2001 ANNUAL REPORT

FIRST SOUTH BANCORP
===================
-------------------

<PAGE>

                                TABLE OF CONTENTS

Letter to Stockholders                                                         1

Selected Consolidated Financial Information and Other Data                     2

Management's Discussion and Analysis of Financial Condition
     and Results of Operations                                                 3

Report of Independent Accountants                                             14

Consolidated Statements of Financial Condition                                15

Consolidated Statements of Operations                                         16

Consolidated Statements of Stockholders' Equity                               17

Consolidated Statements of Cash Flows                                         18

Notes to Consolidated Financial Statements                                    19

Board of Directors                                                            41

Executive Officers                                                            41

Area and City Executives                                                      41

First South Bank Office Locations                                             42

First South Bank ATM Locations                                                42

First South Bank Products and Services                                        43

Stockholder Information                                                       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:

It is a pleasure to present the 2001  operating  results for First South Bancorp
("First  South").  It was another  excellent  year with  earnings  setting a new
record.  We are pleased  that the market  value of First  South's  common  stock
reflected this superior  performance,  increasing  38.3% from year-end 2000. The
appreciation in market value,  combined with a 45.7% increase in the annual cash
dividend,  resulted in a total  return of 41.2% to First South  stockholders  in
2001.

For the year ended  September  30,  2001,  we reported  record  earnings of $5.8
million  representing a 64.3% increase over the $3.5 million earned for the year
ended  September 30, 2000.  Diluted  earnings per share increased 72.6% to $1.95
per  share,  compared  to $1.13 per share for  fiscal  2000.  Our 2001  earnings
produced  a  return  on  average   assets  of  1.1%  and  a  return  on  average
stockholders' equity of 12.3%. Our financial position remains strong.

The year ended  September 30, 2001 was an eventful one for First South and First
South  Bank  (the  "Bank").  The Bank was  recognized  as the  number  one Small
Business  Administration  lender  among  community  banks in the  state of North
Carolina.  We opened two new full service  banking offices located in Washington
and Kinston and we opened a new Operations  Center,  also located in Washington.
We have created a new leasing division called First South Leasing, LLC that will
offer  general  equipment  leases to the  commercial  markets of  eastern  North
Carolina and the Piedmont,  parts of South Carolina and Virginia,  as well as to
the existing commercial accounts and business clients of the Bank. The Bank will
open its twentieth  branch during the last quarter of 2001 and plans to continue
its  expansion  into  additional  outer  markets,  including  areas in  eastern,
southeastern and northeastern North Carolina.

Our  primary  strategy is to focus on  enhancing  the  franchise  value of First
South.  We are committed to building a high  performance  bank,  which  provides
superior  returns to its  stockholders.  We are  continuing to  restructure  the
assets and  liabilities  of the Bank in order to  achieve a higher net  interest
margin.  We will continue to look for acquisition  opportunities and will expand
our branch  operations into new markets.  The consolidation of our industry will
continue and this will create  significant  opportunities for First South. There
will be a greater  emphasis on increasing  our level of efficiency  and customer
service.

This  year has  been a  difficult  year  for  Americans  both  economically  and
personally.  The  challenges  America  has been  presented  this year can not be
understated. The events of September 11th have changed each of us forever and it
is difficult to express the shock, grief and compassion we feel for our country.
Our sympathies go out to all those who suffered a personal loss and to those who
were injured in the attack on our country.

As we work through these difficult  times, it is apparent that our employees are
our greatest  asset.  Our employees are held to high standards and they meet the
challenges  placed  before  them.  I want to thank  them for their  efforts  and
commitment in making First South so successful.

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

                                        Sincerely,

                                        /s/ Tom Vann

                                        Tom Vann
                                        President and
                                        Chief Executive Officer

                                        1
<PAGE>

SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

<TABLE>
<CAPTION>
                                                       At or For the Year Ended September 30,
                                            ------------------------------------------------------------
                                              2001         2000         1999         1998         1997
                                            --------     --------     --------     --------     --------
                                                    (dollars in thousands, except per share data)

Selected Financial Condition Data
---------------------------------
<S>                                         <C>          <C>          <C>          <C>          <C>
Total assets                                $541,195     $559,719     $292,305     $281,479     $249,281
Loans receivable, net                        374,087      366,210      212,054      224,999      197,785
Cash and investment securities                95,191       59,927       12,435       20,119       18,856
Mortgage-backed securities                    48,603      108,519       56,326       27,017       24,818
Deposits                                     471,939      471,942      234,618      204,635      175,116
Borrowings                                     4,909       30,388        1,318       11,933       12,621
Stockholders' equity                          50,769       44,835       48,763       56,714       57,856

Selected Operations Data
------------------------
Interest income                             $ 42,159     $ 36,865     $ 23,129     $ 21,867     $ 18,515
Interest expense                              22,168       19,013        9,979        9,240        8,346
                                            --------     --------     --------     --------     --------
Net interest income                           19,991       17,852       13,150       12,627       10,169
Provision for loan losses                        830          977          120          310          931
Noninterest income                             6,776        3,432        2,874        2,646        1,685
Noninterest expenses                          16,047       14,100       10,255        9,940        6,941
                                            --------     --------     --------     --------     --------
Income before income taxes                     9,890        6,207        5,649        5,023        3,982
Income taxes                                   4,060        2,658        2,453        1,900        1,719
                                            --------     --------     --------     --------     --------
Net income                                  $  5,830     $  3,549     $  3,196     $  3,123     $  2,263
                                            ========     ========     ========     ========     ========
Earnings per share - basic (1)(2)           $   2.01     $   1.14     $   0.91     $   0.80     $   0.35
Earnings per share - diluted (1)(2)             1.95         1.13         0.91         0.80         0.35
Dividends per share (2)                         0.67         0.46         0.31         0.27         0.13

Selected Financial Ratios and Other Data
----------------------------------------

Performance Ratios:
Return on average assets                        1.06%        0.76%        1.09%        1.19%        1.00%
Return on average equity                       12.31         7.71         6.03         5.40         6.57
Interest rate spread                            3.67         3.73         3.95         4.03         4.10
Net interest margin                             3.90         4.05         4.69         5.05         4.67
Average earning assets/average
  interest bearing liabilities                114.06       115.51       131.01       127.57       115.00
Noninterest expense/average assets              2.92         3.03         3.50         3.80         3.06
Efficiency ratio                               59.95        66.25        63.99        65.08        58.55
Dividend payout ratio                          33.33        40.35        34.07        33.75        37.14

Quality Ratios:
Nonperforming assets/total assets               0.29%        0.33%        0.40%        0.43%        0.65%
Nonperforming loans/total loans                 0.28         0.45         0.27         0.36         0.64
Loan loss reserves/total loans                  1.42         1.39         1.53         1.50         1.64
Provision for loan losses/total loans           0.22         0.27         0.06         0.14         0.47

Capital Ratios:
Equity/total assets, end of period              9.38%        8.02%       16.69%       19.95%       23.23%
Average equity/average assets                   8.62         9.89        18.09        22.14        15.17

Other Data:
Full service offices                              19           17            9            8            8
Loans serviced for others                   $295,216     $300,006     $275,255     $250,202     $253,647
</TABLE>

----------------
(1)  Applies to net income of $1,395,900  earned for the period April 8, 1997 to
     September 30, 1997.
(2)  Adjusted for three-for-two stock split on August 19, 1998.

                                        2
<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 the stock of First South Bank (the "Bank")
and operating through the Bank a commercial  banking  business.  The Company has
engaged in no  activities  other than holding the stock of the Bank,  therefore,
this  discussion of consolidated  financial  condition and results of operations
relates  principally to the Bank. The business of the Bank consists  principally
of  attracting  deposits  from the  general  public and using them to  originate
secured and unsecured  commercial  and consumer  loans,  permanent  mortgage and
construction loans secured by single-family  residences,  credit cards and other
loans. The Bank's earnings depend primarily on its net interest income, which is
the difference  between  interest earned on interest earning assets and interest
paid on  interest-bearing  liabilities.  The level of its 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,  influenced  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.

SIGNIFICANT ACTIVITIES AND EVENTS

     On November 30, 1999,  the Company  consummated  the  acquisition  of Green
Street  Financial  Corp ("Green  Street"),  the parent  holding  company of Home
Federal  Savings and Loan  Association of  Fayetteville,  North Carolina  ("Home
Federal"),  with full service  offices  located in  Fayetteville  and Lumberton,
North  Carolina.  The acquisition was accounted for using the purchase method of
accounting for a cash purchase price of $59.2 million,  representing  $15.25 per
share of Green Street common stock.  Summary  financial  information  related to
Green Street  acquisition was as follows  (unaudited):  assets - $162.2 million;
loans  receivable - $125.4 million;  deposits - $101.7  million;  and goodwill -
$288,000.

     On February 18, 2000,  the Bank completed the purchase of six Triangle Bank
("Triangle") branch offices located in Rocky Mount and Tarboro,  North Carolina.
This  acquisition  was accounted for using the purchase method of accounting and
the Bank assumed the deposits of the six Triangle  branch  offices for a premium
of approximately  4.0% of the assumed deposits.  Summary  financial  information
related to the Triangle branches purchase was as follows (unaudited): deposits -
$147.5 million; cash and other assets - $113.4 million; loans receivable - $26.3
million;  deposit  premium - $5.0  million;  and premises  and  equipment - $2.8
million.

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

LIQUIDITY AND CAPITAL RESOURCES

     As a  state  chartered  commercial  bank,  the  Bank  must  meet  liquidity
requirements  established by the North Carolina  Office of the  Commissioner  of
Banks (the  "Commissioner").  Savings banks,  which convert to commercial banks,
are required to maintain 15%  liquidity  pursuant to the  conversion  guidelines
adopted by the Commissioner. The Bank's liquidity ratio, as computed under these
guidelines,  was 24.0% at September  30, 2001 compared to 27.9% at September 30,
2000.

                                        3
<PAGE>

     The Bank's  primary  sources of funds are deposits,  principal and interest
payments on loans,  proceeds from loan and securities  sales,  and advances from
the  Federal  Home Loan Bank of  Atlanta  (the  "FHLB").  While  maturities  and
scheduled  amortization of loans are predictable sources of funds, deposit flows
and mortgage  prepayments  are greatly  influenced by interest  rates,  economic
conditions and local  competition.  The Bank's primary investing activity is the
origination of commercial,  consumer and mortgage loans.  During the years ended
September 30, 2001 and 2000,  the Bank had loan  originations  of $204.6 million
and $176.5 million,  respectively.  The Bank's primary financing  activities are
the attraction of checking, certificate and savings deposits, and obtaining FHLB
advances.

     The  levels  of cash  and  cash  equivalents  is  dependent  on the  Bank's
operating,  financing, lending and investing activities during any given period.
At September 30, 2001 and 2000, cash and cash equivalents  totaled $40.4 million
and $14.7  million,  respectively.  The Bank has other sources of liquidity if a
need for additional funds arises.  During the years ended September 30, 2001 and
2000,  the Bank sold or exchanged  real estate loans  totaling $49.3 million and
$62.8 million, respectively.  Borrowing's consisting of FHLB advances and retail
repurchase  agreements were $4.9 million at September 30, 2001 compared to $30.4
million at September 30, 2000. Other sources of liquidity include investment and
mortgage-backed  securities  designated  as available  for sale,  which  totaled
$103.3 million at September 30, 2001 and $153.7 million at September 30, 2000.

     At September 30, 2001  stockholders'  equity was $50.8 million  compared to
$44.8 million at September 30, 2000. At September 30, 2001 there were  3,016,546
shares of common stock outstanding, net of 1,347,498 treasury shares. Net income
for fiscal 2001 was $5.8 million, compared to $3.5 million for fiscal 2000.

     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 $49.2 million at September  30, 2001,  compared to $43.7
million at September 30, 2000,  substantially  in excess of all such  regulatory
requirements.  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 capital  requirements of both the Commissioner and the FDIC at September 30,
2001 and 2000.

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 overall yield on the Bank's earning assets will
generally increase when interest rates rise over an extended period of time, and
conversely,  yields will  decrease  when  interest  rates  decline.  In general,
interest  expense will increase when interest rates rise over an extended period
of time,  and  conversely  interest  expense 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.

     The  President  of the Bank  reports  interest  rate risk and trends to the
Board of Directors on a regular  basis,  as well as liquidity  and capital ratio
requirements. The Board of Directors 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 of Directors with respect to the Bank's
asset and liability goals and strategies.

     A principal  strategy in managing the Bank's interest rate risk has been to
increase  interest  sensitive  assets such as commercial and consumer  loans. At
September 30, 2001,  the Bank had $178.9  million of commercial  loans and $78.2
million  of  consumer  loans  compared  to $137.9  million  and  $75.0  million,
respectively,  at September  30, 2000.  The Bank had $20.5 million of loans held
for sale at September 30, 2001, compared to $32.4 million at September 30, 2000.
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,  the Bank has emphasized that all purchases of 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 $103.3 million of
investment and  mortgage-backed  securities  classified as available for sale at
September 30, 2001, compared to $153.7 million at September 30, 2000.

                                        4
<PAGE>

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 of  Directors.
Exposure  to  interest  rate  risk is  measured  with the use of  interest  rate
sensitivity analysis to determine the change in NPV in the event of hypothetical
changes in interest rates,  while interest rate sensitivity gap analysis is used
to  determine  the  repricing  characteristics  of assets  and  liabilities.  If
estimated  changes  to NPV and net  interest  income  are not  within the limits
established by the Board,  the Board may direct  management to adjust the Bank's
asset and  liability  mix to bring  interest  rate risk  within  Board  approved
limits.

     NPV  represents  the market value of  portfolio  equity and is equal to the
market value of assets minus the market value of liabilities,  with  adjustments
made for off-balance  sheet items.  This analysis assesses the potential loss in
risk  sensitive  instruments  in the  event of  sudden  and  sustained  1% to 3%
increases and decreases in market interest rates.

     The Bank's Board of Directors has adopted an interest rate risk policy that
establishes maximum increases in NPV of 17%, 36% and 56% and decreases in NPV of
15%,  36% and 61% in the event of sudden and  sustained  1% to 3%  increases  or
decreases in market interest rates.  Table 1 below presents the Bank's projected
changes  in NPV and net  interest  income in the event of sudden  and  sustained
increases  or  decreases  in market  interest  rates for the various  rate shock
levels at September  30,  2001.  At September  30,  2001,  the Bank's  estimated
changes in NPV and net interest  income were within the targets  established  by
the Board of Directors.

TABLE 1 - 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    $ 59,269  $(16,018)     (21.3)%      $ 23,091  $   (765)     (3.2)%
+ 200  bp      65,350    (9,937)     (13.2)         23,203      (653)     (2.7)
+ 100  bp      70,809    (4,478)      (5.9)         23,529      (327)     (1.4)
Base           75,287        --         --          23,856        --        --
- 100  bp      78,681     3,394        4.5          23,935        79        .3
- 200  bp      83,865     8,578       11.4          23,947        91        .4
- 300  bp      88,524    13,237       17.6          23,121      (735)     (3.1)

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

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

                                        5
<PAGE>

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

RATE/VOLUME ANALYSIS

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

TABLE 2 - RATE/VOLUME ANALYSIS

<TABLE>
<CAPTION>
                                                                   Year Ended September 30,
                                 2001                vs.                 2000    2000                vs.                1999
                                 --------------------------------------------    -------------------------------------------

                                          Increase (Decrease) Due to                     Increase (Decrease) Due to
                                 --------------------------------------------    -------------------------------------------

                                                           Rate/                                          Rate/
                                  Volume       Rate       Volume       Total      Volume      Rate       Volume       Total
                                 --------    --------    --------    --------    --------   --------    --------    --------
                                                                        (In thousands)
Interest income:
<S>                              <C>         <C>         <C>         <C>         <C>        <C>         <C>         <C>
 Loans receivable ............   $  4,103    $    145    $     21    $  4,269    $  9,019   $    143    $     67    $  9,229
 Investment securities .......      2,285         (39)        (69)      2,177         994         (7)        (22)        965
 Mortgage-backed securities ..       (439)       (344)         24        (759)      2,598         88          71       2,757
 Other interest-earning assets        (63)       (350)         20        (393)        215        342         228         785
                                 --------    --------    --------    --------    --------   --------    --------    --------
 Total interest-earning assets      5,886        (588)         (4)      5,294      12,826        566         344      13,736
                                 --------    --------    --------    --------    --------   --------    --------    --------

Interest expense:
 Deposits ....................      3,363        (437)        (81)      2,845       7,584        744         601       8,929
 FHLB advances ...............        131         108          25         264           8          1          --           9
 Other interest-bearing
   liabilities ...............         82         (23)        (13)         46          46         26          24          96
                                 --------    --------    --------    --------    --------   --------    --------    --------
 Total interest-bearing
   liabilities ...............      3,576        (352)        (69)      3,155       7,638        771         625       9,034
                                 --------    --------    --------    --------    --------   --------    --------    --------
Change in net interest income    $  2,310    $   (236)   $     65    $  2,139    $  5,188   $   (205)   $   (281)   $  4,702
                                 ========    ========    ========    ========    ========   ========    ========    ========
</TABLE>

                                        6
<PAGE>

TABLE 3 - YIELD/COST ANALYSIS

<TABLE>
<CAPTION>
                                                                     Year Ended September 30,
                                ------------------------------    ------------------------------    ------------------------------
                                             2001                              2000                              1999
                                ------------------------------    ------------------------------    ------------------------------

                                                      Average                           Average                           Average
                                Average                Yield/     Average                Yield/     Average                Yield/
                                Balance    Interest     Cost      Balance    Interest     Cost      Balance    Interest     Cost
                                --------   --------   --------    --------   --------   --------    --------   --------   --------
Interest earning assets:
<S>                             <C>        <C>        <C>         <C>        <C>        <C>         <C>        <C>        <C>
Loans receivable (1)            $369,735   $ 32,760       8.86%   $323,178   $ 28,491       8.81%   $220,123   $ 19,262       8.75%
Investment securities             51,386      3,461       6.74      18,487      1,284       6.95       4,484        319       7.11
Mortgage-backed securities        77,422      5,223       6.75      83,535      5,982       7.16      46,279      3,225       6.97
Other Interest-earning assets     14,547        715       4.92      15,409      1,108       7.19       9,248        323       3.49
                                --------   --------   --------    --------   --------   --------    --------   --------   --------
     Total earning assets        513,090     42,159       8.22     440,609     36,865       8.37     280,134     23,129       8.26
                                           --------   --------               --------   --------               --------   --------

Nonearning assets                 36,225                            25,194                            13,026
                                --------                          --------                          --------
     Total assets               $549,315                          $465,803                          $293,160
                                ========                          ========                          ========

Interest bearing liabilities:
Time deposits                   $323,037     18,496       5.72    $282,159     16,048       5.69    $160,681      8,430       5.25
Demand deposits                   87,309      2,396       2.74      66,015      1,987       3.01      33,470        845       2.52
Savings                           20,450        262       1.28      18,771        274       1.46       6,973        105       1.51
FHLB advances                     13,638        822       6.03      11,046        558       5.05      10,885        549       5.04
Repurchase agreements              5,419        192       3.54       3,471        146       4.21       1,815         50       2.75
                                --------   --------   --------    --------   --------   --------    --------   --------   --------
     Total interest-bearing
       liabilities               449,853     22,168       4.93     381,462     19,013       4.98     213,824      9,979       4.67

Noninterest bearing demand
  deposits                        37,383          0       0.00      28,530          0       0.00      17,618          0       0.00
                                --------   --------   --------    --------   --------   --------    --------   --------   --------
     Total sources of funds      487,236     22,168       4.55     409,992     19,013       4.64     231,442      9,979       4.31
                                           --------   --------               --------   --------               --------   --------

Other liabilities and
  stockholders'equity
Other liabilities                 14,707                             9,753                             8,688
Stockholders' equity              47,372                            46,058                            53,030
                                --------                          --------                          --------
     Total liabilities and
       stockholders' equity     $549,315                          $465,803                          $293,160
                                ========                          ========                          ========
Net interest income                        $ 19,991                          $ 17,852                          $ 13,150
                                           ========                          ========                          ========
Interest rate spread  (2)                                 3.67%                             3.73%                             3.95%
                                                      ========                          ========                          ========
Net yield on earning assets (3)                           3.90%                             4.05%                             4.69%
                                                      ========                          ========                          ========

Ratio of earning assets to
  interest bearing liabilities                         114.06%                           115.51%                           131.01%
                                                      ========                          ========                          ========
</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.

                                        7
<PAGE>

ANALYSIS OF NET INTEREST INCOME

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

     Table 3  above  sets  forth  certain  information  relating  to the  Bank's
statements  of financial  condition and  statements of operations  for the three
years ended September 30, 2001, 2000, and 1999 and reflects the yield on average
earning assets and the average cost of funds for the periods indicated.  Average
balances are derived from month end balances. The Bank does not believe that the
use of month end  balances  instead of  average  daily  balances  has caused any
material difference in the information presented.

RESULTS OF OPERATIONS

Comparison of Financial Condition at September 30, 2001 and 2000

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

     The Bank has  implemented  various  strategies  to sell  certain  loans and
securities  during favorable  interest rate cycles,  and the  securitization  of
certain mortgage loans held for sale into mortgage-backed  securities.  The year
ended September 30, 2001 was an advantageous  period to execute these strategies
due to declining interest rates.

     Loans  receivable,  net of loan  loss  reserves  and  deferred  loan  fees,
increased  to $374.1  million at  September  30,  2001,  from $366.2  million at
September  30, 2000.  The Bank  continues to emphasize the  origination  of both
secured and unsecured  commercial  and consumer loans in order to take advantage
of generally  higher yields as well as shorter  terms to maturity.  From time to
time, the Bank sells selected mortgage loans in the secondary market in order to
reduce  interest  rate and credit risk,  while  retaining  servicing to generate
additional fee income.

     Commercial  loans  increased 29.7% to $178.9 million at September 30, 2001,
from $137.9  million at September 30, 2000.  Consumer  loans  increased  4.2% to
$78.2  million at September  30, 2001 from $75.0  million at September 30, 2000.
This growth reflects the Bank's  emphasis of structuring  itself as a commercial
banking entity.  Commercial and consumer loan  originations  increased to $144.1
million during fiscal 2001, from $122.4 million during fiscal 2000.

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

     Investment  securities  and  mortgage-backed  securities  declined 32.8% to
$103.3 million at September 30, 2001, from $153.7 million at September 30, 2000.
During the year ended  September 30, 2001,  the Bank  increased  its  investment
securities portfolio (primarily U. S. Government and Agency securities) to $54.7
million from $45.2  million at September  30,  2000.  Due to declining  interest
rates during  fiscal 2001 and 2000,  the Bank has  executed  its  aforementioned
strategies of  securitizing  loans into  mortgage-backed  securities and selling
certain  mortgage-backed  securities.  During the years ended September 30, 2001
and 2000, the Bank  exchanged  $12.3 million and $62.8 million of mortgage loans
previously held for sale into  mortgage-backed  securities.  The Bank sold $63.2
million of mortgage-backed  securities during the year ended September 30, 2001,
compared to no sales during the year ended  September  30,  2000.  Net of sales,
securitizations  and  principal  repayments,   the  mortgage-backed   securities
portfolio declined to $48.6 million at September 30, 2001 from $108.5 million at
September 30, 2000.

     Deposits were $471.9 million at September 30, 2001 and 2000,  respectively.
Certificates  of deposit  declined to $312.7 million at September 30, 2000, from
$339.3 million at September 30, 2000. The Bank continued to emphasize attracting
lower cost core deposits, as checking accounts increased 26.7% to $140.1 million
at September 30, 2001, from

                                        8
<PAGE>

$110.6 million at September 30, 2000. During fiscal 2001, the Bank implemented a
strategy  of  managing  its cost of  deposits  by  allowing  certain  high  rate
certificates of deposit to mature amid increasingly  competitive market interest
rates,  offset by the growth in checking  accounts.  The Bank is also  repricing
higher costing  certificates  of deposits at lower rates,  and combined with the
growth of lower costing core checking  accounts,  has been an effective  tool in
managing its deposit cost.

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

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

     During the years ended  September 30, 2001 and 2000,  the Company  declared
four  quarterly  cash  dividends  each,  totaling  $0.67  and  $0.46  per  share
respectively.  These cash dividend  payments  reflect  dividend payout ratios on
basic earnings of 33.3% and 40.4% respectively.  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.

     The  Company's  note  receivable  from the Employee  Stock  Ownership  Plan
("ESOP")  declined to $1.4 million at September  30, 2001,  from $1.8 million at
September   30,  2000,   reflecting   the  release  of  45,932  shares  to  ESOP
participants.  The note is reported as a reduction of  stockholders'  equity and
requires an annual  $349,000  principal  payment plus interest at prime plus one
percent.  Although  shares of common stock of the Company  secure the ESOP note,
the Bank expects to make  discretionary  contributions to the ESOP in amounts at
least equal to the required  principal and interest  payments.  At September 30,
2000, 135,926  unallocated  shares remained in the ESOP,  compared to 181,858 at
September 30, 2000.

     Pursuant to stock repurchase  programs adopted by the Company during fiscal
years 2001 and 2000,  the Company  acquired  143,929  and 390,066  shares of its
common stock,  respectively,  through open market and private purchases.  Shares
acquired under the repurchase program are being held as treasury stock, at cost.
At September 30, 2001,  treasury  shares were 1,347,498  totaling $26.9 million,
compared to 1,203,569  shares  totaling $23.0 million at September 30, 2000. The
Company  believes the repurchase of its  outstanding  common stock will increase
per share  earnings and book value,  provide an  attractive  investment  for the
Company's excess funds and decrease the potential  dilutive effect caused by the
future exercise of stock options.

Comparison of Operating Results for the Years Ended September 30, 2001 and 2000

     Net  Income.  Net  income  increased  to $5.8  million  for the year  ended
September  30, 2001,  from $3.5 million for the year ended  September  30, 2000.
Basic and diluted  earnings  per share  increased  to $2.01 and $1.95 per share,
respectively, for the year ended September 30, 2001, compared to $1.14 and $1.13
per share,  respectively,  for the year ended  September  30, 2000.  The average
number of basic shares  outstanding  (net of unearned ESOP and treasury  shares)
was 2,899,846 and  3,115,768,  respectively,  for the years ended  September 30,
2001 and 2000, reflecting the impact of the stock repurchase program.

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

     Interest  Expense.  Interest  expense  increased 16.6% to $22.2 million for
fiscal  2001,  from $19.0  million  for fiscal  2000.  The  increase in interest
expense on deposits and  borrowings  during 2001 also results from the increased
volume of average  interest-bearing  liabilities  resulting from internal growth
and the  completion  of the prior  year  acquisitions.  The  average  balance of
interest-bearing  liabilities increased 17.9% to $449.9 million for fiscal 2001,
from $381.5 million for fiscal 2000. The average cost of funds was 4.5% for 2001
compared to 4.6% for 2000, reflecting the decline in interest rates during 2001.

                                        9
<PAGE>

     Net Interest  Income.  Net interest income increased 12.0% to $20.0 million
for fiscal  2001,  from $17.9  million  for fiscal  2000.  The  increase  in net
interest  income is  primarily  due to an increase in both the volume of average
interest-earning  assets,  offset by an increase in interest bearing liabilities
and a decline in interest rates during 2001.  The net yield on  interest-earning
assets was 4.1% for fiscal 2001 and 2000, respectively. See Table 2 (Rate/Volume
Analysis) and Table 3 (Yield/Cost Analysis) above for additional  information on
interest income,  interest  expense,  net interest income,  average balances and
yield/cost ratios.

     Provision  for Loan Losses.  The Bank  maintains an allowance for losses on
loans  based  upon  management's  evaluation  of  existing  risks  in  the  loan
portfolio,   the  Bank's  past  loan  loss  experience,   and  current  economic
conditions.  The Bank  provided  $830,000  for loan losses  during  fiscal 2001,
compared to $977,000 for fiscal 2000. These provisions were necessary to support
the  risks  associated  with the  growth of the  commercial  and  consumer  loan
portfolios and the volume of loans acquired in the prior year acquisitions.  The
allowance  for loan losses was $5.4 million at September  30, 2001,  compared to
$5.2  million at  September  30,  2000,  which the Bank  believes is adequate to
absorb  probable  losses in its loan  portfolio.  The ratio of the allowance for
loan losses to total loans, net of loans-in-process  and deferred loan fees, was
1.4% at September 30, 2001 and 2000.

     The Bank uses an  analytical  approach in  determining  the adequacy of its
loan loss  allowance  and the  necessary  provision  for loan losses,  through a
classification  of assets program.  On a quarterly  basis, the loan portfolio is
generally   reviewed,   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.  As a result of this
review and analysis,  loans are classified in appropriate  categories applicable
to their circumstances.  After reviewing current economic conditions, changes in
delinquency  status,  and actual  loan losses  incurred by the Bank,  management
establishes an  appropriate  reserve  percentage  applicable to each category of
assets,  and provision  for loan losses is recorded when  necessary to bring the
allowance to a level consistent with this analysis.  The ratio of non-performing
loans to total loans was .3% at September 30, 2001, compared to .5% at September
30, 2000.

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

     General and Administrative  Expenses.  General and administrative  expenses
increased  13.8% to $16.0 million for fiscal 2001,  from $14.1 million in fiscal
2000.  The  Company's  efficiency  ratio  (noninterest  expenses  divided by net
interest income plus noninterest  income) improved to 59.9% for fiscal 2001 from
66.3%  for  fiscal  2000.  The  largest  single  component  of  these  expenses,
compensation  and fringe  benefits,  increased  12.4% to $9.7 million for fiscal
2001,   from  $8.6  million  for  fiscal  2000.  This  increase  is  principally
attributable to growth in personnel  resulting from two new full-service  branch
offices  opened  during the year  ended  September  30,  2001 and the prior year
acquisitions. In addition, compensation expense related to the ESOP increased to
$1.2 million for fiscal 2001 from  $835,000 for fiscal  2000,  resulting  from a
continuing  increase in the market  value of the  Company's  outstanding  common
stock.

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

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

                                       10
<PAGE>

Comparison of Financial Condition at September 30, 2000 and 1999

     Total assets increased to $559.7 million at September 30, 2000, from $292.3
million  at  September  30,  1999,  reflecting  the Green  Street  and  Triangle
acquisitions.  Loans  receivable  increased 72.7% to $366.2 million at September
30, 2000,  from $212.1 million at September 30, 1999,  also reflecting the Green
Street and Triangle acquisitions.

     Commercial  loans  increased 55.3% to $137.9 million at September 30, 2000,
from $88.8  million at September 30, 1999.  Consumer  loans  increased  47.5% to
$75.0  million at September  30, 2000 from $50.8  million at September 30, 1999.
This growth reflects both the Green Street and Triangle  acquisitions as well as
the  Bank's  emphasis  on  commercial  banking.  Commercial  and  consumer  loan
originations increased to $122.4 million for fiscal 2000, from $86.3 million for
fiscal 1999.

     Residential  real estate mortgage loans increased  109.1% to $159.3 million
at September 30, 2000, from $76.2 million at September 30, 1999,  reflecting the
Green Street acquisition and the Bank's origination volume.  During fiscal 2000,
the Bank originated  $54.1 million of real estate  mortgage  loans,  compared to
$91.2 million  during fiscal 1999.  The Bank sold or exchanged  $62.8 million of
real estate loans during fiscal 1999,  compared to $86.1  million  during fiscal
1999.  Loans  serviced  for others were  $300.0  million at  September  30, 2000
compared to $275.3 million at September 30, 1999.

     Investment  securities and mortgage-backed  securities  increased to $153.7
million at September  30, 2000,  from $59.4  million at September  30, 1999.  To
support  its  acquisition   growth,  the  Bank  implemented  various  investment
strategies  for increasing  required  regulatory  levels.  During the year ended
September 30, 2000,  the Bank  increased  its  investment  securities  portfolio
(primarily U. S. Government and Agency securities) to $45.2 million, compared to
$3.0  million  at  September  30,  1999.  In  addition,  during  2000  the  Bank
securitized certain mortgage loans previously held for sale into mortgage-backed
securities,  resulting  in a  mortgage-backed  securities  portfolio  of  $108.5
million at September 30, 2000, compared to $56.3 million at September 30, 1999.

     Deposits  increased to $471.9  million at September  30, 2000,  from $234.6
million  at  September  30,  1999,  reflecting  the Green  Street  and  Triangle
acquisitions  and the Bank's annual  internal  growth.  Certificates  of deposit
increased  95.1% to $339.3 million at September 30, 2000, from $173.9 million at
September 30, 1999, while checking  accounts  increased 106.6% to $110.6 million
at September 30, 2000, from $53.5 million at September 30, 1999.

     Total  borrowings  increased to $30.4 million at September  30, 2000,  from
$1.3 million at September 30, 1999. Due to the volatility of short-term interest
rates  during  fiscal 2000,  the Bank relied more on FHLB  advances as a funding
source to help  control its exposure to interest  rate risk,  and to support its
operations and liquidity requirements.

     Stockholders'  equity was $44.8 million at September 30, 2000,  compared to
$48.8  million  at  September  30,  1999.  The ratio of  equity to total  assets
decreased to 8.0% at  September  30,  2000,  from 16.7% at  September  30, 1999,
reflecting the leveraging effect of the Green Street and Triangle  acquisitions.
During the years ended  September 30, 2000 and 1999,  the Company  declared four
quarterly cash dividends each,  totaling $0.46 and $0.31 per share respectively.
These cash dividend payments reflect dividend payout ratios on basic earnings of
40.4% and 34.1% respectively.

     The  Company's  note  receivable  from the ESOP declined to $1.8 million at
September  30, 2000,  from $2.3 million at September  30, 1999,  reflecting  the
release of 44,492 shares to ESOP  participants.  At September 30, 2000,  181,858
unallocated  shares  remained in the ESOP,  compared to 226,350 at September 30,
1999.

     During fiscal 2000, the  Management  Recognition  Plan ("MRP"),  a deferred
stock awards plan  established  for the benefit of directors and officers of the
Company and the Bank, was  terminated  upon  distribution  of all remaining plan
shares.  On April 8, 2000,  the  remaining  58,187 of awarded  plan  shares were
vested and  distributed  to  participants.  At September 30, 1999, the 58,187 of
awarded  shares  were  held in trust  for  future  vesting,  and  reported  as a
reduction in stockholders' equity as deferred stock awards.

     Pursuant to stock repurchase  programs adopted by the Company during fiscal
years 2000 and 1999,  the Company  acquired  390,066  and 595,301  shares of its
common stock,  respectively,  and are being held as treasury  stock, at cost. At
September 30, 2000,  treasury  shares were  1,203,569  totaling  $23.0  million,
compared to 813,503 shares totaling $15.8 million at September 30, 1999.

                                       11
<PAGE>

Comparison of Operating Results for the Years Ended September 30, 2000 and 1999

     Net  Income.  Net  income  increased  to $3.5  million  for the year  ended
September  30, 2000,  from $3.2 million for the year ended  September  30, 1999.
Basic and diluted  earnings  per share  increased  to $1.14 and $1.13 per share,
respectively,  for the year ended  September  30,  2000,  compared  to $0.91 per
share,  respectively,  for the year ended September 30, 1999. The average number
of basic shares  outstanding (net of unearned ESOP, MRP and treasury shares) was
3,115,768 and 3,530,811,  respectively,  for the years ended  September 30, 2000
and 1999.

     Interest  Income.  Interest  income  increased  59.4% to $36.9  million for
fiscal 2000, from $23.1 million for fiscal 1999. The increase in interest income
on loans and  investments  during 2000  results  principally  from the growth in
volume of average  interest-earning  assets attributable to the Green Street and
Triangle acquisitions.  The average balance of interest-earning assets increased
57.2% to $440.6  million for fiscal 2000,  from $280.1  million for fiscal 1999.
The yield on average  interest-earning  assets  increased to 8.4% for 2000, from
8.3% for 1999, reflecting an increase in interest rates during 2000.

     Interest  Expense.  Interest  expense  increased 90.5% to $19.0 million for
fiscal  2000,  from $10.0  million  for fiscal  1999.  The  increase in interest
expense on deposits  and  borrowings  during 2000 results  principally  from the
increased  volume of average  interest-bearing  liabilities  attributable to the
Green  Street  Triangle  acquisitions  and rising  interest  rates.  The average
balance of interest-bearing  liabilities  increased 78.4% to $381.50 million for
fiscal  2000,  from $213.8  million for fiscal  1999.  The average cost of funds
increased  to 4.6% for 2000,  from  4.3% for 1999,  reflecting  an  increase  in
interest rates during 2000.

     Net Interest  Income.  Net interest income increased 35.8% to $17.9 million
for fiscal 2000,  from $13.2 million for fiscal 1999.  See Table 2  (Rate/Volume
Analysis) and Table 3 (Yield/Cost Analysis) above for additional  information on
interest income,  interest  expense,  net interest income,  average balances and
yield/cost ratios.

     Provision  for Loan  Losses.  The Bank  provided  $977,000  for loan losses
during fiscal 2000,  compared to $120,000 for fiscal 1999. These provisions were
necessary  to  support  the  volume of loans  acquired  in the Green  Street and
Triangle  transactions,  and  the  risks  associated  with  the  growth  of  the
commercial and consumer loan  portfolio.  The allowance for loan losses was $5.2
million at September  30, 2000,  compared to $3.3 million at September 30, 1999.
The ratio of the  allowance for loan losses to total loans was 1.4% at September
30, 2000,  compared to 1.5% at September 30, 1999.  The ratio of  non-performing
loans to total  loans was .5% at  September  30, 2000 and .3% at  September  30,
1999.

     Other Income. Other income increased 19.4% to $3.4 million for fiscal 2000,
from $2.9 million for fiscal 1999. Loan fees and service charges increased 48.8%
to $1.9 million for fiscal 2000,  from $1.3 million for fiscal 1999,  reflecting
the impact of the Green  Street and Triangle  acquisitions  on the growth of the
commercial and consumer loan portfolios and checking accounts.  Gains from sales
of loans and mortgage-backed  securities declined to $2,000 for fiscal 2000 from
$566,000 for fiscal  1999.  The volume of loans and  mortgage-backed  securities
sold or exchanged  during 2000 was $62.8 million,  compared to $86.1 million for
1999,  reflecting less sales or exchanges due to the competitive  pricing in the
secondary  mortgage  market.  Servicing fee income on loans  serviced for others
increased to $771,000 for 2000 from  $762,000  for 1999,  as loans  serviced for
others increased to $300.0 million at September 30, 2000, from $275.3 million at
September 30, 1999.

     General and Administrative  Expenses.  General and administrative  expenses
increased  37.5% to $14.1 million for fiscal 2000,  from $10.3 million in fiscal
1999.  The  Company's  efficiency  ratio was 66.2% for fiscal 2000,  compared to
63.9% for fiscal 1999. Compensation and fringe benefits, increased 24.3% to $8.6
million for fiscal 2000,  from $6.9 million for fiscal 1999,  reflecting a 50.0%
growth in personnel  resulting from the Green Street and Triangle  acquisitions,
as full time  equivalent  employees  increased to 198 at September 30, 2000 from
132 at September 30, 1999.

     Other noninterest  expenses  including data processing,  deposit insurance,
premises and  equipment,  repairs,  advertising  and office  expenses  sustained
proportionate  incremental  increases  from 1999 to 2000,  supporting  the 91.5%
growth in assets from  September 30, 1999 to September  30, 2000.  During fiscal
2000,  the Bank recorded  amortization  of  intangible  assets and certain other
noninterest  expenses in connection  with the completion of the Green Street and
Triangle  acquisitions,  as well as  completing  its name  change to First South
Bank.

     Income Taxes.  The provision for income taxes increased to $2.7 million for
fiscal 2000 from $2.5  million for fiscal 1999.  The  increase in provision  for
income taxes is the result of the increased  pretax earnings of $6.2 million for
fiscal  2000,  from $5.6  million for fiscal 1999 and the  effective  income tax
rates for each period.

                                       12
<PAGE>

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.

                                       13
<PAGE>

PRICEWATERHOUSECOOPERS [LOGO]
--------------------------------------------------------------------------------
                                                    PricewaterhouseCoopers LLP
                                                    150 Fayetteville Street Mall
                                                    Suite 2300
                                                    Raleigh NC 27601
                                                    Telephone (919) 755 3000
                                                    Facsimile (919) 755 3030

                        REPORT OF INDEPENDENT ACCOUNTANTS

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

In our opinion, the accompanying  consolidated statements of financial condition
and the related consolidated  statements of operations,  of stockholders' equity
and of cash flows  present  fairly,  in all  material  respects,  the  financial
position  of First  South  Bancorp,  Inc.  and  Subsidiary  (the  "Company")  at
September 30, 2001 and 2000, and the results of their  operations and their cash
flows for each of the three years in the period ended  September  30,  2001,  in
conformity with accounting principles generally accepted in the United States of
America.  These  financial  statements are the  responsibility  of the Company's
management;  our  responsibility  is to express  an  opinion on these  financial
statements  based on our audits.  We conducted our audits of these statements in
accordance with auditing  standards  generally  accepted in the United States of
America,  which require that we plan and perform the audit to obtain  reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the  amounts  and  disclosures  in  the  financial  statements,   assessing  the
accounting  principles  used and significant  estimates made by management,  and
evaluating the overall  financial  statement  presentation.  We believe that our
audits provide a reasonable basis for the opinion expressed above.


/s/ PricewaterhouseCoopers LLP

November 2, 2001

                                       14
<PAGE>

<TABLE>
<CAPTION>
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 2001 AND 2000
------------------------------------------------------------------------------------------------------------

                                     ASSETS                                     2001               2000
<S>                                                                        <C>                <C>
Cash and due from banks                                                    $   18,789,868     $   13,124,356
Interest-bearing deposits in financial institutions                            21,659,575          1,617,084
Investment securities - available for sale                                     54,741,784         45,186,391
Mortgage-backed securities - available for sale                                48,603,336        108,518,700
Loans receivable, net:
    Held for sale                                                              20,450,602         32,443,106
    Held for investment                                                       353,636,343        333,766,510
Premises and equipment, net                                                     7,925,610          7,022,819
Deferred income taxes                                                             108,631          2,882,886
Real estate owned                                                                 529,666            220,004
Federal Home Loan Bank of Atlanta stock, at cost
      which approximates market                                                 2,712,500          2,651,300
Accrued interest receivable                                                     3,602,088          3,784,177
Intangible assets                                                               5,273,172          5,044,421
Prepaid expenses and other assets                                               1,791,020          2,060,842
Note receivable                                                                 1,371,006          1,396,051
                                                                           --------------     --------------

          Total assets                                                     $  541,195,201     $  559,718,647
                                                                           ==============     ==============

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
    Demand                                                                 $  140,107,605     $  110,592,166
    Savings                                                                    19,174,806         22,069,124
    Large denomination certificates of deposit                                 61,416,796         56,336,303
    Other time                                                                251,239,701        282,944,074
                                                                           --------------     --------------
          Total deposits                                                      471,938,908        471,941,667
Borrowed money                                                                  4,909,497         30,387,551
Other liabilities                                                              13,578,178         12,554,694
                                                                           --------------     --------------

          Total liabilities                                                   490,426,583        514,883,912

Commitments and contingencies (Notes 10 and 14)

Common stock, $.01 par value, 8,000,000 shares authorized,
    4,364,044 shares issued and outstanding                                        43,640             43,640
Additional paid-in capital                                                     45,303,405         44,583,318
Retained earnings, substantially restricted                                    30,222,064         26,327,863
Treasury stock at cost, 1,347,498 and 1,203,569 shares at September 30,
    2001 and 2000, respectively                                               (26,905,629)       (23,039,101)
Unearned ESOP shares, 135,926 and 181,858 shares at September 30,
    2001 and 2000, respectively                                                (1,359,259)        (1,818,578)
Accumulated other comprehensive income (loss), net                              3,464,397         (1,262,407)
                                                                           --------------     --------------

          Total stockholders' equity                                           50,768,618         44,834,735
                                                                           --------------     --------------

          Total liabilities and stockholders' equity                       $  541,195,201     $  559,718,647
                                                                           ==============     ==============
</TABLE>

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

                                       15
<PAGE>

<TABLE>
<CAPTION>
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
---------------------------------------------------------------------------------------------------------

                                                                2001            2000             1999

Interest income:
<S>                                                         <C>             <C>              <C>
    Interest and fees on loans                              $ 32,759,752    $ 28,491,128     $ 19,261,766
    Interest and dividends on investments and deposits         9,399,416       8,373,756        3,867,259
                                                            ------------    ------------     ------------
               Total interest income                          42,159,168      36,864,884       23,129,025
                                                            ------------    ------------     ------------

Interest expense:
    Interest on deposits                                      21,154,382      18,309,033        9,379,641
    Interest on borrowings                                     1,013,660         703,647          599,422
                                                            ------------    ------------     ------------
               Total interest expense                         22,168,042      19,012,680        9,979,063
                                                            ------------    ------------     ------------

Net interest income before provision for loan losses          19,991,126      17,852,204       13,149,962
Provision for loan losses                                        830,000         977,000          120,000
                                                            ------------    ------------     ------------
               Net interest income                            19,161,126      16,875,204       13,029,962
                                                            ------------    ------------     ------------
Other income:
    Loan fees and service charges                              3,357,623       1,883,646        1,265,974
    Loan servicing fees                                          766,301         771,093          762,125
    Gain on sale of real estate, net                             261,031         119,331           61,027
    Gain on sale of mortgage loans and mortgage-backed
           securities                                          1,800,429           1,706          560,469
    Other income                                                 590,218         656,363          224,118
                                                            ------------    ------------     ------------
               Total other income                              6,775,602       3,432,139        2,873,713
                                                            ------------    ------------     ------------
General and administrative expenses:
    Compensation and fringe benefits                           9,667,115       8,602,946        6,924,085
    Federal insurance premiums                                    91,074          95,382          123,431
    Premises and equipment                                     1,021,167       1,299,158          501,270
    Advertising                                                  208,950         204,735          137,806
    Payroll and other taxes                                      737,267         709,909          520,656
    Data processing                                            1,526,827       1,155,713          806,306
    Amortization of intangibles                                  580,078         344,959               --
    Other                                                      2,214,423       1,687,683        1,241,262
                                                            ------------    ------------     ------------
               Total general and administrative expenses      16,046,901      14,100,485       10,254,816
                                                            ------------    ------------     ------------

Income before income taxes                                     9,889,827       6,206,858        5,648,859

Income taxes                                                   4,059,535       2,657,826        2,452,713
                                                            ------------    ------------     ------------

NET INCOME                                                     5,830,292       3,549,032        3,196,146

Other comprehensive income (loss), net                         4,726,804        (369,877)      (1,378,776)
                                                            ------------    ------------     ------------

Comprehensive income                                        $ 10,557,096    $  3,179,155     $  1,817,370
                                                            ------------    ------------     ------------

Net income per common share:
    Basic                                                   $       2.01    $       1.14     $        .91
                                                            ------------    ------------     ------------

    Diluted                                                 $       1.95    $       1.13     $        .91
                                                            ------------    ------------     ------------
</TABLE>

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

                                       16
<PAGE>

<TABLE>
<CAPTION>
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
---------------------------------------------------------------------------------------------------

                                                                         Retained
                                                         Additional      Earnings,
                                             Common        Paid-in     Substantially    Treasury
                                             Stock         Capital      Restricted        Stock
                                          ------------  ------------   ------------   ------------
<S>                                       <C>           <C>            <C>            <C>
Balance, October 1, 1998                  $     43,640  $ 43,801,987   $ 22,091,243   $ (4,895,754)
Net income                                          --            --      3,196,146             --
Other comprehensive loss, net of taxes              --            --             --             --
MRP amortization                                    --            --             --             --
Acquisition of treasury shares                      --            --             --    (10,875,208)
Dividends ($.31 per share)                          --            --     (1,089,622)            --
Release of ESOP shares                              --       430,023             --             --
                                          ------------  ------------   ------------   ------------

Balance, September 30, 1999                     43,640    44,232,010     24,197,767    (15,770,962)
Net income                                          --            --      3,549,032             --
Other comprehensive loss, net of taxes              --            --             --             --
MRP amortization                                    --       (57,700)            --             --
Acquisition of treasury shares                      --            --             --     (7,268,139)
Dividends ($.46 per share)                          --            --     (1,418,936)            --
Release of ESOP shares                              --       409,008             --             --
                                          ------------  ------------   ------------   ------------

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

Balance, September 30, 2001               $     43,640  $ 45,303,405   $ 30,222,064   $(26,905,629)
                                          ------------  ------------   ------------   ------------

<CAPTION>
                                                                        Accumulated
                                                                           Other
                                            Unearned       Deferred    Comprehensive
                                              ESOP          Stock      Income (Loss),
                                             Shares         Awards          Net            Total
                                          ------------   ------------   ------------   ------------
<S>                                       <C>            <C>            <C>            <C>
Balance, October 1, 1998                  $ (2,687,093)  $ (2,126,299)  $    486,246   $ 56,713,970
Net income                                          --             --             --      3,196,146
Other comprehensive loss, net of taxes              --             --     (1,378,776)    (1,378,776)
MRP amortization                                    --      1,342,907             --      1,342,907
Acquisition of treasury shares                      --             --             --    (10,875,208)
Dividends ($.31 per share)                          --             --             --     (1,089,622)
Release of ESOP shares                         423,593             --             --        853,616
                                          ------------   ------------   ------------   ------------

Balance, September 30, 1999                 (2,263,500)      (783,392)      (892,530)    48,763,033
Net income                                          --             --             --      3,549,032
Other comprehensive loss, net of taxes              --             --       (369,877)      (369,877)
MRP amortization                                    --        783,392             --        725,692
Acquisition of treasury shares                      --             --             --     (7,268,139)
Dividends ($.46 per share)                          --             --             --     (1,418,936)
Release of ESOP shares                         444,922             --             --        853,930
                                          ------------   ------------   ------------   ------------

Balance, September 30, 2000                 (1,818,578)            --     (1,262,407)    44,834,735
Net income                                          --             --             --      5,830,292
Other comprehensive income, net of taxes            --             --      4,726,804      4,726,804
Exercise of stock options                           --             --             --        360,864
Acquisition of treasury shares                      --             --             --     (4,253,215)
Dividends ($.67 per share)                          --             --             --     (1,936,091)
Release of ESOP shares                         459,319             --             --      1,205,229
                                          ------------   ------------   ------------   ------------

Balance, September 30, 2001               $ (1,359,259)  $         --   $  3,464,397   $ 50,768,618
                                          ------------   ------------   ------------   ------------
</TABLE>

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

                                       17
<PAGE>

<TABLE>
<CAPTION>
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
------------------------------------------------------------------------------------------------------------------------

                                                                         2001               2000               1999
                                                                    --------------     --------------     --------------
Operating activities:
<S>                                                                 <C>                <C>                <C>
    Net income                                                      $    5,830,292     $    3,549,032     $    3,196,146
    Adjustments to reconcile net income to net cash
      used in operating activities:
        Provision for loan losses                                          830,000            977,000            120,000
        Depreciation                                                       486,194            421,233            289,150
        ESOP compensation                                                1,205,229            853,930            853,616
        MRP compensation                                                        --            725,692          1,342,907
        Accretion of (premium) discounts on securities                    (103,388)           692,235                371
        Benefit from deferred income taxes                                (376,950)          (321,370)          (825,748)
        Gain on disposal of premises and equipment and
             real estate acquired in settlement of loans                  (261,031)          (119,331)           (64,373)
        Gain on sale of mortgage loans and  mortgage-
             backed securities                                          (1,800,429)            (1,706)          (560,469)
        Originations of loans held for sale, net                       (36,102,872)       (46,229,695)       (60,777,625)
        Proceeds from sale of loans held for sale                       37,087,531                 --         40,597,010
        Other operating activities                                       1,517,679          2,415,094           (337,366)
                                                                    --------------     --------------     --------------
             Net cash provided by (used in) operating activities         8,312,255        (37,037,886)       (16,166,381)
                                                                    --------------     --------------     --------------
Investing activities:
    Proceeds from maturities of investment securities
        available for sale                                                      --          3,000,000                 --
    Purchases of investment securities                                  (5,000,000)       (46,050,000)                --
    Proceeds from principal repayments and sales of
        mortgage-backed securities available for sale                   76,061,309         10,175,821         14,141,098
    Originations of loans held for investment, net
        of principal repayments                                        (21,529,591)       (20,480,237)       (12,863,836)
    Proceeds from disposal of premises and equipment
        and real estate acquired in settlement of loans                    705,310            911,869            655,821
    Purchases of FHLB stock                                                (61,200)           (43,600)           (96,400)
    Purchases of premises and equipment                                 (1,224,834)        (1,614,712)          (312,919)
    Repayment of note receivable                                            25,045              3,949                 --
    Net cash to purchase Green Street Financial Corp.                           --        (26,530,907)                --
    Acquisition of Triangle Bancorp, Inc. branches                              --        113,760,993                 --
                                                                    --------------     --------------     --------------
             Net cash provided by investing activities                  48,976,039         33,133,176          1,523,764
                                                                    --------------     --------------     --------------
Financing activities:
    Net increase in deposit accounts                                        (2,759)        (8,461,007)        29,982,910
    Proceeds from FHLB borrowings                                       72,200,000        125,200,000         61,000,000
    Repayments of  FHLB borrowings                                     (96,200,000)      (101,200,000)       (70,500,000)
    Purchase of treasury shares                                         (4,253,215)        (7,268,139)       (10,875,208)
    Proceeds from exercise of stock options                                360,863                 --                 --
    Cash dividends paid                                                 (1,936,091)        (1,418,936)        (1,089,622)
    Net change in escrow accounts                                         (271,035)            (4,442)          (362,793)
    Net change in repurchase agreements                                 (1,478,054)         2,388,742         (1,114,579)
                                                                    --------------     --------------     --------------
             Net cash (used in) provided by financing activities       (31,580,291)         9,236,218          7,040,708
                                                                    --------------     --------------     --------------

Increase (decrease) in cash and cash equivalents                        25,708,003          5,331,508         (7,601,909)
Cash and cash equivalents, beginning of year                            14,741,440          9,409,932         17,011,841
                                                                    --------------     --------------     --------------

Cash and cash equivalents, end of year                              $   40,449,443     $   14,741,440     $    9,409,932
                                                                    --------------     --------------     --------------
</TABLE>

                                       18
<PAGE>

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

1.   BASIS OF PRESENTATION AND ACCOUNTING POLICIES

     ORGANIZATION AND NATURE OF OPERATIONS

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

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

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

     USE OF ESTIMATES

     The  preparation  of 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  financial  statements  and  the  reported
     amounts of  revenues  and  expenses  during the  reporting  period.  Actual
     results could differ from those estimates.

     CASH AND CASH EQUIVALENTS

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

     INVESTMENTS AND MORTGAGE-BACKED SECURITIES

     Investments in certain  securities are classified into three categories and
     accounted  for as  follows:  (1) debt  securities  that the  entity has the
     positive  intent and the  ability to hold to  maturity  are  classified  as
     held-to-maturity  and  reported  at  amortized  cost;  (2) debt and  equity
     securities that are bought and held  principally for the purpose of selling
     them in the near term are classified as trading  securities and reported at
     fair value, with unrealized gains and losses included in earnings; (3) debt
     and equity securities not classified as either held-to-maturity  securities
     or trading  securities are classified as available for sale  securities and
     reported at fair value,  with  unrealized  gains and losses  excluded  from
     earnings and reported as accumulated other comprehensive income, a separate
     component of equity.  As of September 30, 2001, the Bank has classified all
     investments as available for sale.

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

                                       19
<PAGE>

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

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

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

     LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

     Loans  receivable  held for  investment  are stated at the amount of unpaid
     principal,  reduced  by an  allowance  for  probable  loan  losses  and net
     deferred  origination  fees.  Interest  on  loans is  accrued  based on the
     principal  amount  outstanding and is recognized using the interest method.
     The accrual of interest is discontinued, and accrued but unpaid interest is
     reversed  when,  in  management's  judgment,  it  is  determined  that  the
     collectibility  of interest,  but not necessarily  principal,  is doubtful.
     Generally, this occurs when payment is delinquent in excess of ninety days.

     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  utilizing  the interest
     method.

     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.  At September  30, 2001 and 2000,  and during the
     three  years ended  September  30,  2001,  there were no  individual  loans
     material to the  consolidated  financial  statements  which were defined as
     impaired.

     The Bank uses several  factors in  determining  if a loan is impaired.  The
     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.

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

                                       20
<PAGE>

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

     LOANS HELD FOR SALE

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

     INCOME RECOGNITION ON IMPAIRED AND NONACCRUAL LOANS

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

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

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

     MORTGAGE SERVICING RIGHTS

     In September 2000, the FASB issued SFAS No. 140,  "Accounting for Transfers
     and Servicing of Financial  Assets and  Extinguishments  of Liabilities,  a
     replacement  of SFAS No. 125." It revises the standards for  accounting for
     securitizations  and other transfers of financial assets and collateral and
     requires certain disclosures, but it carries over most of the provisions of
     SFAS No.  125  without  reconsideration.  SFAS  140  requires  a debtor  to
     reclassify  financial  assets pledged as collateral and report these assets
     separately  in the  statement of  financial  position.  It also  requires a
     secured  party  to  disclose  information,   including  fair  value,  about
     collateral  that it has  accepted and is permitted by contract or custom to
     sell or repledge.  SFAS 140 includes specific  disclosure  requirements for
     entities with  securitized  financial  assets and entities that  securitize
     assets.  SFAS 140 is effective  for  transfers  and  servicing of financial
     assets and  extinguishments of liabilities  occurring after March 31, 2000,
     and is effective for recognition and reclassification of collateral and for
     disclosures  relating to  securitization  transactions  and  collateral for
     fiscal years ending after  December 15, 2000.  The adoption of SFAS 140 did
     not have a material effect on financial condition or results of operation.

                                       21
<PAGE>

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

     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 in proportion to and over
     the period of estimated net servicing  income (if servicing  revenue 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.

     During the year ended September 30, 2001, the Company  recorded  additional
     servicing   assets  of   $803,679   as  a  result  of  sales  of  loans  or
     mortgage-backed  securities.  Amortization  of servicing  assets during the
     year  ended  September  30,  2001  aggregated  $62,668.  The fair  value of
     recognized  servicing assets amounted to $925,239 as of September 30, 2001.
     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.

     There was no valuation  allowance for  impairment  of recognized  servicing
     assets during the year ended September 30, 2001.

     PREMISES AND EQUIPMENT

     Premises and equipment are stated at cost less accumulated depreciation and
     amortization.   Depreciation   and   amortization   are   computed  by  the
     straight-line  and accelerated  methods based on estimated service lives of
     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
     ("REO")  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.

     INVESTMENT IN FEDERAL HOME LOAN BANK STOCK

     The Bank is required  to invest in stock of the  Federal  Home Loan Bank of
     Atlanta ("FHLB") in the amount of 1% of its outstanding home loans or 5% of
     its outstanding  advances from the FHLB, whichever is greater. At September
     30, 2001 and 2000, respectively, the Bank owned 27,125 and 26,513 shares of
     the FHLB's $100 par value capital stock.

     INTANGIBLE ASSETS

     Intangible  assets  consist of goodwill and deposit  premiums and are being
     amortized over ten years using the straight-line method.

                                       22
<PAGE>

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

     INCOME TAXES

     Deferred tax asset and liability  balances are determined by application to
     temporary  differences  of the tax rate expected to be in effect when taxes
     will become payable or receivable.  Temporary  differences  are differences
     between the tax basis of assets and liabilities and their reported  amounts
     in the  financial  statements  that will  result in taxable  or  deductible
     amounts in future  years.  The effect on deferred  taxes of a change in tax
     rates is  recognized  in income in the period that  includes the  enactment
     date.

     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 September
     30, 2001, 2000 and 1999, is as follows:

<TABLE>
<CAPTION>
                                                       2001             2000             1999

<S>                                                <C>              <C>              <C>
     Unrealized (losses) gains on securities
         available for sale                        $  8,299,802     $   (616,463)    $ (2,159,473)

     Reclassification of net gains
         recognized in net income                      (421,792)              --         (138,881)

     Income tax benefit (expense) relating to
         unrealized gains (losses) on available
         for sale securities                         (3,151,206)         246,586          919,578
                                                   ------------     ------------     ------------

     Other comprehensive (loss) income, net        $  4,726,804     $   (369,877)    $ (1,378,776)
                                                   ============     ============     ============
</TABLE>

     SEGMENT INFORMATION

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

                                       23
<PAGE>

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

     NEW ACCOUNTING PRONOUNCEMENTS

     On July 20, 2001 the FASB issued SFAS No. 141, Business  Combinations (SFAS
     141), and No. 142,  Goodwill and Other  Intangible  Assets (SFAS 142). SFAS
     Nos. 141 and 142 will change the accounting for business  combinations  and
     goodwill in two  significant  ways.  First,  SFAS No. 141 requires that the
     purchase  method  of  accounting  be  used  for all  business  combinations
     initiated  after June 30, 2001. Use of the  pooling-of-interests  method is
     prohibited.  Second,  SFAS No. 142 changes the accounting for goodwill from
     an amortization  method to an  impairment-only  approach.  Upon adoption of
     SFAS No. 142, the Company will cease to amortization  of goodwill  recorded
     in past business transactions.  Goodwill presently recorded on the books of
     the Company  amounted to $232,162 at September  30, 2001.  Amortization  of
     goodwill amounted to $23,258 during the year ended September 30, 2001.

     The goodwill will be assigned to the related  reporting unit in the Company
     and tested  for  impairment  at least  annually.  The tests will  initially
     involve the  comparison of the  reporting  units fair value to its carrying
     value,  including  goodwill.  If  necessary,  the implied fair value of the
     goodwill  will  be  compared  to the  carrying  value  to  determine  if an
     allowance is  necessary.  The  provisions of SFAS No. 142 are effective for
     fiscal years beginning after December 15, 2001.

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

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

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

2.   SIGNIFICANT ACTIVITIES

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

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

                                       24
<PAGE>

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

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

                                                   2000               1999

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

     In  management's  opinion,  these  unaudited  pro  forma  amounts  are  not
     necessarily  indicative of what the actual  combined  results of operations
     might have been if the  acquisitions had been effective at the beginning of
     fiscal 1998.

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

     The fair values of assets, including goodwill, and liabilities assumed were
     as follows (in thousands):

                                               GREEN STREET         TRIANGLE

     Loans receivable                         $  125,459,235     $   26,162,062
     Premises and equipment                        1,245,957          2,407,409
     Intangible assets                               287,832          4,898,652
     Other assets                                  4,548,219            277,790
     Deposits                                   (101,648,952)      (144,135,727)
     Other liabilities                            (3,361,384)        (3,371,179)
                                              --------------     --------------
     Net cash paid (received)
      for acquisitions                        $   26,530,907     $ (113,760,993)
                                              ==============     ==============

3.   INVESTMENT SECURITIES

     Investment  securities  at September 30, 2001 and 2000,  are  classified as
     available  for sale  according to  management's  intent and  summarized  as
     follows:

<TABLE>
<CAPTION>
                                                                     GROSS UNREALIZED           ESTIMATED
                                                 AMORTIZED     ----------------------------       MARKET
                                                   COST           GAINS           LOSSES          VALUE
                                               ------------    ------------    ------------    ------------
<S>                                            <C>             <C>             <C>             <C>
     2001:
          U.S. Treasury and Agency Notes       $ 50,461,308    $  4,280,476    $         --    $ 54,741,784
                                               ------------    ------------    ------------    ------------

     2000:
          U.S. Treasury and Agency Notes       $ 45,357,920    $    230,003    $    401,532    $ 45,186,391
                                               ============    ============    ============    ============
</TABLE>

                                       25
<PAGE>

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

     U.S.  Treasury and Agency notes at September  30, 2001,  are  contractually
     scheduled to mature as follows:

                                                                   ESTIMATED
                                                AMORTIZED            MARKET
                                                   COST               VALUE
                                              --------------     --------------
     Due after one year through five years    $   45,446,788     $   49,080,078
     Due after five years through ten years        5,014,520          5,661,706
                                              --------------     --------------
                                              $   50,461,308     $   54,741,784
                                              ==============     ==============

4.   MORTGAGE-BACKED SECURITIES

     Mortgage-backed  securities at September 30, 2001 and 2000,  are classified
     as available for sale  according to  management's  intent and summarized as
     follows:

<TABLE>
<CAPTION>
                                                                     GROSS UNREALIZED           ESTIMATED
                                                 AMORTIZED     ----------------------------       MARKET
                                                   COST           GAINS           LOSSES          VALUE
                                               ------------    ------------    ------------    ------------
<S>                                            <C>             <C>             <C>             <C>
     2001:
          FHLMC participation certificates,
          maturing from years 2003 to 2028     $ 47,120,820    $  1,482,516    $         --    $ 48,603,336
                                               ------------    ------------    ------------    ------------

     2000:
          FHLMC participation certificates,
          maturing from years 2003 to 2030     $110,462,189    $    166,593    $ (2,110,082)   $108,518,700
                                               ============    ============    ============    ============
</TABLE>

     Mortgage-backed   securities  at  September  30,  2001,  are  contractually
     scheduled to mature as follows:

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

     Due after one year through five years    $      533,840     $      551,389
     Due after five years through ten years        3,457,138          3,551,121
     Due after ten years                          43,129,842         44,500,826
                                              --------------     --------------
                                              $   47,120,820     $   48,603,336
                                              ==============     ==============

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

     Mortgage-backed  securities with a carrying value of  $63,181,244,  $0, and
     $5,520,194  were sold during the years ended  September 30, 2001,  2000 and
     1999,  respectively.  Gross realized gains on the sales of  mortgage-backed
     securities  were  $421,792,  $0, and $138,881  during 2001,  2000 and 1999,
     respectively.  There were no gross  realized  losses during 2001,  2000 and
     1999.

     Mortgage-backed   securities  with  an  amortized  cost  of   approximately
     $5,492,322  and  $5,437,740  were pledged as  collateral  for deposits from
     public entities at September 30, 2001 and 2000, respectively.

                                       26
<PAGE>

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

5.   LOANS RECEIVABLE

     Loans receivable at September 30, 2001 and 2000, are summarized as follows:

                                                   2001               2000

     Mortgage loans                           $  123,196,766     $  159,328,698
     Consumer loans                               78,184,965         75,001,720
     Commercial loans                            178,856,021        137,941,182
                                              --------------     --------------
                Total                            380,237,752        372,271,600
     Less:
         Allowance for loan losses                (5,401,358)        (5,159,353)
         Deferred loan fees                         (749,449)          (902,631)
                                              --------------     --------------
     Loans receivable, net                    $  374,086,945     $  366,209,616
                                              ==============     ==============

     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 10).

     During  2001,  2000 and 1999,  the Bank  exchanged  loans with  outstanding
     principal   balances  of   $12,298,139,   $62,789,209,   and   $45,527,117,
     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 September 30, 2001 and 2000,  are fixed rate mortgage loans with an
     estimated  market  value  of  approximately  $20,500,000  and  $32,400,000,
     respectively.

     Net  gains  on  sales  of  loans  receivable  held  for  sale  amounted  to
     $1,378,637, $1,706, and $303,324 during the years ended September 30, 2001,
     2000 and 1999, respectively.

     The changes in the allowance for loan losses for the years ended  September
     30, 2001, 2000 and 1999, are as follows:

<TABLE>
<CAPTION>
                                                       2001             2000             1999

<S>                                                <C>              <C>              <C>
     Balance at beginning of year                  $  5,159,353     $  3,297,256     $  3,364,588
     Provisions for loan losses                         830,000          977,000          120,000
     Balance transferred in acquisition                      --          962,999               --
     Loans charged off                                 (655,506)        (157,092)        (265,384)
     Recoveries                                          67,511           79,190           78,052
                                                   ------------     ------------     ------------
     Balance at end of year                        $  5,401,358     $  5,159,353     $  3,297,256
                                                   ============     ============     ============
</TABLE>

                                       27
<PAGE>

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

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

                                                   2001               2000
     Loans contractually past due 90 days
         or more and/or on nonaccrual status:
           Residential                        $      570,704     $    1,365,949
           Consumer and commercial                   491,676            279,826
                                              --------------     --------------

                                              $    1,062,380     $    1,645,775
                                              ==============     ==============

     During the years ended September 30, 2001,  2000 and 1999,  interest income
     of  approximately  $43,000,  $40,000,  and  $9,000,  respectively,  was not
     recorded related to loans accounted for on a nonaccrual basis.

6.   PREMISES AND EQUIPMENT

     Premises  and  equipment  at  September  30, 2001 and 2000,  consist of the
     following:

                                                   2001               2000

     Land                                     $    2,566,219     $    2,566,219
     Office buildings                              5,793,501          5,009,762
     Furniture, fixtures and equipment             3,083,963          2,566,530
     Vehicles                                        323,205            290,031
                                              --------------     --------------
                                                  11,766,888         10,432,542
     Less accumulated depreciation                 3,841,278          3,409,723
                                              --------------     --------------
                Total                         $    7,925,610     $    7,022,819
                                              ==============     ==============

7.   EMPLOYEE BENEFIT PLANS

     The Company  participates in a multi-employer  defined benefit pension plan
     which  covers  substantially  all  employees.  Expenses of the plan for the
     years ended September 30, 2001, 2000 and 1999, were $69,017,  $258,600, and
     $133,000, respectively.

     The Company  participates in a  multi-employer  defined  contribution  plan
     which covers  substantially  all employees.  Under the plan,  employees may
     contribute from 1% to 15% of compensation,  subject to an annual maximum as
     determined  by the  Internal  Revenue  Code.  The  Company  makes  matching
     contributions of 50% of employees' contributions up to 6% of the employees'
     salaries.  The plan provides that employees'  contributions are 100% vested
     at all  times  and the  Bank's  contributions  vest  25% for  each  year of
     service.  The expenses related to the Company's  contributions to this plan
     for the years ended  September  30,  2001,  2000 and 1999,  were  $115,174,
     $84,924, and $76,985, respectively.

                                       28
<PAGE>

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

     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  September  30,  2001,  2000 and 1999,
     aggregated  $617,127,  $544,327,  and  $516,985,  respectively.  The  plans
     generally  include  provisions  for  forfeitures  of  unvested  portions of
     payments, and vesting in the event of death or disability.

     On  April  8,  1998,  the  Company's  Stockholders  approved  a  Management
     Recognition  Plan ("MRP") for directors and key employees.  The Company was
     authorized to fund the acquisition of and award up to 174,570 shares (4% of
     shares issued in the stock  conversion) to be awarded by a committee of the
     Board of Directors.  The Company  completed the  acquisition  of MRP shares
     during  fiscal 1998.  On April 8, 1998,  174,570  shares  (market  value of
     $4,029,258  and  aggregate  cost of  $3,275,299)  were  awarded  to certain
     officers and employees.  The vesting schedule  provided that 33-1/3% of the
     shares were earned and became  non-forfeitable  on April 8, 1998,  1999 and
     2000.

     The shares issued to the MRP plan were recorded as outstanding  shares, and
     the unvested portion was recorded as unearned compensation through a contra
     equity  account.  The  consolidated  statements of operations for the years
     ended September 30, 2001, 2000 and 1999,  include  compensation  expense of
     $0,  $725,692,  and  $1,342,907,  respectively,  relating to the  scheduled
     vesting of MRP shares.

8.   EMPLOYEE STOCK OWNERSHIP PLAN

     The Company's  Board of Directors  adopted an Employee Stock Ownership Plan
     ("ESOP"),  effective  October 1, 1996.  Employees  of the  Company  and its
     subsidiaries who have attained age 21 and completed one year of service are
     eligible to  participate  in the ESOP,  provided  that any employee who was
     employed   full-time   on  the  closing   date  of  the  Stock   Conversion
     automatically  became a participant  on October 1, 1996.  The ESOP is to be
     funded by  contributions  made by the Company or the Bank in cash or shares
     of Common Stock.  Allocations to  participants'  accounts occur annually on
     September 30.  Shares are committed to be released for financial  statement
     purposes  when the Bank makes  scheduled  payments on the ESOP note payable
     and will be  allocated to  employees  for services  rendered in the current
     accounting period. Employees vest in their allocated ESOP shares over three
     years.  The number of shares legally released and allocated is based on the
     ratio of the  actual  principal  payments  amount  to the  remaining  total
     principal  payments  for  the  ESOP  note  payable.  The  Bank  expects  to
     contribute  sufficient  funds to the ESOP to repay the note  payable over a
     ten-year  period,  plus  such  other  amounts  as the  Company's  Board  of
     Directors may determine in its discretion.

     Initially,  the ESOP acquired  349,140 shares of the Company's common stock
     financed by $3,491,400  in  borrowings  by the ESOP from the Company.  This
     loan is  secured  by the  shares of Common  Stock  purchased  and  earnings
     thereon.  At  September  30, 2001 and 2000,  213,213  and  167,282  shares,
     respectively, have been allocated to participants' accounts and 135,927 and
     181,858  shares,   with  an  estimated   market  value  of  $4,322,479  and
     $4,182,734,  respectively,  remain  unallocated.  All allocated  shares are
     considered   outstanding  for  earnings  per  share  purposes,   while  the
     unallocated shares are not included in the calculation.

                                       29
<PAGE>

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

     The principal  balance of the ESOP loan was  $1,359,259  and  $1,818,578 at
     September 30, 2001 and 2000, respectively.  The Bank is using the dividends
     declared  on  shares  held by the  ESOP to  reduce  the  outstanding  debt.
     Dividends  on  allocated  shares are  treated as a  reduction  of  retained
     earnings. Dividends on unallocated shares are treated only as debt service,
     and  there is no  reduction  of  retained  earnings.  Compensation  expense
     related to the ESOP is based on the  average  fair  market  value of shares
     during the period since the prior  allocation date through the dates shares
     are committed to be released.  The financial statements for the years ended
     September  30,  2001,  2000  and  1999,  include  compensation  expense  of
     $1,205,230, $835,135, and $853,616, respectively, related to the ESOP.

9.   STOCK OPTION PLAN

     On April 8, 1998, the  Shareholders of the Company approved the First South
     Bancorp, Inc. 1997 Stock Option Plan (the "Plan"). The purpose of this Plan
     is to advance the interests of the Company through  providing  selected key
     employees and Directors of the Bank and the Company with the opportunity to
     purchase  shares.  The Plan  reserves  436,425  shares for grant within ten
     years of the effective date. The option price is required to be 100% of the
     stock's fair market value as defined, with an exception for any shareholder
     with more than a 10% ownership interest in the Company.  The exercise price
     is required to be 110% of the stock's fair market  value for these  options
     holders.  Vesting is  determined  on the date of the grant.  Options have a
     10-year life;  however,  there are additional  limitations for shareholders
     with more than a 10% ownership interest in the Company. The Plan also has a
     change of control  provision under which all options  immediately vest if a
     change of control, as defined, occurs.

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

<TABLE>
<CAPTION>
                                                                  For the year ended
                                  September 30, 2001              September 30, 2000              September 30, 1999
                             ----------------------------    ----------------------------    ----------------------------
                             As Reported      Pro Forma      As Reported      Pro Forma      As Reported      Pro Forma

<S>                          <C>             <C>             <C>             <C>             <C>             <C>
     Net income              $  5,830,292    $  5,742,412    $  3,549,032    $  3,464,965    $  3,196,146    $  3,138,174
     Earnings per common
          share - basic              2.01            1.95            1.14            1.11             .91             .89
     Earnings per common
          share - diluted            1.95            1.92            1.13            1.11             .91             .89
</TABLE>

                                       30
<PAGE>

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

     The fair value of each option grant is estimated on the date of grant using
     the Black-Scholes  option-pricing model with the following weighted-average
     assumptions used for grants in 2001, 2000 and 1999, respectively:  dividend
     growth rate of 22%, 17%, and 15%; expected  volatility of 18.9%,  18.6% and
     20.8%; risk-free interest rates of 5.84%, 5.78%, and 5.05% in 2001; 6.0% in
     2000 and 7.1% in 1999; and expected lives of 7 years.

     A summary  of the status of the Plan as of  September  30,  2001,  2000 and
     1999, and changes during the years then ended,  including  weighted-average
     exercise price ("Price"), is presented below:

<TABLE>
<CAPTION>
                                                 2001                    2000                    1999
                                          SHARES      PRICE       SHARES      PRICE       SHARES      PRICE
                                         --------    --------    --------    --------    --------    --------

<S>                                      <C>         <C>          <C>        <C>         <C>         <C>
     Outstanding at beginning of year     413,303    $  18.25     404,303    $  18.24     398,303    $  18.25
     Granted                               19,000       25.63      21,000       18.26       6,000       17.75
     Cancellations                        (23,400)      18.35     (12,000)      18.25
                                         --------                --------                --------
     Outstanding at year end              408,903       18.54     413,303       18.25     404,303       18.24
                                         --------                --------                --------

     Weighted-average fair value of
        options granted during the year              $   5.14                $   4.02                $   5.04
                                                     --------                --------                --------
</TABLE>

     The following table summarizes additional information about the Option Plan
     at September 30, 2001,  including  weighted-average  remaining  contractual
     life ("Life") and Price:

                              Options Outstanding           Options Exercisable
                        -------------------------------     -------------------
                        Shares       Life       Price       Shares      Price

     $17.75 - 27.23     408,903    6.8 years   $  18.54     389,903    $  18.37

10.  BORROWED MONEY

     Borrowed money represents advances from the FHLB and repurchase agreements.
     There were no advances  outstanding  from the FHLB at  September  30, 2001.
     Advances  from the FHLB had a weighed  average  rate of 6.94%  and  totaled
     $24,000,000 at September 30, 2000.

     At  September  30, 2001 and 2000,  repurchase  agreements  outstanding  had
     average rates of 1.93% and 4.38%,  and totaled  $4,909,497 and  $6,387,552,
     respectively.

     At September 30, 2001,  repurchase  agreements were  collateralized by U.S.
     government agency  obligations with a principal balance of $7,000,000.  The
     Company has pledged all of its stock in the FHLB and certain  loans secured
     by one to four family  residential  mortgages as  collateral  for actual or
     potential  borrowings from the FHLB. At September 30, 2001, the Company had
     an additional $115,000,000 of credit available with the FHLB.

                                       31
<PAGE>

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

11.  INCOME TAXES

     The  components  of income tax expense for the years  ended  September  30,
     2001, 2000 and 1999, are as follows:

<TABLE>
<CAPTION>
                                                       2001             2000             1999

<S>                                                <C>              <C>              <C>
     Current:
       Federal                                     $  3,877,218     $  2,665,596     $  2,712,909
       State                                            559,267          313,600          565,552
                                                   ------------     ------------     ------------
                                                      4,436,485        2,979,196        3,278,461
                                                   ------------     ------------     ------------

     Deferred:
            Federal                                    (310,782)        (287,542)        (719,993)
            State                                       (66,168)         (33,828)        (105,755)
                                                   ------------     ------------     ------------
                                                       (376,950)        (321,370)        (825,748)
                                                   ------------     ------------     ------------

     Total                                         $  4,059,535     $  2,657,826     $  2,452,713
                                                   ============     ============     ============
</TABLE>

     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 September 30, 2001, 2000 and 1999, are as follows:

<TABLE>
<CAPTION>
                                                       2001             2000             1999

<S>                                                <C>              <C>              <C>
     Expected income tax expense at 34%            $  3,362,541     $  2,110,332     $  1,920,612
     State income taxes, net of federal income tax      325,445          296,998          270,298
     Non-deductible ESOP, other expenses and
         other adjustments                              371,549          250,496          261,803
                                                   ------------     ------------     ------------

                                                   $  4,059,535     $  2,657,826     $  2,452,713
                                                   ============     ============     ============
</TABLE>

                                       32
<PAGE>

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

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

                                                   2001               2000
     Deferred income tax assets:
         Deferred directors' fees             $      578,037     $      548,288
         Allowance for loan losses                 1,752,708          1,490,452
         Employee benefits                           740,189            747,790
         Unrealized losses on securities
           available for sale                             --            852,611
         Loans mark-to-market                        315,198            123,823
         Other                                       363,408            180,154
                                              --------------     --------------
                                                   3,749,540          3,943,118
                                              --------------     --------------
     Deferred income tax liabilities:
         Unrealized gains on securities
           available for sale                      2,298,594                 --
         Depreciation and amortization               347,515            315,426
         Carrying value - land                       386,200            386,200
         Mortgage servicing rights                   357,327             71,149
         Deferred loan origination fees
           and costs                                  55,472             91,656
         FHLB stock                                  195,801            195,801
                                              --------------     --------------
                                                   3,640,909          1,060,232
                                              --------------     --------------

     Net deferred income tax asset            $      108,631     $    2,882,886
                                              ==============     ==============

     Retained earnings at September 30, 2001, include  approximately  $1,850,000
     for which no deferred income tax liability has been recognized. This amount
     represents an allocation  of income to bad debt  deductions  for income tax
     purposes  only.  Reductions of the amount so allocated  for purposes  other
     than for tax bad debt losses or  adjustments  arising from carryback of net
     operating losses could create taxable income,  in certain remote instances,
     which would be subject to the then current corporate income tax rate.

12.  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 September 30, 2001, that the Bank meets
     all capital adequacy requirements to which it is subject.

                                       33
<PAGE>

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

     As of  September  30,  2001,  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 September 30,
     2001 and 2000, are presented in the table below (dollars in thousands):

<TABLE>
<CAPTION>
                                                                                                        To Be Well
                                                                                                       Capitalized
                                                                              For Capital              Under Prompt
                                                        Actual              Adequacy Purpose        Action Provisions
                                                 --------------------     --------------------     --------------------
                                                  Amount      Ratio        Amount      Ratio        Amount      Ratio
                                                 --------    --------     --------    --------     --------    --------
     2001:
<S>                                              <C>             <C>      <C>              <C>     <C>             <C>
     Total Capital (to Risk Weighted Assets)     $ 47,627        12.8%    $ 29,835         8.0%    $ 37,294        10.0%
     Tier I Capital (to Risk Weighted Assets)      42,956        11.5%      14,917         4.0%      22,376         6.0%
     Tier I Capital (to Average Assets)            42,956         8.1%      21,246         4.0%      26,557         5.0%

     2000:
     Total Capital (to Risk Weighted Assets)     $ 45,655        13.0%    $ 28,214         8.0%    $ 35,268        10.0%
     Tier I Capital (to Risk Weighted Assets)      41,237        11.7%      14,107         4.0%      21,161         6.0%
     Tier I Capital (to Average Assets)            41,237         7.7%      21,523         4.0%      26,904         5.0%
</TABLE>

13.  EARNINGS PER SHARE

     The following table provides a reconciliation of income available to common
     stockholders  and the average number of shares  outstanding  (less unearned
     ESOP shares,  unearned  deferred stock awards and treasury  shares) for the
     years ended September 30, 2001, 2000 and 1999. Options to purchase 408,903,
     413,303 and 404,303  shares of common stock were  outstanding  at September
     30, 2001,  2000, and 1999,  respectively.  For the year ended September 30,
     1999,  no options were included in the  computation  of diluted EPS because
     the options'  exercise  price was greater than the average  market price of
     common shares for each of the years.

<TABLE>
<CAPTION>
                                                       2001             2000             1999
<S>                                                <C>              <C>              <C>

     Net income (numerator)                        $  5,830,292     $  3,549,032     $  3,196,146
                                                   ============     ============     ============
     Weighted average shares outstanding
         for basic EPS (denominator)                  2,899,846        3,115,768        3,530,811
     Dilutive effect of stock options                    85,580           11,104               --
                                                   ------------     ------------     ------------
     Adjusted shares for diluted EPS                  2,985,426        3,126,872        3,530,811
                                                   ============     ============     ============
</TABLE>

                                       34
<PAGE>

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

14.  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  $295,216,089  and
     $286,238,000 at September 30, 2001 and 2000, respectively.  Servicing loans
     for others generally consists of collecting mortgage payments,  maintaining
     escrow   accounts,   disbursing   payment  to  investors  and   foreclosure
     processing.  Loan  servicing  income is recorded  on the accrual  basis and
     includes  servicing fees from investors and certain charges  collected from
     borrowers, such as late payment fees.

     At September 30, 2001 and 2000,  mortgage  servicing rights reported in the
     consolidated statements of financial condition,  net of amortization,  were
     $925,239 and $184,228, respectively.

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

     The Company is a party to financial instruments with off-balance sheet risk
     in the  normal  course  of  business  to meet  the  financing  needs of its
     customers 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 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 September 30, 2001 and 2000, is as follows:

                                                   2001               2000
     Commitments to extend credit:
         Commitments to originate loans       $   57,413,601     $   44,052,960
         Undrawn balances on lines of credit
             and undrawn balances on credit
             reserves (overdraft protection)      48,197,325         43,864,361
                                              --------------     --------------

                                              $  105,610,926     $   87,917,321
                                              ==============     ==============

                                       35
<PAGE>

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

     Included in the commitments to originate loans as of September 30, 2001 and
     2000,  are  fixed   interest  rate  loan   commitments  of  $7,758,283  and
     $6,917,438,   respectively.  The  shorter  duration  of  interest-sensitive
     liabilities,  to the extent they are used to fund these  fixed-rate  loans,
     indicates  that the Company is exposed to interest rate risk because,  in a
     rising rate  environment,  liabilities  will be repricing  faster at higher
     interest rates,  thereby reducing the market value of fixed-rate  long-term
     assets and net interest income.

     The  Company's  lending is  concentrated  primarily  in  Beaufort,  Craven,
     Cumberland, Edgecombe,  Fayetteville,  Lenoir, Lumberton, Nash, Pasquotank,
     Pitt, Robeson,  Tarboro 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.

16.  PARENT COMPANY FINANCIAL INFORMATION

     The Company's  principal  asset is its  investment  in the Bank.  Condensed
     financial  statements  of the parent  company as of September  30, 2001 and
     2000, and for the three years ended September 30, 2001, are as follows:

<TABLE>
<CAPTION>
                                                       2001             2000             1999
<S>                                                <C>              <C>              <C>
     CONDENSED BALANCE SHEETS
     Cash                                          $  1,902,285     $  1,055,374     $  1,151,744
     Due from subsidiary                                931,535          477,287        5,368,089
     Investment in wholly-owned subsidiary           49,203,538       43,692,079       42,563,204
     Other assets                                         8,856            8,747           12,115
                                                   ------------     ------------     ------------
             Total assets                          $ 52,046,214     $ 45,233,487     $ 49,095,152
                                                   ============     ============     ============

     Other liabilities                             $  1,277,596     $    398,752     $    332,119
     Stockholders' equity                            50,768,618       44,834,735       48,763,033
                                                   ------------     ------------     ------------
             Total liabilities and stockholders'
                equity                             $ 52,046,214     $ 45,233,487     $ 49,095,152
                                                   ============     ============     ============
</TABLE>

<TABLE>
<CAPTION>
                                                       2001             2000             1999
<S>                                                <C>              <C>              <C>
     CONDENSED STATEMENTS OF INCOME
     Interest income, net                          $    166,623     $    204,090     $    234,242
     Equity in earnings of subsidiary                 5,772,653        3,471,752        3,121,370
     Miscellaneous expenses                             108,984          126,810          159,466
                                                   ------------     ------------     ------------
     Net income                                    $  5,830,292     $  3,549,032     $  3,196,146
                                                   ============     ============     ============

                                       36
<PAGE>

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

<CAPTION>
                                                       2001             2000             1999
<S>                                                <C>              <C>              <C>
     CONDENSED STATEMENTS OF CASH FLOWS
     Operating activities:
         Net income                                $  5,830,292     $  3,549,032     $  3,196,146
         Adjustments to reconcile net income
             to net cash provided by operating
             activities:
           Equity in undistributed earnings of
            subsidiary                               (5,772,653)      (3,471,752)      (3,121,370)
           ESOP compensation                          1,205,229          853,930          853,616
           MRP compensation                                  --          725,692        1,342,907
           Other operating activities                   878,733           70,001          628,213
                                                   ------------     ------------     ------------
                Net cash provided by operating
                 activities                           2,141,601        1,726,903        2,899,512
                                                   ------------     ------------     ------------
     Investing activities:
         Repayments of advances to subsidiary         4,533,752        6,863,802        9,257,445
                                                   ------------     ------------     ------------
                Net cash provided by investing
                 activities                           4,533,752        6,863,802        9,257,445
                                                   ------------     ------------     ------------
     Financing activities:
         Proceeds from exercise of stock options        360,864               --               --
         Purchase of treasury shares                 (4,253,215)      (7,268,139)     (10,875,208)
         Dividends paid                              (1,936,091)      (1,418,936)      (1,089,622)
                                                   ------------     ------------     ------------

                Net cash used in financing
                 activities                          (5,828,442)      (8,687,075)     (11,964,830)
                                                   ------------     ------------     ------------

     Net (decrease) increase in cash                    846,911          (96,370)         192,127
     Cash at beginning of year                        1,055,374        1,151,744          959,617
                                                   ------------     ------------     ------------

     Cash at end of year                           $  1,902,285     $  1,055,374     $  1,151,744
                                                   ============     ============     ============
</TABLE>

17.  QUARTERLY FINANCIAL DATA (UNAUDITED)

     Summarized unaudited quarterly financial data for the years ended September
     30, 2001 and 2000, is as follows (in thousands):

<TABLE>
<CAPTION>
                                      Fourth      Third       Second      First
                                     --------    --------    --------    --------
     2001:
<S>                                  <C>         <C>         <C>         <C>
     Interest income                 $  9,794    $ 10,231    $ 10,863    $ 11,271
     Interest expense                   4,560       5,298       5,967       6,343
     Provision for loan losses             50          --         540         240
     Noninterest income                 1,933       1,690       1,853       1,299
     Noninterest expense                4,498       3,949       3,898       3,701
     Income tax expense                 1,082       1,090         946         941
                                     --------    --------    --------    --------
     Net income                      $  1,537    $  1,584    $  1,365    $  1,345
                                     ========    ========    ========    ========

     Net income per common share:
         Basic                       $    .54    $    .55    $    .47    $    .46
         Diluted                     $    .52    $    .53    $    .46    $    .45
                                     ========    ========    ========    ========
</TABLE>

                                       37
<PAGE>

FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                      Fourth      Third       Second      First
                                     --------    --------    --------    --------
2000:
<S>                                  <C>         <C>         <C>         <C>
     Interest income                 $ 10,783    $ 10,099    $  9,178    $  6,805
     Interest expense                   5,921       5,241       4,680       3,171
     Provision for loan losses            300         250         200         227
     Noninterest income                   950       1,052         815         615
     Noninterest expense                3,768       4,058       3,631       2,643
     Income tax expense                   762         699         628         569
                                     --------    --------    --------    --------
     Net income                      $    982    $    903    $    854    $    810
                                     ========    ========    ========    ========

     Net income per common share:
         Basic and diluted           $    .32    $    .30    $    .27    $    .25
                                     ========    ========    ========    ========
</TABLE>

18.  FAIR VALUES OF FINANCIAL INSTRUMENTS

     Statement of Financial  Accounting  Standards No. 107,  "Disclosures  about
     Fair  Value of  Financial  Instruments"  ("SFAS  No.  107"),  requires  the
     disclosure  of  estimated  fair values for  financial  instruments.  Quoted
     market prices, if available,  are utilized as an estimate of the fair value
     of  financial  instruments.  Because no quoted  market  prices  exist for a
     significant part of the Company's financial instruments,  the fair value of
     such  instruments has been derived based on management's  assumptions  with
     respect to future economic conditions, the amount and timing of future cash
     flows  and  estimated  discount  rates  with  respect  to  future  economic
     conditions,  the  amount  and  timing of future  cash  flows and  estimated
     discount rates.  Different  assumptions  could  significantly  affect these
     estimates.  Accordingly,  the net  realizable  value  could  be  materially
     different from the estimates  presented  below. In addition,  the estimates
     are only indicative of individual financial  instruments' values and should
     not be considered an indication of the fair value of the Company taken as a
     whole.

     Fair values have been estimated  using data which  management  considers as
     the best available,  and estimation  methodologies  deemed suitable for the
     pertinent category of financial instrument.  The estimation  methodologies,
     resulting fair values,  and recorded carrying amounts at September 30, 2001
     and 2000, 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 3 and 4 to
     the financial  statements.  These are based on quoted market  prices,  when
     available.  If a  quoted  market  price  is not  available,  fair  value is
     estimated using quoted market prices for similar securities.

                                       38
<PAGE>

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

     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>
                                           2001                            2000
                               ----------------------------    ----------------------------
                                Estimated        Carrying       Estimated        Carrying
                                Fair Value        Amount        Fair Value        Amount
                               ------------    ------------    ------------    ------------
<S>                            <C>             <C>             <C>             <C>
     1 - 4 family mortgages    $123,737,283    $121,735,028    $157,985,659    $157,650,137
     Consumer                    77,088,028      77,193,937      73,079,204      74,100,552
     Non-residential            175,157,980     175,157,980     134,458,927     134,458,927
                               ------------    ------------    ------------    ------------

                               $375,983,291    $374,086,945    $365,523,790    $366,209,616
                               ============    ============    ============    ============
</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  $159,282,411  and  $132,661,290  at September  30, 2001 and 2000,
     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 September 30, 2001 and 2000, are as follows:

                                                   2001               2000
     Certificates of deposits:
        Carrying amount                       $  312,656,497     $  339,280,377
        Estimated fair value                     317,751,119        340,318,757

     Advances for Federal Home Loan Bank:
        Carrying amount                       $           --     $   24,000,000
        Estimated fair value                              --         24,000,000

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

     There is no material  difference  between the carrying amount and estimated
     fair value of  off-balance  sheet items totaling  $105,610,926  in 2001 and
     $87,917,321  in 2000,  which  are  primarily  comprised  of  unfunded  loan
     commitments.

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

                                       40
<PAGE>

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

19.  SUPPLEMENTAL CASH FLOW INFORMATION

     Supplemental  cash flow information for the years ended September 30, 2001,
     2000 and 1999, is as follows:

<TABLE>
<CAPTION>
                                                       2001             2000             1999
<S>                                                <C>              <C>              <C>
     Real estate acquired in settlement of loans   $    918,091     $    411,040     $    764,023
     Exchange of loans for mortgage-backed
         securities                                  12,298,139       62,789,209       45,527,117
     Cash paid for interest                          22,391,730       19,012,680        9,960,689
     Cash paid for income taxes                       3,350,211        2,769,000        2,787,000
     Dividends declared, not paid                       518,511          387,220          332,119
</TABLE>

                                       41
<PAGE>

<TABLE>
<CAPTION>
                               BOARD OF DIRECTORS

<S>                                <C>                            <C>
DR. FREDERICK H. HOWDY             LINLEY H. GIBBS, JR.           EDMUND T. BUCKMAN, JR.
CHAIRMAN                           VICE CHAIRMAN                  Retired
President                          Retired                        Washington, NC
Drs. Freshwater and Howdy, P.A.    Washington, NC
Washington, NC

FREDERICK N. HOLSCHER              CHARLES E. PARKER, JR.         H. D. REAVES, JR.
Partner                            Vice President                 Former President And
Rodman, Holscher, Francisco &      Robinson Insurance Agency        Chief Executive Officer
  Peck, P.A.                       New Bern, NC                   Home Federal Savings & Loan
Washington, NC                                                    Fayetteville, NC

Marshall T. Singleton              Thomas A. Vann
Co-Owner                           President and Chief
B. E. Singleton & Sons               Executive Officer
Washington, NC                     First South Bank
                                   Washington, NC

                               EXECUTIVE OFFICERS

THOMAS A. VANN                     JACK L. ASHLEY                 GARY J. BROCK
President and                      Executive Vice President       Executive Vice President
Chief Executive Officer            Chief Operating Officer        Credit Administration

WALTER P. HOUSE                    WILLIAM L. WALL                MARY R. BOYD
Executive Vice President           Executive Vice President       Senior Vice President
Mortgage Operations                Chief Financial Officer and    Loan Servicing
                                   Secretary

SHERRY L. CORRELL                  KRISTIE W. HAWKINS             WILLIAM R. OUTLAND
Senior Vice President              Treasurer                      Senior Vice President
Deposit Administration             Controller                     Consumer Lending

                            AREA AND CITY EXECUTIVES

JAMES F. BUCKMAN, IV               GEORGE R. HAMILTON             MICHAEL L. HARDIN
Senior Vice President              Senior Vice President          Senior Vice President
Area Executive                     Area Executive                 City Executive
Washington                         Rocky Mount                    Lumberton
Chocowinity                        Tarboro

WILLIAM L. HEDGEPETH, II           RUSSELL A. LAY                 DAVID M. POPE
Senior Vice President              Senior Vice President          Vice President
City Executive                     Area Executive                 City Executive
Fayetteville                       Elizabeth City                 Kinston

JAMES R. ROSE, JR.                 JAMES L. THOMPSON              GUY P. WILLIAMS, JR.
Senior Vice President              Vice President                 Senior Vice President
Area Executive                     City Executive                 City Executive
Greenville                         Tarboro                        New Bern
Kinston

                                       41
<PAGE>

<CAPTION>
                        FIRST SOUTH BANK OFFICE LOCATIONS

<S>                                <C>                            <C>
CHOCOWINITY                        ELIZABETH CITY                 GREENVILLE
2999 Highway 17 South              604 East Ehringhaus Street     301 East Arlington Blvd
252-940-4970                       252-335-0848                   252-321-2600

FAYETTEVILLE                       KINSTON                        LUMBERTON
241 Green Street                   827 Hardee Road                600 North Chestnut Street
910-438-3681                       252-522-9466                   910-739-3274
3107 Raeford Road                  2430 Heritage Street           3000 North Elm Street
910-484-2116                       252-523-9449                   910-608-5031

NEW BERN                           ROCKY MOUNT                    WASHINGTON
202 Craven Street                  300 Sunset Avenue              1311 Carolina Avenue
252-636-2997                       252-972-9661                   252-946-4178

1725 Glenburnie Road               2901 Sunset Avenue             300 North Market Street
252-636-2997                       252-451-1259                   252-940-4945

                                   1378 Benvenue Road             1328 John Small Avenue
                                   252-442-8375                   252-940-5000

TARBORO                            450 North Winstead Avenue      Credit Administration
100 East Hope Lodge Street         252-937-1900                   239 West Main Street
252-823-0157                                                      252-946-4178

                                   3635 North Halifax Road        Operations Center
                                   252-451-8700                   220 Creekside Drive
                                   (in Smith's Red & White/       252-946-4178
                                    Dortches)

                         FIRST SOUTH BANK ATM* LOCATIONS

CHOCOWINITY                        ELIZABETH CITY                 FAYETTEVILLE
2999 Highway 17 South              604 East Ehringhaus Street     241 Green Street
                                                                  3107 Raeford Road

GREENVILLE                         KINSTON                        LUMBERTON
301 East Arlington Blvd            2430 Heritage Street           3000 North Elm Street
                                                                  3551 Fayetteville Road

NEW BERN                           ROCKY MOUNT                    WASHINGTON
1725 Glenburnie Road               300 Sunset Avenue              1311 Carolina Avenue
                                   2901 Sunset Avenue             300 North Market Street
                                   1378 Benvenue Road             1328 John Small Avenue
TARBORO                            450 North Winstead Avenue
1202 Western Blvd                  3635 North Halifax Road
</TABLE>

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

                                       42
<PAGE>

                     FIRST SOUTH BANK PRODUCTS AND SERVICES

PERSONAL BANKING SERVICES

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

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

     SAVINGS ACCOUNTS:
          Regular Savings
          Custodial Savings

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

COMMERCIAL BANKING SERVICES

     CHECKING ACCOUNTS:
          Commercial Checking
          Commercial Money Market Checking
          Business Interest Checking
          Simple Business Checking
          Simple Business Plus Checking

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

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

                                       43
<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 trades on the Nasdaq Stock Market under the symbol
FSBK.

STOCK PRICE INFORMATION
The  following  table sets forth the high and low trade  price  information  and
dividends declared per share for the periods indicated.

       Quarter Ended                         High         Low      Dividends
       -------------                         ----         ---      ---------
     December 31, 1999                     $ 18.875    $ 17.125    $    .10
     March 31, 2000                          18.875      17.375         .10
     June 30, 2000                            20.00      18.375         .13
     September 30, 2000                       23.25       19.25         .13

     December 31, 2000                        24.78       21.75         .13
     March 31, 2001                           25.00     23.0625         .18
     June 30, 2001                            27.50     24.6875         .18
     September 30, 2001                       36.25       26.50         .18

REGISTRAR AND TRANSFER AGENT
Inquiries regarding stock transfer,  registration,  lost certificates or changes
in name and  address  should be  directed to the stock  registrar  and  transfer
agent:

     Registrar and Transfer Company
     10 Commerce Drive
     Cranford, New Jersey 07016
     (800) 866-1340

FORM 10-K
The Company's annual report on Form 10-K, filed with the Securities and Exchange
Commission, is available to shareholders without charge by writing: William L.
Wall, Chief Financial Officer, 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.

ANNUAL MEETING
The Annual Meeting of Stockholders of First South Bancorp, Inc. will be held
Thursday, February 21, 2002 at 11:00 a.m., at the main office of First South
Bank, 1311 Carolina Avenue, Washington, North Carolina.

<TABLE>
<CAPTION>
<S>                              <C>                       <C>
GENERAL COUNSEL                  SPECIAL COUNSEL           INDEPENDENT ACCOUNTANTS
Rodman, Holscher, Francisco &    Stradley Ronon Stevens    PricewaterhouseCoopers LLP
   Peck, P.A.                       & Young, LLP           Suite 2300
320 North Market Street          Suite 700                 150 Fayetteville Street Mall
Washington, NC  27889            1220 19th Street, N.W.    Raleigh, NC  27601
                                 Washington, DC 20036
</TABLE>

                                       44
<PAGE>

                              FIRST SOUTH BANCORP
                              ===================
                              -------------------
                              1311 Carolina Avenue
                              P.O. Box 2047
                              Washington, North Carolina 27889
                              (252)946-4178 Fax (252)946-3873