2006 Annual Report

First South Bancorp

<PAGE>

                                TABLE OF CONTENTS

Letter to Stockholders                                                         1

Selected Consolidated Financial Information and Other Data                     3

Management's Discussion and Analysis of Financial Condition
  and Results of Operations                                                    4

Report of Independent Registered Public Accounting Firm                       15

Consolidated Statements of Financial Condition                                16

Consolidated Statements of Operations                                         17

Consolidated Statements of Changes in Stockholders' Equity                    18

Consolidated Statements of Cash Flows                                         19

Notes to Consolidated Financial Statements                                    20

Board of Directors                                                            41

Executive Officers                                                            41

Area Executives & Subsidiary Executives                                       41

City & Branch Executives                                                      41

First South Bank Office Locations                                             42

Stockholder Information                                                       43

Comparative Stock Performance Graph                                           44

                                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:

The financial performance achieved by First South Bancorp ("First South") and
its wholly owned subsidiary, First South Bank ("Bank") during the year ended
December 31, 2006 yielded a significant return on investment for our
stockholders. During 2006, we accomplished our financial and strategic
objectives, set a new earnings record and continued to enhance shareholder
value.

For 2006, we are again pleased to report record earnings of $17.2 million
representing a 21.7% increase over the $14.1 million earned in 2005. Diluted
earnings per share increased 22.0% to $1.72 per share for 2006 from $1.41 per
share for 2005. The significance of these earnings has been the Bank's success
of managing the interest sensitivity gap relationship between the maturity and
repricing of its interest-earning assets and interest-bearing liabilities. This
has allowed us to sustain the volume of our net interest income during a period
of rising interest rates, slower loan growth, and competitive pressure on
deposit flows in the market areas we serve.

Total assets of First South grew by 9.1% to $910.5 million at year-end 2006,
from $834.2 million at year-end 2005. In addition, total loans and leases
increased to $761.4 million and deposits increased to $800.2 million,
respectively, at year-end 2006. Internal growth was strong in a very competitive
environment and the Bank's reliance on borrowings was minimal.

We also continued placing efforts on controlling operating expenses, resulting
in a 43.1% efficiency ratio for 2006. In addition, our key performance ratios,
return on average assets (ROA) and return on average equity (ROE), continue to
place us at the top of our peer group. Our ROA and ROE was 1.9% and 23.5%,
respectively, for 2006.

The total return to our stockholders increased significantly in 2006. During
2006, the Board of Directors declared a three-for-two stock split, increased the
quarterly cash dividend payment rate by 25.0%, and when combined with the
appreciation in the market price of our common stock, resulted in a 38.3% total
return to our shareholders.

We enjoyed many positive events during 2006. We received national and statewide
recognition for our operating efficiency, 3-year return on equity and various
operating performance ratios including return on average equity, return on
capital, net interest margin and total one-year return from American Banker, ABA
Banking Journal, Business North Carolina, U. S. Banker, and the Charlotte
Business Journal. First South was listed in the new NASDAQ Global Select Market,
which places us in a peer group of the top listed companies in the world. In
addition, we retained our listing in the Russell Index of funds, which helps
raise First South's visibility with investors that rely on the Russell Indexes
as part of their investment strategy. We are pleased with these recognitions, as
they further exemplify the market awareness of First South and the Bank among
both the business and investment communities.

During 2006, we relocated our limited service office in Avon, North Carolina to
a new full service office in Buxton, North Carolina, and we are currently
renovating a new full service office in Durham, North Carolina. We recently
acquired a new site to locate a third full service office in Greenville, North
Carolina. This expansion will allow us to better serve the banking needs in our
growing market area, expand our customer base in existing markets and represents
a continuation of the growth of our branch office network. In addition, this
year we completed the construction and occupancy of a new credit administration
operations center. This has provided us a centralized facility in order to be
more responsive in meeting the credit needs and providing administrative support
to our growing commercial banking customer base.


                                        1

<PAGE>

During 2007, we will focus on refurbishing a portion of our existing branch
offices, in order to improve their efficiency and allow us to offer a broader
range of services.

Many of our future strategies will focus on enhancing First South's franchise
value. Our goal is to continue being a high performance bank, both in
profitability and growth without compromising service. We are committed to our
shareholders, our customers, and our employees.

We will continue to review the structure of the assets and liabilities of the
Bank in order to meet the challenges of a changing world. We will use internal
and external growth to meet our strategic plan. As the consolidation of our
industry continued, this should create significant opportunities for First South
to expand into new markets.

The outstanding financial results achieved this year would not have been
possible without the hard work and dedication of our professional staff. We are
appreciative and proud of their accomplishments. They are committed to First
South, its principles and to providing their customers the highest possible
level of service. We will continue to invest in our employees, which will
ultimately result in improved service to our customers and enhanced shareholder
value.

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, we
welcome your comments or suggestions and we look forward to your continued
support.

                                      Sincerely,


                                      /s/ Tom Vann
                                      ----------------------------------
                                      Tom Vann
                                      President and
                                      Chief Executive Officer


                                        2

<PAGE>

           SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

<TABLE>
<CAPTION>
                                                  At or For the Years Ended December 31, 2006, 2005,
                                                                 2004, 2003 and 2002
                                                 --------   -----------------------------------------
                                                 12/31/06   12/31/05   12/31/04   12/31/03   12/31/02
                                                 --------   --------   --------   --------   --------
                                                     (dollars in thousands, except per share data)
<S>                                              <C>        <C>        <C>        <C>        <C>
Selected Financial Condition Data
Total assets                                     $910,548   $834,234   $722,051   $675,836   $628,473
Loans receivable, net                             761,437    708,929    631,816    553,200    490,914
Cash and investment securities                     82,258     74,771     52,997     84,996     90,259
Mortgage-backed securities                         36,729     22,702      9,209     11,715     23,526
Deposits                                          800,188    733,753    628,537    583,173    526,327
Borrowings                                         21,450     22,098     25,102     29,648     38,195
Stockholders' equity                               78,797     68,190     59,695     55,164     50,100

Selected Operations Data
Interest income                                  $ 67,752   $ 53,176   $ 40,180   $ 36,905   $ 36,826
Interest expense                                   25,607     15,464      9,692     10,186     12,473
                                                 --------   --------   ---------  --------   --------
Net interest income                                42,145     37,712     30,488     26,719     24,353
Provision for credit losses                           933      1,711        968        988      1,756
Noninterest income                                  9,259      8,207      8,750     10,502      8,462
Noninterest expenses                               22,207     21,132     19,592     17,979     16,337
                                                 --------   --------   ---------  --------   --------
Income before income taxes                         28,264     23,076     18,678     18,254     14,722
Income taxes                                       11,072      8,947      6,966      6,841      5,210
                                                 --------   --------   ---------  --------   --------
Net income                                       $ 17,192   $ 14,129   $ 11,712   $ 11,413   $  9,512
                                                 ========   ========   =========  ========   ========

Per Share Data
Earnings per share - basic                  (1)  $   1.77   $   1.49   $   1.25   $   1.22   $   0.97
Earnings per share - diluted                (1)      1.72       1.41       1.19       1.15       0.91
Dividends per share                         (1)      0.68       0.53       0.45       0.35       0.29

Selected Financial Ratios and Other Data
Performance Ratios:

Return on average assets                             1.93%      1.78%      1.64 %     1.76%      1.64%
Return on average equity                            23.45      21.92      20.50      22.06      18.39
Interest rate spread                                 4.94       5.04       4.63       4.46       4.43
Net interest margin                                  5.05       5.11       4.66       4.49       4.54
Average earning assets/average
  interest bearing liabilities                     119.20     118.66     116.63     114.16     116.03
Noninterest expense/average assets                   2.50       2.67       2.75       2.77       2.81
Efficiency ratio                                    43.14      45.95      49.87      48.30      49.79
Dividend payout ratio                               38.42      35.87      36.36      29.09      31.19

Quality Ratios:
Nonperforming assets/total assets                    0.37%      0.27%      0.34 %     0.41%      0.31%
Nonperforming loans/total loans                      0.36       0.32       0.37       0.47       0.31
Allowance for credit losses/total loans              1.29       1.29       1.30       1.36       1.40
Provision for credit losses/total loans              0.12       0.24       0.15       0.18       0.36

Capital Ratios and Other Data:
Equity/total assets, end of period                   8.65%      8.18%      8.28 %     8.16%      7.97%
Average equity/average assets                        8.24       8.13       8.02       7.96       8.90
Full service offices                                   26         26         25         22         21
Loans serviced for others                        $245,633   $260,632   $277,252   $288,917   $262,504
</TABLE>

(1)   Adjusted for three-for-two stock splits on May 25, 2006, April 23, 2004
      and April 19, 2002.


                                        3

<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, 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 Global Select
Market under the symbol FSBK.

Stock Split. On May 25, 2006 the Company paid a three-for-two stock split, in
the form of a 50% stock dividend, to stockholders of record as of May 4, 2006.
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.

Liquidity and Capital Resources. 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 loan 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 and lease
financing receivables. 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 depend on the Bank's operating,
financing, lending and investing activities during any given period. At December
31, 2006 and 2005, cash and cash equivalents totaled $25.8 million and $32.9
million, respectively. The Bank has other sources of liquidity if a need for
additional funds arises. Investment and mortgage-backed securities available for
sale totaled $91.5 million at December 31, 2006 and $62.5 million at December
31, 2005. During the years ended December 31, 2006 and 2005, the Bank sold or
exchanged real estate loans of $18.4 million and $29.2 million, respectively.
Borrowings consisting of FHLB advances, junior subordinated debentures and
retail repurchase agreements were $21.4 million at December 31, 2006 compared to
$22.1 million at December 31, 2005. The Bank has pledged its FHLB Atlanta stock
and certain loans as collateral for actual or potential FHLB advances. The Bank
has a minimum credit availability with the FHLB of 40% of the Bank's total
assets. At December 31, 2006 the Bank had unused credit availability with the
FHLB of $357.3 million, compared to $327.1 million at December 31, 2005.

The Company had $10.3 million of junior subordinated debentures at December 31,
2006 and 2005, respectively, issued through a private placement pooled trust
preferred securities offering by First South Preferred Trust I, a Delaware
statutory trust. The trust preferred securities bear interest at a rate of 2.95%
over three-month LIBOR payable quarterly, have a 30-year maturity and are first
redeemable, in whole or in part, on or after September 30, 2008, with certain
exceptions. For regulatory purposes, the $10.3 million total of trust preferred
securities qualifies as Tier 1 capital for the Company and the Bank, to the
extent such proceeds have been invested in the Bank and the Company. Proceeds
from the trust preferred securities were used by the statutory trust to purchase
junior subordinated debentures issued by the Company. For additional
information, see Note 19 of Notes to Consolidated Financial Statements.


                                        4

<PAGE>

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 $81.1 million at December 31, 2006, compared to $75.5 million at
December 31, 2005. 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, 2006 and
2005.

At December 31, 2006, stockholders' equity was $78.8 million, compared to $68.2
million at December 31, 2005. Net income for fiscal 2006 was $17.2 million,
compared to $14.1 million for fiscal 2005. At December 31, 2006 there were
9,788,133 shares of common stock outstanding, net of 1,466,089 treasury shares.

Contractual Obligations and Commitments. In the normal course of business there
are various outstanding contractual obligations of the Company that will require
future cash outflows. In addition, there are commitments and contingent
liabilities, such as commitments to extend credit, which may or may not require
future cash outflows. Table 1 below reflects contractual obligations of the
Company outstanding as of December 31, 2006.

Table 1 - Contractual Obligations and Commitments

<TABLE>
<CAPTION>
                                                           Payments Due by Period
                                          ---------------------------------------------------------
                                                      Less Than                              Over
         Contractual Obligations            Total       1 Year    1-3 Years   4-5 Years    5 Years
---------------------------------------   ---------   ---------   ---------   ---------   ---------
                                                               (In thousands)
<S>                                        <C>         <C>         <C>          <C>        <C>
Borrowed money                             $ 11,140    $  6,000    $ 5,140      $   --     $    --
Junior subordinated debentures               10,310          --         --          --      10,310
Lease obligations                             1,189         441        560         188          --
Deposits                                    800,188     759,309     38,070       2,809          --
                                           --------    --------    -------      ------     -------

    Total contractual cash obligations     $822,827    $765,750    $43,770      $2,997     $10,310
                                           ========    ========    =======      ======     =======
</TABLE>

<TABLE>
<CAPTION>
                                                 Amount of Commitment Expiration Per Period
                                          ---------------------------------------------------------
                                            Total
                                           Amounts    Less than                             Over
           Other Commitments              Committed     1 Year    1-3 Years   4-5 Years    5 Years
---------------------------------------   ---------   ---------   ---------   ---------   ---------
                                                               (In thousands)
<S>                                        <C>          <C>        <C>          <C>        <C>
Commitments to originate loans             $ 98,085     $83,268    $14,817      $   --     $     --
Undrawn balances on lines of credit and
  undrawn balances on credit reserves        54,345         703      3,123       3,781       46,738
Standby letters of credit                     2,720       2,720         --          --           --
                                           --------     -------    -------      ------     --------

    Total other commitments                $155,150     $86,691    $17,940      $3,781     $46, 738
                                           ========     =======    =======      ======     ========
</TABLE>

In the normal course of business, the Company may enter into purchase agreements
for goods or services. In management's opinion, the dollar amount of such
agreements at December 31, 2006 is not material and has not been included in
Table 1 above.

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 2 below for additional information
on the effects of net interest income caused by changes in interest rates.


                                        5

<PAGE>

Interest rate risk and trends, liquidity and capital ratio requirements are
reported 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 primary approach in managing the Bank's interest rate risk has been to
increase interest sensitive assets such as commercial loans, consumer loans and
lease financing receivables. At December 31, 2006, the Bank had $697.3 million
of commercial loans, consumer loans and lease receivables, compared to $650.5
million at December 31, 2005. The Bank had $25.6 million of loans held for sale
at December 31, 2006, compared to $10.8 million at December 31, 2005. 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, a majority of investment and mortgage-backed 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 $91.5 million of
investment and mortgage-backed securities classified as available for sale at
December 31, 2006, compared to $62.5 million at December 31, 2005.

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, it 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 19%, 39% and 60% and
decreases in NPV of 19%, 37% and 54% in the event of sudden and sustained 1% to
3% increases or decreases in market interest rates. Table 2 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, 2006. At December 31, 2006, the Bank's
estimated changes in NPV and net interest income were within the targets
established by the Board.

Table 2 - Projected Change in NPV and Net Interest Income

                 Net Portfolio Value             Net Interest Income
 Change    ------------------------------   ------------------------------
in Rates   $ Amount   $ Change   % Change   $ Amount   $ Change   % Change
--------   --------   --------   --------   --------   --------   --------
                          (Dollars in thousands)
+ 300 bp   $ 99,289   $(9,526)    (8.8)%    $ 46,672   $ 3,111       7.1%
+ 200 bp    102,756    (6,059)    (5.6)       45,638     2,077       4.8
+ 100 bp    106,089    (2,726)    (2.5)       44,654     1,093       2.5
Base        108,815        --       --        43,561        --        --
- 100 bp    109,055       240      0.2        42,316    (1,245)     (2.9)
- 200 bp    106,828    (1,987)    (1.8)       40,833    (2,728)     (6.3)
- 300 bp    104,321    (4,494)    (4.1)       39,113    (4,448)    (10.2)


                                        6

<PAGE>

The NPV calculation is based on the net present value of discounted cash flows
utilizing market prepayment assumptions.

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.

Certain shortcomings are inherent in the method of analysis presented in Table
2. 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-sensitive liabilities exceeds the amount of
interest-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 3 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 Company'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 4 below sets forth certain information relating to the Company's
Statements of Financial Condition and Statements of Operations for the three
years ended December 31, 2006, 2005, and 2004, 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 Company does not believe that
using month end balances rather than average daily balances has caused any
material difference in the information presented.


                                        7

<PAGE>

Table 3 - Rate/Volume Analysis

<TABLE>
<CAPTION>
                                            Year Ended December 31,              Year Ended December 31,
                                       ----------------------------------   -----------------------------------
                                                2006  vs.  2005                      2005  vs.  2004
                                       ----------------------------------   -----------------------------------
                                          Increase (Decrease) Due to            Increase (Decrease) Due to
                                       ----------------------------------   -----------------------------------
                                                                    (In thousands)
                                                          Rate/                                 Rate/
                                       Volume    Rate    Volume    Total    Volume    Rate     Volume    Total
                                       ------   ------   ------   -------   ------   -------   ------   -------
<S>                                    <C>      <C>      <C>      <C>       <C>      <C>       <C>      <C>
Interest income:
Loans receivable                       $4,544   $7,610   $  687   $12,841   $5,483   $ 7,067   $1,055   $13,605
Investment securities                     978     (221)    (111)      646     (535)     (349)      67      (817)
Mortgage-backed securities              1,181       11       25     1,217      (36)      (23)       2       (57)
Other interest-earning assets            (202)     170      (96)     (128)     108        72       85       265
                                       ------   ------   ------   -------   ------   -------   ------   -------
  Total earning assets                  6,501    7,570      505    14,576    5,020     6,767    1,209    12,996
                                       ------   ------   ------   -------   ------   -------   ------   -------

Interest expense:
Deposits                                1,657    6,877      783     9,317    1,233     3,840      530     5,603
FHLB advances                             192      127      201       520     (184)      133      (93)     (144)
Other interest-bearing liabilities         28      270        9       307       63       221       28       312
                                       ------   ------   ------   -------   ------   -------   ------   -------
  Total interest-bearing liabilities    1,877    7,274      993    10,144    1,112     4,194      465     5,771
                                       ------   ------   ------   -------   ------   -------   ------   -------
Change in net interest income          $4,624   $  296   $ (488)  $ 4,432   $3,908   $ 2,573   $  744   $ 7,225
                                       ======   ======   ======   =======   ======   =======   ======   =======
</TABLE>

<TABLE>
<CAPTION>
                                            Year Ended December 31,                Year Ended December 31,
                                       ----------------------------------   -----------------------------------
                                                2004  vs.  2003                       2003  vs.  2002
                                       ----------------------------------   -----------------------------------
                                           Increase (Decrease) Due to           Increase (Decrease) Due to
                                       ----------------------------------   -----------------------------------
                                                                    (In thousands)
                                                          Rate/                                 Rate/
                                       Volume    Rate    Volume    Total    Volume    Rate     Volume    Total
                                       ------   ------   ------   -------   ------   -------   ------   -------
<S>                                    <C>      <C>      <C>      <C>       <C>      <C>       <C>      <C>
Interest income:
Loans receivable                       $4,853   $ (430)  $  (65)  $ 4,358   $5,737   $(3,586)  $(666)   $ 1,485
Investment securities                    (649)     123      (24)     (550)     (79)      (62)      1       (140)
Mortgage-backed securities               (478)     (47)      21      (504)  (1,057)     (126)     61     (1,122)
Other interest-earning assets             (34)       7       (2)      (29)    (114)      (52)     22       (144)
                                       ------   ------   ------   -------   ------   --------  ------   -------
  Total earning assets                  3,692     (347)     (70)    3,275    4,487    (3,826)   (582)        79
                                       ------   ------   ------   -------   ------   --------  ------   -------

Interest expense:
Deposits                                  477   (1,433)     (69)   (1,025)   1,275    (3,369)   (346)    (2,440)
FHLB advances                              62       68       49       179      184       (17)   (109)        58
Other interest-bearing liabilities        118      125      109       352       30        38      27         95
                                       ------   ------   ------   -------   ------   --------  ------   -------
  Total interest-bearing liabilities      657   (1,240)      89      (494)   1,489    (3,348)   (428)    (2,287)
                                       ------   ------   ------   -------   ------   --------  ------   -------
Change in net interest income          $3,035   $  893   $ (159)  $ 3,769   $2,998   $  (478)  $(154)   $ 2,366
                                       ======   ======   ======   =======   ======   ========  ======   =======
</TABLE>


                                        8

<PAGE>

Table 4 - Yield/Cost Analysis

<TABLE>
<CAPTION>
                                                Year Ended December 31,      Year Ended December 31,      Year Ended December 31,
                                              ---------------------------  ---------------------------  ----------------------------
                                                          2006                         2005                         2004
                                              ---------------------------  ---------------------------  ----------------------------
                                                                                  (In thousands)
                                                                  Average                      Average                      Average
                                               Average             Yield/   Average             Yield/   Average             Yield/
                                               Balance  Interest    Cost    Balance  Interest    Cost    Balance  Interest    Cost
                                              --------  --------  -------  --------  --------  -------  --------  --------  -------
<S>                                           <C>        <C>      <C>      <C>        <C>      <C>      <C>        <C>      <C>
Interest earning assets:
Loans receivable  (1)                         $748,296   $63,198    8.45%  $686,357   $50,357    7.34%  $597,260   $36,752    6.15%
Investment securities                           51,919     2,600    5.01     34,596     1,954    5.65     42,881     2,771    6.46
Mortgage-backed securities                      30,941     1,725    5.58      9,303       508    5.46      9,927       565    5.69
Other interest-earning assets                    3,397       229    6.74      7,817       357    4.57      3,586        92    2.57
                                              --------   -------  ------   --------   -------  ------   --------   -------  ------
    Total earning assets                       834,553    67,752    8.12    738,073    53,176    7.20    653,654    40,180    6.15
                                                         -------  ------              -------  ------              -------  ------
Nonearning assets                               55,349                       53,826                       58,511
                                              --------                     --------                     --------
    Total assets                              $889,902                     $791,899                     $712,165
                                              ========                     ========                     ========
Interest bearing liabilities:
Time deposits                                 $502,167    21,674    4.32   $429,127    13,247    3.08   $347,217     7,734    2.23
Demand deposits                                145,206     2,153    1.48    147,852     1,260    0.85    158,543     1,172    0.74
Savings                                         20,993        32    0.15     23,028        35    0.15     21,553        33    0.15
FHLB advances                                   15,035       641    4.26      5,808       121    2.08     19,108       265    1.39
Junior subordinated debentures                  10,310       815    7.90     10,310       633    6.14     10,310       448    4.48
Repurchase agreements                            6,417       292    4.55      5,863       167    2.85      4,019        40    1.00
                                              --------   -------  ------   --------   -------  ------   --------   -------  ------
  Total interest-bearing liabilities           700,128    25,607    3.66    621,988    15,463    2.49    560,750     9,692    1.73
                                                         -------  ------              -------  ------              -------  ------
Noninterest bearing demand deposits            104,693         0    0.00     94,719         0    0.00     78,996         0    0.00
                                              --------   -------  ------   --------   -------  ------   --------   -------  ------
  Total sources of funds                       804,821    25,607    3.18    716,707    15,463    2.16    639,746     9,692    1.52
                                                         -------  ------              -------  ------              -------  ------
Other liabilities and stockholders'equity:
Other liabilities                               11,751                       10,748                       15,288
Stockholders' equity                            73,330                       64,444                       57,131
                                              --------                     --------                     --------
  Total liabilities and stockholders' equity  $889,902                     $791,899                     $712,165
                                              ========                     ========                     ========
Net interest income                                      $42,145                      $37,713                      $30,488
                                                         =======                      =======                      =======
Interest rate spread (2)                                            4.94%                        5.04%                        4.63%
                                                                  ======                       ======                       ======
Net yield on earning assets (3)                                     5.05%                        5.11%                        4.66%
                                                                  ======                       ======                       ======
Ratio of earning assets to interest bearing
  liabilities                                                     119.20%                      118.66%                      116.63%
                                                                  ======                       ======                       ======
</TABLE>

----------
(1)   Includes classified loans.

(2)   Represents the difference between the yield on earning assets and the
      average cost of funds.

(3)   Represents the net interest income divided by average earning assets.


                                        9

<PAGE>

Results of Operations

Comparison of Financial Condition at December 31, 2006 and 2005

Total assets increased 9.1% to $910.5 million at December 31, 2006 from $834.2
million at December 31, 2005. Earning assets increased 10.6% to $857.7 million
at December 31, 2006 from $775.6 million at December 31, 2005, reflecting
continued net growth in the securities and loan and leases receivable
portfolios. Earning assets were 94.2% of total assets at December 31, 2006,
compared to 93.0 % at December 31, 2005.

Loans and lease receivables, net of allowance for loan losses and deferred loan
fees, increased 7.4% to $761.4 million at December 31, 2006 from $708.9 million
at December 31, 2005. The Bank continues to emphasize the origination of both
secured and unsecured commercial and consumer loans, in order to take advantage
of shorter terms to maturity in managing its exposure to market and interest
rate risk due to changes in interest rates. The Bank also sells selected
mortgage loans in the secondary mortgage market in order to reduce its exposure
to interest rate and credit risk, while retaining servicing to generate
additional fee income. Loans serviced for others totaled $245.6 million at
December 31, 2006 compared to $260.6 million serviced at December 31, 2005.

Commercial loans and lease receivables increased 8.2% to $593.5 million at
December 31, 2006 from $548.6 million at December 31, 2005. Consumer loans
increased 2.0% to $103.8 million at December 31, 2006 from $101.8 million at
December 31, 2005. This growth reflects the Bank's continuing focus of the
growth and development of its commercial and consumer loan and lease receivables
portfolio. Commercial and consumer loans and lease receivables originations were
$395.9 million during fiscal 2006, compared to $474.1 million during fiscal
2005, reflecting the slow down in origination volumes due to the rise in
interest rates.

Residential real estate mortgage loans increased 9.8% to $74.7 million at
December 31, 2006 from $68.0 million at December 31, 2005, reflecting loan
origination volume, principal repayments, loan sales and securitizations. During
fiscal 2006, the Bank originated $94.5 million of residential mortgage loans,
compared to $119.3 million during fiscal 2005. The Bank sold $1.2 million of
loans held for sale during fiscal 2006, compared to $12.9 million sold during
fiscal 2005, reflecting the slow down in origination and refinancing volumes due
to the rise in interest rates. During fiscal 2006, the Bank implemented a
strategy to hold current held for sale mortgage loan originations for possible
securitization into available for sale mortgage-backed securities in order to
support future liquidity management needs.

Investment and mortgage-backed securities increased 44.4% to $93.2 million at
December 31, 2006, from $64.5 million at December 31, 2005. During fiscal 2006,
$10.0 million of investment maturities were reinvested into $25.0 million of
purchases of investment securities available for sale, compared to $16.0 million
of investment maturities reinvested into $25.0 million of purchases of
investment securities available for sale in 2005. The Bank securitized $17.2
million of mortgage loans for mortgage-backed securities during fiscal 2006,
compared to $16.4 million securitized during fiscal 2005. The Bank sold no
investment or mortgage-backed securities available for sale during fiscal 2006
or fiscal 2005.

Goodwill related to prior period acquisitions was $4.2 million at December 31,
2006 and 2005, respectively, and is not amortized according to provisions of
financial accounting standards. The unamortized balance of the Company's
goodwill is tested for impairment quarterly. The Company has performed its
quarterly impairment tests and has determined there was no impairment of
goodwill as of December 31, 2006 or December 31, 2005.

Deposits increased 9.1% to $800.2 million at December 31, 2006 from $733.8
million at December 31, 2005. Certificates of deposit increased 10.6% to $517.0
million at December 31, 2006 from $467.4 million at December 31, 2005. The Bank
continued to market lower cost core deposits during 2006, resulting in net
checking account growth of 8.1% to $264.7 million at December 31, 2006 from
$244.9 million at December 31, 2005. The Bank manages its cost of deposits by
constantly monitoring the volume and rates being paid on maturing certificates
of deposits in relationship to current funding needs and competitive market
interest rates. During fiscal 2006 and 2005, the Bank repriced maturing
certificates of deposits at competitive market rates, and combined with the
growth of lower costing checking accounts, has provided an effective means of
managing its deposit cost.

Total borrowings were $21.4 million at December 31, 2006 compared to $22.1
million at December 31, 2005. FHLB advances and junior subordinated debentures
were $16.3 million at December 31, 2006, compared to $15.8 million at December
31, 2005. Borrowings in the form of repurchase agreements were $5.1 million at
December 31, 2006, compared to $6.3 million at December 31, 2005, representing
funds held in cash management accounts for commercial banking customers.


                                       10

<PAGE>

Stockholders' equity increased 15.6% to $78.8 million at December 31, 2006, from
$68.2 million at December 31, 2005. The consolidated equity to assets ratio was
8.7% and 8.2% at December 31, 2006 and December 31, 2005, respectively.
Accumulated other comprehensive loss was $579,000 at December 31, 2006 compared
to $371,000 at December 31, 2005, reflecting a decrease in unrealized gains on
available for sale securities, net of deferred income taxes, resulting from an
increase in interest rates during the respective periods.

During the years ended December 31, 2006 and 2005, the Company declared four
quarterly cash dividends each, totaling $0.68 and $0.53 per share respectively.
These cash dividend payments reflect dividend payout ratios on basic earnings of
38.4% for fiscal 2006 and 35.9% for fiscal 2005. 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.

Pursuant to stock repurchase programs adopted by the Company during fiscal years
2006 and 2005, the Company acquired 24,537 and 9,303 shares of its common stock,
respectively, through both open market and private purchases. Shares acquired
under the repurchase program are being held as treasury stock, at cost. At
December 31, 2006, treasury shares were 1,466,089 totaling $29.1 million,
compared to 1,660,452 shares totaling $28.8 million at December 31, 2005. The
Company will use the repurchased shares of its outstanding common stock for
general corporate purposes including the future exercise of stock options and
funding shares issued pursuant to potential future stock splits.

During fiscal 2006 and 2005, 532,979 and 152,478 shares, respectively, were
issued on the exercise of stock options. In addition, during fiscal 2006 and
2005, 151,695 and 17,477 shares were tendered to pay for the exercise price of
stock options being exercised and income taxes incident to such option
exercises.

Comparison of Operating Results for the Years Ended December 31, 2006 and 2005

Net Income. Net income increased 21.7% to $17.2 million for the year ended
December 31, 2006 from $14.1 million for the year ended December 31, 2005. Basic
earnings per share increased 18.8% to $1.77 per share for the year ended
December 31, 2006 from $1.49 per share for the year ended December 31, 2005.
Diluted earnings per share increased 22.0% to $1.72 per share for the year ended
December 31, 2006 from $1.41 per share for the year ended December 31, 2005. The
average numbers of basic shares were 9,714,565 and 9,488,073 and the average
numbers of diluted shares were 10,002,869 and 9,980,222, respectively, for the
years ended December 31, 2006 and 2005. Return on average assets and return on
average equity were 1.9% and 23.5% respectively for fiscal 2006, compared to
1.8% and 21.9% for fiscal 2005.

Interest Income. Interest income increased 27.4% to $67.8 million for fiscal
2006 from $53.2 million for fiscal 2005. During 2006 the increase in interest
income resulted from a combination of an increase in interest rates and the
increase in the volume of interest-earning assets, enabling the Bank to earn an
increased level of interest income. The average balance of interest-earning
assets increased 13.1% to $834.6 million for fiscal 2006, from $738.1 million
for fiscal 2005. The yield on average interest-earning assets was 8.1% and 7.2%
for fiscal 2006 and 2005, respectively.

Interest Expense. Interest expense increased 65.6% to $25.6 million for fiscal
2006 from $15.5 million for fiscal 2005. The increase in interest expense also
reflects the increase in interest rates and the increase in the volume average
interest-bearing liabilities, offset by an increase in noninterest-bearing
checking accounts. The average balance of interest-bearing liabilities increased
12.6% to $700.1 million for fiscal 2006 from $622.0 million for fiscal 2005. The
average balance of noninterest-bearing deposits increased 10.5% to $104.7
million for fiscal 2006 from $94.7 million for fiscal 2005. The average cost of
funds (including noninterest-bearing deposits) was 3.2% for 2006, compared to
2.2% for 2005, reflecting a rising interest rate environment during fiscal 2006
and 2005.

Net Interest Income. Net interest income increased 11.8% to $42.1 million for
fiscal 2006 from $37.7 million for fiscal 2005. The increase in net interest
income during 2006 is attributable to a 23.5% greater increase in the volume of
average interest-earning assets as compared to the increase in the volume of
interest-bearing liabilities, and the increase in noninterest-bearing deposits.
The net yield on interest-earning assets (net interest income divided by average
interest-earning assets) was 5.1% for both fiscal 2006 and 2005, respectively.
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
4.9% for fiscal 2006, compared to 5.0% for fiscal 2005.

See Table 3 - Rate/Volume Analysis and Table 4 - Yield/Cost Analysis above for
additional information on interest income, interest expense, net interest
income, average balances and yield/cost ratios.


                                       11

<PAGE>

Provision for Credit Losses. The Bank provided $933,000 for credit losses during
fiscal 2006, compared to $1.7 million for fiscal 2005. These provisions were
necessary to absorb probable losses in the loan and lease portfolio and unfunded
commitments, and to support the inherent risks associated with the growth of the
commercial and consumer loan and lease receivable portfolio. The Bank maintains
both general and specific allowances for loan and lease losses and a reserve for
unfunded loan commitments (collectively the allowance for credit losses) based
upon management's evaluation of risk in the loan and lease portfolio, unfunded
commitments and past loss experience. The Bank's methodology for evaluating its
allowance for credit losses includes amounts specifically allocated to loans and
leases that are individually determined to be impaired, and general allowances
allocated to groups of loans and leases not individually assessed for
impairment. The allowance for loan and lease losses and reserve for unfunded
commitments was $9.2 million and $765,000, respectively, at December 31, 2006,
compared to $8.1 million and $1.1 million at December 31, 2005. The ratio of the
allowance for credit losses to total loans and leases was 1.3% at both December
31, 2006 and 2005, which the Bank believes is adequate. The ratio of
non-performing loans to total loans was .4% at December 31, 2006 and .3% at
December 31, 2005.

The Bank uses an analytical asset classification process to determine the
adequacy of its allowance for credit losses, reserve for unfunded commitments
and necessary provisions for credit losses. The loan and lease portfolio is
reviewed quarterly 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 categories
applicable to their circumstances as a result of this analysis. After reviewing
current economic conditions, changes in delinquency status, and actual losses
incurred by the Bank, management establishes an appropriate reserve percentage
applicable to each category of assets, and provisions for credit losses are
recorded when necessary to bring the allowances to a level consistent with this
analysis.

Noninterest Income. Noninterest income increased 12.8% to $9.3 million for
fiscal 2006 from $8.2 million for fiscal 2005. Other income consists of fees,
service charges and servicing fees earned on loans, service charges and
insufficient funds fees collected on deposit accounts, gains from sales of loans
and mortgage-backed securities and other miscellaneous income. Fees and service
charges increased 9.9% to $6.7 million for fiscal 2006 from $6.1 million for
fiscal 2005. Fees, service charges earned and insufficient funds fees collected
during the respective periods is attributable to the volume of loan, deposit
account, and insufficient funds transactions processed during each period, and
the collection of related fees and service charges. Servicing fee income on
loans serviced for others declined 2.6% to $666,000 for fiscal 2006 from
$684,000 for fiscal 2005, as loans serviced for others declined to $245.6
million at year end 2006 from $260.6 million at year end 2005.

Gains from sales of mortgage loans increased to $330,000 for fiscal 2006 from
$199,000 for fiscal 2005. The volume of loans sold or exchanged for
mortgage-backed securities during fiscal 2006 was $18.4 million, compared to
$29.2 million sold during fiscal 2005. The Bank may sell certain held for sale
mortgage loans during favorable interest rate windows, while retaining other
current held for sale mortgage loan originations for securitization into
available for sale mortgage-backed securities. In addition, the sale of mortgage
loans also provides liquidity necessary to support the Bank's operating,
financing and lending activities.

Noninterest Expenses. Noninterest expenses increased 5.1% to $22.2 million for
fiscal 2006 from $21.1 million in fiscal 2005. The Company's efficiency ratio
(noninterest expenses as a percentage of net interest income plus noninterest
income) improved to 43.1% for fiscal 2006 compared to 46.0% for fiscal 2005. The
efficiency ratio measures the proportion of net operating revenues that are
absorbed by overhead expenses.

The largest single component of these expenses is compensation and fringe
benefits, which increased 7.1% to $13.6 million for fiscal 2006 from $12.7
million for fiscal 2005. Full-time equivalent employees were 275 at December 31,
2006 compared to 270 at December 31, 2005. The net growth in personnel results
from opening three full-service banking offices in 2005 and administrative staff
required to support the $76.3 million net growth in assets during fiscal 2006.

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. Other noninterest expenses including advertising,
deposit insurance, premises and equipment, payroll and other taxes, repairs and
maintenance, and office expenses have also grown from period to period in
conjunction with the growth in earning assets and deposit accounts.

Income Taxes. The provision for income taxes increased 23.7% to $11.1 million
for fiscal 2006 from $8.9 million for fiscal 2005. The increase in provision for
income taxes is primarily the result of the 22.5% increase of pretax earnings to
$28.3 million for fiscal 2006 from $23.1 million for fiscal 2005. Changes in the
amount of income tax provisions reflect changes in pretax income and expenses,
the application of permanent and temporary differences, and the income tax rates
in effect during each period. The effective income tax rates for fiscal 2006 and
2005 were 39.2% and 38.8%, respectively.


                                       12

<PAGE>

Comparison of Operating Results for the Years Ended December 31, 2005 and 2004

Net Income. Net income increased 20.6% to $14.1 million for the year ended
December 30, 2005 from $11.7 million for the year ended December 31, 2004.
Diluted earnings per share increased 18.4% to $1.41 per share for the year ended
December 31, 2005 from $1.19 per share for the year ended December 31, 2004. The
average number diluted shares were 9,980,222 and 9,835,724, respectively, for
the years ended December 31, 2005 and 2004. Return on average assets and return
on average equity were 1.8% and 21.9% respectively for fiscal 2005, compared to
1.6% and 20.5% for fiscal 2004.

Interest Income. Interest income increased 32.3% to $53.2 million for fiscal
2005 from $40.2 million for fiscal 2004. During 2005 the increase in interest
income resulted from a combination of an increase in interest rates and the
increase in the volume of interest-earning assets, enabling the Bank to earn an
increased level of interest income. The average balance of interest-earning
assets increased 12.9% to $738.1 million for fiscal 2005, from $653.7 million
for fiscal 2004. The yield on average interest-earning assets was 7.2% and 6.2%
for 2005 and 2004, respectively.

Interest Expense. Interest expense increased 59.5% to $15.5 million for fiscal
2005 from $9.7 million for fiscal 2004. The increase in interest expense also
reflects the increase in interest rates and the increase in the volume average
interest-bearing liabilities, offset by an increase in noninterest-bearing
checking accounts. The average balance of interest-bearing liabilities increased
10.9% to $622.0 million for fiscal 2005 from $560.8 million for fiscal 2004. The
average balance of noninterest-bearing deposits increased 19.9% to $94.7 million
for fiscal 2005 from $79.0 million for fiscal 2004. The average cost of funds
was 2.2% for 2005, compared to 1.5% for 2004, reflecting a rising interest rate
environment during 2005.

Net Interest Income. Net interest income increased 23.7% to $37.7 million for
fiscal 2005 from $30.5 million for fiscal 2004. The increase in net interest
income during 2005 is attributable to a 37.9% greater increase in the volume of
average interest-earning assets as compared to the increase in the volume of
interest-bearing liabilities, and the increase in noninterest-bearing deposits.
The net yield on interest-earning assets was 5.1% for fiscal 2005, compared to
4.7% fiscal 2004. The Bank's interest rate spread was 5.0% for fiscal 2005,
compared to 4.4% for fiscal 2004.

Provision for Credit Losses. The Bank provided $1.7 million for credit losses
during fiscal 2005, compared to $968,000 for fiscal 2004. These provisions were
necessary to absorb probable losses in the loan portfolio and to support the
inherent risks associated with growth in commercial and consumer loans. The Bank
maintains an allowance for loan losses and a reserve for unfunded commitments
(collectively the allowance for credit losses) based upon management's
evaluation of risk in the loan and lease receivable portfolio and past loss
experience. The allowance for loan and lease losses was $8.1 million at December
31, 2005 and $8.3 million at December 31, 2004, and the reserve for unfunded
commitments was $1.1 million at December 31, 2005 and none at December 31, 2004.
The ratio of the allowance for credit losses to total loans was 1.3% at both
December 31, 2005 and December 31, 2004, respectively, which the Bank believes
is adequate. The ratio of non-performing loans to total loans was .3% at
December 31, 2005 and .4% at December 31, 2004.

Noninterest Income. Noninterest income declined 6.2% to $8.2 million for fiscal
2005 from $8.8 million for fiscal 2004. Fees and service charges declined 5.6%
to $6.1 million for fiscal 2005 from $6.5 million for fiscal 2004, reflecting
the volume of loan, deposit account, and insufficient funds transactions
processed during each period, and the collection of related fees and service
charges. Servicing fee income on loans serviced for others declined 5.6% to
$684,000 for fiscal 2005 from $724,000 for fiscal 2004, as loans serviced for
others declined to $260.6 million at year end 2005 from $277.3 million at year
end 2004.

Gains from sales of loans, investments and mortgage-backed securities declined
to $199,000 for fiscal 2005 from $597,000 for fiscal 2004. The volume of loans
and mortgage-backed securities sold during fiscal 2005 was $29.2 million,
compared to $39.9 million sold during fiscal 2004, reflecting a strategy to
retain current held for sale mortgage loan originations for securitization into
available for sale mortgage-backed securities. In addition, loan sales provide
liquidity necessary to support the Bank's operating, financing and lending
activities.

Noninterest Expenses. Noninterest expenses increased 7.7% to $21.1 million for
fiscal 2005 from $19.6 million in fiscal 2004. The Company's efficiency ratio
improved to 46.0% for fiscal 2005 compared to 49.9% for fiscal 2004.

The largest single component of these expenses is compensation and fringe
benefits, which increased 5.7% to $12.7 million for fiscal 2005 from $12.0
million for fiscal 2004. Full-time equivalent employees increased to 270 at
December 31, 2005 from 250 at December 31, 2004. This growth is due to
additional personnel resulting from purchasing three full-service banking
offices and administrative staff required to support the $111.1 million net
growth in assets during fiscal 2005.


                                       13

<PAGE>

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. Other noninterest expenses including advertising,
deposit insurance, premises and equipment, payroll and other taxes, repairs and
maintenance, and office expenses have also grown from period to period in
conjunction with the growth in earning assets and deposit accounts.

Income Taxes. The provision for income taxes increased 28.4% to $8.9 million for
fiscal 2005 from $7.0 million for fiscal 2004. The increase in provision for
income taxes is primarily the result of the 23.5% increase of pretax earnings to
$23.1 million for fiscal 2005 from $18.7 million for fiscal 2004, and an
increase in the federal tax rate from 34% to 35% during 2005 based on an
increased volume of federal taxable income. Changes in the amount of income tax
provisions reflect changes in pretax income and expenses, the application of
permanent and temporary differences, and the income tax rates in effect during
each period. The effective income tax rates for fiscal 2005 and 2004 were 38.8%
and 37.3%, respectively.

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.

Off-Balance Sheet Arrangements. See Note 14 of the "Notes to Consolidated
Financial Statements" for a full description of financial instruments with
off-balance sheet risk to which the Bank is a party in the normal course of
business to meet the financing needs of its customers and to reduce its own
exposure to fluctuations in interest rates. 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.

New Accounting Pronouncements. See Note 1 of the "Notes to Consolidated
Financial Statements" for a full description of new accounting pronouncements
including the respective effective dates of adoption and effects on results of
operations and financial condition.


                                       14

<PAGE>

                      [Turlington and Company, L.L.P LOGO]

                          Turlington and Company, L.L.P
                          Certified Public Accountants

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying consolidated statement of financial condition
of First South Bancorp, Inc. and Subsidiary as of December 31, 2006 and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for the year ended December 31, 2006. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit. The consolidated financial statements of First
South Bancorp, Inc. and Subsidiary for the years ended December 31, 2005 and
2004 were audited by other auditors whose report dated March 7, 2006 (except for
the stock split described in Note 1 as to which the date is May 25, 2006)
expressed an unqualified opinion on those statements.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

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

We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of First South
Bancorp, Inc.'s internal control over financial reporting as of December 31,:
2006, based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission,
and our report dated March 6, 2007 expressed an unqualified opinion on both
management's assessment of the Company's internal control over financial
reporting and the effectiveness of the Company's internal control over financial
reporting.


/s/ Turlington and Company, L.L.P
--------------------------------------
Lexington, North Carolina
March 6, 2007

                                   ----------
                  509 East Center Street o Post Office Box 1697
                           o Lexington, North Carolina
                         27293-1697 Office: 336-249-6856
                            o Facsimile: 336-248-8697


                                       15

<PAGE>

FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31, 2006 and 2005

<TABLE>
<CAPTION>
                                                                  2006           2005
                                                              ------------   ------------
<S>                                                           <C>            <C>
ASSETS
Cash and due from banks                                       $ 24,608,819   $ 32,523,922
Interest-bearing deposits in financial institutions              1,194,801        419,470
Investment securities - available for sale                      56,454,127     41,827,690
Mortgage-backed securities - available for sale                 35,066,627     20,639,067
Mortgage-backed securities - held for investment                 1,662,540      2,063,310
Loans receivable, net
  Held for sale                                                 25,576,080     10,845,783
  Held for investment                                          735,860,969    698,083,024
Premises and equipment, net                                      8,898,009      8,831,170
Real estate owned                                                  634,434         13,886
Federal Home Loan Bank of Atlanta stock, at cost
  which approximates market                                      1,933,300      1,689,200
Accrued interest receivable                                      5,398,477      4,288,600
Goodwill                                                         4,218,576      4,218,576
Mortgage servicing rights                                        1,266,530      1,402,085
Identifiable intangible assets                                     227,940        259,380
Income tax receivable                                            1,605,102      1,145,814
Prepaid expenses and other assets                                5,941,574      5,982,857
                                                              ------------   ------------
    Total assets                                              $910,547,905   $834,233,834
                                                              ============   ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
  Demand                                                      $264,722,202   $244,879,590
  Savings                                                       18,481,271     21,509,653
  Large denomination certificates of deposit                   181,078,901    153,954,109
  Other time                                                   335,906,107    313,409,713
                                                              ------------   ------------
    Total deposits                                             800,188,481    733,753,065
Borrowed money                                                  11,139,947     11,787,528
Junior subordinated debentures                                  10,310,000     10,310,000
Other liabilities                                               10,112,899     10,192,769
                                                              ------------   ------------
    Total liabilities                                          831,751,327    766,043,362
                                                              ------------   ------------

Commitments and contingencies (Note 14)
Common stock, $.01 par value, 25,000,000 shares authorized,
  11,254,222 and 8,000,000 issued; 9,788,133 and 6,339,548
  shares outstanding, respectively                                  97,881         63,395
Additional paid-in capital                                      38,165,536     37,624,894
Retained earnings, substantially restricted                     70,217,380     59,661,079
Treasury stock at cost                                         (29,104,894)   (28,787,979)
Accumulated other comprehensive loss, net                         (579,325)      (370,917)
                                                              ------------   ------------
    Total stockholders' equity                                  78,796,578     68,190,472
                                                              ------------   ------------
    Total liabilities and stockholders' equity                $910,547,905   $834,233,834
                                                              ============   ============
</TABLE>

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


                                       16

<PAGE>

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

Years Ended December 31, 2006, 2005 and 2004

<TABLE>
<CAPTION>
                                                             2006          2005         2004
                                                         -----------   -----------   -----------
<S>                                                      <C>           <C>           <C>
Interest income
  Interest and fees on loans                             $63,198,115   $50,357,203   $36,751,526
  Interest and dividends on investments and deposits       4,553,439     2,818,847     3,428,131
                                                         -----------   -----------   -----------
    Total interest income                                 67,751,554    53,176,050    40,179,657
                                                         -----------   -----------   -----------
Interest expense
  Interest on deposits                                    23,858,628    14,542,548     8,938,856
  Interest on borrowings                                     932,559       288,329       304,846
  Interest on junior subordinated debentures                 815,331       632,629       448,319
                                                         -----------   -----------   -----------
    Total interest expense                                25,606,518    15,463,506     9,692,021
                                                         -----------   -----------   -----------
Net interest income before provision for credit losses    42,145,036    37,712,544    30,487,636
Provision for credit losses                                  932,878     1,711,197       968,000
                                                         -----------   -----------   -----------
  Net interest income                                     41,212,158    36,001,347    29,519,636
                                                         -----------   -----------   -----------
Other income
  Fees and service charges                                 6,723,391     6,116,949     6,479,309
  Loan servicing fees                                        666,032       684,135       724,363
  Gain on sale of real estate, net                            10,237       215,928        23,037
  Gain on sale of mortgage loans                             329,743       199,414       508,218
  Gain on sale of mortgage-backed securities                      --            --        88,844
  Other income                                             1,529,644       990,165       926,699
                                                         -----------   -----------   -----------
    Total other income                                     9,259,047     8,206,591     8,750,470
                                                         -----------   -----------   -----------
General and administrative expenses
  Compensation and fringe benefits                        13,582,647    12,682,779    12,000,690
  Federal insurance premiums                                  95,012        89,523        86,666
  Premises and equipment                                   1,776,903     1,761,934     1,618,024
  Advertising                                                207,246       187,536       185,468
  Payroll and other taxes                                  1,305,008     1,143,214     1,023,813
  Data processing                                          2,362,751     2,270,449     2,060,986
  Amortization of intangible assets                          375,463       403,999       300,745
  Other                                                    2,502,015     2,592,604     2,315,233
                                                         -----------   -----------   -----------
    Total general and administrative expenses             22,207,045    21,132,038    19,591,625
                                                         -----------   -----------   -----------
Income before income taxes                                28,264,160    23,075,900    18,678,481
Income taxes                                              11,071,804     8,947,196     6,966,040
                                                          ----------    ----------    ----------
NET INCOME                                                17,192,356    14,128,704    11,712,441
Other comprehensive loss, net of taxes                      (208,408)   (1,244,045)   (1,383,503)
                                                         -----------   -----------   -----------
Comprehensive income                                     $16,983,948   $12,884,659   $10,328,938
                                                         ===========   ===========   ===========
Net income per common share
  Basic                                                  $      1.77   $      1.49   $      1.25
  Diluted                                                $      1.72   $      1.41   $      1.19
</TABLE>

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


                                       17

<PAGE>

FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

Years Ended December 31, 2006, 2005 and 2004

<TABLE>
<CAPTION>
                                                                                                 Accumulated
                                                                   Retained                         other
                                                   Additional      earnings,                    comprehensive
                                        Common       paid-in     substantially     Treasury        income
                                         stock       capital       restricted        stock       (loss), net        Total
                                       --------   ------------   -------------   ------------   -------------   ------------
<S>                                    <C>        <C>            <C>             <C>             <C>            <C>
Balance, December 31, 2003             $ 41,903   $ 49,020,632   $ 43,171,318    $(39,326,931)   $ 2,256,631    $ 55,163,553

Net income                                   --             --     11,712,441              --             --      11,712,441
Other comprehensive loss, net                --             --             --              --     (1,383,503)     (1,383,503)
Exercise of stock options                   834       (980,779)            --       1,418,734             --         438,789
Tax benefit, stock options exercised         --        279,334             --              --             --         279,334
Shares traded to exercise options          (145)       329,517             --        (366,669)            --         (37,297)
Acquisition of treasury shares             (773)            --             --      (2,211,917)            --      (2,212,690)
Dividends ($.45 per share)                                         (4,265,280)                                    (4,265,280)
3-for-2 stock split                      20,828    (10,832,989)       (20,828)     10,832,989             --              --
                                       --------   ------------   ------------    ------------    -----------    ------------

Balance, December 31, 2004               62,647     37,815,715     50,597,651     (29,653,794)       873,128      59,695,347

Net income                                   --             --     14,128,704              --             --      14,128,704
Other comprehensive loss, net                --             --             --              --     (1,244,045)     (1,244,045)
Exercise of stock options                 1,017     (1,060,993)                     1,741,721             --         681,745
Tax benefit, stock options exercised         --        490,923             --              --             --         490,923
Shares traded to exercise options          (176)       379,249             --        (539,273)            --         (160,200)
Acquisition of treasury shares             (93)             --             --        (336,633)            --       (336,726)
Dividends ($.53 per share)                   --             --     (5,065,276)             --             --      (5,065,276)
                                       --------   ------------   ------------    ------------    -----------    ------------

Balance, December 31, 2005               63,395     37,624,894     59,661,079     (28,787,979)      (370,917)     68,190,472

Net income                                   --             --     17,192,356              --             --      17,192,356
Other comprehensive loss, net                --             --                             --       (208,408)       (208,408)
Exercise of stock options                 3,706     (5,963,302)            --        6,605,460            --         645,864
Tax benefit, stock options exercised         --      3,965,214             --                             --       3,965,214
Shares traded to exercise options        (1,517)     2,412,280             --      (6,054,715)            --      (3,643,952)
Acquisition of treasury shares            (245)                            --        (867,660)            --        (867,905)
Stock based compensation                     --        126,450             --              --             --         126,450
Dividends ($.68 per share)                   --             --     (6,594,848)             --             --      (6,594,848)
3-for-2 stock split                      32,542             --        (41,207)             --             --          (8,665)
                                       --------   ------------   ------------    ------------    -----------    ------------

Balance, December 31, 2006             $ 97,881   $ 38,165,536   $ 70,217,380    $(29,104,894)   $  (579,325)   $ 78,796,578
                                       ========   ============   ============    ============    ===========    ============
</TABLE>

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


                                       18

<PAGE>

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

Years Ended December 31, 2006, 2005 and 2004

<TABLE>
<CAPTION>
                                                                    2006            2005            2004
                                                                -------------   ------------   ------------
<S>                                                             <C>             <C>            <C>
Operating activities
  Net income                                                    $  17,192,356   $ 14,128,704   $ 11,712,441
  Adjustments to reconcile net income to net
    cash provided by (used in) operating activities
      Provision for credit losses                                     932,878      1,711,197        968,000
      Depreciation                                                    843,017        839,387        754,332
      Amortization of intangibles                                     375,463        403,999        325,741
      Impairment of real estate owned                                      --             --         19,178
      Accretion of discounts on securities, net                        59,769        (84,657)      (101,337)
      Deferred income taxes                                          (201,747)      (546,141)     1,141,688
      Gain on disposal of premises and equipment
        and real estate owned                                        (157,856)      (258,741)       (21,745)
      Gain on loans held for sale and mortgage-
          backed securities                                          (329,743)      (199,414)      (597,062)
      Stock based compensation expense                                126,450             --             --
      Originations of loans held for sale, net                    (32,791,666)   (33,898,697)   (34,985,086)
      Proceeds from sale of loans held for sale                     1,187,887     12,859,144     37,614,277
      Other operating activities                                   (1,936,077)       156,243     (1,646,103)
                                                                -------------   ------------   ------------
          Net cash provided by (used in) operating activities     (14,699,269)    (4,888,976)    15,184,324
                                                                -------------   ------------   ------------

Investing activities
  Proceeds from maturities of investment securities
    available for sale                                             10,050,000     16,000,000     16,000,000
  Purchases of investment securities available for sale           (25,000,000)   (27,000,000)             -
  Proceeds from principal repayments and sales of
    mortgage-backed securities available for sale                   2,682,350      1,663,783      4,941,963
  Proceeds from principal repayments of
    mortgage-backed securities held for investment                    400,770        506,048        272,126
  Originations of loans held for investment, net
    of principal repayments                                       (39,762,587)   (73,624,172)   (82,539,233)
  Proceeds from disposal of premises and equipment
    and real estate owned                                             847,830      1,229,700        262,152
  Sales (purchases) of FHLB stock                                    (244,100)       136,000        302,000
  Purchases of premises and equipment                              (1,094,382)    (1,193,777)    (1,183,726)
  Repayment of note receivable                                             --      1,156,557         96,146
  Net cash received in branch acquisition                                  --             --     15,771,621
                                                                -------------   ------------   ------------
       Net cash used in investing activities                      (52,120,119)   (81,125,861)   (46,076,951)
                                                                -------------   ------------   ------------

Financing activities
  Net increase in deposit accounts                                 66,435,416    105,216,360     27,017,259
  Net increase (decrease) in FHLB borrowings                          500,000     (5,000,000)    (5,500,000)
  Purchase of treasury shares                                        (867,905)      (336,726)    (2,212,690)
  Proceeds from exercise of stock options, net of tax benefit         967,126      1,012,468        680,826
  Cash paid for dividends and fractional shares                    (6,207,440)    (4,867,849)    (4,032,865)
  Net change in repurchase agreements                              (1,147,581)     1,995,628        953,841
                                                                -------------   ------------   ------------

       Net cash provided by financing activities                   59,679,616     98,019,881     16,906,371
                                                                -------------   ------------   ------------

Increase (decrease) in cash and cash equivalents                   (7,139,772)    12,005,044    (13,986,256)

Cash and cash equivalents, beginning of year                       32,943,392     20,938,348     34,924,604
                                                                -------------   ------------   ------------

Cash and cash equivalents, end of year                          $  25,803,620   $ 32,943,392   $ 20,938,348
                                                                =============   ============   ============
</TABLE>

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


                                       19

<PAGE>

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

As of And For The Years Ended December 31, 2006, 2005 and 2004

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.

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.

A decline in the market value of any AFS or HTM security below cost that is
deemed to be other-than-temporary results in a reduction in carrying amount to
fair value. The impairment is charged to earnings and a new cost basis for the
security is established. To determine whether an impairment is
other-than-temporary, the Company considers whether it has the ability and
intent to hold the investment until a market price recovery and considers
whether evidence indicating the cost of the investment is recoverable outweighs
evidence to the contrary. Evidence considered in this assessment includes the
reasons for the impairment, the severity and duration of the impairment, changes
in value subsequent to year-end, and forecasted performance of the investee.

Premiums and discounts on debt securities are recognized as adjustments to
interest income using the interest method over the period to maturity. Gains and
losses on the sale of securities are determined using the specific
identification method.

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.


                                       20

<PAGE>

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (Continued)

LOANS RECEIVABLE AND ALLOWANCE FOR CREDIT LOSSES

Loans receivable held for investment are stated at the amount of unpaid
principal, reduced by an allowance for probable credit 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, 2006 and 2005
there were no loans, individually or in the aggregate, that are material to the
consolidated financial statements which were defined as impaired.

The allowance for credit 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 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 carrying value of the
loans sold, adjusted for the recognition of any servicing assets retained.

As a part of its normal business operations, the Bank originates mortgage loans
that have been approved by secondary investors. The Bank issues a rate lock
commitment to a borrower and concurrently "locks-in" with a secondary market
investor, under a best efforts delivery mechanism. The terms of the loan are set
by the secondary investors and are transferred within a short time period of the
Bank initially funding the loan. The Bank receives origination fees from
borrowers and servicing release premiums from investors that are recognized when
the loan is sold on the Statement of Operations in the line item "Gain on sale
of mortgage loans and mortgage-backed securities". Between the initial funding
of the loans by the Bank and subsequent purchase by the investor, the Bank
carries the loans on its Statement of Financial Condition at the lower of cost
or fair market value.


                                       21

<PAGE>

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (Continued)

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 credit 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 and liabilities are amortized on a straight line basis over the
average period of estimated net servicing income (if servicing revenues exceed
servicing costs) or net servicing loss (if servicing costs exceed servicing
revenues). All servicing assets or liabilities are assessed for impairment or
increased obligation based on their fair value.

The Company recorded amortization of mortgage servicing rights of $344,023,
$372,559 and $277,078 for prepayments during the years ended December 31, 2006,
2005 and 2004, respectively. There were no impairments recognized during the
years ended December 31, 2006, 2005 and 2004.

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.

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. There were no valuation adjustments recognized during
the years ended December 31, 2006 and 2005. The Company recognized valuation
adjustment of approximately $19,178 during the year ended December 31, 2004.


                                       22

<PAGE>

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (Continued)

INVESTMENT IN FEDERAL HOME LOAN BANK STOCK

The Bank is required to invest in Class B capital stock, par value $100, of the
Federal Home Loan Bank of Atlanta ("FHLB"). The FHLB capital stock requirement
is based on the sum of a membership stock component totaling 20% of the Bank's
total assets plus an activity based stock component of 4.5% of outstanding FHLB
advances. At December 31, 2006 and 2005, the Bank owned 19,333 and 16,892 shares
of the FHLB's capital stock, respectively.

The Bank carries this investment at cost. Due to the redemption provisions of
the FHLB, the Company estimated that fair value equals cost and that this
investment was not impaired at December 31, 2006.

GOODWILL AND INTANGIBLE ASSETS

Net assets of companies acquired in purchase transactions are recorded at fair
value at the date of acquisition, as such, the historical cost basis of
individual assets and liabilities are adjusted to reflect their fair value.
Identified intangible assets resulting from the branch acquisitions described in
Note 20 are amortized on a straight-line basis over 10 years, resulting in
amortization expense of approximately $31,000 per year. 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.

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 years ended December 31,
2006, 2005 and 2004, the Company incurred advertising expense totaling $207,246,
$187,536 and $185,468, 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 years ended December 31, 2006, 2005 and 2004
is as follows:

                                       Years ended December 31,
                                 -----------------------------------
                                    2006        2005         2004
                                 ---------  -----------  -----------
Unrealized losses on securities
  available for sale             $(357,109) $(2,006,525) $(2,248,414)
Tax benefit                        148,701      762,480      917,500
Reclassification of net gains
  recognized in net income              --           --      (88,844)
Tax expense                             --           --       36,255
                                 ---------  -----------  -----------
Other comprehensive loss, net    $(208,408) $(1,244,045) $(1,383,503)
                                 =========  ===========  ===========


                                       23

<PAGE>

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (Continued)

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.

STOCK SPLIT

On May 25, 2006 the Company paid a three-for-two stock split, in the form of a
50% stock dividend, to stockholders of record as of May 4, 2006. 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.

RECLASSIFICATION

Certain amounts in the 2005 and 2004 consolidated financial statements have been
reclassified to conform with the 2006 presentation. These reclassifications had
no effect on previously reported net income or stockholders' equity.

NEW ACCOUNTING PRONOUNCEMENTS

In February 2006, the FASB issued Statement of Financial Accounting Standards
No. 155 ("SFAS No. 155"), "Accounting for Certain Hybrid Financial Instruments
-- an Amendment of SFAS No. 133 and 140". This Statement permits fair value
remeasurement for any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation; clarifies which
interest-only strips and principal-only strips are not subject to the
requirements of SFAS No. 133; establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation; clarifies that concentrations of credit risk
in the form of subordination are not embedded derivatives; and amends SFAS No.
140 to eliminate the prohibition on a qualifying special-purpose entity from
holding a derivative financial instrument that pertains to a beneficial interest
other than another derivative financial instrument. SFAS No. 155 is effective
for all financial instruments acquired or issued after the beginning of the
fiscal years beginning after September 15, 2006. The Company will adopt SFAS No.
155 on January 1, 2007 with no expected material effect on its consolidated
financial statements.

In March 2006, the FASB issued Statement of Financial Accounting Standards No.
156 ("SFAS No. 156"), "Accounting for Servicing of Financial Assets -- an
amendment of SFAS No. 140". This Statement requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation to
service a financial asset by entering into a servicing contract; requires all
separately recognized servicing assets and servicing liabilities to be initially
measured at fair value, if practicable; permits an entity to choose either of
the Amortization or Fair Value subsequent measurement methods for each class of
separately recognized servicing assets and servicing liabilities; and requires
separate presentation of servicing assets and servicing liabilities measured at
fair value in the statement of financial position. SFAS No. 156 is effective for
fiscal years beginning after September 15, 2006. The Company will adopt SFAS No.
156 on January 1, 2007 with no material effect on its consolidated financial
statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157 ("SFAS No. 157"), "Fair Value Measurements". This Statement defines fair
value, establishes a framework for measuring fair value in generally accepted
accounting principles (GAAP), and expands disclosures about fair value
instruments. This Statement applies under other accounting pronouncements that
require or permit fair value measurements, the FASB having previously concluded
in those accounting pronouncements that fair value is the relevant measure
attribute. Accordingly, this statement does not require any new fair value
measurements. However, for some entities, SFAS No. 157 will change current
practice. SFAS No. 157 is effective for fiscal years beginning after November
15, 2007, and interim periods within those fiscal years. The Company is
currently evaluating the impact SFAS No. 157 may have on its consolidated
financial statements.


                                       24

<PAGE>

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (Continued)

NEW ACCOUNTING PRONOUNCEMENTS (Continued)

In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 158 ("SFAS No. 158"), "Employers' Accounting for Defined Benefit Pension and
Other Postretirement Plans - an Amendment of FASB Statements No. 87, 88, 106,
and 132(R)". This Statement improves financial reporting by requiring an
employer to recognize the overfunded or underfunded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income. SFAS
No. 158 also improves financial reporting by requiring an employer to measure
the funded status of a plan as of the date of its year-end statement of
financial position, with limited exceptions. SFAS No. 158 is effective for
fiscal years ending after December 15, 2006 for an employer with publicly traded
equity securities. The Company adopted SFAS No. 158 during the year ended
December 31, 2006 with no material effect on its consolidated financial
statements, since the Company does not have a defined benefit pension plan.

In June 2006, the FASB issued Financial Interpretation No. 48, ("FIN 48"),
"Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement
No. 109". This Interpretation prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return; and also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006 and as a result, is effective for the Company
in the first quarter of fiscal 2007. The Company is currently evaluating the
impact FIN 48 may have on its consolidated financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin Topic 1N, "Financial
Statements - Considering the Effects of Prior Year Misstatements When
Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"). SAB
108 addresses how a registrant should quantify the effect of an error on its
financial statements. SAB 108 concludes that a dual approach should be used to
compute the amount of a misstatement, using both the "rollover" (current year
income statement perspective) and "iron curtain" (year-end balance sheet
perspective) methods. SAB 108 does not address how to evaluate materiality
(quantitative and qualitative effects of a misstatement on the financial
statements). The SEC's views on evaluating the materiality of an error are
covered in SAB Topic 1M, "Financial Statements - Materiality" ("SAB 99"). SAB
108 is effective for fiscal years ending after November 15, 2006 (i.e. December
31, 2006 for a calendar year-end company). The Company adopted SAB 108 for its
fiscal year ending December 31, 2006 with no material effect on its consolidated
financial statements.

The FASB issues exposure drafts for proposed statements of financial accounting
standards. Such exposure drafts are subject to comment from the public, to
revisions by the FASB and to final issuance by the FASB as statements of
financial accounting standards. The company considers the effect of proposed
statements on its consolidated financial statements and monitors the status of
changes to and proposed effective dates of exposure drafts.

2. INVESTMENT SECURITIES

Investment securities at December 31, 2006 and 2005 are classified as available
for sale according to management's intent and summarized as follows:

<TABLE>
<CAPTION>
                                                  Gross       Gross     Estimated
                                   Amortized   unrealized  unrealized     market
                                      cost        gains      losses       value
                                  -----------  ----------  ----------  -----------
<S>                               <C>           <C>        <C>         <C>
December 31, 2006:
  U.S. Treasury and Agency Notes  $56,931,292   $ 94,931   $(572,096)  $56,454,127
                                  ===========   ========   =========   ===========
December 31, 2005:
  U.S. Treasury and Agency Notes  $42,041,062   $227,097   $(440,469)  $41,827,690
                                  ===========   ========   =========   ===========
</TABLE>

The following tables show U.S. Treasury and Agency Notes unrealized losses and
fair value, aggregated by length of time that individual securities have been in
a continuous unrealized loss position, at December 31, 2006 and 2005. The
current year unrealized losses on these investment securities are a result of
volatility in the market during 2006 and relate to twelve U.S. Treasury and
Agency Notes. All unrealized losses on U.S. Treasury and Agency Notes are
considered by management to be temporary given the credit ratings on these
investment securities.


                                       25

<PAGE>

2. INVESTMENT SECURITIES (Continued)

<TABLE>
<CAPTION>
                                                                                 2006
                                              -------------------------------------------------------------------------
                                                Less Than 12 Months       12 Months or More              Total
                                              -----------------------  -----------------------  -----------------------
                                                  Fair     Unrealized      Fair     Unrealized      Fair     Unrealized
                                                 value       losses       value       losses       value       losses
                                              -----------  ----------  -----------  ----------  -----------  ----------
<S>                                           <C>          <C>         <C>          <C>         <C>          <C>
Securities available for sale:
  U.S. Treasury and Agency Notes              $14,682,646  $(173,527)  $26,642,632  $(398,569)  $41,325,278  $(572,096)
                                              ===========  =========   ===========  =========   ===========  =========
</TABLE>

<TABLE>
<CAPTION>
                                                                                 2005
                                              -------------------------------------------------------------------------
                                                Less Than 12 Months       12 Months or More              Total
                                              -----------------------  -----------------------  -----------------------
                                                  Fair     Unrealized      Fair     Unrealized      Fair     Unrealized
                                                 value       losses       value       losses       value       losses
                                              -----------  ----------  -----------  ----------  -----------  ----------
<S>                                           <C>          <C>         <C>          <C>         <C>          <C>
Securities available for sale:
  U.S. Treasury and Agency Notes              $26,584,939  $(440,469)  $        --  $      --   $26,584,939  $(440,469)
                                              ===========  =========   ===========  =========   ===========  =========
</TABLE>

U.S. Treasury and Agency notes at December 31, 2006 are contractually scheduled
to mature as follows:

                                                     Estimated
                                        Amortized      market
                                           cost        value
                                       -----------  -----------
Due within one year                    $ 8,993,479  $ 8,991,635
Due after one year through five years   47,937,813   47,462,492
                                       -----------  -----------
  Total                                $56,931,292  $56,454,127
                                       ===========  ===========

There were no sales of U.S. Treasury and Agency Notes during the years ended
December 31, 2006, 2005 and 2004. U.S. Treasury and Agency Notes with an
amortized cost of approximately $13.4 million and $17.0 million were pledged to
secure deposits from public entities and repurchase agreements at December 31,
2006 and 2005, respectively.

3. MORTGAGE-BACKED SECURITIES

Mortgage-backed securities at December 31, 2006 and 2005 are classified as
available for sale according to management's intent and summarized as follows:

<TABLE>
<CAPTION>
                                                      Gross        Gross      Estimated
                                       Amortized    unrealized   unrealized     market
                                          cost         gains       losses       value
                                      -----------  -----------  -----------  -----------
<S>                                   <C>          <C>           <C>         <C>
December 31, 2006:
  FHLMC participation certificates,
    maturing from years 2007 to 2036  $35,532,221  $   135,332   $(600,926)  $35,066,627
                                      ===========  ===========   =========   ===========

December 31, 2005:
  FHLMC participation certificates,
    maturing from years 2007 to 2035  $21,011,344  $   113,072   $(485,349)  $20,639,067
                                      ===========  ===========   =========   ===========
</TABLE>

Mortgage-backed securities at December 31, 2006 and 2005 are classified as held
for investment according to management's intent and summarized as follows:

<TABLE>
<CAPTION>
                                                      Gross        Gross      Estimated
                                       Amortized    unrealized   unrealized     market
                                          cost        gains        losses       value
                                      -----------  -----------  -----------  -----------
<S>                                   <C>          <C>           <C>         <C>
December 31, 2006:
  FHLMC participation certificate,
    maturing during 2013              $ 1,662,540  $        --   $ (99,487)  $ 1,563,053
                                      ===========  ===========   =========   ===========

December 31, 2005:
  FHLMC participation certificate,
    maturing during 2013              $ 2,063,310  $        --   $ (97,677)  $ 1,965,633
                                      ===========  ===========   =========   ===========
</TABLE>


                                       26

<PAGE>

3. MORTGAGE-BACKED SECURITIES (Continued)

The following tables present mortgage-backed securities unrealized losses and
fair values, aggregated by length of time that individual securities have been
in a continuous unrealized loss position, at December 31, 2006 and 2005. The
current year unrealized losses on these investment securities are a result of
volatility in the market during 2006 and relate to eight FHLMC participation
certificates. All unrealized losses on FHLMC participation certificates are
considered by management to be temporary given the credit ratings on these
investment securities.

<TABLE>
<CAPTION>
                                                                          2006
                                        ------------------------------------------------------------------------
                                          Less Than 12 Months       12 Months or More              Total
                                        -----------------------  -----------------------  ----------------------
                                            Fair     Unrealized      Fair     Unrealized      Fair     Unrealized
                                           value       losses       value       losses       value       losses
                                        -----------  ----------  -----------  ----------  -----------  ---------
<S>                                     <C>           <C>        <C>           <C>        <C>          <C>
Securities available for sale:
  FHLMC participation certificates      $ 8,598,800   $ (81,158) $14,955,333   $(519,768) $23,554,133  $(600,926)
                                        ===========   =========  ===========   =========  ===========  =========
Securities held for investment:
  FHLMC participation certificate       $        --   $      --  $ 1,563,053   $ (99,487) $ 1,563,053  $ (99,487)
                                        ===========   =========  ===========   =========  ===========  =========
</TABLE>

<TABLE>
<CAPTION>
                                                                          2005
                                        ------------------------------------------------------------------------
                                          Less Than 12 Months       12 Months or More              Total
                                        -----------------------  -----------------------  ----------------------
                                            Fair     Unrealized      Fair     Unrealized      Fair     Unrealized
                                           value       losses       value       losses       value       losses
                                        -----------  ----------  -----------  ----------  -----------  ---------
<S>                                     <C>           <C>        <C>           <C>        <C>          <C>
Securities available for sale:
  FHLMC participation certificate       $15,869,526   $(485,349) $        --   $      --  $15,869,526  $(485,349)
                                        ===========   =========  ===========   =========  ===========  =========
Securities held for investment:
  FHLMC participation certificate       $        --   $      --  $ 1,965,633   $ (97,677) $ 1,965,633  $ (97,677)
                                        ===========   =========  ===========   =========  ===========  =========
</TABLE>

Mortgage-backed securities, classified as available for sale or held for
investment, at December 31, 2006 are contractually scheduled to mature as
follows:

                                                      Estimated
                                         Amortized      market
                                            cost        value
                                        -----------  -----------
Due one year or less                    $    10,313  $    10,528
Due after one year through five years       207,882      210,963
Due after five years through ten years    4,941,304    4,896,834
Due after ten years                      32,035,262   31,511,355
                                        -----------  -----------
  Total                                 $37,194,761  $36,629,680
                                        ===========  ===========

Expected maturities may differ from contractual maturities because borrowers
have the right to call or prepay obligations with or without call or prepayment
penalties. No mortgage-backed securities were sold in 2006 or 2005.
Mortgage-backed securities with a carrying value of approximately $2.5 million
were sold during the year ended December 31, 2004. Net realized gains on the
sale of mortgage-backed securities were $88,844 during the year ended December
31, 2004. Mortgage-backed securities with an amortized cost of approximately
$307,474 and $476,566 were pledged as collateral for treasury tax and loan
deposits at December 31, 2006 and 2005, respectively.

4. LOANS RECEIVABLE

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

                                      2006          2005
                                  ------------  ------------
Mortgage loans                    $ 74,690,012  $ 68,022,652
Consumer loans                     103,785,611   101,833,555
Commercial loans                   580,902,157   536,638,140
Leasing                             12,640,043    11,981,099
                                  ------------  ------------
  Total                            772,017,823   718,475,446
                                  ------------  ------------
Less: Allowance for loan losses     (9,157,597)   (8,113,416)
  Deferred loan fees, net           (1,423,177)   (1,433,223)
                                  ------------  ------------
Loans receivable, net             $761,437,049  $708,928,807
                                  ============  ============


                                       27

<PAGE>

4. LOANS RECEIVABLE (Continued)

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 9).

During the years ended December 31, 2006, 2005, and 2004 the Bank exchanged
loans with outstanding principal balances of $17,203,225, $16,354,875 and
$2,841,484, 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, 2006 and 2005 are fixed rate mortgage loans with an estimated
market value of approximately $25,963,341 and $11,029,237, respectively.

Net gains on sales of loans receivable held for sale amounted to $329,743,
$199,414 and $508,218 for the years ended December 31, 2006, 2005 and 2004,
respectively.

Activity in the allowance for credit losses, which includes the allowance for
loan and lease losses and the reserve for unfunded commitments for the years
ended December 31, 2006, 2005 and 2004, is summarized as follows:

                               Allowance for  Reserve for
                              Loan and Lease    Unfunded   Allowance for
                                  Losses      Commitments  Credit Losses
                              --------------  -----------  -------------
Balance at December 31, 2003    $7,633,709     $       --   $ 7,633,709
Provisions for credit losses       968,000             --       968,000
Loans charged off                 (301,636)            --      (301,636)
Recoveries                          43,309             --        43,309
                                ----------     ----------   -----------
Balance at December 31, 2004     8,343,382             --     8,343,382
Provisions for credit losses       602,308      1,108,889     1,711,197
Loans charged off                 (845,228)            --      (845,228)
Recoveries                          12,954             --        12,954
                                ----------     ----------   -----------
Balance at December 31, 2005     8,113,416      1,108,889     9,222,305
Provisions for credit losses     1,276,827      (343,949)       932,878
Loans charged off                 (342,094)            --      (342,094)
Recoveries                         109,448             --       109,448
                                ----------     ----------   -----------
Balance at December 31, 2006    $9,157,597     $  764,940   $ 9,922,537
                                ==========     ==========   ===========

Following is a summary of the principal balances of loans on nonaccrual status
and loans past due over ninety days:

                                                        December 31,
                                                  ----------------------
                                                     2006        2005
                                                  ----------  ----------
Loans contractually past due over 90 days and/or
  on nonaccrual status:
    Mortgage residential                          $  934,022  $1,362,590
    Consumer and commercial                        1,806,353     896,254
                                                  ----------  ----------
      Total                                       $2,740,375  $2,258,844
                                                  ==========  ==========

For the years ended December 31, 2006, 2005 and 2004, interest income of
approximately $143,407, $143,189 and $121,000, respectively, was not recorded
related to loans accounted for on a nonaccrual basis.


                                       28

<PAGE>

5. PREMISES AND EQUIPMENT

Premises and equipment consist of the following:

                                         December 31,
                                   ------------------------
                                       2006         2005
                                   -----------  -----------
Land                               $ 2,809,449  $ 2,847,880
Office buildings and improvements    7,129,462    6,601,871
Furniture, fixtures and equipment    4,507,943    4,281,794
Vehicles                               449,095      403,542
Construction in process                 33,682       14,303
                                   -----------  -----------
                                    14,929,631   14,149,390
Less accumulated depreciation        6,031,622    5,318,220
                                   -----------  -----------
  Total                            $ 8,898,009  $ 8,831,170
                                   ===========  ===========

The Company leases certain branch facilities and equipment under separate
agreements that expire at various dates through August 15, 2012. Future rentals
under these leases are as follows:

  2007    $  441,358
  2008       382,305
  2009       177,480
  2010       108,010
  2011        79,372
Thereafter        --
          ----------

  Total   $1,188,525
          ==========

Rental expense amounting to approximately $444,412, $395,919 and $389,000 during
the years ended December 31, 2006, 2005 and 2004, respectively, is included in
premises and equipment expense on the accompanying consolidated statements of
operations.

6. DEPOSITS

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

2007                 $476,105,884
2008                   32,566,759
2009                    5,503,389
2010                    1,493,328
2011                    1,315,648
Thereafter                     --
                     ------------
Total time deposits  $516,985,008
                     ============

7. EMPLOYEE BENEFIT PLANS

The Company participated in a multi-employer defined benefit pension plan which
covered substantially all employees; however, effective January 31, 2002 the
Company's Board of Directors approved a plan to freeze the accrual of future
benefits under the plan. Consequently, no new employees became eligible to
participate in the plan after January 31, 2002. Effective October 1, 2004 the
Company withdrew from the plan. Active employees who were participating in the
plan became 100% vested on that date and could select from a variety of benefit
payment options based on their age and benefit payment amount. Expenses of the
plan for unfunded liability, withdrawal fees, administrative fees and PBGC
premiums the years ended December 31, 2006, 2005 and 2004 were $9,470, $0 and
$624,968, respectively.

The Company also participates in a multi-employer defined contribution plan
which covers substantially all employees. During the year ended December 31,
2006, employees may contribute from 1% to 100% of compensation, subject to an
annual maximum as determined by the Internal Revenue Code, which is an increase
in the contribution of 1% to 15% of compensation allowed during the years ended
December 31, 2005 and 2004. The Company makes matching contributions of 100% of
employees' contributions up to 5% of the employees' salaries.


                                       29

<PAGE>

7. EMPLOYEE BENEFIT PLANS (Continued)

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 years ended December 31,
2006, 2005 and 2004 were $354,235, $326,549 and $283,966, 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 years ended December 31, 2006, 2005 and 2004 aggregated $471,509,
$486,662 and $500,089, respectively. The plans generally include provisions for
forfeitures of unvested portions of payments, and vesting in the event of death
or disability. The total liability under this plan was approximately $3,308,663
at December 31, 2006 and is included in other liabilities in the accompanying
consolidated statements of financial condition.

8. STOCK BASED COMPENSATION

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
"Share-Based Payment," ("SFAS No. 123R") which was issued by the Financial
Accounting Standards Board ("FASB") in December 2004. SFAS No. 123R revises SFAS
No. 123, "Accounting for Stock Based Compensation," and supersedes APB Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and its related
interpretations. SFAS No. 123R requires recognition of the cost of employee
services received in exchange for an award of equity instruments in the
financial statements over the period the employee is required to perform the
services in exchange for the award (presumptively the vesting period). SFAS No.
123R also requires measurement of the cost of employee services received in
exchange for an award based on the grant-date fair value of the award. SFAS No.
123R also amends SFAS No. 95, "Statement of Cash Flows," to require that excess
tax benefits be reported as financing cash inflows, rather than as a reduction
of taxes paid, which is included within operating cash flows. The Company
adopted SFAS No. 123R using the modified prospective application as permitted
under SFAS No. 123R. Accordingly, prior period amounts have not been restated.
Under this application, the Company is required to record compensation expense
for all awards granted after the date of adoption and for the unvested portion
of previously granted awards that remain outstanding at the date of adoption.
Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value
method as prescribed by APB 25 and thus recognized no compensation expense for
options granted with exercise prices equal to the fair market value of the
Company's common stock on the date of grant.

The Company has one share-based compensation 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. At December 31,
2006, the Plan includes 538,374 granted unexercised shares and 988,277 shares
available to be granted. 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.

A summary of option activity under the Plan as of December 31, 2006, and changes
during the year ended December 31, 2006 is presented below:

<TABLE>
<CAPTION>
                                                                     Aggregate
                                     Options     Options             Intrinsic
Year Ended December 31, 2006:       Available  Outstanding   Price     Value
-----------------------------       ---------  -----------  ------  -----------
<S>                                 <C>         <C>         <C>     <C>
  Outstanding at December 31, 2005  1,003,977   1,055,653   $ 7.34
  Granted                             (20,500)     20,500   $29.22
  Forfeited                             4,800      (4,800)  $19.31
  Exercised                                --    (532,979)  $ 5.74
                                    ---------   ---------   ------
Outstanding at December 31, 2006      988,277     538,374   $ 9.74  $11,975,810
                                    =========   =========           ===========
</TABLE>

The amount of cash received and value of shares tendered for payment of option
exercises for the December 31, 2006 was $3,058,144. The tax benefits realized
for the tax deductions from option exercise of the share-based payment
arrangements totaled $3,965,214 for the year ended December 31, 2006.


                                       30

<PAGE>

8. STOCK BASED COMPENSATION (Continued)

The intrinsic value of options exercised during the year ended December 31, 2006
was $11,309,095.

A summary of nonvested option shares as of December 31, 2006, and changes during
the year ended December 31, 2006 is presented below:

Year Ended December 31, 2006:      Shares   Price
-----------------------------     -------  ------
  Nonvested at December 31, 2005   75,300  $18.22
  Granted                          20,500  $29.22
  Forfeited                        (4,800) $19.31
  Vested                          (37,750) $12.97
                                  -------
  Nonvested at December 31, 2006   53,250  $22.89
                                  =======

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, 2006, dividend
growth rate of 17%; expected volatility of 22.3%; risk-free interest rates
ranging from 4.70% to 5.06%; and expected lives of 6 years. The weighted-average
fair value of options granted during the year ended December 31, 2006 was $6.03.

As of December 31, 2006, there was $174,614 of total unrecognized compensation
cost related to non-vested share-based compensation arrangements granted under
the Company's stock option plans. That cost is expected to be recognized the
next 4.5 years.

The following table summarizes additional information about the Company's
outstanding options and exercisable options as of December 31, 2006, including
weighted-average remaining contractual term expressed in years ("Life") and
weighted average exercise price ("Price"):

                              Outstanding         Exercisable
                         ---------------------  ---------------
Range of Exercise Price   Shares  Life   Price   Shares   Price
-----------------------  -------  ----  ------  -------  ------
  $5.41 - 5.50           324,475  1.27  $ 5.41  324,475  $ 5.41
  $6.87 - 10.37           51,067  4.47  $ 8.41   51,067  $ 8.41
  $14.97 - 16.61          91,332  6.38  $15.64   87,582  $15.64
  $16.77 - 29.28          61,500  8.49  $20.40   22,000  $19.10
  $30.81 - 33.30          10,000  9.57  $32.54        -  $    -
                         -------                -------
                         538,374  3.07  $ 9.65  485,124  $ 8.19
                         =======                =======

The adoption of SFAS 123R and its fair value compensation cost recognition
provisions are different from the recognition provisions under SFAS 123 and the
intrinsic value method for compensation cost allowed under APB 25. As a result
of adopting SFAS 123R the Company's income before income taxes and net income
for the year ended December 31, 2006 is $126,450 and $115,038 lower, than if it
had continued to account for share-based compensation under APB 25. Basic
earnings per share and diluted earnings per share for the year ended December
31, 2006 are $.01 lower, respectively, than if the Company had continued to
account for share-based compensation under APB 25.

The following table illustrates the effect on net income available to common
stockholders if the Company had applied the fair value recognition provisions of
SFAS No. 123 to the year earlier period:

<TABLE>
<CAPTION>
                                                             Years Ended December 31,
                                                --------------------------------------------------
                                                          2005                      2004
                                                ------------------------  ------------------------
                                                As Reported   Pro Forma   As Reported   Pro Forma
                                                -----------  -----------  -----------  -----------
<S>                                             <C>          <C>          <C>          <C>
Net income attributable to common shareholders  $14,128,704  $14,007,413  $11,712,441  $11,627,766
Stock based compensation, net of tax effect     $        --  $   121,291  $        --  $    84,675
Net income per share - basic                    $      1.49  $      1.47  $      1.25  $      1.24
Net income per share - diluted                  $      1.41  $      1.41  $      1.19  $      1.18
</TABLE>


                                       31

<PAGE>

8. STOCK BASED COMPENSATION (Continued)

A summary of the status of the Plan as of December 31, 2005 and 2004, and
changes during the years then ended, including weighted-average exercise price
("Price"), is presented below:

                                        Years ended December 31,
                                  ------------------------------------
                                         2005               2004
                                  -----------------  -----------------
                                    Shares    Price    Shares    Price
                                  ---------  ------  ---------  ------
Outstanding at beginning of year  1,160,961  $ 6.79  1,279,062  $ 6.63
Granted                              53,175   19.37     20,625   15.53
Cancellations                      (158,483)   7.29   (138,726)   6.59
                                  ---------          ---------
Outstanding at year end           1,055,653    7.34  1,160,961    6.79
                                  =========          =========
Weighted-average fair value of
options granted during the year              $ 3.17             $ 2.31
                                             ======             ======

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 years ended December 31, 2005 and 2004,
respectively, dividend growth rate of 17% for each period; expected volatility
of 21.4%, and 21.7%; and risk-free interest rates ranging from 4.03% to 4.47%
during the year ended December 31, 2005; 3.59% to 4.11% during the year ended
December 31, 2004; and expected lives of 6 years.

9. BORROWED MONEY

Borrowed money represents advances from the FHLB and repurchase agreements.
Advances outstanding from the FHLB at December 31, 2006 and 2005 had a weighted
average rate of 5.50% and 4.40%, respectively, and totaled $6,000,000 and
$5,500,000, respectively. These advances have a scheduled maturity date of
January 3, 2008.

At December 31, 2006 and December 31, 2005, repurchase agreements outstanding
had average rates of 4.69% and 3.59%, and totaled $5,139,947 and $6,287,528,
respectively.

At December 31, 2006 and 2005, repurchase agreements were collateralized by U.S.
government agency obligations with a principal balance of $10,000,000 and
$7,000,000, respectively. 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,
2006 and 2005, the Company had approximately $175.7 million and $160.8 million,
respectively, of additional credit available with the FHLB.

10. INCOME TAXES

The components of income tax expense for the years ended December 31, 2006, 2005
and 2004 are as follows:

                   Years Ended December 31,
             -----------------------------------
                 2006        2005        2004
             -----------  ----------  ----------
Current
  Federal    $ 9,378,947  $7,925,068  $4,817,313
  State        1,894,604   1,568,269   1,007,039
             -----------  ----------  ----------
              11,273,551   9,493,337   5,824,352
             -----------  ----------  ----------
Deferred
  Federal       (165,994)   (496,214)  1,004,496
  State          (35,753)    (49,927)    137,192
             -----------  ----------  ----------
                (201,747)   (546,141)  1,141,688
             -----------  ----------  ----------
  Total      $11,071,804  $8,947,196  $6,966,040
             ===========  ==========  ==========


                                       32

<PAGE>

10. INCOME TAXES (Continued)

Reconciliations of the expected income tax expense at statutory tax rates with
income tax expense reported in the statements of operations for the years ended
December 31, 2006, 2005 and 2004 are as follows:

                                          Years Ended December 31,
                                    -----------------------------------
                                        2006        2005        2004
                                    -----------  ----------  ----------
Expected income tax expense at 35%  $ 9,892,456  $8,076,565  $6,350,684
State income taxes, net of federal
  income tax                          1,208,253     986,922     755,192
Other expenses and adjustments          (28,905)   (116,291)   (139,836)
                                    -----------  ----------  ----------

    Total                           $11,071,804  $8,947,196  $6,966,040
                                    ===========  ==========  ==========

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

                                                      Years Ended December 31,
                                                      ------------------------
                                                         2006          2005
                                                      ----------    ----------
Deferred income tax assets
  Deferred directors' fees                            $  562,648    $  584,251
  Allowance for credit losses                          3,820,651     3,410,155
  Employee benefits                                      771,798       758,035
  Loans mark-to-market                                   152,968        72,464
  Unrealized losses on securities available for sale     363,433       214,732
  Other                                                   57,862        57,419
                                                      ----------    ----------
                                                       5,729,360     5,097,056
                                                      ----------    ----------
Deferred income tax liabilities
  Depreciation and amortization                        3,483,047     3,350,886
  Carrying value - land                                  395,000       395,000
  Mortgage servicing rights                              500,279       553,824
  Deferred loan origination fees and costs               807,690       598,819
  FHLB stock                                             141,451       141,451
  Other                                                       --        50,958
                                                      ----------    ----------
                                                       5,327,467     5,090,938
                                                      ----------    ----------
Net deferred income tax asset                         $  401,893    $    6,118
                                                      ==========    ==========

11. 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, 2006, that the Bank meets all capital adequacy
requirements to which it is subject. The Company's most significant asset is its
investment in First South Bank. Consequently, the information concerning capital
ratios is essentially the same for the Company and the Bank.


                                       33

<PAGE>

11. REGULATORY CAPITAL REQUIREMENTS (Continued)

As of December 31, 2006, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as 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, 2006
and 2005 are presented in the table below (dollars in thousands):

<TABLE>
<CAPTION>
                                                                             Minimum to
                                                                               be Well
                                                                             Capitalized
                                                             Minimum for    under Prompt
                                                               Capital       Corrective
                                                              Adequacy         Action
                                               Actual         Purposes       Provisions
                                          ---------------  --------------  --------------
                                           Amount   Ratio   Amount  Ratio   Amount  Ratio
                                          -------  ------  -------  -----  -------  -----
<S>                                       <C>       <C>    <C>       <C>   <C>      <C>
December 31, 2006:
Total Capital (to Risk Weighted Assets)   $86,444   11.7%  $58,943   8.0%  $73,678  10.0%
Tier I Capital (to Risk Weighted Assets)   77,225   10.5%   29,471   4.0%   44,207   6.0%
Tier I Capital (to Average Assets)         77,225    8.5%   36,154   4.0%   45,193   5.0%

December 31, 2005:
Total Capital (to Risk Weighted Assets)   $80,015   11.7%  $54,940   8.0%  $68,675  10.0%
Tier I Capital (to Risk Weighted Assets)   71,423   10.4%   27,470   4.0%   41,205   6.0%
Tier I Capital (to Average Assets)         71,423    8.6%   33,125   4.0%   41,406   5.0%
</TABLE>

12. EARNINGS PER SHARE

The following table provides a reconciliation of income available to common
stockholders and the average number of shares outstanding (less unearned
deferred stock awards and treasury shares) for the years ended December 31,
2006, 2005 and 2004. Options to purchase 538,374, 1,055,653 and 1,160,961 shares
of common stock were outstanding at December 31, 2006, 2005, and 2004
respectively.

                                            Years Ended December 31,
                                     -------------------------------------
                                         2006         2005        2004
                                     -----------  -----------  -----------
Net income (numerator)               $17,192,356  $14,128,704  $11,712,441
                                     ===========  ===========  ===========

Weighted average shares outstanding
  for basic EPS (denominator)          9,714,565    9,488,073    9,377,799
Dilutive effect of stock options         288,304      492,149      457,925
                                     -----------  -----------  -----------
Adjusted shares for diluted EPS       10,002,869    9,980,222    9,835,724
                                     ===========  ===========  ===========

For the years ended December 31, 2006 and 2005, there were 8,000 and 10,800,
respectively, options that were antidilutive since the exercise price exceeded
the average market price of the Company's common stock for the year. These
options have been omitted from the calculation of diluted earnings per share for
2006.

13. 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 $245,620,000, $260,632,000 and
$277,252,000 at December 31, 2006, 2005, and 2004 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.


                                       34

<PAGE>

13. MORTGAGE BANKING ACTIVITIES (Continued)

At December 31, 2006 and 2005, mortgage servicing rights reported in the
consolidated statements of financial condition, net of amortization, were
$1,266,530 and $1,402,085 respectively.

During the years ended December 31, 2006 and 2005 respectively, the Company
recorded additional servicing assets of $208,468 and $75,866 as a result of
sales of loans or mortgage-backed securities. Amortization of servicing assets
during the years ended December 31, 2006, 2005, and 2004 aggregated $344,023,
$372,559, and $277,077, respectively. The fair value of recognized servicing
assets amounted to approximately $2,300,000 and $1,843,000 as of December 31,
2006 and 2005, respectively. 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.

14. FINANCIAL INSTRUMENTS 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 and
to reduce its own exposure to fluctuations in interest rates. 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.

A summary of the contractual amounts of the Company's exposure to off-balance
sheet risk as of December 31, 2006 and 2005 is as follows:

                                              December 31,
                                      ---------------------------
                                          2006           2005
                                      ------------   ------------
Commitments to extend credit          $ 98,085,000   $156,852,000
Undrawn balances on lines of credit
  and undrawn balances on credit
  reserves (overdraft protection)       54,345,000     53,637,000
Standby letters of credit                2,720,000      2,031,000
                                      ------------   ------------
  Total                               $155,150,000   $212,520,000
                                      ============   ============

Included in the commitments to originate loans as of December 31, 2006 and
December 31, 2005, are fixed interest rate loan commitments of approximately
$16.0 million and $23.8 million, 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,
Dare, Edgecombe, Lenoir, Durham, Nash, Pasquotank, Pitt, Robeson, Wake, 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.


                                       35

<PAGE>

15. 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, 2006, 2005 and 2004 are as
follows:

<TABLE>
<CAPTION>
                                                                     Years Ended December 31,
                                                            -----------------------------------------
                                                                2006           2005           2004
                                                            ------------   ------------   -----------
<S>                                                         <C>            <C>            <C>
CONDENSED BALANCE SHEETS
Cash                                                        $  1,673,729   $  1,307,746   $ 1,071,439
Due from subsidiary                                                   --             --            --
Investment in wholly-owned subsidiary                         81,093,299     75,530,645    68,072,782
Other assets                                                   8,003,533      2,929,991     1,931,609
                                                            ------------   ------------   -----------
      Total assets                                          $ 90,770,561   $ 79,768,382   $71,075,830
                                                            ============   ============   ===========
Junior subordinated debentures                              $ 10,310,000   $ 10,310,000   $10,310,000
Other liabilities                                              1,663,983      1,267,910     1,070,483
Stockholders' equity                                          78,796,578     68,190,472    59,695,347
                                                            ------------   ------------   -----------
      Total liabilities and stockholders' equity            $ 90,770,561   $ 79,768,382   $71,075,830
                                                            ============   ============   ===========
CONDENSED STATEMENTS OF INCOME
Interest income, net                                        $         --   $         --   $        --
Interest on junior subordinated debentures                       815,331        632,629       448,319
Equity in earnings of subsidiary                              17,846,544     14,597,194    12,074,429
Miscellaneous income                                             161,143        164,139        86,331
                                                            ------------   ------------   -----------
      Net income                                            $ 17,192,356   $ 14,128,704   $11,712,441
                                                            ============   ============   ===========
CONDENSED STATEMENTS OF CASH FLOWS
Operating activities:
  Net income                                                $ 17,192,356   $ 14,128,704   $11,712,441
  Adjustments to reconcile net income
    to net cash provided by operating activities:
    Amortization of intangibles                                   24,996         24,996        24,996
    Equity in undistributed earnings of subsidiary           (17,846,544)   (14,597,194)   (5,351,168)
    Other operating activities                                (8,146,306)    (1,023,368)     (589,996)
                                                            ------------   ------------   -----------
      Net cash provided by (used in) operating activities     (8,775,498)    (1,466,862)    5,796,273
                                                            ------------   ------------   -----------
Investing activities:
  Payments for investments in and advances to subsidiary              --             --            --
  Repayments of advances to subsidiary                                --             --            --
  Upstream dividend received from First South Bank            15,115,171      5,895,276            --
                                                            ------------   ------------   -----------
      Net cash provided by investing activities               15,115,171      5,895,276            --
                                                            ------------   ------------   -----------
Financing activities:
  Proceeds from exercise of stock options                      1,093,576      1,012,468       680,826
  Purchase of treasury shares                                   (867,905)      (336,726)   (2,212,690)
  Cash paid for dividends and fractional shares               (6,199,361)    (4,867,849)   (4,032,865)
                                                            ------------   ------------   -----------
      Net cash used in financing activities                   (5,973,690)    (4,192,107)   (5,564,729)
                                                            ------------   ------------   -----------
Net increase in cash                                             365,983        236,307       231,544
Cash at beginning of year                                      1,307,746      1,071,439       839,895
                                                            ------------   ------------   -----------
Cash at end of year                                         $  1,673,729   $  1,307,746   $ 1,071,439
                                                            ============   ============   ===========
</TABLE>


                                       36

<PAGE>

16. QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized unaudited quarterly financial data for the years ended December 31,
2006 and 2005 is as follows (in thousands):

                               Fourth    Third     Second    First
                              -------   -------   -------   -------
2006:
Interest income               $17,849   $17,528   $16,794   $15,581
Interest expense                7,343     6,960     6,082     5,221
Provision for credit losses        --       150       437       346
Noninterest income              2,190     2,516     2,311     2,244
Noninterest expense             5,532     5,758     5,562     5,358
Income tax expense              2,799     2,859     2,737     2,677
                              -------   -------   -------   -------
Net income                    $ 4,365   $ 4,317   $ 4,287   $ 4,223
                              =======   =======   =======   =======
Net income per common share
  Basic                       $   .45   $   .44   $   .44   $   .44
  Diluted                     $   .43   $   .43   $   .43   $   .42

                               Fourth    Third     Second    First
                              -------   -------   -------   -------
2005:
Interest income               $14,931   $13,912   $12,602   $11,732
Interest expense                4,560     4,350     3,588     2,965
Provision for credit losses       266       394       413       638
Noninterest income              2,133     2,265     1,909     1,901
Noninterest expense             5,507     5,432     5,222     4,973
Income tax expense              2,615     2,327     2,057     1,949
                              -------   -------   -------   -------
Net income                    $ 4,116   $ 3,674   $ 3,231   $ 3,108
                              =======   =======   =======   =======
Net income per common share
  Basic                       $   .43   $   .39   $   .34   $   .33
  Diluted                     $   .41   $   .37   $   .32   $   .31

17. 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.


                                       37

<PAGE>

17. FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)

The estimation methodologies, resulting fair values, and recorded carrying
amounts at December 31, 2006 and 2005 were as follows:

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 2 and 3 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, 2006             December 31, 2005
                         ---------------------------   ---------------------------
                           Estimated      Carrying       Estimated      Carrying
                          fair value       amount       fair value       amount
                         ------------   ------------   ------------   ------------
<S>                      <C>            <C>            <C>            <C>
1 - 4 family mortgages   $ 74,623,870   $ 73,891,745   $ 67,994,412   $ 67,292,687
Consumer                  101,571,532    102,448,552     99,701,568    100,544,156
Non-residential           585,096,751    585,096,752    541,091,964    541,091,964
                         ------------   ------------   ------------   ------------
  Total                  $761,592,153   $761,437,049   $708,787,944   $708,928,807
                         ============   ============   ============   ============
</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
$283,203,473 and $266,389,243 at December 31, 2006 and 2005, 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, 2006 and 2005 are as follows:

                                           2006           2005
                                       ------------   ------------
Certificates of deposits
  Carrying amount                      $516,985,008   $467,363,822
  Estimated fair value                  520,987,553    466,326,243

Advances for Federal Home Loan Bank:
  Carrying amount                      $  6,000,000   $  5,500,000
  Estimated fair value                    6,000,000      5,500,000

The carrying amount of accrued interest receivable, FHLB stock, note receivable,
junior subordinated debentures, accrued interest payable, and repurchase
agreements approximates their fair value.

There is no material difference between the carrying amount and estimated fair
value of off-balance sheet items totaling $155,150,000 and $212,520,000 at
December 31, 2006 and 2005, respectively, which are primarily comprised of
unfunded loan commitments.

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


                                       38

<PAGE>

18. SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental cash flow information for the years ended December 31, 2006, 2005
and 2004 is as follows:

<TABLE>
<CAPTION>
                                                           Year ended December 31,
                                                   --------------------------------------
                                                       2006          2005          2004
                                                   -----------   -----------   ----------
<S>                                                <C>           <C>           <C>
Real estate acquired in settlement of loans        $ 1,051,764   $   793,184   $  193,709
Exchange of loans for mortgage-backed securities    17,203,225    16,354,875    2,841,484
Cash paid for interest                              25,572,320    15,443,427    9,741,103
Cash paid for income taxes                           8,360,047     9,272,923    4,452,185
Dividends declared, not paid                         1,663,983     1,267,910    1,070,482
</TABLE>

Noncash assets acquired in branch acquisitions are presented in Note 20.

19. JUNIOR SUBORDINATED DEBENTURES OWED TO UNCONSOLIDATED SUBSIDIARY TRUST AND
CORPORATION-OBLIGATED MANDATORILY REDEEMABLE PREFERRED TRUST SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY DEBENTURES OF THE COMPANY

The Company has sponsored a trust, First South Preferred Trust I (the Trust), of
which 100% of the common equity is owned by the Company. The Trust was formed
for the purpose of issuing company-obligated preferred trust securities (the
Preferred Trust Securities) to third-party investors and investing the proceeds
from the sale of such Preferred Trust Securities solely in junior subordinated
debt securities of the Company (the Debentures). The Debentures held by the
Trust are the sole assets of the Trust. Distributions on the Preferred Trust
Securities issued by the Trust are payable quarterly at a rate equal to the
interest rate being earned by the Trust on the Debentures held by that Trust.
The Preferred Trust Securities are subject to mandatory redemption, in whole or
in part, upon repayment of the Debentures. The Company has entered into an
agreement, which fully and unconditionally guarantees the Preferred Trust
Securities subject to the terms of the guarantee. The Debentures held by the
Trust are first redeemable, in whole or in part, by the Company on or after
September 30, 2008.

In the fourth quarter of 2003, as a result of applying the provisions of FIN
46R, governing when an equity interest should be consolidated, the Company was
required to deconsolidate the subsidiary Trust from its financial statements.
The deconsolidation of the net assets and results of operations of the Trust had
virtually no impact on the Company's financial statements or liquidity position
since the Company continues to be obligated to repay the Debentures held by the
Trust and guarantees repayment of the Preferred Trust Securities issued by the
Trust. The consolidated debt obligation related to the Trust increased from $10
million to $10.3 million upon deconsolidation with the difference representing
the Company's common ownership interest in the Trust.

Subject to certain limitations, the Junior Subordinated Debentures qualify as
Tier I capital for the Company under Federal Reserve Board guidelines.

Consolidated debt obligations as of December 31, 2006 related to a subsidiary
Trust holding solely Debentures of the Company follows:

LIBOR + 2.95% junior subordinated debentures owed to
  First South Preferred Trust I due September 26, 2033        $10,000,000

LIBOR + 2.95% junior subordinated debentures owed to
  First South Preferred Trust I due September 26, 2033            310,000
                                                              -----------
Total junior subordinated debentures owed to unconsolidated
  subsidiary trust                                            $10,310,000
                                                              ===========


                                       39

<PAGE>

20. ACQUISITIONS

On February 20, 2004, the Company completed the acquisition of two Central
Carolina Bank (CCB) retail banking locations. This acquisition was accounted for
using the purchase method of accounting and the Bank assumed the deposits of the
two CCB branches for a premium of approximately 1.5% of the assumed deposits.

The fair value of assets, including identifiable intangible assets, and
liabilities assumed were as follows (in thousands):

Loans receivable                           $  2,212
Premises and equipment                           75
Core deposit intangible                         314
Deposits                                    (18,373)
                                           --------
Net cash received in branch acquisitions   $(15,772)
                                           ========

The Company recorded $31,440 in core deposit intangible amortization expense
during the years ended December 31, 2006 and 2005. Amortization expense related
to this intangible is anticipated to be approximately $31,000 per year over the
next 5 years, with the remaining balance totaling approximately $104,000 to be
amortized thereafter. These estimates are subject to change in future periods to
the extent management determines it is necessary to make adjustments to the
carrying value or estimated useful life of this amortizing intangible asset.


                                       40

<PAGE>

                               BOARD OF DIRECTORS

Frederick N. Holscher
Chairman
Partner
Rodman, Holscher, Francisco,
& Peck, P.A.
Washington, NC

Charles E. Parker, Jr.
Senior Vice President
Robinson & Stith Insurance
New Bern, NC

Marshall T. Singleton
Vice Chairman
Co-Owner
B. E. Singleton & Sons
Washington, NC

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

Linley H. Gibbs, Jr.
Retired
Washington, NC

Thomas A. Vann
President and
Chief Executive Officer
First South Bank
Washington, NC

Frederick H. Howdy
President
Drs. Freshwater & Howdy, P.A.
Washington, NC

                               EXECUTIVE OFFICERS

Thomas A. Vann
President and
Chief Executive Officer

Sherry L. Correll
Executive Vice President
Deposit Operations

Larry W. Mallard
Executive Vice President
Chief Operating Of. cer

Paul S. Jaber
Executive Vice President
Mortgage Operations

William L. Wall
Executive Vice President
Chief Financial Officer and
Secretary

Mary R. Boyd
Executive Vice President
Loan Servicing

James W. Hoose, Jr.
Executive Vice President
Chief Credit Officer

Kristie W. Hawkins
Treasurer
Controller

                          AREA & SUBSIDIARY EXECUTIVES

Timothy M. Brown
Senior Vice President
Area Executive
Cape Fear Region

Guy P. Williams, Jr.
Senior Vice President
Area Executive
Tar River Region

James F. Buckman, IV
Senior Vice President
Area Executive
Pamlico Region

Donnie L.G. Bunn
President
First South Leasing, LLC.
Greenville, NC

Russel A. Lay
Senior Vice President
Area Executive
Albemarle Region

Dennis A. Nichols
Senior Vice President
Area Executive
Neuse Region

                            CITY & BRANCH EXECUTIVES

Jerry G. Hannah
Vice President
City Executive
Kinston, NC

Rhonda B. McLeod
Assistant Vice President
City Executive
Hope Mills, NC

Clyle F. Swanner, Jr.
Vice President
City Executive
Washington, NC

Joseph M. Johnson
Senior Vice President
City Executive
Durham, NC

Robert C. Pfeiffer
Senior Vice President
City Executive
Elizabeth City, NC

Thomas S. Lewis
Vice President
Branch Executive
Rocky Mount, NC

Donald B. Strickland, Jr.
Senior Vice President
City Executive
Greenville, NC

Kenneth W. Marshall, Jr.
Assistant Vice President
City Executive
Buxton, NC

William P. Stone
Vice President
City Executive
Lumberton, NC


                                       41

<PAGE>

                        FIRST SOUTH BANK OFFICE LOCATIONS

Buxton
47560 NC Highway 12
Buxton, NC 27920
(252) 995-3250

Chocowinity
2999 Highway 17 South
Chocowinity, NC 27817
(252) 940-4970

Durham
4215-01 University Drive
Durham, NC 27707
(919) 403-1000

Elizabeth City
604 East Ehringhaus Street
Elizabeth City, NC 27906
(252) 335-0848

Fayetteville
241 Green Street
Fayetteville, NC 28302
(910) 483-3681

705 Executive Place
Fayetteville, NC 28305
(910) 484-2116

Greenville
301 East Arlington Boulevard
Greenville, NC 27835
(252) 321-2600

907 East Firetower Road
Greenville, NC 27835
(252) 355-4644

Hope Mills
3103 North Main Street
Hope Mills, NC 28348
(910) 423-0952

Kill Devil Hills
1906 South Croatan Highway
Kill Devil Hills, NC 27948
(252) 441-9935

Kinston
2430 Herritage Street
Kinston, NC 28503
(252) 523-9449

Lumberton
600 North Chestnut Street
Lumberton, NC 28359
(910) 739-3274

3000 North Elm Street
Lumberton, NC 28359
(910) 608-5031

New Bern
202 Craven Street
New Bern, NC 28561
(252) 636-2997

1725 Glenburnie Road
New Bern, NC 28561
(252) 636-3569

2019 South Glenburnie Road
New Bern, NC 28561
(252) 637-1110

Rocky Mount
300 Sunset Avenue
Rocky Mount, NC 27804
(252) 972-9661

2901 Sunset Avenue
Rocky Mount, NC 27804
(252) 451-1259

1378 Benvenue Road
Rocky Mount, NC 27804
(252) 442-8375

450 North Winstead Avenue
Rocky Mount, NC 27804
(252) 937-1900

3635 North Halifax Road
Rocky Mount, NC 27804
(252) 451-8700

Raleigh
4800 Six Forks Road, Suite 115
Raleigh, NC 27609
(919) 783-5222

Tarboro
100 East Hope Lodge Street
Tarboro, NC 27886
(252) 823-0157

Washington
1311 Carolina Avenue
Washington, NC 27889
(252) 946-4178

300 North Market Street
Washington, NC 27889
(252) 940-4945

1328 John Small Avenue
Washington, NC 27889
(252) 940-5000

Credit Administration
220 Creekside Drive
Washington, NC 27889
(252) 975-4800

Operations Center
220 Creekside Drive
Washington, NC 27889
(252) 946-4178

Loan Production Office
Island Land Centre
3210 North Croatan Highway
Kill Devil Hills, NC 27948
(252) 441-8743

First South Leasing
1035 Director Court, Unit C
Greenville, NC 27858
(252) 355-4536

UVEST Investment Consultants

Donald Rudolph
1311 Carolina Avenue
Washington, NC 27889
(252) 940-4904

Chris Harp
2901 Sunset Avenue
Rocky Mount, NC 27804
(252) 451-0867

Brian Tarumoto
241 Green Street
Fayetteville, NC 28302
(910) 483-3686

                                              Member FDIC o Equal Housing Lender


                                       42

<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 Global Select
Market under the symbol FSBK. As of March 1, 2007, there were 885 registered
stockholders of record.

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, 2006       (1)  $25.33   $22.70      $.17
June 30, 2006        (1)   34.72    23.85       .17
September 30, 2006         34.72    28.50       .17
December 31, 2006          33.60    29.65       .17

March 31, 2005       (1)   19.00    15.62       .13
June 30, 2005        (1)   24.17    18.21       .13
September 30, 2005   (1)   24.13    20.79       .13
December 31, 2005    (1)   25.33    19.65       .14

----------
(1)   Adjusted for three-for-two stock split on May 25, 2006.

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 headings "About Us - Newsroom - SEC Filings:
EDGAR-Online". 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 bill.wall@firstsouthnc.com.

Annual Meeting

The Annual Meeting of Stockholders of First South Bancorp, Inc. will be held
Thursday, May 24, 2007 at 11:00 a.m., at the main office of First South Bank,
1311 Carolina Avenue, Washington, North Carolina.

<TABLE>
<S>                                     <C>                           <C>
General Counsel                         Special Counsel               Independent Accountants
Rodman, Holscher, Francisco & Peck, PA  Muldoon Murphy & Aguggia LLP  Turlington and Company, LLP
320 North Market Street                 5101 Wisconsin Avenue, NW     509 East Center Street
Washington, NC 27889                    Washington, DC 20016          Lexington, NC 27293
</TABLE>


                                       43

<PAGE>

                       COMPARATIVE STOCK PERFORMANCE GRAPH

      The graph and table which follow show the cumulative total return on the
Common Stock for the period from December 31, 2001 through December 31, 2006
with (1) the total cumulative return of all companies whose equity securities
are traded on the Nasdaq Stock Market and (2) the total cumulative return of
banking companies traded on the Nasdaq Stock Market. The comparison assumes $100
was invested on December 31, 2001 in the Company's Common Stock and in each of
the foregoing indices and assumes reinvestment of dividends. The stockholder
returns shown on the performance graph are not necessarily indicative of the
future performance of the Common Stock or of any particular index.

                 COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
           Among First South Bancorp, Inc., The NASDAQ Composite Index
                           And The NASDAQ Bank Index

  [THE FOLLOWING TABLE WAS REPRESENTED BY LINE CHART IN THE PRINTED MATERIAL.]

*     $100 invested on 12/31/01 in stock or index-including reinvestment of
      dividends. Fiscal year ending December 31.

<TABLE>
<CAPTION>
                           12/31/01   12/31/02   12/31/03   12/31/04   12/31/05   12/31/06
                           --------   --------   --------   --------   --------   --------
<S>                         <C>        <C>        <C>        <C>        <C>        <C>
First South Bancorp Inc.    $100.00    $162.88    $170.93    $183.53    $259.45    $359.39
NASDAQ                      $100.00    $ 68.85    $101.86    $112.16    $115.32    $127.52
NASDAQ Bank                 $100.00    $ 59.14    $ 89.11    $103.85    $130.57    $166.05
</TABLE>


                                       44

<PAGE>

                               First South Bancorp
                              1311 Carolina Avenue
                                  P.O. Box 2047
                        Washington, North Carolina 27889
                      (252) 946-4178 o Fax (252) 946-3873
                              www.firstsouthnc.com