benefits  increased  12.4% to $9.7  million for fiscal  2001,  from $8.6
million for fiscal 2000.  This increase is  attributable  to growth in personnel
resulting from two new full-service  branch offices opened during the year ended
September 30, 2001 and the prior year  acquisitions.  In addition,  compensation
expense  related to the ESOP  increased  to $1.2  million  for fiscal  2001 from
$835,000 for fiscal  2000,  resulting  from a continuing  increase in the market
value of the Company's outstanding common stock.

Data  processing  expense  grew  proportionately  with the  growth  in  customer
accounts  and  transaction  activity  primarily  attributable  to the  growth in
earning  assets and deposits from the prior year  acquisitions.  The increase in
amortization  of  intangible  assets  is  directly  related  to a full  year  of
amortizing the intangible  assets  associated with the prior year  acquisitions.
Other noninterest expenses, including advertising,  deposit insurance,  premises
and equipment,  repairs and maintenance,  and office  expenses,  have also grown
proportionately  from  period to period  with the growth in  earning  assets and
checking accounts.

Income  Taxes.  The  provision  for income  taxes  increased to $4.1 million for
fiscal 2001 from $2.7  million for fiscal 2000.  The  increase in provision  for
income taxes is the result of the increased  pretax earnings of $9.9 million for
fiscal 2001 from $6.2 million for fiscal 2000 and the effective income tax rates
for each period.

IMPACT OF INFLATION AND CHANGING  PRICES.  The financial  statements of the Bank
and  accompanying  footnotes  have been  prepared in accordance  with  generally
accepted  accounting  principles.  They  require the  measurement  of  financial
position  and  operating   results  in  terms  of  historical   dollars  without
considering the change in the relative  purchasing  power of money over time and
due to inflation.  The impact of inflation is reflected in the increased cost of
the Bank's operations.  Unlike most industrial companies,  nearly all the assets
and  liabilities  of the Bank are monetary.  As a result,  interest rates have a
greater impact on the Bank's  performance  than do the effects of general levels
of inflation. Interest rates do not necessarily move in the same direction or to
the same extent as the price of goods and services.

FORWARD LOOKING STATEMENTS. The Private Securities Litigation Reform Act of 1995
states that the  disclosure  of forward  looking  information  is desirable  for
investors and encourages  such disclosure by providing a safe harbor for forward
looking statements by corporate  management.  This Annual Report,  including the
Letter to  Stockholders  and  Management's  Discussion and Analysis of Financial
Condition and Results of Operations,  contains  forward looking  statements that
involve  risk and  uncertainty.  In order to  comply  with the terms of the safe
harbor, the Company notes that a variety of risks and uncertainties  could cause
its actual  results and  experience to differ  materially  from the  anticipated
results  or  other  expectations  expressed  in the  Company's  forward  looking
statements.  There are risks and  uncertainties  that may affect the operations,
performance,  development,  growth  projections  and  results  of the  Company's
business.  They include, but are not limited to, economic growth,  interest rate
movements,  timely development of technology enhancements for products, services
and operating systems, the impact of competitive products, services and pricing,
customer requirements,  regulatory changes and similar matters.  Readers of this
report are cautioned not to place undue reliance on forward  looking  statements
that are subject to influence by these risk  factors and  unanticipated  events.
Accordingly,   actual   results   may  differ   materially   from   management's
expectations.

                                       19
<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
First South Bancorp, Inc.
Washington, North Carolina

In our opinion, the accompanying  consolidated statements of financial condition
and  the  related   consolidated   statements  of  operations,   of  changes  in
stockholders' equity and of cash flows present fairly, in all material respects,
the  financial  position  of First  South  Bancorp,  Inc.  and  Subsidiary  (the
"Company") at December 31, 2002 and December 31, 2001,  and the results of their
operations  and their cash flows for the year ended December 31, 2002, the three
months ended December 31, 2001 and for each of the two years in the period ended
September 30, 2001, in conformity with accounting  principles generally accepted
in  the  United  States  of  America.   These   financial   statements  are  the
responsibility of the Company's management;  our responsibility is to express an
opinion on these  financial  statements  based on our audits.  We conducted  our
audits of these  statements in  accordance  with  auditing  standards  generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable  assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence  supporting the amounts and  disclosures  in the financial  statements,
assessing the  accounting  principles  used and  significant  estimates  made by
management,  and evaluating the overall  financial  statement  presentation.  We
believe  that our audits  provide a reasonable  basis for the opinion  expressed
above.

As  discussed  in Note 1 and 7 to the  consolidated  financial  statements,  the
Company  adopted the provisions of Statement of Financial  Accounting  Standards
No.  142,  Goodwill  and Other  Intangible  Assets and  Statement  of  Financial
Accounting Standards No. 147, Acquisition of Certain Financial Institutions.


/s/ PricewaterhouseCoopers LLP
February 24, 2003
Raleigh, North Carolina

                                       20
<PAGE>

FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2002 AND 2001
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                  2002            2001
                                     ASSETS
<S>                                                           <C>             <C>
Cash and due from banks                                       $ 30,540,790    $ 20,292,541
Interest-bearing deposits in financial institutions              3,931,369       1,390,541
Investment securities - available for sale                      55,786,842      54,061,442
Mortgage-backed securities - available for sale                 23,526,435      43,903,624
Loans receivable, net:
   Held for sale                                                38,664,967      29,283,037
   Held for investment                                         452,248,942     376,330,018
Premises and equipment, net                                      7,825,003       7,934,288
Deferred income taxes                                                   --         652,566
Real estate owned                                                  401,632         677,399
Federal Home Loan Bank of Atlanta stock, at cost
   which approximates market                                     2,402,500       2,712,500
Accrued interest receivable                                      3,403,195       3,465,523
Goodwill                                                         4,218,576       4,218,576
Mortgage servicing rights                                        1,642,172       1,030,368
Prepaid expenses and other assets                                2,544,807       2,000,783
Note receivable                                                  1,336,194       1,364,383
                                                              ------------    ------------

     Total assets                                             $628,473,424    $549,317,589
                                                              ============    ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
   Demand                                                     $199,615,945    $152,563,977
   Savings                                                      18,950,380      18,864,783
   Large denomination certificates of deposit                   80,021,790      63,318,050
   Other time                                                  227,739,049     240,841,695
                                                              ------------    ------------
     Total deposits                                            526,327,164     475,588,505
Borrowed money                                                  38,194,727       5,441,340
Other liabilities                                               13,851,721      17,256,363
                                                              ------------    ------------

     Total liabilities                                         578,373,612     498,286,209

Commitments and contingencies (Notes 10, 14 and 15)

Common stock, $.01 par value, 8,000,000 shares authorized,
   6,545,848 shares issued at December 31, 2002 and 2001            65,458          43,640
Additional paid-in capital                                      48,466,569      48,494,267
Retained earnings, substantially restricted                     35,086,795      28,548,510
Treasury stock at cost, 2,341,936 and 2,099,561 shares
   at December 31, 2002 and 2001, respectively                 (37,317,469)    (28,703,532)
Accumulated other comprehensive income, net                      3,798,459       2,648,496
                                                              ------------    ------------

             Total stockholders' equity                         50,099,812      51,031,381
                                                              ------------    ------------

             Total liabilities and stockholders' equity       $628,473,424    $549,317,590
                                                              ============    ============
</TABLE>

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

                                       21
<PAGE>

FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2002,
THREE MONTHS ENDED DECEMBER 31, 2001 AND
YEARS ENDED SEPTEMBER 30, 2001 AND 2000
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                   DECEMBER 31,    DECEMBER 31,     SEPTEMBER 30,   SEPTEMBER 30,
                                                       2002            2001             2001            2000
Interest income:
<S>                                                <C>             <C>              <C>             <C>
    Interest and fees on loans                     $ 30,908,736    $  7,714,883     $ 32,759,752    $ 28,491,128
    Interest and dividends on investments
     and deposits                                     5,917,460       1,752,656        9,399,416       8,373,756
                                                   ------------    ------------     ------------    ------------
          Total interest income                      36,826,196       9,467,539       42,159,168      36,864,884
                                                   ------------    ------------     ------------    ------------

Interest expense:
    Interest on deposits                             12,404,022       4,080,585       21,154,382      18,309,033
    Interest on borrowings                               69,513          11,630        1,013,660         703,647
                                                   ------------    ------------     ------------    ------------
          Total interest expense                     12,473,535       4,092,215       22,168,042      19,012,680
                                                   ------------    ------------     ------------    ------------

Net interest income before provision
 for loan losses                                     24,352,661       5,375,324       19,991,126      17,852,204
Provision for loan losses                             1,756,000              --          830,000         977,000
                                                   ------------    ------------     ------------    ------------
          Net interest income                        22,596,661       5,375,324       19,161,126      16,875,204
                                                   ------------    ------------     ------------    ------------
Non-interest income:
    Loan fees and service charges                     4,631,839       1,108,324        3,357,623       1,883,646
    Loan servicing fees                                 691,197         198,358          766,301         771,093
    Gain on sale of real estate, net                     73,766           4,929          261,031         119,331
    Gain on sale of mortgage loans                      302,315              --          421,792              --
    Gain on sale of mortgage-backed securities        1,883,683         191,842        1,378,637           1,706
    Other income                                        879,867         121,532          590,218         656,363
                                                   ------------    ------------     ------------    ------------
          Total non-interest income                   8,462,667       1,624,985        6,775,602       3,432,139
                                                   ------------    ------------     ------------    ------------
Non-interest expenses:
    Compensation and fringe benefits                  9,720,932       2,236,299        9,667,115       8,602,946
    ESOP termination expense                                 --       3,143,467               --              --
    Federal insurance premiums                           84,604          21,470           91,074          95,382
    Premises and equipment                            1,320,811         294,588        1,021,167       1,299,158
    Advertising                                         210,403          25,989          208,950         204,735
    Payroll and other taxes                             861,618         179,738          737,267         709,909
    Data processing                                   1,776,503         418,539        1,526,827       1,155,713
    Amortization of mortgage servicing rights           152,087          26,674           62,668          18,669
    Goodwill and other intangible assets                     --         129,358          517,410         326,290
    Other                                             2,210,409         499,520        2,214,423       1,687,683
                                                   ------------    ------------     ------------    ------------
          Total non-interest expenses                16,337,367       6,975,642       16,046,901      14,100,485
                                                   ------------    ------------     ------------    ------------

Income before income taxes                           14,721,961          24,667        9,889,827       6,206,858

Income taxes                                          5,210,349       1,164,640        4,059,535       2,657,826
                                                   ------------    ------------     ------------    ------------

NET INCOME (LOSS)                                     9,511,612      (1,139,973)       5,830,292       3,549,032

Other comprehensive income (loss), net of taxes       1,149,963        (815,901)       4,726,804        (369,877)
                                                   ------------    ------------     ------------    ------------

Comprehensive income (loss)                        $ 10,661,575    $ (1,955,874)    $ 10,557,096    $  3,179,155
                                                   ============    ============     ============    ============

Net income (loss) per common share:
    Basic                                          $       2.18    $       (.26)    $       1.34    $        .76
                                                   ============    ============     ============    ============

    Diluted                                        $       2.06    $       (.26)    $       1.30    $        .76
                                                   ============    ============     ============    ============
</TABLE>

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

                                       22
<PAGE>

FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2002,
THREE MONTHS ENDED DECEMBER 31, 2001 AND
YEARS ENDED SEPTEMBER 30, 2001 AND 2000
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                    RETAINED
                                                                   ADDITIONAL       EARNINGS,                       UNEARNED
                                                      COMMON        PAID-IN       SUBSTANTIALLY     TREASURY          ESOP
                                                      STOCK         CAPITAL        RESTRICTED        STOCK           SHARES
                                                   ------------   ------------    ------------    ------------    ------------
<S>                                                <C>            <C>             <C>             <C>             <C>
BALANCE, SEPTEMBER 30, 1999                        $     43,640   $ 44,232,010    $ 24,197,767    $(15,770,962)   $ (2,263,500)
Net income                                                   --             --       3,549,032              --              --
Other comprehensive loss, net of taxes                       --             --              --              --              --
MRP amortization                                             --        (57,700)             --              --              --
Acquisition of treasury shares                               --             --              --      (7,268,139)             --
Dividends ($.46 per share)                                   --             --      (1,418,936)             --              --
Release of ESOP shares                                       --        409,008              --              --         444,922
                                                   ------------   ------------    ------------    ------------    ------------

BALANCE, SEPTEMBER 30, 2000                              43,640     44,583,318      26,327,863     (23,039,101)     (1,818,578)
Net income                                                   --             --       5,830,292              --              --
Other comprehensive income, net of taxes                     --             --              --              --              --
Exercise of stock options                                    --        (25,823)             --         386,687              --
Acquisition of treasury shares                               --             --              --      (4,253,215)             --
Dividends ($.67 per share)                                   --             --      (1,936,091)             --              --
Release of ESOP shares                                       --        745,910              --              --         459,319
                                                   ------------   ------------    ------------    ------------    ------------

BALANCE, SEPTEMBER 30, 2001                              43,640     45,303,405      30,222,064     (26,905,629)     (1,359,259)
                                                   ------------   ------------    ------------    ------------    ------------
Net loss                                                     --             --      (1,139,973)             --              --
Other comprehensive loss, net of taxes                       --             --              --              --              --
Exercise of stock options                                    --        (10,235)             --         110,610              --
Acquisition of treasury shares                               --             --              --      (1,908,513)             --
Dividends ($.18 per share)                                   --             --        (533,581)             --              --
Release of ESOP shares                                       --      3,201,097              --              --       1,359,259
                                                   ------------   ------------    ------------    ------------    ------------

BALANCE, DECEMBER 31, 2001                               43,640     48,494,267      28,548,510     (28,703,532)             --
                                                   ------------   ------------    ------------    ------------    ------------
Net income                                                   --             --       9,511,613              --              --
Other comprehensive income, net of taxes                     --             --              --              --              --
Exercise of stock options                                    --        (27,698)             --         255,814              --
Acquisition of treasury shares                               --             --              --      (8,869,751)             --
Dividends ($.68 per share)                                   --             --      (2,945,698)             --              --
3 for 2 stock split, including fractional shares         21,818             --         (27,630)             --              --
                                                   ------------   ------------    ------------    ------------    ------------

BALANCE, DECEMBER 31, 2002                         $     65,458   $ 48,466,569    $ 35,086,795    $(37,317,469)   $         --
                                                   ============   ============    ============    ============    ============

<CAPTION>
                                                                   ACCUMULATED
                                                                      OTHER
                                                     DEFERRED      COMPREHENSIVE
                                                      STOCK       INCOME (LOSS),
                                                      AWARDS           NET            TOTAL
                                                   ------------    ------------    ------------
<S>                                                <C>             <C>             <C>
BALANCE, SEPTEMBER 30, 1999                        $   (783,392)   $   (892,530)   $ 48,763,033
Net income                                                   --              --       3,549,032
Other comprehensive loss, net of taxes                       --        (369,877)       (369,877)
MRP amortization                                        783,392              --         725,692
Acquisition of treasury shares                               --              --      (7,268,139)
Dividends ($.46 per share)                                   --              --      (1,418,936)
Release of ESOP shares                                       --              --         853,930
                                                   ------------    ------------    ------------

BALANCE, SEPTEMBER 30, 2000                                  --      (1,262,407)     44,834,735
Net income                                                   --              --       5,830,292
Other comprehensive income, net of taxes                     --       4,726,804       4,726,804
Exercise of stock options                                    --              --         360,864
Acquisition of treasury shares                               --              --      (4,253,215)
Dividends ($.67 per share)                                   --              --      (1,936,091)
Release of ESOP shares                                       --              --       1,205,229
                                                   ------------    ------------    ------------

BALANCE, SEPTEMBER 30, 2001                                  --       3,464,397      50,768,618
                                                   ------------    ------------    ------------
Net loss                                                     --              --      (1,139,973)
Other comprehensive loss, net of taxes                       --        (815,901)       (815,901)
Exercise of stock options                                    --              --         100,375
Acquisition of treasury shares                               --              --      (1,908,513)
Dividends ($.18 per share)                                   --              --        (533,581)
Release of ESOP shares                                       --              --       4,560,356
                                                   ------------    ------------    ------------

BALANCE, DECEMBER 31, 2001                                   --       2,648,496      51,031,381
                                                   ------------    ------------    ------------
Net income                                                   --              --       9,511,613
Other comprehensive income, net of taxes                     --       1,149,963       1,149,963
Exercise of stock options                                    --              --         228,116
Acquisition of treasury shares                               --              --      (8,869,751)
Dividends ($.68 per share)                                   --              --      (2,945,698)
3 for 2 stock split, including fractional shares             --              --          (5,812)
                                                   ------------    ------------    ------------

BALANCE, DECEMBER 31, 2002                         $         --    $  3,798,459    $ 50,099,812
                                                   ============    ============    ============
</TABLE>

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

                                       23
<PAGE>

FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2002,
THREE MONTHS ENDED DECEMBER 31, 2001 AND
YEARS ENDED SEPTEMBER 30, 2001 AND 2000
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                          DECEMBER 31,     DECEMBER 31,    SEPTEMBER 30,    SEPTEMBER 30,
                                                              2002             2001             2001             2000
                                                          ------------     ------------     ------------     ------------
Operating activities:
<S>                                                       <C>              <C>              <C>              <C>
    Net income (loss)                                     $  9,511,612     $ (1,139,973)    $  5,830,292     $  3,549,032
    Adjustments to reconcile net income (loss) to net
      cash provided by (used in) operating activities:
        Provision for loan losses                            1,756,000               --          830,000          977,000
        Depreciation                                           654,936          145,271          486,194          421,233
        Impairment of servicing asset                          246,074               --               --               --
        Impairment of real estate owned                        237,000
        ESOP compensation                                           --        3,225,564        1,205,229          853,930
        MRP compensation                                            --               --               --          725,692
        Amortization of discounts on securities, net          (186,528)         (46,632)        (103,388)         692,235
        Benefit from deferred income taxes                     477,214               --         (376,950)        (321,370)
        Gain on disposal of premises and equipment
          and real estate owned                               (158,375)          (4,239)        (261,031)        (119,331)
        Gain on loans held for sale and mortgage-
          backed securities                                 (2,185,998)        (191,842)      (1,800,429)          (1,706)
        Originations of loans held for sale, net           (94,692,353)     (20,657,550)     (36,102,872)     (46,229,695)
        Proceeds from sale of loans held for sale           87,194,106       12,016,957       37,087,531               --
        Other operating activities                          (5,200,274)       3,530,322        1,517,679        2,415,094
                                                          ------------     ------------     ------------     ------------
            Net cash (used in) provided by operating
              activities                                    (2,346,586)      (3,122,122)       8,312,255      (37,037,886)
                                                          ------------     ------------     ------------     ------------
Investing activities:
    Proceeds from maturities of investment securities
      available for sale                                            --        4,066,850               --        3,000,000
    Purchases of investment securities                              --               --       (5,000,000)     (46,050,000)
    Proceeds from principal repayments and sales of
      mortgage-backed securities available for sale         20,982,429               --       76,061,309       10,175,821
    Originations of loans held for investment, net
      of principal repayments                              (81,835,982)     (23,020,190)     (21,529,591)     (20,480,237)
    Proceeds from disposal of premises and equipment
      and real estate owned                                  1,286,890          187,570          705,310          911,869
    Proceeds from sale of credit card portfolio              3,299,080               --               --               --
    Sales (purchases) of FHLB stock                            310,000               --          (61,200)         (43,600)
    Purchases of premises and equipment                       (773,420)        (158,498)      (1,224,834)      (1,614,712)
    Repayment of note receivable                                28,189            6,623           25,045            3,949
    Net cash to purchase Green Street Financial Corp.               --               --               --      (26,530,907)
    Acquisition of Triangle Bancorp, Inc. branches                  --               --               --      113,760,993
                                                                                                             ------------
            Net cash (used in) provided by investing
              activities                                   (56,702,814)     (18,917,645)      48,976,039       33,133,176
                                                          ------------     ------------     ------------     ------------
Financing activities:
    Net increase (decrease) in deposit accounts             50,738,659        3,649,597           (2,759)      (8,461,007)
    Proceeds from FHLB borrowings                           84,500,000        1,000,000       72,200,000      125,200,000
    Repayments of  FHLB borrowings                         (51,500,000)              --      (96,200,000)    (101,200,000)
    Purchase of treasury shares                             (8,869,751)        (573,721)      (4,253,215)      (7,268,139)
    Cash paid for fractional shares                             (5,812)              --               --               --
    Proceeds from exercise of stock options                    228,116          100,375          360,863               --
    Cash dividends paid                                     (2,945,698)        (518,511)      (1,936,091)      (1,418,936)
    Net change in escrow accounts                              (60,424)          83,823         (271,035)          (4,442)
    Net change in repurchase agreements                       (246,613)        (468,157)      (1,478,054)       2,388,742
                                                          ------------     ------------     ------------     ------------
            Net cash provided by (used in) financing
              activities                                    71,838,477        3,273,406      (31,580,291)       9,236,218
                                                          ------------     ------------     ------------     ------------

Increase (decrease) in cash and cash equivalents            12,789,077      (18,766,361)      25,708,003        5,331,508
Cash and cash equivalents, beginning of year                21,683,082       40,449,443       14,741,440        9,409,932
                                                          ------------     ------------     ------------     ------------

Cash and cash equivalents, end of year                    $ 34,472,159     $ 21,683,082     $ 40,449,443     $ 14,741,440
                                                          ============     ============     ============     ============
</TABLE>

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

                                       24
<PAGE>

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

1.   BASIS OF PRESENTATION AND ACCOUNTING POLICIES

     ORGANIZATION AND NATURE OF OPERATIONS
     First  South  Bancorp,  Inc.  (the  "Company")  is a bank  holding  company
     incorporated under the laws of the State of Virginia. First South Bank (the
     "Bank"),  the wholly  owned  subsidiary  of the Company,  is organized  and
     incorporated  under the laws of the state of North  Carolina.  The  Federal
     Reserve  Board  regulates  the Company and the  Federal  Deposit  Insurance
     Corporation  and the North  Carolina  Office of the  Commissioner  of Banks
     regulate the Bank.

     The consolidated  financial statements include the accounts of the Company,
     the Bank, and the Bank's wholly owned subsidiary, First South Leasing, LLC.
     All significant intercompany balances and transactions have been eliminated
     in consolidation.

     The Company follows accounting  principles generally accepted in the United
     States of America  and  general  practices  within the  financial  services
     industry as summarized below:

     USE OF ESTIMATES
     The  preparation of  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 the
     reported  amounts of assets and  liabilities  and  disclosure of contingent
     assets and liabilities at the date of the consolidated financial statements
     and the  reported  amounts of revenues and  expenses  during the  reporting
     period. Actual results could differ from those estimates.

     CASH AND CASH EQUIVALENTS
     Cash and cash equivalents  include demand and time deposits (with remaining
     maturities  of ninety days or less at time of purchase) at other  financial
     institutions and federal funds sold. Generally, federal funds are purchased
     and sold for one-day periods.

     INVESTMENTS AND MORTGAGE-BACKED SECURITIES
     Investments in certain  securities are classified into three categories and
     accounted  for as  follows:  (1) debt  securities  that the  entity has the
     positive  intent and the  ability to hold to  maturity  are  classified  as
     held-to-maturity  and  reported  at  amortized  cost;  (2) debt and  equity
     securities that are bought and held  principally for the purpose of selling
     them in the near term are classified as trading  securities and reported at
     fair value, with unrealized gains and losses included in earnings; (3) debt
     and equity securities not classified as either held-to-maturity  securities
     or trading  securities are classified as available for sale  securities and
     reported at fair value,  with  unrealized  gains and losses  excluded  from
     earnings and reported as accumulated other comprehensive income, a separate
     component of equity. At December 31, 2002 and 2001, the Bank has classified
     all investments as available for sale.

     Premiums and discounts on debt securities are recognized as interest income
     using the interest method over the period to maturity.

     Mortgage-backed  securities represent  participating  interests in pools of
     long-term first mortgage loans.  Premiums and discounts are amortized using
     the interest  method over the  remaining  period to  contractual  maturity,
     adjusted for anticipated prepayments.

     Gains  and  losses  on the sale of  securities  are  determined  using  the
     specific identification method.

                                       25
<PAGE>

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

     LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
     Loans  receivable  held for  investment  are stated at the amount of unpaid
     principal,  reduced by an  allowance  for  probable  loan losses and net of
     deferred  origination  fees.  Interest  on  loans is  accrued  based on the
     principal amount outstanding and is recognized using the interest method.

     Loan origination  fees, as well as certain direct loan  origination  costs,
     are deferred.  Such costs and fees are recognized as an adjustment to yield
     over the contractual lives of the related loans.

     Commitment  fees to originate or purchase  loans are  deferred,  and if the
     commitment  is  exercised,  recognized  over  the  life  of the  loan as an
     adjustment of yield. If the commitment expires unexercised, commitment fees
     are  recognized  in income  upon  expiration  of the  commitment.  Fees for
     originating  loans for other financial  institutions are recognized as loan
     fee income.

     A loan is considered impaired,  based on current information and events, if
     it is  probable  that the Bank  will be  unable to  collect  the  scheduled
     payments of principal  or interest  when due  according to the  contractual
     terms  of the loan  agreement.  Uncollateralized  loans  are  measured  for
     impairment  based  on the  present  value of  expected  future  cash  flows
     discounted  at  the  historical   effective   interest   rate,   while  all
     collateral-dependent  loans are measured for  impairment  based on the fair
     value of the collateral.  The Bank uses several factors in determining if a
     loan is  impaired.  Internal  asset  classification  procedures  include  a
     thorough review of significant loans and lending  relationships and include
     the  accumulation  of related data. This data includes loan payment status,
     borrowers'  financial  data and borrowers'  operating  factors such as cash
     flows,  operating  income or loss, etc. At December 31, 2002, one loan with
     an  outstanding  balance of $124,000  was  considered  to be  impaired.  At
     December 31, 2001 and during the three  months ended  December 31, 2001 and
     the years ended September 30, 2001 and 2000, there were no individual loans
     material to the  consolidated  financial  statements  which were defined as
     impaired.

     The  allowance  for loan  losses is  increased  by  charges  to income  and
     decreased  by  charge-offs  (net  of  recoveries).   Management's  periodic
     evaluation  of the  adequacy of the  allowance  is based on the Bank's past
     loan loss  experience,  known and inherent risks in the portfolio,  adverse
     situations that may affect the borrower's  ability to repay,  the estimated
     value of any underlying collateral, and current economic conditions.  While
     management  believes  that it has  established  the allowance in accordance
     with  accounting  principles  generally  accepted  in the United  States of
     America  and has taken into  account  the views of its  regulators  and the
     current economic environment,  there can be no assurance that in the future
     the Bank's  regulators or risks in its portfolio  will not require  further
     increases in the allowance.

     LOANS HELD FOR SALE
     Loans  originated and intended for sale are carried at the lower of cost or
     aggregate estimated market value. Net unrealized losses are recognized in a
     valuation  allowance  as charges  to  income.  Gains and losses on sales of
     whole or participating interests in real estate loans are recognized at the
     time of  sale  and are  determined  by the  difference  between  net  sales
     proceeds  and  the  Bank's  basis  of the  loans  sold,  adjusted  for  the
     recognition of any servicing assets retained.

                                       26
<PAGE>

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

     INCOME RECOGNITION ON IMPAIRED AND NONACCRUAL LOANS
     Loans,  including impaired loans, are generally classified as nonaccrual if
     they are past due as to maturity or payment of  principal or interest for a
     period of more than 90 days,  unless such loans are well-secured and in the
     process of  collection.  If a loan or a portion of a loan is  classified as
     doubtful or is partially  charged off, the loan is generally  classified as
     nonaccrual.  Loans  that are on a current  payment  status or past due less
     than 90 days may also be  classified  as nonaccrual if repayment in full of
     principal and/or interest is in doubt.

     Loans may be returned to accrual  status when all  principal  and  interest
     amounts contractually due (including  arrearages) are reasonably assured of
     repayment  within an  acceptable  period of time,  and there is a sustained
     period of repayment performance  (generally a minimum of six months) by the
     borrower,  in  accordance  with  the  contractual  terms  of  interest  and
     principal.

     While a loan is classified as nonaccrual and the future  collectibility  of
     the  recorded  loan  balance  is  doubtful,  collections  of  interest  and
     principal  are generally  applied as a reduction to principal  outstanding,
     except in the case of loans with scheduled  amortization  where the payment
     is  generally   applied  to  the  oldest   payment  due.  When  the  future
     collectibility  of the recorded loan balance is expected,  interest  income
     may be  recognized  on a cash basis  limited to that which  would have been
     recognized on the recorded loan balance at the  contractual  interest rate.
     Receipts  in  excess of that  amount  are  recorded  as  recoveries  to the
     allowance  for  loan  losses  until  prior   charge-offs  have  been  fully
     recovered.

     MORTGAGE SERVICING RIGHTS
     When mortgage loans, or mortgage-backed  securities, are sold, the proceeds
     are allocated between the related loans and the retained mortgage servicing
     rights based on their relative fair values.

     Servicing  assets are  amortized  over the average  period of estimated net
     servicing  income  (if  servicing  revenue  exceed  servicing  cots) or net
     servicing  loss  (if  servicing  costs  exceed  servicing  revenues).   All
     servicing assets are assessed for impairment or increased  obligation based
     on their fair value.

     The  Company  recorded  impairment  to  servicing  assets of  $246,074  for
     prepayments  during  the  year  ended  December  31,  2002.  There  were no
     impairments  recognized during the three months ended December 31, 2001 and
     the years ended  September  30,  2001 and  September  30,  2000  related to
     mortgage servicing rights.

     PREMISES AND EQUIPMENT
     Premises and equipment are stated at cost less accumulated  depreciation or
     amortization,  if  a  capital  lease.  Depreciation  and  amortization  are
     computed  using the  straight-line  method based on the  estimated  service
     lives  of  the  assets.  Useful  lives  range  from  10  to  40  years  for
     substantially  all  premises  and  from 3 to 20  years  for  equipment  and
     fixtures.

                                       27
<PAGE>

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

     REAL ESTATE OWNED
     Assets acquired  through loan foreclosure are recorded as real estate owned
     at the lower of the  estimated  fair value of the property  less  estimated
     costs to sell at the date of foreclosure or the carrying amount of the loan
     plus unpaid accrued interest.  The carrying amount is subsequently  reduced
     by  additional  allowances  which are charged to earnings if the  estimated
     fair value  declines  below its initial value plus any  capitalized  costs.
     Costs related to the improvement of the property are  capitalized,  whereas
     costs  related to holding the  property  are  expensed.  For the year ended
     December  31,  2002,  the  Company  recognized  valuation   adjustments  of
     $237,000.

     INVESTMENT IN FEDERAL HOME LOAN BANK STOCK
     The Bank is required  to invest in stock of the  Federal  Home Loan Bank of
     Atlanta ("FHLB") in the amount of 1% of its outstanding home loans or 5% of
     its outstanding  advances from the FHLB,  whichever is greater. At December
     31, 2002 and December 31, 2001,  the Bank owned 24,025 and 27,125 shares of
     the FHLB's $100 par value capital stock.

     INTANGIBLE ASSETS
     Effective  January 1, 2002, the Company adopted the provisions of Statement
     of Financial  Accounting Standards No. 142, "Goodwill and Other Intangibles
     Assets,"  ("SFAS No. 142") which  required the Company to  discontinue  the
     amortization of goodwill  associated with acquisitions  accounted for under
     the purchased method of accounting.  In addition,  in the fourth quarter of
     2002,  the  Company  adopted  the  provisions  of  Statement  of  Financial
     Accounting   Standards   No.  147,   "Acquisition   of  Certain   Financial
     Institutions,"  ("SFAS No.  147")  which  required  to the Company to cease
     amortization of  unidentifiable  intangible  assets associated with certain
     branch  acquisitions.  SFAS No. 147 also  required  the  Company to reverse
     amortization  expense  within  the  scope  of SFAS  No.  147  that had been
     recorded in the first nine months of 2002.  Accordingly,  the  consolidated
     financial  statements for each of the three  quarters  ended  September 30,
     2002 have been  restated to reflect the effects of adopting SFAS No. 147 as
     if it had been adopted on January 1, 2002. The total amount of amortization
     expense reversed for the nine months ended September 30, 2002 was $489,000.

     As a result of adopting the provisions of SFAS No.'s 142 and 147,  goodwill
     is not  amortized,  but is reviewed for  potential  impairment on an annual
     basis at the reporting unit level.  The impairment test is performed in two
     phases.  The first step of the goodwill  impairment  test, used to identify
     potential  impairment,  compares the fair value of the reporting  unit with
     its carrying amount, including goodwill. If the fair value of the reporting
     unit  exceeds  its  carrying  amount,  goodwill  of the  reporting  unit is
     considered not impaired;  however,  if the carrying amount of the reporting
     unit exceeds its fair value an additional procedure must be performed. That
     additional  procedure  compares  the  implied  fair value of the  reporting
     unit's  goodwill (as defined in SFAS No. 142) with the  carrying  amount of
     that  goodwill.  An  impairment  loss is  recorded  to the extent  that the
     carrying  amount  of  goodwill  exceeds  its  implied  fair  value.   Other
     intangible  assets are evaluated for impairment if events and circumstances
     indicate a possible impairment.  Such evaluation of other intangible assets
     is based on undiscounted cash flow  projections.  The Company has performed
     its  annual  impairment  test and has  determined  that  there  has been no
     impairment of goodwill as of December 31, 2002.

                                       28
<PAGE>

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

     INCOME TAXES
     The Company  reports income taxes in accordance with Statement of Financial
     Accounting  Standards No. 109,  "Accounting  for Income  Taxes," ("SFAS No.
     109") which requires the recognition of deferred tax assets and liabilities
     for the temporary  difference between financial  statement and tax basis of
     the Company's assets and liabilities  using the enacted tax rates in effect
     in the years in which the  differences  are expected to reverse.  Valuation
     allowances are provided if, based upon the weight of available evidence, it
     is more  likely than not that some or all of the  deferred  tax assets will
     not be realized.

     ADVERTISING
     Advertising costs are expensed as incurred. For the year ended December 31,
     2002,  the three  months  ended  December  31,  2001,  and the years  ended
     September  30, 2001 and 2000,  the  Company  incurred  advertising  expense
     totaling $210,403, $25,989, $208,950, and $204,735, respectively.

     COMPREHENSIVE INCOME
     The  Company's  other  comprehensive  income  relates to  unrealized  gains
     (losses) on  available  for sale  securities.  Information  concerning  the
     Company's other comprehensive income (loss) for the year ended December 31,
     2002,  three months ended  December 31, 2001 and the years ended  September
     30, 2001 and 2000, is as follows:

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,     SEPTEMBER 30,
                                                2002             2001              2001            2000
                                            ------------     ------------     ------------     ------------
<S>                                         <C>              <C>              <C>              <C>
Unrealized gains (losses) on
    securities available for sale           $  2,144,112     $ (1,359,836)    $  8,299,802     $   (616,463)

Reclassification of net gains
    recognized in net income                    (302,315)              --         (421,792)              --

Income tax (expense) benefit relating
    to unrealized (losses) gains on
    available for sale securities               (691,834)         543,935       (3,151,206)         246,586
                                            ------------     ------------     ------------     ------------

Other comprehensive income (loss), net      $  1,149,963     $   (815,901)    $  4,726,804     $   (369,877)
                                            ============     ============     ============     ============
</TABLE>

     SEGMENT INFORMATION
     The Company  follows the  provisions  of SFAS No.  131,  "Disclosure  About
     Segments  of  an  Enterprise  and  Related  Information,"  which  specifies
     guidelines for determining an entity's  operating segments and the type and
     level of financial  information to be disclosed.  Based on these guidelines
     management has determined  that the Bank operates in one business  segment,
     the providing of general commercial financial services to customers located
     in its market areas.  The various  products are those generally  offered by
     community  banks.  The  allocation  of Bank  resources  is based on overall
     performance of the Bank, rather than individual branches or products.

     NEW ACCOUNTING PRONOUNCEMENTS
In June 2001,  the FASB issued SFAS No. 143,  "Accounting  for Asset  Retirement
Obligations"  (SFAS 143),  and SFAS No. 144,  "Accounting  for the Impairment or
Disposal of Long-Lived Assets" (SFAS 144).

                                       29
<PAGE>

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

     SFAS 143  requires  that  obligations  associated  with the  retirement  of
     tangible   long-lived   assets  be  recorded  as  a  liability  when  those
     obligations are incurred,  with the amount of liability  initially measured
     at fair value.  SFAS 143 is effective  for financial  statements  beginning
     after June 15, 2002,  though early adoption is encouraged.  The application
     of  this  statement  is not  expected  to  have a  material  impact  on the
     Company's consolidated financial statements.

     SFAS 144 supersedes SFAS 121,  "Accounting for the Impairment of Long-Lived
     Assets and for  Long-Lived  Assets to be Disposed  Of." SFAS 144 applies to
     all  long-lived  assets  including  discontinued  operations,   and  amends
     Accounting Principle Board Opinion No 30, "Reporting the Effect of Disposal
     of a Segment of a Business,  and  Extraordinary,  Unusual and  Infrequently
     Occurring  Events and  Transactions."  SFAS 144  requires  that  long-lived
     assets  that are to be disposed of by sale be measured at the lower of book
     or fair  value  less  cost to sell.  SFAS 144 is  effective  for  financial
     statements  issued for fiscal years  beginning  after December 15, 2001 and
     its  provisions  are generally  expected to be applied  prospectively.  The
     application of this statement is not expected to have a material  impact on
     the Company's consolidated financial statements.

     In June 2002, the FASB issued SFAS 146,  "Accounting  for Costs  Associated
     with Exit or  Disposal  Activities."  This  Statement  addresses  financial
     accounting  and  reporting  for  costs  associated  with  exit or  disposal
     activities and nullifies  Emerging Issues Task Force (EITF) Issue No. 94-3,
     "Liability  Recognition for Certain Employee Termination Benefits and Other
     Costs  to  Exit  an  Activity   (including  Certain  Costs  Incurred  in  a
     Restructuring)." The provisions of this Statement are effective for exit or
     disposal  activities  that are  initiated  after  December  31,  2002.  The
     application of this statement is not expected to have a material  impact on
     the Company's consolidated financial statements.

     In November  2002,  the FASB  issued FIN 45,  "Guarantor's  Accounting  and
     Disclosure  Requirements for Guarantees,  Including Indirect  Guarantees of
     Indebtedness of Others." This Interpretation  elaborates on the disclosures
     to be made by a guarantor  in its interim and annual  financial  statements
     about its obligations under certain  guarantees that it has issued. It also
     clarifies that a guarantor is required to recognize,  at the inception of a
     guarantee,  a liability for the fair value of the obligation  undertaken in
     issuing the guarantee. The application of this statement is not expected to
     have a material impact on the Company's consolidated financial statements.

     In December 2002,  the FASB issued SFAS 148,  "Accounting  for  Stock-Based
     Compensation  -- Transition and  Disclosure."  This  Statement  amends FASB
     Statement No. 123,  "Accounting for Stock-Based  Compensation,"  to provide
     alternative  methods of transition for a voluntary change to the fair value
     based  method of  accounting  for  stock-based  employee  compensation.  In
     addition,  this Statement  amends the disclosure  requirements of Statement
     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
     application of this statement is not expected to have a material  impact on
     the Company's consolidated financial statements.

                                       30
<PAGE>

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

     In  January  2003,  the FASB  issued  FIN 46,  "Consolidation  of  Variable
     Interest Entities - an  interpretation of ARB No. 51." This  Interpretation
     addresses  consolidation  by  business  enterprises  of  variable  interest
     entities,  which  have  the  following  characteristics:   (1)  The  equity
     investment  at risk is not  sufficient  to permit the entity to finance its
     activities  without  additional  subordinated  financial support from other
     parties, which is provided through other interests that will absorb some or
     all of the expected losses of the entity, and (2) The equity investors lack
     one or more of the  following  essential  characteristics  of a controlling
     financial  interest:  (a) The direct or indirect  ability to make decisions
     about the entity's  activities through voting rights or similar rights, (b)
     The  obligation to absorb the expected  losses of the entity if they occur,
     which makes it possible for the entity to finance its activities, or (c) he
     right to receive the expected residual returns of the entity if they occur,
     which is the  compensation  for the risk of absorbing the expected  losses.
     The application of this statement is not expected to have a material impact
     on the Company's consolidated financial statements.

2.   SIGNIFICANT ACTIVITIES

     During the three months ended December 31, 2001, the Company terminated its
     Employee  Stock  Ownership  Plan (See Note 8 for  further  details  of this
     transaction).

     On November 30, 1999,  the Company  consummated  the  acquisition  of Green
     Street Financial Corp. ("Green Street"), the parent holding company of Home
     Federal Savings and Loan Association of Fayetteville,  North Carolina, with
     full service offices located in Fayetteville and Lumberton, North Carolina.
     The  acquisition  was accounted for using the purchase method of accounting
     for a cash purchase price of $59.2 million,  representing  $15.25 per share
     of Green Street common stock.

     Concurrently  with the Green Street  acquisition,  the Company  changed its
     name to First South Bancorp, Inc.

     The following  table reflects the unaudited pro forma  combined  results of
     operations,  assuming  the  acquisition  had  occurred at the  beginning of
     fiscal 2000 and 1999:

                                                        2000            1999

     Net interest income                            $ 17,409,204    $ 16,235,962
     Net income                                        3,580,032       3,384,146
     Net earnings per diluted share                         1.14             .96

     In  management's  opinion,  these  unaudited  pro  forma  amounts  are  not
     necessarily  indicative of what the actual  combined  results of operations
     might have been if the  acquisition  had been effective at the beginning of
     fiscal 1999.

     On February 18, 2000,  the Bank  completed the  acquisition of six Triangle
     Bank ("Triangle") branch offices located in Rocky Mount and Tarboro,  North
     Carolina.  This  acquisition was accounted for using the purchase method of
     accounting  and the Bank assumed the  deposits of the six  Triangle  branch
     offices for a premium of approximately 4.0% of the assumed deposits.

                                       31
<PAGE>

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

     The fair values of assets, including goodwill, and liabilities assumed were
     as follows:

                                                GREEN STREET        TRIANGLE
                                                -------------     -------------
     Loans receivable                           $ 125,459,235     $  26,162,062
     Premises and equipment                         1,245,957         2,407,409
     Goodwill                                         287,832         4,898,652
     Other assets                                   4,548,219           277,790
     Deposits                                    (101,648,952)     (144,135,727)
     Other liabilities                             (3,361,384)       (3,371,179)
                                                -------------     -------------

     Net cash paid (received)
       for acquisitions                         $  26,530,907     $(113,760,993)
                                                =============     =============

3.   INVESTMENT SECURITIES

     Investment  securities  at December 31, 2002 and 2001,  are  classified  as
     available  for sale  according to  management's  intent and  summarized  as
     follows:

<TABLE>
<CAPTION>
                                                             GROSS UNREALIZED           ESTIMATED
                                        AMORTIZED      ----------------------------       MARKET
                                           COST           GAINS           LOSSES          VALUE
                                       ------------    ------------    ------------    ------------

December 31, 2002:

<S>                                    <C>             <C>             <C>             <C>
     U.S. Treasury and Agency Notes    $ 50,694,469    $  5,092,373    $         --    $ 55,786,842
                                       ------------    ------------    ------------    ------------

December 31, 2001:

     U.S. Treasury and Agency Notes    $ 50,507,941    $  3,553,501    $         --    $ 54,061,442
                                       ------------    ------------    ------------    ------------
</TABLE>

     U.S.  Treasury and Agency notes at December  31,  2002,  are  contractually
     scheduled to mature as follows:

                                                                    ESTIMATED
                                                  AMORTIZED          MARKET
                                                    COST              VALUE
                                                -------------     -------------

Due after one year through five years           $  50,694,469     $  55,786,842

                                       32
<PAGE>

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

4.   MORTGAGE-BACKED SECURITIES

     Mortgage-backed securities at December 31, 2002 and 2001, are classified as
     available  for sale  according to  management's  intent and  summarized  as
     follows:


<TABLE>
<CAPTION>
                                                             GROSS UNREALIZED           ESTIMATED
                                        AMORTIZED      ----------------------------       MARKET
                                           COST           GAINS           LOSSES          VALUE
                                       ------------    ------------    ------------    ------------
<S>                                    <C>             <C>             <C>             <C>
December 31, 2002:
     FHLMC participation
     certificates, maturing from
     years 2003 to 2028                $ 22,373,855    $  1,152,580    $        --     $ 23,526,435
                                       ------------    ------------    ------------    ------------

December 31, 2001:
     FHLMC participation
     certificates, maturing from
     years 2003 to 2028                $ 43,053,970    $    867,943    $    (18,289)   $ 43,903,624
                                       ------------    ------------    ------------    ------------
</TABLE>

     Mortgage-backed   securities  at  December  31,  2002,  are   contractually
     scheduled to mature as follows:


                                                                    ESTIMATED
                                                  AMORTIZED          MARKET
                                                    COST              VALUE
                                                -------------     -------------
Due after one year through five years           $     290,986     $     308,473
                                                -------------     -------------
Due after five years through ten years              3,479,381         3,665,725
                                                -------------     -------------
Due after ten years                                18,603,488        19,552,237
                                                -------------     -------------

                                                $  22,373,855     $  23,526,435
                                                =============     =============

     Expected   maturities  may  differ  from  contractual   maturities  because
     borrowers have the right to call or prepay obligations with or without call
     or prepayment penalties.

     Mortgage-backed  securities  with  a  carrying  value  of  $6,171,430,  $0,
     $63,181,244,  and $0 were sold during the year ended December 31, 2002, the
     three months ended  December 31, 2001 and during the years ended  September
     30,  2001 and  2000,  respectively.  Net  realized  gains  on the  sales of
     mortgage-backed securities were $302,315, $0, $421,792, and $0, during year
     ended  December  31, 2002,  the three  months  ended  December 31, 2001 and
     during the years ended September 30, 2001 and 2000, respectively.

     Mortgage-backed   securities  with  an  amortized  cost  of   approximately
     $4,460,964  and  $5,103,367  were pledged as  collateral  for deposits from
     public entities at December 31, 2002 and December 31, 2001.

                                       33
<PAGE>

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

5.   LOANS RECEIVABLE

     Loans receivable at December 31, 2002 and 2001, are summarized as follows:

                                                    2000              1999

Mortgage loans                                  $ 121,951,696     $ 133,395,094
Consumer loans                                     81,862,401        77,775,818
Commercial loans                                  294,993,169       200,621,122
                                                -------------     -------------

     Total                                        498,807,266       411,792,034

Less:
  Allowance for loan losses                        (6,958,587)       (5,370,820)
  Deferred loan fees                                 (934,770)         (808,159)
                                                -------------     -------------

Loans receivable, net                           $ 490,913,909     $ 405,613,055
                                                =============     =============

     The Bank has pledged its eligible real estate loans to collateralize actual
     or  potential  borrowings  from the Federal  Home Loan Bank of Atlanta (See
     Note 11).

     During the years  ended  September  30, 2001 and 2000,  the Bank  exchanged
     loans with outstanding  principal  balances of $12,298,139 and $62,789,209,
     respectively, with the Federal Home Loan Mortgage Corporation ("FHLMC") for
     mortgage-backed securities of equal value.

     The Bank originates mortgage loans for portfolio  investment or sale in the
     secondary  market.  During the period of  origination,  mortgage  loans are
     designated as either held for sale or for investment purposes. Transfers of
     loans held for sale to the  investment  portfolio are recorded at the lower
     of cost or market value on the transfer  date.  Loans  receivable  held for
     sale at December  31, 2002 and  December  31, 2001 are fixed rate  mortgage
     loans with an  estimated  market  value of  approximately  $40,300,000  and
     $29,900,000, respectively.

     Net  gains  on  sales  of  loans  receivable  held  for  sale  amounted  to
     $1,883,682,  $202,724,  $1,378,637,  and $1,706 for the year ended December
     31, 2002,  three months ended December 31, 2001, and during the years ended
     September 30, 2001 and 2000, respectively.

     The changes in the  allowance  for loan losses for the year ended  December
     31,  2002,  three  months  ended  December  31,  2001 and the  years  ended
     September 30, 2001 and 2000, are as follows:

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
                                            ------------     ------------     ------------     ------------
<S>                                         <C>              <C>              <C>              <C>
Balance at beginning of year                $  5,370,820     $  5,401,358     $  5,159,353     $  3,297,256
Provisions for loan losses                     1,756,000               --          830,000          977,000
Balance transferred in acquisition                    --               --               --          962,999
Loans charged off                               (192,902)         (42,376)        (655,506)        (157,092)
Recoveries                                        24,669           11,838           67,511           79,190
                                            ------------     ------------     ------------     ------------

Balance at end of year                      $  6,958,587     $  5,370,820     $  5,401,358     $  5,159,353
                                            ============     ============     ============     ============
</TABLE>

                                       34
<PAGE>

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

     The following is a summary of the principal balances of loans on nonaccrual
     status and loans past due ninety days or more:

                                                DECEMBER 31,      DECEMBER 31,
                                                    2002              2001
                                                -------------     -------------
Loans contractually past due 90 days or
  more and/or on nonaccrual status:
     Residential                                $     603,414     $     863,724
                                                -------------     -------------
     Consumer and commercial                          892,991           389,225
                                                -------------     -------------

                                                $   1,496,405     $   1,252,949
                                                =============     =============

     At December 31, 2002 and 2001, interest income of approximately $37,000 and
     $51,000, respectively, was not recorded related to loans accounted for on a
     nonaccrual basis.

6.   PREMISES AND EQUIPMENT

     Premises and equipment at December 31, 2002 and December 31, 2001,  consist
     of the following:

                                                DECEMBER 31,      DECEMBER 31,
                                                    2002              2001
                                                -------------     -------------

Land                                            $   2,542,615     $   2,566,219
Office buildings                                    5,854,158         5,811,385
Furniture, fixtures and equipment                   3,595,056         3,206,671
Vehicles                                              348,269           326,082
                                                -------------     -------------
                                                   12,340,098        11,910,357
Less accumulated depreciation                       4,515,095         3,976,069
                                                -------------     -------------

           Total                                $   7,825,003     $   7,934,288
                                                =============     =============

7.   GOODWILL AND OTHER INTANGIBLES

     The following table provides a reconciliation of reported net income (loss)
     for the  prior-years  to adjusted  earnings had SFAS 142 been applied as of
     the beginning of fiscal 2000.

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
                                            ------------     ------------     ------------     ------------
<S>                                         <C>              <C>              <C>              <C>
Reported net (loss) earnings                   9,511,612       (1,139,973)       5,830,292        3,549,033
                                            ------------     ------------     ------------     ------------
Add back amortization (net of tax):
  Goodwill and other
      indefinite-lived intangibles                    --           77,615          310,446          195,774
                                            ------------     ------------     ------------     ------------

Adjusted net (loss) income                     9,511,612       (1,062,358)       6,140,738        3,744,807
                                            ============     ============     ============     ============

Net income (loss) per common share:

    Basic                                   $       2.18     $      (0.25)    $       1.41     $       0.80
                                            ============     ============     ============     ============

    Diluted                                 $       2.06     $      (0.25)    $       1.37     $       0.80
                                            ============     ============     ============     ============
</TABLE>

                                       35
<PAGE>

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

8.   EMPLOYEE BENEFIT PLANS

     The Company  participates in a multi-employer  defined benefit pension plan
     which covers  substantially  all employees.  Effective January 31, 2002 the
     Company's  Board of  Directors  approved  a plan to freeze  the  accrual of
     future benefits. As such, no new employee shall become a participant in the
     plan after January 31, 2002.  However,  employees who were participating in
     the plan as of January 31, 2002 shall continue to participate in accordance
     with the  provisions  of the plan,  however the accrual of future  benefits
     will cease.  Expenses of the plan for the year ended December 31, 2002, the
     three months ended December 31, 2001 and the years ended September 30, 2001
     and 2000 were $67,079, $69,000, $69,017, and $258,600, respectively.

     The Company also participates in a multi-employer defined contribution plan
     which covers  substantially  all employees.  Under the plan,  employees may
     contribute from 1% to 15% of compensation,  subject to an annual maximum as
     determined  by the  Internal  Revenue  Code.  The  Company  makes  matching
     contributions of 50% of employees' contributions up to 6% of the employees'
     salaries.  The plan provides that employees'  contributions are 100% vested
     at all  times  and the  Bank's  contributions  vest  25% for  each  year of
     service.  The expenses related to the Company's  contributions to this plan
     for the year ended  December 31, 2002,  the three months ended December 31,
     2001 and the  years  ended  September  30,  2001 and 2000,  were  $167,757,
     $32,305, $115,174, and $84,924, respectively.

     Directors and certain officers participate in deferred  compensation plans.
     These plans generally  provide for fixed payments  beginning at retirement.
     These payments are earned over service periods of up to ten years,  and can
     include provisions for deferral of current payments. The expense related to
     these plans during the year ended December 31, 2002, the three months ended
     December  31,  2001 and the  years  ended  September  30,  2001  and  2000,
     aggregated $609,976,  $159,373, $617,127, and $544,327,  respectively.  The
     plans generally include  provisions for forfeitures of unvested portions of
     payments, and vesting in the event of death or disability.

     On  April  8,  1998,  the  Company's  Stockholders  approved  a  Management
     Recognition  Plan ("MRP") for directors and key employees.  The Company was
     authorized to fund the acquisition of and award up to 261,855 shares (4% of
     shares issued in the stock  conversion) to be awarded by a committee of the
     Board of Directors.  The Company  completed the  acquisition  of MRP shares
     during  fiscal 1998.  On April 8, 1998,  261,855  shares  (market  value of
     $4,029,258  and  aggregate  cost of  $3,275,299)  were  awarded  to certain
     officers and employees.  The vesting schedule  provided that 33-1/3% of the
     shares were earned and became  non-forfeitable  on April 8, 1998,  1999 and
     2000.

     The shares issued to the MRP plan were recorded as outstanding  shares, and
     the unvested portion was recorded as unearned compensation through a contra
     equity  account.  The  consolidated  statements of operations  for the year
     ended  September  30,  2000,  includes  compensation  expense of  $725,692,
     relating to the scheduled vesting of MRP shares.

9.   EMPLOYEE STOCK OWNERSHIP PLAN

     Effective  December 31, 2001,  the Company  terminated  its Employee  Stock
     Ownership  Plan  ("ESOP").  As a result of this  termination,  the  Company
     recognized an additional $3,143,467 in related compensation expenses.

                                       36
<PAGE>

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

     Upon adoption,  the ESOP acquired  523,710  shares of the Company's  common
     stock  financed by  $3,491,400  in borrowings by the ESOP from the Company.
     This loan was secured by the shares of Common Stock  purchased and earnings
     thereon.  At December  31, 2001,  422,560  shares,  have been  allocated to
     participants'  accounts.  As a  result  of  the  termination  there  are no
     unallocated  shares.  All allocated  shares are considered  outstanding for
     earnings per share purposes,  while the unallocated shares are not included
     in the calculation.

     As a result of the  termination all debt  outstanding has been repaid.  The
     principal  balance at  September  30,  2001 was  $1,359,259.  The Bank used
     dividends  declared on 3,670  unallocated  shares totaling  $24,467 and the
     sale  of  59,677  unallocated  shares  totaling  $1,334,792  to  repay  the
     outstanding debt. Dividends on allocated shares were treated as a reduction
     of retained earnings.  Dividends on unallocated shares were treated only as
     debt service, and there was no reduction of retained earnings. Compensation
     expense  related to the ESOP was based on the average  fair market value of
     shares during the period since the prior  allocation date through the dates
     shares are committed to be released. The financial statements for the three
     months ended  December 31, 2001 and the years ended  September 30, 2001 and
     2000, include compensation expense of $3,225,564, $1,205,229, and $835,135,
     respectively, related to the ESOP and its termination.

10.  STOCK OPTION PLAN

     On April 8, 1998, the  Shareholders of the Company approved the First South
     Bancorp, Inc. 1997 Stock Option Plan (the "Plan"). The purpose of this Plan
     is to advance the interests of the Company through  providing  selected key
     employees and Directors of the Bank and the Company with the opportunity to
     purchase  shares.  The Plan reserves  1,181,022 shares for grant within ten
     years of the effective date. The option price is required to be 100% of the
     stock's fair market value as defined, with an exception for any shareholder
     with more than a 10% ownership interest in the Company.  The exercise price
     is required to be 110% of the stock's fair market  value for these  options
     holders.  Vesting is  determined  on the date of the grant.  Options have a
     10-year life;  however,  there are additional  limitations for shareholders
     with more than a 10% ownership interest in the Company. The Plan also has a
     change of control  provision under which all options  immediately vest if a
     change of control, as defined, occurs.

     The  Company  has  adopted  SFAS  No.  123,  "Accounting  for  Stock  Based
     Compensation."  As  permitted  by SFAS No.  123,  the Company has chosen to
     apply APB Opinion No. 25,  "Accounting  for Stock Issued to Employees," and
     related  interpretations.   Accordingly,  no  compensation  cost  has  been
     recognized for options granted under the Option Plan. Had compensation cost
     for the Company's  Option Plan been  determined  based on the fair value at
     the grant  dates for  awards  under the  Option  Plan  consistent  with the
     methods of SFAS No. 123, the  Company's net income and net income per share
     would have been reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                               FOR THE THREE MONTHS ENDED
                          December 31, 2002          December 31, 2001            September 30, 2001        September 30, 2000
                       -----------------------   --------------------------    ------------------------   -----------------------
                      As Reported   Pro Forma    As Reported    Pro Forma     As Reported    Pro Forma   As Reported   Pro Forma

<S>                    <C>          <C>          <C>            <C>            <C>           <C>          <C>          <C>
Net income             $9,511,613   $9,363,642   $(1,139,973)   $(1,154,254)   $5,830,292    $5,742,412   $3,549,032   $3,464,965
Earnings per common
    share - basic           2.18         2.15          (.26)          (.27)          1.34         1.32          .76          .74
Earnings per common
    share - diluted         2.06         2.02          (.26)          (.27)          1.30         1.28          .76          .74
</TABLE>

                                       37
<PAGE>

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

     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 for the year ended December 31, 2002, the three
     months ended  December 31, 2001 and the years ended  September 30, 2001 and
     2000,  respectively:  dividend  growth  rate of 17%,  22%,  22%,  and  17%;
     expected volatility of 26.3%, 18.5%, 18.9%, 18.6%; risk-free interest rates
     ranging from 3.79% to 5.12% during the year ended December 31, 2002 ; 4.75%
     during the three months ended December 31, 2001;  5.84%,  5.78%,  and 5.05%
     during the year ended  September  30, 2001;  and 6.0% during the year ended
     September 30, 2000; and expected lives of 7 years.

     A summary of the status of the Plan as of  December  31,  2002 and 2001 and
     September  30,  2001 and 2000,  and  changes  during the years then  ended,
     including weighted-average exercise price ("Price"), is presented below:

<TABLE>
<CAPTION>
                                                                   FOR THE THREE MONTHS ENDED
                                     DECEMBER 31, 2002      DECEMBER 31, 2001     SEPTEMBER 30, 2001     SEPTEMBER 30, 2000
                                    -------------------    -------------------    -------------------    -------------------
                                     Shares      Price      Shares      Price      Shares      Price      SHARES          PRICE
                                    --------     ------    --------     ------    --------     ------    --------     ------

<S>                                  <C>         <C>        <C>         <C>        <C>         <C>        <C>         <C>
Outstanding at beginning of year     603,605     $12.45     613,355     $12.36     619,955     $12.17     606,455     $12.16
Granted                               53,100      29.72       6,000      21.50      28,500      17.09      31,500      12.17
Cancellations                        (21,075)     13.22     (15,750)     12.17     (35,100)     12.23     (18,000)     12.17
                                    --------               --------               --------               --------
Outstanding at year end              635,630      13.87     603,605      12.45     613,355      12.36     619,955      12.17
                                    ========               ========               ========               ========

Weighted-average fair value of
  options granted during the year                $10.30                 $ 4.59                 $ 3.43                 $ 2.68
                                                 ======                 ======                 ======                 ======
</TABLE>

     The following table summarizes additional information about the Option Plan
     at December 31, 2002, including weighted-average remaining contractual life
     ("Life") and Price:

                          OPTIONS OUTSTANDING           OPTIONS EXERCISABLE
                     ------------------------------     -------------------
                      SHARES       LIFE      PRICE       SHARES      PRICE
                     --------     ------     ------     --------     ------
$ 11.83 - 12.38       553,730       5.11     $12.17      553,730     $12.17
$ 15.00 - 18.15        24,300       7.34     $17.42       16,800     $17.10
$ 20.75 - 24.33        27,750       8.41     $22.08       10,500     $21.07
$ 30.23 - 36.70        29,850       9.64     $35.58        1,000     $36.00
                     --------                           --------

                      635,630                            582,030
                     ========                           ========

11.  BORROWED MONEY

     Borrowed money represents advances from the FHLB and repurchase agreements.
     Advances  outstanding  from the FHLB at  December  31,  2002 and 2001 had a
     weighted  average  rate  of  1.3%  and  1.83%,  respectively,  and  totaled
     $34,000,000 and $1,000,000, respectively.

     At  December  31,  2002  and  December  31,  2001,   repurchase  agreements
     outstanding had average rates of .53% and 0.43%, and totaled $4,194,727 and
     $4,441,340, respectively.

                                       38
<PAGE>

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

     At December 31, 2002 and 2001, repurchase agreements were collateralized by
     U.S.  government agency obligations with a principal balance of $7,000,000.
     The Company  has  pledged  all of its stock in the FHLB and  certain  loans
     secured by one to four  family  residential  mortgages  as  collateral  for
     actual or  potential  borrowings  from the FHLB.  At December  31, 2002 and
     2001,  the  Company  had   approximately   $91,600,000  and   $114,000,000,
     respectively, of additional credit available with the FHLB.

12.  INCOME TAXES

     The  components of income tax expense for the year ended December 31, 2002,
     the three months ended December 31, 2001 and the years ended  September 30,
     2001 and 2000, are as follows:

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
<S>                                         <C>              <C>              <C>              <C>
Current:
  Federal                                   $  4,091,587     $  1,028,407     $  3,877,218     $  2,665,596
  State                                          641,548          136,233          559,267          313,600
                                            ------------     ------------     ------------     ------------
                                               4,733,135        1,164,640        4,436,485        2,979,196
                                            ------------     ------------     ------------     ------------

Deferred:
  Federal                                        390,096               --         (310,782)        (287,542)
  State                                           87,118               --          (66,168)         (33,828)
                                            ------------     ------------     ------------     ------------
                                                 477,214               --         (376,950)        (321,370)
                                            ------------     ------------     ------------     ------------
Total                                       $  5,210,349     $  1,164,640     $  4,059,535     $  2,657,826
                                            ============     ============     ============     ============
</TABLE>

     Reconciliations  of the expected  income tax expense at statutory tax rates
     with income tax expense  reported in the  statements of operations  for the
     year ended  December 31, 2002, the three months ended December 31, 2001 and
     the years ended September 30, 2001 and 2000, are as follows:

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
<S>                                         <C>              <C>              <C>              <C>
Expected income tax expense at 34%          $  5,005,467     $      8,387     $  3,362,541     $  2,110,332
State income taxes, net of federal
  income tax                                     680,155          144,153          325,445          296,998
Non-deductible ESOP, other
  expenses and other adjustments                (475,273)       1,012,100          371,549          250,496
                                            ------------     ------------     ------------     ------------
                                            $  5,210,349     $  1,164,640     $  4,059,535     $  2,657,826
                                            ============     ============     ============     ============
</TABLE>

                                       39
<PAGE>

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

     The  components  of  deferred  income  tax assets  and  liabilities  are as
     follows:

                                                DECEMBER 31,      DECEMBER 31,
                                                    2002              2001

Deferred income tax assets:
  Deferred directors' fees                      $     606,750     $     578,037
  Allowance for loan losses                         2,079,734         1,752,708
  Employee benefits                                   696,865           740,189
  Loans mark-to-market                                616,091           315,198
  Other                                               276,252           363,408
                                                -------------     -------------
                                                    4,275,692         3,749,540
                                                -------------     -------------
Deferred income tax liabilities:
  Unrealized gains on securities
      available for sale                            2,446,494         1,754,659
  Depreciation and amortization                       993,871           347,515
  Carrying value - land                               386,200           386,200
  Mortgage servicing rights                           634,207           357,327
  Deferred loan origination fees and costs             92,047            55,472
  FHLB stock                                          195,801           195,801
                                                -------------     -------------
                                                    4,748,620         3,096,974
                                                -------------     -------------
Net deferred income tax (liability) asset       $    (472,928)    $     652,566
                                                -------------     -------------

13.  REGULATORY CAPITAL REQUIREMENTS

     Dividend   payments   made  by  the  Company  are  subject  to   regulatory
     restrictions  under Federal  Reserve Board policy as well as to limitations
     under applicable  provisions of Virginia corporate law. The Federal Reserve
     Board may prohibit a bank holding  company from paying any dividends if the
     holding  company's  bank  subsidiary is  classified as  "undercapitalized."
     Under Virginia law, dividends may be paid out of surplus or, if there is no
     surplus,  out of net profits  for the fiscal year in which the  dividend is
     declared  and  for the  preceding  fiscal  year.  Furthermore,  under  FDIC
     regulations,  the Bank is prohibited from making any capital  distributions
     if,  after  making  the  distribution,  the Bank  would  have:  (i) a total
     risk-based  capital  ratio  of less  than  8.0%;  (ii) a Tier 1  risk-based
     capital  ratio of less than 4.0%;  or (iii) a  leverage  ratio of less than
     4.0%.

     The Bank is subject to various regulatory capital requirements administered
     by the federal and state banking agencies.  Failure to meet minimum capital
     requirements  can  initiate  certain  mandatory,  and  possibly  additional
     discretionary,  actions by  regulators  that, if  undertaken,  could have a
     direct material  effect on the Bank's  financial  statements.  Quantitative
     measures  established by regulation to ensure capital  adequacy require the
     Bank to maintain  minimum  amounts  and  ratios,  as set forth in the table
     below.  Management  believes,  as of December 31, 2002, that the Bank meets
     all capital adequacy requirements to which it is subject.

                                       40
<PAGE>

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

     As of  December  31,  2002,  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 well capitalized the Bank
     must maintain minimum amounts and ratios,  as set forth in the table below.
     There are no conditions or events since that  notification  that management
     believes have changed the Bank's category.

     The Bank's actual regulatory  capital amounts and ratios as of December 31,
     2002 and 2001, are presented in the table below (dollars in thousands):

<TABLE>
<CAPTION>
                                                                                              TO BE WELL
                                                                                             CAPITALIZED
                                                                      FOR CAPITAL            UNDER PROMPT
                                                  ACTUAL            ADEQUACY PURPOSE      ACTION PROVISIONS
                                            ------------------     ------------------     ------------------
                                             AMOUNT     RATIO       AMOUNT     RATIO       AMOUNT     RATIO
                                            --------    ------     --------    ------     --------    ------
December 31, 2002:
<S>                                         <C>           <C>      <C>            <C>     <C>           <C>
Total Capital (to Risk Weighted Assets)     $ 48,240      10.5%    $ 36,763       8.0%    $ 45,954      10.0%
Tier I Capital (to Risk Weighted Assets)      42,481       9.2%      18,382       4.0%      27,572       6.0%
Tier I Capital (to Average Assets)            42,481       7.0%      24,160       4.0%      30,200       5.0%

December 31, 2001:
Total Capital (to Risk Weighted Assets)     $ 48,992      12.7%    $ 30,910       8.0%    $ 38,638      10.0%
Tier I Capital (to Risk Weighted Assets)      44,156      11.4%      15,455       4.0%      23,183       6.0%
Tier I Capital (to Average Assets)            44,156       8.1%      21,885       4.0%      27,357       5.0%
</TABLE>

14.  EARNINGS PER SHARE

     The following table provides a reconciliation of income available to common
     stockholders  and the average number of shares  outstanding  (less unearned
     ESOP shares,  unearned  deferred stock awards and treasury  shares) for the
     year ended  December 31, 2002, the three months ended December 31, 2001 and
     the years ended September 30, 2001 and 2000.  Options to purchase  635,630,
     603,605,  613,355,  and 619,955 shares of common stock were  outstanding at
     December  31,  2002,  December  31, 2001 and  September  30, 2001 and 2000,
     respectively.  For the three months ended December 31, 2001,  none of these
     options  were  included in the  computation  of diluted EPS because the per
     share amounts  calculated  would be  anti-dilutive  because of the reported
     loss.

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
<S>                                         <C>              <C>              <C>              <C>

Net (loss) income (numerator)               $  9,511,612     $ (1,139,973)    $  5,830,292     $  3,549,032
                                            ============     ============     ============     ============

Weighted average shares outstanding
     for basic EPS (denominator)               4,364,925        4,308,369        4,349,769        4,673,652
Dilutive effect of stock options                 263,509               --          128,370           16,656
                                            ------------     ------------     ------------     ------------
Adjusted shares for diluted EPS                4,628,434        4,308,369        4,478,139        4,690,308
                                            ============     ============     ============     ============
</TABLE>

                                       41
<PAGE>

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

15.  MORTGAGE BANKING ACTIVITIES

     Mortgage  loans  serviced for others are not  included in the  accompanying
     consolidated  statements  of  financial  condition.  The  unpaid  principal
     balances of  mortgage  loans  serviced  for others  were  $261,823,025  and
     $274,239,995 at December 31, 2002 and 2001,  respectively.  Servicing loans
     for others generally consists of collecting mortgage payments,  maintaining
     escrow   accounts,   disbursing   payment  to  investors  and   foreclosure
     processing.  Loan  servicing  income is recorded  on the accrual  basis and
     includes  servicing fees from investors and certain charges  collected from
     borrowers, such as late payment fees.

     At December 31, 2002 and 2001,  mortgage  servicing  rights reported in the
     consolidated statements of financial condition,  net of amortization,  were
     $1,642,173 and $1,030,368, respectively.

     During the year ended December 31, 2002 and the three months ended December
     31, 2001, respectively, the Company recorded additional servicing assets of
     $1,009,966  and  $131,804 as a result of sales of loans or  mortgage-backed
     securities. Amortization of servicing assets during the year ended December
     31, 2002 and the three months ended December 31, 2001  aggregated  $152,087
     and $26,674,  respectively.  The fair value of recognized  servicing assets
     amounted to  $1,642,173  and  $1,030,368  as of December 31, 2002 and 2001,
     respectively. In addition during the year ended December 31, 2002, recorded
     an impairment  related to its  servicing  assets in the amount of $246,074.
     The Company's  significant  assumptions  used to estimate  their fair value
     include weighted  average life,  prepayment  speeds,  and expected costs to
     transfer servicing to a third party.

16.  FINANCIAL  INSTRUMENT WITH  OFF-BALANCE  SHEET RISK AND  SIGNIFICANT  GROUP
     CONCENTRATION OF CREDIT RISK:

     The Company is a party to financial instruments with off-balance sheet risk
     in the  normal  course  of  business  to meet  the  financing  needs of its
     customers. These financial instruments include commitments to extend credit
     and involve, to varying degrees,  elements of credit and interest rate risk
     in excess of the amount recognized in the consolidated balance sheet.

     The Company's  exposure to credit loss in the event of  non-performance  by
     the other  party to the  financial  instrument  for  commitments  to extend
     credit is represented by the contractual amount of those  instruments.  The
     Company uses the same credit policies in making commitments and conditional
     obligations as it does for on-balance sheet instruments.

     Commitments  to extend credit are  agreements to lend to a customer as long
     as there is no  violation of any  condition  established  in the  contract.
     Commitments  generally  have fixed  expiration  dates or other  termination
     clauses  and may  require  payment of a fee.  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 on management's credit evaluation of the borrower.

                                       42
<PAGE>

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

     A  summary  of  the  contractual  amounts  of  the  Company's  exposure  to
     off-balance sheet risk as of December 31, 2002 and December 31, 2001, is as
     follows:

                                                    2002              2001

Commitments to extend credit:
  Commitments to originate loans                $  75,656,713     $  50,204,542
                                                -------------     -------------
  Undrawn balances on lines of credit
    and undrawn balances on credit
    reserves (overdraft protection)                48,483,675        48,626,867
                                                -------------     -------------
                                                $ 124,140,388     $  98,831,409
                                                =============     =============

     Included in the  commitments to originate loans as of December 31, 2002 and
     December 31, 2001, are fixed  interest rate loan  commitments of $8,275,646
     and $11,655,067,  respectively.  The shorter duration of interest-sensitive
     liabilities,  to the extent they are used to fund these  fixed-rate  loans,
     indicates  that the Company is exposed to interest rate risk because,  in a
     rising rate  environment,  liabilities  will be repricing  faster at higher
     interest rates,  thereby reducing the market value of fixed-rate  long-term
     assets and net interest income.

     The  Company's  lending is  concentrated  primarily  in  Beaufort,  Craven,
     Cumberland,   Edgecombe,  Lenoir,  Nash,  Pasquotank,  Pitt,  Robeson,  and
     surrounding counties in North Carolina. Credit has been extended to certain
     of the Company's customers through multiple lending transactions.

     Since many of the  commitments  are expected to expire  without being drawn
     upon,   amounts   reported  do  not  necessarily   represent   future  cash
     requirements.

                                       43
<PAGE>

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

17.  PARENT COMPANY FINANCIAL  INFORMATION The Company's  principal asset is its
     investment  in the  Bank.  Condensed  financial  statements  of the  parent
     company as of December 31, 2002 and 2001 and  September  30, 2001 and 2000,
     and for the year ended  December 31, 2002,  the three months ended December
     31, 2001 and the years ended September 30, 2001 and 2000, are as follows:

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
<S>                                         <C>              <C>              <C>              <C>
CONDENSED BALANCE SHEETS
Cash                                        $    847,452     $    734,906     $  1,902,285     $  1,055,374
Due from subsidiary                                   --        4,157,099          931,535          477,287
Investment in wholly-owned subsidiary         49,982,524       46,710,200       49,203,538       43,692,079
Other assets                                       3,945           28,620            8,856            8,747
                                            ------------     ------------     ------------     ------------
    Total assets                            $ 50,833,921     $ 51,630,825     $ 52,046,214     $ 45,233,487
                                            ============     ============     ============     ============

Other liabilities                           $    734,109     $    599,444     $  1,277,596     $    398,752
Stockholders' equity                          50,099,812       51,031,381       50,768,618       44,834,735
                                            ------------     ------------     ------------     ------------
    Total liabilities and
      stockholders' equity                  $ 50,833,921     $ 51,630,825     $ 52,046,214     $ 45,233,487
                                            ============     ============     ============     ============
</TABLE>

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
<S>                                         <C>              <C>              <C>              <C>

CONDENSED STATEMENTS OF INCOME
Interest income, net                        $         --     $     21,690     $    166,623     $    204,090
Equity in earnings of subsidiary               9,572,855       (1,144,436)       5,772,653        3,471,752
Miscellaneous expenses                            61,243           17,227          108,984          126,810
                                            ------------     ------------     ------------     ------------
    Net income (loss)                       $  9,511,612     $ (1,139,973)    $  5,830,292     $  3,549,032
                                            ============     ============     ============     ============
</TABLE>

                                       44
<PAGE>

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

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
<S>                                         <C>              <C>              <C>              <C>
CONDENSED STATEMENTS OF CASH FLOWS
Operating activities:
  Net income (loss)                         $  9,511,612     $ (1,139,973)    $  5,830,292     $  3,549,032
  Adjustments to reconcile net income
   (loss) to net cash provided by
   operating activities:
   Equity in undistributed earnings of
     subsidiary                               (2,122,362)       1,144,436       (5,772,653)      (3,471,752)
   ESOP compensation                                  --        4,560,356        1,205,229          853,930
   MRP compensation                                   --               --               --          725,692
   Other operating activities                    153,529         (697,915)         878,733           70,001
                                            ------------     ------------     ------------     ------------
   Net cash provided by operating
     activities                                7,542,779        3,866,904        2,141,601        1,726,903
                                            ------------     ------------     ------------     ------------
Investing activities:
  Repayments of advances to subsidiary         4,157,100       (2,692,564)       4,533,752        6,863,802
                                            ------------     ------------     ------------     ------------
    Net cash provided by (used in)
      investing activities                     4,157,100       (2,692,564)       4,533,752        6,863,802
                                            ------------     ------------     ------------     ------------
Financing activities:
  Proceeds from exercise of stock options        228,115          100,375          360,864               --
  Purchase of treasury shares                 (8,869,750)      (1,908,513)      (4,253,215)      (7,268,139)
  Dividends paid                              (2,945,698)        (533,581)      (1,936,091)      (1,418,936)
                                            ------------     ------------     ------------     ------------
  Net cash used in financing activities      (11,587,333)      (2,341,719)      (5,828,442)      (8,687,075)
                                            ------------     ------------     ------------     ------------
Net increase (decrease) in cash                  112,546       (1,167,379)         846,911          (96,370)
Cash at beginning of year                        734,906        1,902,285        1,055,374        1,151,744
                                            ------------     ------------     ------------     ------------
Cash at end of year                         $    847,452     $    734,906     $  1,902,285     $  1,055,374
                                            ============     ============     ============     ============
</TABLE>

                                       45
<PAGE>

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

18.  QUARTERLY FINANCIAL DATA (UNAUDITED)

     Summarized  unaudited quarterly financial data for the years ended December
     31, 2002 and September 30, 2001, is as follows (in thousands):

                                         FOURTH     THIRD      SECOND     FIRST
                                         ------     ------     ------     ------
2002:
Interest income                          $9,367     $9,226     $9,185     $9,048
                                         ------     ------     ------     ------
Interest expense                          2,872      3,043      3,198      3,361
Provision for loan losses                   684        430        333        309
Noninterest income                        2,626      2,122      1,911      1,804
Noninterest expense                       4,518      4,085      3,993      3,741
Income tax expense                        1,393      1,336      1,219      1,262
                                         ------     ------     ------     ------

Net income                               $2,526     $2,454     $2,353     $2,179
                                         ======     ======     ======     ======

Net income per common share:
     Basic                               $  .60     $  .56     $  .53     $  .49
     Diluted                             $  .56     $  .53     $  .50     $  .47
                                         ======     ======     ======     ======

                                         FOURTH     THIRD      SECOND     FIRST
                                         ------     ------     ------     ------
2001:
Interest income                          $9,794    $10,231    $10,863    $11,271
Interest expense                          4,560      5,298      5,967      6,343
Provision for loan losses                    50         --        540        240
Noninterest income                        1,933      1,690      1,853      1,299
Noninterest expense                       4,498      3,949      3,898      3,701
Income tax expense                        1,082      1,090        946        941
                                         ------     ------     ------     ------

Net income                               $1,537     $1,584     $1,365     $1,345
                                         ======     ======     ======     ======

Net income per common share:
     Basic                               $  .36     $  .37     $  .31     $  .30
     Diluted                             $  .34     $  .35     $  .31     $  .30
                                         ======     ======     ======     ======

19.  FAIR VALUES OF FINANCIAL INSTRUMENTS

     Statement of Financial  Accounting  Standards No. 107,  "Disclosures  about
     Fair  Value of  Financial  Instruments"  ("SFAS  No.  107"),  requires  the
     disclosure  of  estimated  fair values for  financial  instruments.  Quoted
     market prices, if available,  are utilized as an estimate of the fair value
     of  financial  instruments.  Because no quoted  market  prices  exist for a
     significant part of the Company's financial instruments,  the fair value of
     such  instruments has been derived based on management's  assumptions  with
     respect to future economic conditions, the amount and timing of future cash
     flows  and  estimated  discount  rates  with  respect  to  future  economic
     conditions,  the  amount  and  timing of future  cash  flows and  estimated
     discount rates.  Different  assumptions  could  significantly  affect these
     estimates.  Accordingly,  the net  realizable  value  could  be  materially
     different from the estimates  presented  below. In addition,  the estimates
     are only indicative of individual financial  instruments' values and should
     not be considered an indication of the fair value of the Company taken as a
     whole.  Fair  values  have  been  estimated  using  data  which  management
     considers  as the  best  available,  and  estimation  methodologies  deemed
     suitable for the pertinent category of financial instrument. The estimation
     methodologies,  resulting  fair values,  and recorded  carrying  amounts at
     December 31, 2002 and 2001, were as follows:

                                       46
<PAGE>

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

     Cash and cash  equivalents are by definition  short-term and do not present
     any  unanticipated  credit  issues.  Therefore,  the  carrying  amount is a
     reasonable  estimate of fair value. The estimated fair values of investment
     securities and mortgage backed  securities are provided in Notes 3 and 4 to
     the financial  statements.  These are based on quoted market  prices,  when
     available.  If a  quoted  market  price  is not  available,  fair  value is
     estimated using quoted market prices for similar securities.

     The fair  value of the net loan  portfolio  has been  estimated  using  the
     present  value of expected  cash  flows,  discounted  at an  interest  rate
     adjusted  for  servicing  costs  and  giving   consideration  to  estimated
     prepayment risk and credit loss factors, as follows:

<TABLE>
<CAPTION>
                                  DECEMBER 31,                    DECEMBER 31,
                                      2002                            2001
                          ----------------------------    ----------------------------
                           ESTIMATED        CARRYING       ESTIMATED        CARRYING
                           FAIR VALUE        AMOUNT        FAIR VALUE        AMOUNT
                          ------------    ------------    ------------    ------------
<S>                       <C>             <C>             <C>             <C>
1 - 4 family mortgages    $123,608,167    $120,591,198    $133,116,482    $131,934,750
Consumer                    80,398,723      80,772,516      77,001,289      76,812,819
Non-residential            289,550,195     289,550,195     196,865,486     196,865,486
                          ------------    ------------    ------------    ------------
                          $493,557,085    $490,913,909    $406,983,257    $405,613,055
                          ============    ============    ============    ============
</TABLE>

     The fair value of deposit  liabilities  with no stated  maturities has been
     estimated  to equal the  carrying  amount (the  amount  payable on demand),
     totaling  $218,566,325  and  $171,428,760  at  December  31, 2002 and 2001,
     respectively.  The fair value  estimates for these  products do not reflect
     the benefits that the Bank receives  from the low-cost,  long-term  funding
     they provide. These benefits are considered significant.

     The fair value of  certificates  of deposits and advances  from the FHLB is
     estimated  by  discounting  the future cash flows  using the current  rates
     offered  for  similar   deposits  and  advances  with  the  same  remaining
     maturities. The carrying value and estimated fair values of certificates of
     deposit and FHLB advances at December 31, 2002 and 2001, are as follows:

                                                    2002              2001
                                                -------------     -------------
Certificates of deposits:
     Carrying amount                            $ 307,760,839     $ 304,159,745
                                                -------------     -------------
     Estimated fair value                         312,110,400       307,269,097
                                                -------------     -------------

Advances for Federal Home Loan Bank:
     Carrying amount                            $  34,000,000     $   1,000,000
                                                -------------     -------------
     Estimated fair value                          34,000,000         1,000,000
                                                -------------     -------------

     The carrying amount of repurchase  agreements  approximates the fair value.
     The  interest  rate on these  agreements  is a  floating  rate based on the
     federal fund's daily rate.

                                       47
<PAGE>

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

     There is no material  difference  between the carrying amount and estimated
     fair value of off-balance sheet items totaling  $97,687,000 at December 31,
     2002 and $98,831,409 at December 31, 2001, which are primarily comprised of
     unfunded loan commitments.

     The Company's remaining assets and liabilities are not considered financial
     instruments.

20.  SUPPLEMENTAL CASH FLOW INFORMATION

     Supplemental cash flow information for the year ended December 31, 2002 and
     the three months ended December 31, 2001 and the years ended  September 30,
     2001 and 2000, is as follows:

<TABLE>
<CAPTION>
                                            DECEMBER 31,     DECEMBER 31,     SEPTEMBER 30,    SEPTEMBER 30,
                                                2002             2001             2001             2000
<S>                                         <C>              <C>              <C>              <C>
Real estate acquired in settlement
  of loans                                  $    861,499     $    326,515     $    918,091     $    411,040
Exchange of loans for mortgage-backed
  securities                                          --               --       12,298,139       62,789,209
Cash paid for interest                        12,569,916        4,161,729       22,391,730       19,012,680
Cash paid for income taxes                     5,819,151        1,360,075        3,350,211        2,769,000
Dividends declared, not paid                     712,992          533,581          518,511          387,220
Repurchase of unearned ESOP shares                    --        1,334,792               --               --
</TABLE>

                                       48
<PAGE>

                               BOARD OF DIRECTORS

LINLEY H. GIBBS, JR.
CHAIRMAN
Retired
Washington, NC

FREDERICK H. HOWDY
President
Drs. Freshwater and Howdy, P.A.
Washington, NC

MARSHALL T. SINGLETON
Co-Owner
B. E. Singleton & Sons
Washington, NC

FREDERICK N. HOLSCHER
VICE CHAIRMAN
Partner
Rodman, Holscher, Francisco,
and Peck
Washington, NC

CHARLES E. PARKER, JR.
Vice President
Robinson Insurance Agency
New Bern, NC

THOMAS A. VANN
President and
Chief Executive Officer
First South Bank
Washington, NC

EDMUND T. BUCKMAN, JR.
Retired
Washington, NC

H. D. REAVES, JR.
Former President and
Chief Executive Officer
Home Federal Savings & Loan
Fayetteville, NC

                               EXECUTIVE OFFICERS

THOMAS A. VANN
President and
Chief Executive Officer

MARY R. BOYD
Executive Vice President
Loan Servicing

KRISTIE W. HAWKINS
Treasurer
Controller

JACK L. ASHLEY
Senior Executive Vice President
Chief Operating Officer

SHERRY L. CORRELL
Executive Vice President
Deposit Operations

WILLIAM L. WALL
Executive Vice President
Chief Financial Officer and
Secretary

PAUL S. JABER
Executive Vice President
Mortgage Operations

                                 AREA EXECUTIVES

JAMES F. BUCKMAN, IV
Senior Vice President
Area Executive
Pamlico/Albemarle Region

JAMES R. ROSE, JR.
Senior Vice President
Area Executive
Neuse Region

WILLIAM L. HEDGEPETH, II
Senior Vice President
Area Executive
Cape Fear Region

ROBERT D. ROSS
Senior Vice President
Area Executive
Triangle Region

G. LEONARD PITTMAN, JR.
Senior Vice President
Area Executive
Tar River Region

                                       49
<PAGE>

                        FIRST SOUTH BANK OFFICE LOCATIONS

CHOCOWINITY
2999 Highway 17 South
252-940-4970

ELIZABETH CITY
604 East Ehringhaus Street
252-335-0848

FAYETTEVILLE
241 Green Street
910-438-3681

3107 Raeford Road
910-484-2116

GREENVILLE
301 East Arlington Boulevard
252-321-2600

KILL DEVIL HILLS
1906 South Croatan Drive
252-441-9935

KINSTON
827 Hardee Road
252-522-9466

2430 Heritage Street
252-523-9449

LUMBERTON
600 North Chestrnut Street
910-739-3274

3000 North Elm Street
910-608-5031

NEW BERN
202 Craven Street
252-636-2997

1725 Glenburnie Road
252-636-3569

ROCKY MOUNT
300 Sunset Avenue
252-972-9661

2901 Sunset Avenue
252-451-1259

1378 Benvenue Road
252-442-8375

450 North Winstead Avenue
252-937-1900

3635 North Halifax Road
252-451-8700
(In Smith's Red & White/Dortches)

RALEIGH
Loan Production Office
8408 Six Forks Road
919-845-9897

TARBORO
100 East Hope Lodge Street
252-823-0157

WASHINGTON
1311 Carolina Avenue
252-946-4178

300 North Market Street
252-940-4945

1328 John Small Avenue
252-940-5000

Credit Administration
239 West Main Street
252-946-4178

Operations Center
220 Creekside Drive
252-946-4178

First South Leasing, LLC
239 West Main Street
252-946-4178

                         FIRST SOUTH BANK ATM* LOCATIONS

CHOCOWINITY
2999 Highway 17 South

ELIZABETH CITY
604 East Ehringhaus Street

FAYETTEVILLE
241 Green Street
3107 Raeford Road

GREENVILLE
301 East Arlington Boulevard

KILL DEVIL HILLS
1906 South Croatan Highway

KINSTON
2430 Heritage Street

LUMBERTON
3000 North Elm Street
3551 Fayetteville Road

NEW BERN
1725 Glenburnie Road

ROCKY MOUNT
300 Sunset Avenue
2901 Sunset Avenue
1378 Benvenue Road
450 North Winstead Avenue
3635 North Halifax Road

TARBORO
1202 Western Boulevard

WASHINGTON
1311 Carolina Avenue
300 North Market Street
1328 John Small Avenue

----------------
*Member of Star and Cirrus ATM Networks
*Member FDIC

                                       50

FIRST SOUTH BANK PRODUCTS AND SERVICES

PERSONAL BANKING SERVICES

CHECKING ACCOUNTS:
     Free Basic Checking
     Free Senior Checking (age 50 and over)
     Executive Checking
     Preferred Checking
     Money Market Checking

LENDING SERVICES:
     Consumer Loans
     Home Equity Loans
     Mortgage Loans
     FHA/VA Financing
     Reserve Lines
     VISA Credit Services

SAVINGS ACCOUNTS:
     Regular Savings
     Custodial Savings

OTHER PERSONAL BANKING SERVICES:
     AccessLine 24-Hour Telephone Banking
     Automated Teller Machines (ATMs)
     24-Hour Banking Cards (ATM)
     Certificates of Deposit
     Individual Retirement Accounts
     VISA CheckCards
     Drive-Thru Windows
     Night Depository
     Safe Deposit Boxes
     Wire Transfers

COMMERCIAL BANKING SERVICES
CHECKING ACCOUNTS:
     Commercial Checking
     Commercial Money Market Checking
     Business Interest Checking
     Simple Business Checking
     Simple Business Plus Checking

LENDING SERVICES:
     Commercial Real Estate Loans
     Commercial Business Loans
     SBA Loans
     Lines of Credit

OTHER COMMERCIAL BANKING SERVICES:
     Cash Management Sweep Products
     Total Treasury Manager
     VISA Merchant Services
     Letters of Credit
     Night Depository
     Wire Transfers
     Cash Services (Coin and Currency)

OTHER FINANCIAL SERVICES

FIRST SOUTH LEASING, LLC

In August of 2001,  First South Bank  addressed  the  growing  demand in eastern
North Carolina for a community bank to offer leasing  services by creating First
South Leasing, LLC. First South Leasing special-izes in general equipment leases
with markets that extend into the Tidewater Virginia and South Carolina regions,
and as far west as the Piedmont Region.

Advantages of Leasing include:

o    Leasing frees working capital for other uses.
o    Leasing offers fixed payments.
o    Properly  structured  lease  payments are 100% tax deductible as a business
     expense.
o    Leasing  provides  a hedge  against  inflation:  by paying off a lease with
     tomorrow's   dollars,  a  business  can  replace  leased  equipment  before
     obsolescence reduces efficiency and profits.

To find out more,  call  toll-free  at  1-800-845-6576.  Leasing  frees  working
capital for other uses. Leasing offers fixed payments.

UVEST INVESTMENT SERVICES

Through a  partnership  with UVEST  Investment  Services,  First  South Bank now
offers investment  services.  UVEST, which is headquartered in Charlotte,  North
Carolina, is a registered securities  broker-dealer and a member of the National
Association of Securities Dealers (NASD) and the Securities Investors Protection
Corporation (SIPC), as well as the Securities Industry Association (SIA).

With an  appointment,  an  investment  consultant  can be available at any First
South Bank location for a free, no obligation consultation. Discuss a full range
of  broker-age  services  including   financial  analysis,   professional  money
management,   stocks,  bonds,  mutual  funds,  annuities,  and  more.  For  more
information,  contact Steve Wiggins  (252-946-4178) or Tony Russ (252-451-0867),
Investment Consultants, or call toll-free at 1-800-946-4178.

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                  Investment products are not FDIC insured, are
                    not bank guaranteed, and may lose value.
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