UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q


(Mark
One)


x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934





For the
quarterly period ended June 30, 2010.





OR


o
            TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934


For the
transition period from to .





Commission
File Number: 0-22219





FIRST SOUTH BANCORP,
INC.


(Exact
name of registrant as specified in its charter)





Virginia
                
                56-1999749(State
      or other jurisdiction of
                
                (IRS
      Employerincorporation
      or organization)
                
                Identification
      No.)





1311 Carolina Avenue,
Washington, North Carolina 27889


(Address
of principal executive offices)


(Zip
Code)





(252)
946-4178


(Registrant's
telephone number, including area code)





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


Yes  x                No
o





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).  Yes o         
No o





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





Large
      Accelerated Filer o
                  
                  Accelerated
      Filer  xNon-Accelerated
      Filer o
                  
                  Smaller
      Reporting Company o(Do
      not check if a Smaller Reporting Company)




Indicate
by check mark whether registrant is a shell company (as defined by Rule 12b-2 of
the Exchange Act).


Yes o       
No  x





Number of
shares of common stock outstanding as of August 6, 2010: 9,743,971









CONTENTS





PAGEPART
      I.  FINANCIAL
      INFORMATIONItem
      1.
                              Financial
      StatementsConsolidated
      Statements of Financial Condition as of June 30, 2010(unaudited)
      and December 31, 2009
                              
                              1Consolidated
      Statements of Operations for the Three and Six Months
endedJune
      30, 2010 and 2009 (unaudited)
                              
                              2Consolidated
      Statements of Stockholders' Equity for the Six Months
endedJune
      30, 2010 (unaudited)
                              
                              3Consolidated
      Statements of Cash Flows for the Six Months endedJune
      30, 2010 and 2009 (unaudited)
                              
                              4Notes
      to Consolidated Financial Statements (unaudited)
                              
                              5Item
      2.
                              Management's
      Discussion and Analysis of Financial Condition andResults
      of Operation
                              
                              11Item
      3.
                              Quantitative
      and Qualitative Disclosures About Market Risk
                              
                              19Item
      4.
                              Controls
      and Procedures
                              
                              19PART
      II.  OTHER
      INFORMATIONItem
      1.
                              Legal
      Proceedings
                              
                              20Item
      1A.
                              Risk
      Factors
                              
                              20Item
      2.
                              Unregistered
      Sales of Equity Securities and Use of Proceeds
                              
                              21Item
      3.
                              Defaults
      Upon Senior Securities
                              
                              21Item
      4.
                              [Reserved]
                              
                              21Item
      5.
                              Other
      Information
                              
                              21Item
      6.
                              Exhibits
                              
                              21Signatures
                              
                              22Exhibits









PART
I.  FINANCIAL INFORMATION
 Item
1.  Financial Statements.
 
 First
South Bancorp, Inc. and Subsidiary
 Consolidated
Statements of Financial Condition
 
 June
      30,
                            
                            
                            December
      31,2010
                            
                            
                            2009*(unaudited)AssetsCash
      and due from banks
                            
                            $
                            17,374,290
                            
                            
                            $
                            17,758,370Interest-bearing
      deposits in financial institutions
                            
                            
                            17,363,166
                            
                            
                            
                            11,879,794Investment
      securities - available for sale
                            
                            
                            0
                            
                            
                            
                            407,317Mortgage-backed
      securities - available for sale
                            
                            
                            92,180,716
                            
                            
                            
                            96,725,468Mortgage-backed
      securities - held for investment
                            
                            
                            377,886
                            
                            
                            
                            513,882Loans
      and leases receivable, net:Held
      for sale
                            
                            
                            5,489,717
                            
                            
                            
                            6,548,980Held
      for investment
                            
                            
                            639,367,915
                            
                            
                            
                            652,106,538Premises
      and equipment, net
                            
                            
                            9,239,594
                            
                            
                            
                            8,539,759Other
      real estate owned
                            
                            
                            8,451,905
                            
                            
                            
                            10,561,071Federal
      Home Loan Bank of Atlanta stock, at cost which approximates
      market
                            
                            
                            3,889,500
                            
                            
                            
                            3,889,500Accrued
      interest receivable
                            
                            
                            2,936,167
                            
                            
                            
                            3,318,141Goodwill
                            
                            
                            4,218,576
                            
                            
                            
                            4,218,576Mortgage
      servicing rights
                            
                            
                            1,267,915
                            
                            
                            
                            1,278,688Identifiable
      intangible assets
                            
                            
                            117,900
                            
                            
                            
                            133,620Income
      tax receivable
                            
                            
                            2,057,614
                            
                            
                            
                            1,831,598Prepaid
      expenses and other assets
                            
                            
                            8,437,655
                            
                            
                            
                            10,179,333Total
      assets
                            
                            $
                            812,770,516
                            
                            
                            $
                            829,890,635Liabilities
      and Stockholders' EquityDeposits:Demand
                            
                            $
                            224,949,564
                            
                            
                            $
                            224,507,362Savings
                            
                            
                            25,155,189
                            
                            
                            
                            23,137,391Large
      denomination certificates of deposit
                            
                            
                            227,899,105
                            
                            
                            
                            224,198,974Other
      time
                            
                            
                            216,536,319
                            
                            
                            
                            216,667,331Total
      deposits
                            
                            
                            694,540,177
                            
                            
                            
                            688,511,058Borrowed
      money
                            
                            
                            12,665,012
                            
                            
                            
                            37,380,388Junior
      subordinated debentures
                            
                            
                            10,310,000
                            
                            
                            
                            10,310,000Other
      liabilities
                            
                            
                            8,145,185
                            
                            
                            
                            7,475,085Total
      liabilities
                            
                            
                            725,660,374
                            
                            
                            
                            743,676,531Common
      stock, $.01 par value, 25,000,000 shares authorized; 11,254,222 issued;
      9,743,971 and 9,742,296  shares outstanding,
      respectively
                            
                            
                            97,440
                            
                            
                            
                            97,423Additional
      paid-in capital
                            
                            
                            35,858,430
                            
                            
                            
                            35,841,364Retained
      earnings, substantially restricted
                            
                            
                            81,321,585
                            
                            
                            
                            82,111,114Treasury
      stock at cost
                            
                            
                            (32,122,465
                            )
                            
                            
                            (32,158,074
                            )Accumulated
      other comprehensive income, net
                            
                            
                            1,955,152
                            
                            
                            
                            322,277Total
      stockholders' equity
                            
                            
                            87,110,142
                            
                            
                            
                            86,214,104Total
      liabilities and stockholders' equity
                            
                            $
                            812,770,516
                            
                            
                            $
                            829,890,635
 
 *Derived
from audited consolidated financial statements
 
 See
Notes to Consolidated Financial Statements.
  1
 
 First
South Bancorp, Inc. and Subsidiary
 Consolidated
Statements of Operations
 (unaudited)
 
 Three Months Ended
                  
                  
                  Six Months EndedJune 30
                  
                  
                  June 302010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Interest
      income:Interest
      and fees on loans
                  
                  $
                  9,792,800
                  
                  
                  $
                  11,564,315
                  
                  
                  $
                  19,901,754
                  
                  
                  $
                  23,265,950Interest
      and dividends on investments and deposits
                  
                  
                  1,036,289
                  
                  
                  
                  877,624
                  
                  
                  
                  2,078,562
                  
                  
                  
                  1,746,709Total
      interest income
                  
                  
                  10,829,089
                  
                  
                  
                  12,441,939
                  
                  
                  
                  21,980,316
                  
                  
                  
                  25,012,659Interest
      expense:Interest
      on deposits
                  
                  
                  2,094,488
                  
                  
                  
                  4,098,542
                  
                  
                  
                  4,248,126
                  
                  
                  
                  8,277,479Interest
      on borrowings
                  
                  
                  81,071
                  
                  
                  
                  340,951
                  
                  
                  
                  220,167
                  
                  
                  
                  680,751Interest
      on junior subordinated notes
                  
                  
                  82,768
                  
                  
                  
                  106,870
                  
                  
                  
                  162,784
                  
                  
                  
                  217,308Total
      interest expense
                  
                  
                  2,258,327
                  
                  
                  
                  4,546,363
                  
                  
                  
                  4,631,077
                  
                  
                  
                  9,175,538Net
      interest income
                  
                  
                  8,570,762
                  
                  
                  
                  7,895,576
                  
                  
                  
                  17,349,239
                  
                  
                  
                  15,837,121Provision
      for credit losses
                  
                  
                  2,070,000
                  
                  
                  
                  1,700,000
                  
                  
                  
                  4,490,000
                  
                  
                  
                  3,220,000Net
      interest income after provision for credit losses
                  
                  
                  6,500,762
                  
                  
                  
                  6,195,576
                  
                  
                  
                  12,859,239
                  
                  
                  
                  12,617,121Non-interest
      income:Fees
      and service charges
                  
                  
                  1,795,404
                  
                  
                  
                  1,891,452
                  
                  
                  
                  3,425,920
                  
                  
                  
                  3,641,937Loan
      servicing fees
                  
                  
                  187,046
                  
                  
                  
                  164,164
                  
                  
                  
                  366,780
                  
                  
                  
                  322,828Gain
      (loss) on sale of other real estate, net
                  
                  
                  21,223
                  
                  
                  
                  5,285
                  
                  
                  
                  33,720
                  
                  
                  
                  (74,448
                  )Gain
      on sale of mortgage loans
                  
                  
                  173,428
                  
                  
                  
                  430,218
                  
                  
                  
                  365,525
                  
                  
                  
                  688,102Gain
      on sale of mortgage-backed securities
                  
                  
                  455,399
                  
                  
                  
                  -
                  
                  
                  
                  935,481
                  
                  
                  
                  -Gain
      on sale of investment securities
                  
                  
                  2,406
                  
                  
                  
                  452,344
                  
                  
                  
                  2,406
                  
                  
                  
                  917,866Other  income
                  
                  
                  195,717
                  
                  
                  
                  269,067
                  
                  
                  
                  394,963
                  
                  
                  
                  536,768Total
      non-interest income
                  
                  
                  2,830,623
                  
                  
                  
                  3,212,530
                  
                  
                  
                  5,524,795
                  
                  
                  
                  6,033,053Non-interest
      expense:Compensation
      and fringe benefits
                  
                  
                  4,115,034
                  
                  
                  
                  3,591,503
                  
                  
                  
                  7,806,236
                  
                  
                  
                  6,999,175Federal
      deposit insurance premiums
                  
                  
                  286,614
                  
                  
                  
                  540,046
                  
                  
                  
                  583,879
                  
                  
                  
                  680,209Premises
      and equipment
                  
                  
                  438,565
                  
                  
                  
                  455,940
                  
                  
                  
                  897,750
                  
                  
                  
                  919,855Advertising
                  
                  
                  33,851
                  
                  
                  
                  40,176
                  
                  
                  
                  65,414
                  
                  
                  
                  63,017Payroll
      and other taxes
                  
                  
                  340,096
                  
                  
                  
                  335,373
                  
                  
                  
                  716,710
                  
                  
                  
                  687,094Data
      processing
                  
                  
                  644,671
                  
                  
                  
                  604,654
                  
                  
                  
                  1,263,068
                  
                  
                  
                  1,203,669Amortization
      of intangible assets
                  
                  
                  107,475
                  
                  
                  
                  135,460
                  
                  
                  
                  224,960
                  
                  
                  
                  249,330Other
                  
                  
                  774,633
                  
                  
                  
                  810,192
                  
                  
                  
                  1,683,096
                  
                  
                  
                  1,712,910Total
      non-interest expense
                  
                  
                  6,740,939
                  
                  
                  
                  6,513,344
                  
                  
                  
                  13,241,113
                  
                  
                  
                  12,515,259Income
      before income taxes
                  
                  
                  2,590,446
                  
                  
                  
                  2,894,762
                  
                  
                  
                  5,142,921
                  
                  
                  
                  6,134,915Income
      taxes
                  
                  
                  1,032,084
                  
                  
                  
                  1,134,884
                  
                  
                  
                  2,034,862
                  
                  
                  
                  2,370,519Net
      income
                  
                  $
                  1,558,362
                  
                  
                  $
                  1,759,878
                  
                  
                  $
                  3,108,059
                  
                  
                  $
                  3,764,396Per
      share data:Basic
      earnings per share
                  
                  $
                  0.16
                  
                  
                  $
                  0.18
                  
                  
                  $
                  0.32
                  
                  
                  $
                  0.39Diluted
      earnings per share
                  
                  $
                  0.16
                  
                  
                  $
                  0.18
                  
                  
                  $
                  0.32
                  
                  
                  $
                  0.39Dividends
      per share
                  
                  $
                  0.20
                  
                  
                  $
                  0.20
                  
                  
                  $
                  0.40
                  
                  
                  $
                  0.40Weighted
      average shares-Basic
                  
                  
                  9,743,971
                  
                  
                  
                  9,738,096
                  
                  
                  
                  9,743,244
                  
                  
                  
                  9,738,096Weighted
      average shares-Diluted
                  
                  
                  9,744,679
                  
                  
                  
                  9,738,096
                  
                  
                  
                  9,743,598
                  
                  
                  
                  9,738,096
 
 See
Notes to Consolidated Financial Statements.
  2
 
 First
South Bancorp, Inc. and Subsidiary
 Consolidated
Statements of Stockholders' Equity
 Six
Months Ended June 30, 2010
 (unaudited)
 
 AccumulatedRetained
                  
                  
                  
                  
                  
                  OtherAdditional
                  
                  
                  Earnings,
                  
                  
                  
                  
                  
                  ComprehensiveCommon
                  
                  
                  Paid-in
                  
                  
                  Substantially
                  
                  
                  Treasury
                  
                  
                  Income,Stock
                  
                  
                  Capital
                  
                  
                  Restricted
                  
                  
                  Stock
                  
                  
                  Net
                  
                  
                  TotalBalance,
      December 31, 2009
                  
                  $
                  97,423
                  
                  
                  $
                  35,841,364
                  
                  
                  $
                  82,111,114
                  
                  
                  $
                  (32,158,074
                  )
                  
                  $
                  322,277
                  
                  
                  $
                  86,214,104Net
      income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,108,059
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,108,059Other
      comprehensive income, net of taxes
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,632,875
                  
                  
                  
                  1,632,875Exercise
      of stock options
                  
                  
                  17
                  
                  
                  
                  (26,414
                  )
                  
                  
                  
                  
                  
                  
                  35,609
                  
                  
                  
                  
                  
                  
                  
                  9,212Stock
      based compensation
                  
                  
                  
                  
                  
                  
                  43,480
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  43,480Dividends
      ($0.40 per share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (3,897,588
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (3,897,588
                  )Balance,
      June 30, 2010
                  
                  $
                  97,440
                  
                  
                  $
                  35,858,430
                  
                  
                  $
                  81,321,585
                  
                  
                  $
                  (32,122,465
                  )
                  
                  $
                  1,955,152
                  
                  
                  $
                  87,110,142
 
 See
Notes to Consolidated Financial Statements.
  3
  First South Bancorp, Inc. and Subsidiary
 Consolidated
Statements of Cash Flows
 (unaudited)
 
 Six Months EndedJune 302010
                                
                                
                                2009Operating
      activities:Net
      income
                                
                                $
                                3,108,059
                                
                                
                                $
                                3,764,396Adjustments
      to reconcile net income to net cash used in operating
      activities:Provision
      for credit losses
                                
                                
                                4,490,000
                                
                                
                                
                                3,220,000Depreciation
                                
                                
                                378,374
                                
                                
                                
                                428,268Amortization
      of intangibles
                                
                                
                                224,960
                                
                                
                                
                                249,330Accretion
      of discounts on securities, net
                                
                                
                                -
                                
                                
                                
                                (64,444
                                )Loss
      (gain) on disposal of premises and equipment and other real estate
      owned
                                
                                
                                (37,016
                                )
                                
                                
                                73,883Gain
      on sale of loans held for sale
                                
                                
                                (365,525
                                )
                                
                                
                                (688,102
                                )Gain
      on sale of mortgage-backed securities available for sale
                                
                                
                                (935,481
                                )
                                
                                
                                -Gain
      on sale of investment securities available for sale
                                
                                
                                (2,406
                                )
                                
                                
                                (917,866
                                )Stock
      based compensation expense
                                
                                
                                43,480
                                
                                
                                
                                28,156Originations
      of loans held for sale, net
                                
                                
                                (30,554,989
                                )
                                
                                
                                (73,006,800
                                )Proceeds
      from sale of loans held for sale
                                
                                
                                17,141,501
                                
                                
                                
                                9,830,718Other
      operating activities
                                
                                
                                3,023,102
                                
                                
                                
                                (2,253,803
                                )Net
      cash used in operating activities
                                
                                
                                (3,485,941
                                )
                                
                                
                                (59,336,264
                                )Investing
      activities:Proceeds
      from maturity of investment securities available for sale
                                
                                
                                -
                                
                                
                                
                                10,000,000Proceeds
      from sale of investment securities available for sale
                                
                                
                                507,406
                                
                                
                                
                                20,917,866Proceeds
      from sale of mortgage-backed securities available for sale
                                
                                
                                17,440,693
                                
                                
                                
                                -Proceeds
      from principal repayments of mortgage-backed securities available for
      sale
                                
                                
                                5,479,099
                                
                                
                                
                                6,782,625Proceeds
      from principal repayments of mortgage-backed securities held for
      investment
                                
                                
                                135,996
                                
                                
                                
                                185,080Originations
      of loans held for investment, net of principal repayments
                                
                                
                                4,726,260
                                
                                
                                
                                35,075,702Proceeds
      from disposal of premises and equipment and other real estate
      owned
                                
                                
                                3,948,286
                                
                                
                                
                                4,029,626Purchase
      of investment securities
                                
                                
                                -
                                
                                
                                
                                (5,000,000
                                )Purchase
      of FHLB stock
                                
                                
                                -
                                
                                
                                
                                (230,900
                                )Purchase
      of premises and equipment
                                
                                
                                (1,078,209
                                )
                                
                                
                                (92,327
                                )Net
      cash provided by investing activities
                                
                                
                                31,159,531
                                
                                
                                
                                71,667,672Financing
      activities:Net
      increase in deposit accounts
                                
                                
                                6,029,119
                                
                                
                                
                                14,584,523Net
      decrease in FHLB borrowings
                                
                                
                                (25,000,000
                                )
                                
                                
                                -Proceeds
      from exercise of stock options, net of tax benefit
                                
                                
                                9,212
                                
                                
                                
                                -Cash
      paid for dividends
                                
                                
                                (3,897,253
                                )
                                
                                
                                (3,895,238
                                )Net
      change in repurchase agreements
                                
                                
                                284,624
                                
                                
                                
                                (2,863,008
                                )Net
      cash provided (used) by financing activities
                                
                                
                                (22,574,298
                                )
                                
                                
                                7,826,277Increase
      in cash and cash equivalents
                                
                                
                                5,099,292
                                
                                
                                
                                20,157,685Cash
      and cash equivalents, beginning of period
                                
                                
                                29,638,164
                                
                                
                                
                                26,720,359Cash
      and cash equivalents, end of period
                                
                                $
                                34,737,456
                                
                                
                                $
                                46,878,044Supplemental
      disclosures:Other
      real estate acquired in settlement of loans
                                
                                $
                                3,522,363
                                
                                
                                $
                                8,150,331Dividends
      declared, not paid
                                
                                $
                                1,948,794
                                
                                
                                $
                                1,947,619Exchange
      of loans for mortgage-backed securities
                                
                                $
                                14,838,276
                                
                                
                                $
                                56,242,195
 
 See
Notes to Consolidated Financial Statements.
  4




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





Note 1.  Basis of
Presentation.  The accompanying unaudited consolidated
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America and with the instructions to
Form 10-Q and Regulation S-X.  Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial
statements.  In the opinion of management, all adjustments necessary
for fair presentation of the financial position and results of operations for
the periods presented are included, none of which are other than normal
recurring accruals.  The financial statements of First South Bancorp,
Inc. (the “Company”) and First South Bank (the “Bank”) are presented on a
consolidated basis.  The results of operations for the quarter ended
June 30, 2010 are not necessarily indicative of the results of operations that
may be expected for the year ended December 31, 2010.





Note 2.  Earnings Per
Share.  Basic and diluted earnings per share for the three and
six months ended June 30, 2010 are based on weighted average shares of common
stock outstanding, excluding treasury shares.  Diluted earnings per
share include the potentially dilutive effect of the Company’s stock option
plans.  For the three and six month periods ended June 30, 2010 there
were 708 and 354 stock options respectively, that were dilutive because their
exercise price exceeded the average market price of the Company’s common stock,
compared to none that were dilutive for the three and six months ended June 30,
2009.





Note 3. Allowance for Credit
Losses.  Activity in the allowance for credit losses, including
the allowances for loan and lease losses and unfunded loan commitments, is
summarized as follows:





Allowance forLoan and
                  Lease Losses
                
                
                Allowance forUnfundedCommitments
                
                
                Allowance For
                  Credit LossesBalance
      at December 31, 2009
                
                $
                13,503,940
                
                
                $
                240,282
                
                
                $
                13,744,222Provision
      for credit losses
                
                
                2,420,000
                
                
                
                -
                
                
                
                2,420,000Reclassification
                
                
                62,313
                
                
                
                (62,313
                )
                
                
                -Loans
      and leases charged-off
                
                
                (2,841,550
                )
                
                
                -
                
                
                
                (2,841,550
                )Loans
      and leases recovered
                
                
                76,409
                
                
                
                -
                
                
                
                76,409Net
      (charge-offs)/recoveries
                
                
                (2,765,141
                )
                
                
                -
                
                
                
                (2,765,141
                )Balance
      at March 31, 2010
                
                
                13,221,112
                
                
                
                177,969
                
                
                
                13,399,081Provision
      for credit losses
                
                
                2,070,000
                
                
                
                -
                
                
                
                2,070,000Reclassification
                
                
                6,733
                
                
                
                (6,733
                )
                
                
                -Loans
      and leases charged-off
                
                
                (7,532,178
                )
                
                
                -
                
                
                
                (7,532,178
                )Loans
      and leases recovered
                
                
                185,626
                
                
                
                -
                
                
                
                185,626Net
      (charge-offs)/recoveries
                
                
                (7,346,552
                )
                
                
                -
                
                
                
                (7,346,552
                )Balance
      at June 30, 2010
                
                $
                7,951,293
                
                
                $
                171,236
                
                
                $
                8,122,529





June 30,2010
              
              
              December 31,
                2009Allowance
      for Credit Losses RatiosAllowances
      for loan and lease losses/total loans and leases
              
              
              1.21
              %
              
              
              2.00
              %Allowance
      for unfunded loan commitments/unfunded commitments
              
              
              0.20
              %
              
              
              0.27
              %Allowance
      for credit losses/total loans and leases
              
              
              1.24
              %
              
              
              2.04
              %





5




Note 4. Comprehensive
Income.Comprehensive income
includes net income and all other changes to the Company's equity, with the
exception of transactions with shareholders ("other comprehensive
income").  The Company's only component of other comprehensive income
is unrealized gains and losses on available for sale
securities.  Unrealized gains and losses on available for sale
securities are primarily impacted by purchases and sales of available for sale
securities and changes in interest rates between the respective reporting
periods.  Information concerning other comprehensive income for the
three and six month periods ended June 30, 2010 and 2009 is as
follows:





Three MonthsEnded
                  6/30/10
                
                
                Three MonthsEnded
                  6/30/09
                
                
                Six MonthsEnded
                  6/30/10
                
                
                Six MonthsEnded
                  6/30/09Net
      income
                
                $
                1,558,362
                
                
                $
                1,759,878
                
                
                $
                3,108,059
                
                
                $
                3,764,396Reclassification
      of gain on sale of securities
                
                
                457,805
                
                
                
                452,344
                
                
                
                937,887
                
                
                
                917,866Gains
      (losses) unrealized, net of income taxes
                
                
                1,060,054
                
                
                
                (1,359,030
                )
                
                
                694,988
                
                
                
                (1,927,840
                )Other
      comprehensive income (loss)
                
                
                1,517,859
                
                
                
                (906,686
                )
                
                
                1,632,875
                
                
                
                (1,009,974
                )Comprehensive
      income
                
                $
                3,076,221
                
                
                $
                853,192
                
                
                $
                4,740,934
                
                
                $
                2,754,422





Note 5.  Stock-Based
Compensation.   The Company had two stock-based
compensation plans at June 30, 2010.  Shares outstanding are for
grants under the Company’s 1997 Stock Option Plan (the “1997 Plan”) and the 2008
Equity Incentive Plan (the “2008 Plan”) (collectively, the “Plans”). The 1997
Plan matured on April 8, 2008 and no additional options may be granted under
that plan.  At June 30, 2010, the 1997 Plan had 123,741 granted
unexercised shares. At June 30, 2010, the 2008 Plan includes 73,000 granted
unexercised shares and 885,000 shares available to be granted. During the three
and six months ended June 30, 2010, no restricted shares were granted under the
2008 Plan.





Stock
options expire ten years from the date of grant and vest over service periods
ranging from one year to five years.  Options granted under the 2008
Plan are granted at the closing sales price of the Company’s common stock on the
NASDAQ Stock Market on the date of grant. The Company settles stock option
exercises with treasury shares.





The net
compensation cost charged against income for the Plans was $20,782 and $43,481
for the three and six months ended June 30, 2010, and $17,388 and $28,157 for
the three and six months ended June 30, 2009. As of June 30, 2010, total
unrecognized compensation cost on granted unexercised shares was $239,861. That
cost is expected to be recognized during the next 3.5 years.





No income
tax benefits were recognized from the exercise of stock options in the three and
six months ended June 30, 2010 or 2009.





There was
no intrinsic value of options exercised during the three and six months ended
June 30, 2010, as no options were exercised, compared to $11,357 of intrinsic
value during both the three and six months ended June 30, 2009.





The
average fair value of options granted during the three and six months ended June
30, 2010 was $4.58 and $4.25, compared to $4.06 and $3.55 during the three and
six months ended June 30, 2009.  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 the three and
six months ended June 30, 2010 and 2009:




6




Three MonthsEnded6/30/10
                  
                  
                  Three MonthsEnded
                    6/30/09
                  
                  
                  Six MonthsEnded
                    6/30/10
                  
                  
                  Six MonthsEnded
                    6/30/09Dividend
      growth rate
                  
                  
                  5.3
                  %
                  
                  
                  5.3
                  %
                  
                  
                  5.3
                  %
                  
                  
                  5.3
                  %Expected
      volatility
                  
                  
                  36.5
                  %
                  
                  
                  37.0
                  %
                  
                  
                  36.6
                  %
                  
                  
                  36.1
                  %Average
      risk-free interest rate
                  
                  
                  2.8
                  %
                  
                  
                  3.2
                  %
                  
                  
                  3.1
                  %
                  
                  
                  2.5
                  %Expected
      lives - years
                  
                  
                  6
                  
                  
                  
                  6
                  
                  
                  
                  6
                  
                  
                  
                  6





A summary
of option activity under the Plans as of June 30, 2010 and 2009, and changes
during the three and six month periods ended June 30, 2010 and 2009, is
presented below:





OptionsOutstanding
                        
                        
                        Price
                        
                        
                        Aggregate
                          Intrinsic ValuePeriod Ended June 30,
2010:Outstanding
      at December 31, 2009
                        
                        
                        171,770
                        
                        
                        $
                        16.04Granted
                        
                        
                        27,000
                        
                        
                        $
                        11.11Forfeited
                        
                        
                        (3,500
                        )
                        
                        $
                        18.02Exercised
                        
                        
                        (1,675
                        )
                        
                        $
                        5.50Outstanding
      at March 31, 2010
                        
                        
                        193,595
                        
                        
                        $
                        15.41
                        
                        
                        $
                        (562,874
                        )Granted
                        
                        
                        7,000
                        
                        
                        $
                        12.29Forfeited
                        
                        
                        (3,854
                        )
                        
                        $
                        16.03Exercised
                        
                        
                        0
                        
                        
                        $
                        0.00Outstanding
      at June 30, 2010
                        
                        
                        196,741
                        
                        
                        $
                        15.28
                        
                        
                        $
                        (919,650
                        )Vested
      and Exercisable at June 30, 2010
                        
                        
                        122,958
                        
                        
                        $
                        16.24
                        
                        
                        $
                        (692,240
                        )Period Ended June 30, 2009:Outstanding
      at December 31, 2008
                        
                        
                        172,295
                        
                        
                        $
                        17.52Granted
                        
                        
                        15,000
                        
                        
                        $
                        9.73Forfeited
                        
                        
                        (1,375
                        )
                        
                        $
                        28.79Exercised
                        
                        
                        0
                        
                        
                        $
                        0.00Outstanding
      at March 31, 2009
                        
                        
                        185,920
                        
                        
                        $
                        16.81
                        
                        
                        $
                        (1,150,476
                        )Granted
                        
                        
                        3,000
                        
                        
                        $
                        10.71Forfeited
                        
                        
                        0
                        
                        
                        $
                        0.00Exercised
                        
                        
                        0
                        
                        
                        $
                        0.00Outstanding
      at June 30, 2009
                        
                        
                        188,920
                        
                        
                        $
                        16.71
                        
                        
                        $
                        (1,150,746
                        )Vested
      and Exercisable at June 30, 2009
                        
                        
                        135,845
                        
                        
                        $
                        16.14
                        
                        
                        $
                        (616,806
                        )





A summary
of nonvested option shares as of June 30, 2010 and 2009, and changes during the
three and six month periods ended June 30, 2010 and 2009, is presented
below:





Shares
                          
                          
                          PricePeriod Ended June 30,
2010:Nonvested
      at December 31, 2009
                          
                          
                          58,158
                          
                          
                          $
                          16.16Granted
                          
                          
                          27,000
                          
                          
                          $
                          11.11Forfeited
                          
                          
                          (3,500
                          )
                          
                          $
                          18.02Vested
                          
                          
                          (8,950
                          )
                          
                          $
                          16.05Nonvested
      at March 31, 2010
                          
                          
                          72,708
                          
                          
                          $
                          14.21Granted
                          
                          
                          7,000
                          
                          
                          $
                          12.29Forfeited
                          
                          
                          (2,500
                          )
                          
                          $
                          12.95Vested
                          
                          
                          (3,425
                          )
                          
                          $
                          22.31Nonvested
      at June 30, 2010
                          
                          
                          73,783
                          
                          
                          $
                          13.69Period Ended June 30, 2009:Nonvested
      at December 31, 2008
                          
                          
                          43,275
                          
                          
                          $
                          22.68Granted
                          
                          
                          15,000
                          
                          
                          $
                          9.73Forfeited
                          
                          
                          0
                          
                          
                          $
                          0.00Vested
                          
                          
                          (4,150
                          )
                          
                          $
                          24.22Nonvested
      at March 31, 2009
                          
                          
                          54,125
                          
                          
                          $
                          18.97Granted
                          
                          
                          3,000
                          
                          
                          $
                          10.71Forfeited
                          
                          
                          0
                          
                          
                          $
                          0.00Vested
                          
                          
                          (4,050
                          )
                          
                          $
                          23.34Nonvested
      at June 30, 2009
                          
                          
                          53,075
                          
                          
                          $
                          18.17




7




The
following table summarizes additional information about the Company’s
outstanding options and exercisable options as of June 30, 2010, including
weighted-average remaining contractual term expressed in years ("Life") and
weighted average exercise price (“Price”):





Outstanding
                      
                      
                      ExercisableRange of Exercise Price
                      
                      Shares
                      
                      
                      Life
                      
                      
                      Price
                      
                      
                      Shares
                      
                      
                      Price$6.17
      – 13.82
                      
                      
                      96,408
                      
                      
                      
                      6.38
                      
                      
                      $
                      10.27
                      
                      
                      
                      39,408
                      
                      
                      $
                      8.65$14.97
      – 16.49
                      
                      
                      36,208
                      
                      
                      
                      2.57
                      
                      
                      $
                      16.09
                      
                      
                      
                      36,208
                      
                      
                      $
                      16.09$16.77
      – 25.22
                      
                      
                      50,875
                      
                      
                      
                      6.63
                      
                      
                      $
                      20.68
                      
                      
                      
                      35,792
                      
                      
                      $
                      20.71$26.17
      – 33.27
                      
                      
                      13,250
                      
                      
                      
                      5.59
                      
                      
                      $
                      28.82
                      
                      
                      
                      11,550
                      
                      
                      $
                      28.73196,741
                      
                      
                      
                      5.69
                      
                      
                      $
                      15.28
                      
                      
                      
                      122,958
                      
                      
                      $
                      16.24





The fair
value compensation cost recognition provisions for share based payments are
different from the recognition provisions and the intrinsic value method for
recording compensation cost. The following table reflects the net impact of fair
value compensation cost recognition on income before income taxes, net income,
basic earnings per share and diluted earnings per share for the three and six
month periods ended June 30, 2010 and 2009:


ThreeMonthsEnded
                    6/30/10
                  
                  
                  ThreeMonthsEnded
                    6/30/09
                  
                  
                  Six
      MonthsEnded
                    6/30/10
                  
                  
                  Six
      MonthsEnded
                    6/30/09Reduced
      net income before income taxes
                  
                  $
                  20,782
                  
                  
                  $
                  17,388
                  
                  
                  $
                  43,481
                  
                  
                  $
                  28,157Reduced
      net income
                  
                  $
                  20,030
                  
                  
                  $
                  17,316
                  
                  
                  $
                  42,424
                  
                  
                  $
                  28,085Reduced
      basic earnings per share
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.00Reduced
      diluted earnings per share
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.00





Note 6.  Fair Value
Hierarchy.  A fair value hierarchy prioritizes the inputs of
valuation techniques used to measure fair value of nonfinancial assets and
liabilities. The inputs are evaluated and an overall level for the fair value
measurement is determined. This overall level is an indication of the market
observability of the fair value measurement. Financial accounting standards
clarify fair value in terms of the price in an orderly transaction between
market participants to sell an asset or transfer a liability in the principal
(or most advantageous) market for the asset or liability at the measurement date
(an exit price). In order to determine the fair value or the exit price, the
Bank must determine the unit of account, highest and best use, principal market,
and market participants.  These determinations allow the Bank to
define the inputs for fair value and level of hierarchy.  Outlined
below is the application of the fair value hierarchy to the Bank’s financial
assets that are carried at fair value.




8




Level
1-inputs to the valuation methodology are quoted prices (unadjusted) in active
markets for identical assets or liabilities that the reporting entity has the
ability to access at the measurement date. A quoted price in an active market
provides the most reliable evidence of fair value and shall be used to measure
fair value whenever available. The type of assets carried at Level 1 fair value
generally includes investments such as U. S. Treasury and U. S. government
agency securities.





Level
2-inputs to the valuation methodology include quoted prices for similar assets
or liabilities in active markets and price quotations can vary substantially
either over time or among market makers. The type of assets carried at Level 2
fair value generally includes investment securities such as Government Sponsored
Enterprises (“GSEs”) and the Bank’s investment in other real estate
owned.





Level
3-inputs to the valuation methodology are unobservable to the extent that
observable inputs are not available.  Unobservable inputs are
developed based on the best information available in the circumstances and might
include the Bank’s own assumptions.  The Bank shall not ignore
information about market participant assumptions that is reasonably available
without undue cost and effort. The type of assets carried at Level 3 fair value
generally include investments backed by non-traditional mortgage loans or
certain state or local housing agency obligations,  of which the Bank
has no such assets or liabilities.





Assets
measured at fair value on a recurring basis as of June 30, 2010 and
2009:





Quoted Prices
                  In Active
                  Markets forIdentical Assets
                
                
                Significant
                  Other
                  Observable
                  Inputs
                
                
                SignificantUnobservable
                  InputsDescription
                
                6/30/10
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Available
      for sale securities:Investment
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -Mortgage-backed
                
                
                92,180,716
                
                
                
                -
                
                
                
                92,180,716
                
                
                
                -Total
      June 30, 2010
                
                $
                92,180,716
                
                
                $
                -
                
                
                $
                92,180,716
                
                
                $
                -





Quoted Prices
                    In Active
                    Markets forIdentical Assets
                  
                  
                  Significant
                    Other
                    Observable
                    Inputs
                  
                  
                  Significant
      Unobservable
                    InputsDescription
                  
                  6/30/09
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Available
      for sale securities:Investment
                  
                  $
                  10,464,294
                  
                  
                  $
                  -
                  
                  
                  $
                  10,464,294
                  
                  
                  $
                  -Mortgage-backed
                  
                  
                  80,949,144
                  
                  
                  
                  -
                  
                  
                  
                  80,949,144
                  
                  
                  
                  -Total
      June 30, 2009
                  
                  $
                  91,413,438
                  
                  
                  $
                  -
                  
                  
                  $
                  91,413,438
                  
                  
                  $
                  -





Assets
measured at fair value on a non-recurring basis as of June 30, 2010 and
2009:





Quoted Prices
                  In Active
                  Markets forIdentical Assets
                
                
                Significant
                  Other
                  Observable
                  Inputs
                
                
                SignificantUnobservable
                  InputsDescription
                
                6/30/10
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Impaired
      loans, net
                
                $
                15,499,732
                
                
                $
                -
                
                
                $
                15,499,732
                
                
                $
                -Other
      real estate owned
                
                
                8,451,905
                
                
                
                -
                
                
                
                8,451,905
                
                
                
                -Total
      June 30, 2010
                
                $
                23,951,637
                
                
                $
                -
                
                
                $
                23,951,637
                
                
                $
                -




9




Quoted Prices
                  In Active
                  Markets forIdentical Assets
                
                
                Significant
                  Other
                  Observable
                  Inputs
                
                
                SignificantUnobservable
                  InputsDescription
                
                6/30/09
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Impaired
      loans, net
                
                $
                9,133,922
                
                
                $
                -
                
                
                $
                9,133,922
                
                
                $
                -Other
      real estate owned
                
                
                10,407,831
                
                
                
                -
                
                
                
                10,407,831
                
                
                
                -Total
      June 30, 2009
                
                $
                19,541,753
                
                
                $
                -
                
                
                $
                19,951,753
                
                
                $
                -





Quoted
market price for similar assets in active markets is the valuation technique for
determining fair value of available for sale securities. Unrealized gains on
available for sale securities are included in the “accumulated other
comprehensive income” component of the Stockholders’ Equity section of the
Consolidated Statements of Financial Condition.





The
Company does not record loans at fair value on a recurring basis. However, when
a loan is considered impaired, an impairment write down is taken, based on the
estimated fair value of the loan. The fair value of impaired loans is estimated
using one of several methods, including collateral value, market value of
similar debt, enterprise value, liquidation value and discounted cash flows.
Those impaired loans not requiring a write down represent loans for which the
fair value of the expected repayments or collateral exceed the recorded
investments in such loans. Impaired loans where a write down is taken based on
fair value of collateral require classification in the fair value hierarchy.
When the fair value of the collateral is based on an observable market price or
a current appraised value, the Company records the impaired loan as
non-recurring Level 2. When an appraised value is not available or management
determines the fair value of the collateral is further impaired below the
appraised value and there is no observable market price, the Company classifies
the impaired loan as non-recurring Level 3.





Other
real estate owned (“OREO”) acquired through loan foreclosure is recorded at fair
value upon transfer of the loans to foreclosed assets, based on the appraised
market value of the property. Subsequently, foreclosed assets are carried at the
lower of carrying value or fair value. Fair value is based upon independent
market prices, appraised values of the collateral or management’s estimation of
the value of the collateral. When fair value of the collateral is based on an
observable market price or a current appraised value, the Company records the
foreclosed asset as non-recurring Level 2. When an appraised value is not
available or management determines the fair value of the collateral is impaired
below the appraised value and there is no observable market price, the Company
classifies the foreclosed asset as non-recurring Level 3.Fair value
adjustments of $686,362 and $1,704,200 were made to OREO during the three and
six months ended June 30, 2010, compared to $65,000 and $1,851,580 during the
three and six months ended June 30, 2009.





Net gains
(losses) realized and included in earnings for the three and six months ended
June 30, 2010 and 2009 are reported in other revenues as follows:





ThreeMonthsEnded
                    6/30/10
                  
                  
                  ThreeMonthsEnded
                    6/30/09
                  
                  
                  Six MonthsEnded
                    6/30/10
                  
                  
                  Six MonthsEnded
                    6/30/09Gain
      (loss) on sale of real estate, net
                  
                  $
                  21,223
                  
                  
                  $
                  5,285
                  
                  
                  $
                  33,720
                  
                  
                  $
                  (74,448
                  )





No
liabilities were measured at fair value on a recurring or non-recurring basis
during the three and six months periods ended June 30, 2010 or
2009.




10




Item
2.  Management's Discussion and Analysis of Financial Condition and
Results of Operation.


First
South Bancorp, Inc. (the "Company") was formed for the purpose of issuing common
stock and owning 100% of the stock of First South Bank (the "Bank") and
operating through the Bank a commercial banking business.  Therefore,
the discussion below focuses primarily on the Bank's results of
operations.  The Bank has one significant operating segment, the
providing of general commercial banking services to its markets located in the
state of North Carolina.  The Company’s common stock is traded on the
NASDAQ Global Select Market under the symbol "FSBK".





Comparison of Financial Condition at
June 30, 2010 and December 31, 2009.  Total assets were $812.8
million at June 30, 2010, compared to $829.9 million at December 31, 2009.
Earning assets were $740.7 million at June 30, 2010, compared to $761.9 million
at December 31, 2009, reflecting the net change in the composition of earning
assets, as further discussed below. Earning assets were 91.1% of total assets at
June 30, 2010, compared to 91.8% at December 31, 2009.





Interest-bearing
overnight deposits in financial institutions were $17.4 million at June 30,
2010, compared to $11.9 million at December 31, 2009.  Overnight funds
are available to fund loan originations, liquidity management activities and
support daily operations of the Bank.





No
investment securities were held as available for sale at June 30, 2010, compared
to $407,000 at December 31, 2009.  There were no maturities of
investment securities available for sale during the quarters ended June 30,
2010, compared to $10.0 million of maturities for both the three and six months
ended June 30,  2009.  The Bank sold $507,000 of investment
securities available for sale during the three and six months ended June 30,
2010, compared to $10.5 million and $20.9 million sold during the three and six
months ended June 30, 2009.





Mortgage-backed
securities available for sale were $92.2 million at June 30, 2010, compared to
$96.7 million at December 31, 2009. The Bank may sell mortgage-backed securities
to support a more balanced sensitivity to future interest rate changes and may
securitize mortgage loans held for sale into mortgage-backed securities to
support adequate liquidity levels.  During the three and six months
ended June 30, 2010, the Bank sold $9.0 million and $17.4 million of
mortgage-backed securities available for sale, compared to none for the three
and six months ended June 30, 2009.  During the three and six months
ended June 30, 2010, $6.0 million and $14.8 million of mortgage loans held for
sale were securitized into mortgage-backed securities available for sale,
compared to $34.9 million and $56.2 million securitized during the three and six
months ended June 30, 2009.





Mortgage-backed
securities held for investment were $378,000 at June 30, 2010, compared to
$514,000 at December 31, 2009, reflecting scheduled principal
payments.





Based on
current market prices, unrealized gains on available for sale securities
increased to $2.0 million at June 30, 2010, from $322,000 at December 31, 2009.
See “Note 4. Comprehensive Income” of “Notes to Consolidated Financial
Statements (Unaudited)” for additional information.





Loans
held for sale were $5.5 million at June 30, 2010, compared to $6.5 million at
December 31, 2009. The Bank sells certain mortgage loans to support a more
balanced sensitivity to future interest rate changes. Proceeds from loan sales
were $7.8 million and $17.1 million for the three and six months ended June 30,
2010, compared to $2.4 million and $9.8 million for the three and six months
ended June 30, 2009.  Proceeds from loan sales are used to fund
liquidity needs of the Bank, including new loan originations, repayment of
borrowings, deposit outflows and general banking operations.  Loans
serviced for others increased to $299.4 million at June 30, 2010, from $289.3
million at December 31, 2009.




11




Net loans
and leases receivable held for investment declined to $639.4 million at June 30,
2010, from $652.1 million at December 31, 2009. During the three and six months
ended June 30, 2010, certain loans held for investment were subjects of
foreclosure and transferred to other real estate owned, as discussed
below.  In addition, a portion of the proceeds from principal
repayments on loans held for investment are also used to fund the liquidity
needs of the Bank, as discussed above.





Non-accrual
loans increased to $12.3 million at June 30, 2010, from $5.8 million at December
31, 2009, as the current economy continues to present a challenging credit
environment for the Bank and its customers.  Restructured loans were
$5.6 million at June 30, 2010, compared to $4.3 million at December 31,
2009.  The level of non-accrual and restructured loans is attributable
to the current economic environment.  Downward pressure continues to
be placed on the housing and real estate markets, significantly impacting credit
quality of certain borrowers and property values in the Bank’s market area.
Management believes it has thoroughly evaluated its non-performing loans and
they are either well collateralized or adequately reserved. However, there can
be no assurance in the future that regulators, increased risks in the loan
portfolio, adverse changes in economic conditions or other factors will not
require further adjustments to the allowance for credit losses.





Other
real estate owned declined to $8.5 million at June 30, 2010, from $10.6 million
at the December 31, 2009, reflecting the net of sales, new foreclosures of
certain non-performing loans and fair value adjustments.  During the
six month period ended June 30, 2010 there were $3.5 million of new
foreclosures, $4.0 million of sales and $1.6 million of fair value adjustments.
Other real estate owned consists of residential and commercial properties,
developed building lots and a partially developed residential subdivision. The
Bank believes the adjusted carrying values of these properties are
representative of their fair market values, although there can be no assurances
that the ultimate sales will be equal to or greater than the carrying
values.  See “Note 6.  Fair Value Heirarchy” of “Notes to
Consolidated Financial Statements (Unaudited)” for additional
information.





Deposits
increased to $694.5 million at June 30, 2010, from $688.5 million at December
31, 2009.  Demand accounts (personal and business checking accounts
and money market accounts) increased to $224.9 million at June 30, 2010, from
$224.5 million at December 31, 2009.





Time
deposits increased to $444.4 million at June 30, 2010, from $440.9 million at
December 31, 2009.  During this period, the Bank chose to not match
higher time deposit rates being offered by certain competitive financial
institutions in its market area, in order to control its time deposit
cost.  The Bank has been pricing new and maturing time deposits within
the current lower rate environment, and combined with the growth of lower
costing checking accounts, is effectively managing its deposit
cost.  See “Interest Expense” below for additional information
regarding the Bank’s cost of funds.





Borrowed
money consisting of Federal Home Loan Bank (“FHLB”) advances and repurchase
agreements declined to $12.7 million at June 30, 2010, from $37.4 million at
December 31, 2009.  FHLB advances declined to $10.0 million at June
30, 2010, from $35.0 million at December 31, 2009, as the Bank repaid a
$25.0 million, 3.0% fixed-rate advance.  Repurchase agreements (cash
management accounts for commercial banking customers) increased to $2.7 million
at June 30, 2010, from $2.4 million at December 31, 2009.





Stockholders'
equity increased to $87.1 million at June 30, 2010, from $86.2 million at
December 31, 2009, reflecting the net effect of earnings, dividend payments and
changes in accumulated other comprehensive income.  The equity to
assets ratio was 10.7% at June 30, 2010 compared to 10.4% at December 31,
2009.  See "Consolidated Statements of Stockholders' Equity" for
additional information.




12




Accumulated
other comprehensive income increased $2.0 million at June 30, 2010, from
$322,000 at December 31, 2009, reflecting the net change in unrealized gains on
available for sale securities portfolio based on current market
prices.  See “Note 4. Comprehensive Income” of “Notes to Consolidated
Financial Statements (Unaudited)” for additional information.





The Bank
is subject to various capital requirements administered by federal and state
banking agencies. At June 30, 2010, the Bank's regulatory capital ratios were in
excess of all regulatory requirements and were the following: Total Risk-Based
Capital – 13.62%; Tier 1 Risk-Based Capital – 12.37%; and Tier 1 Leverage
Capital – 9.99%.  See "Liquidity and Capital Resources" below for
additional information.





On June
23, 2010, the Company declared a cash dividend of $0.20 per share, payable July
22, 2010 to stockholders of record as of July 5, 2010.  This dividend
payment represents a 125.0% payout ratio of the basic earnings per share for the
quarter ended June 30, 2010, and is the Company's 53rd consecutive quarterly
cash dividend.  The Board of Directors (the “Board”) determined the
dividend payment rate was appropriate in consideration of the Company’s capital
position and operating results.  Any future dividends will depend upon
the Company’s financial condition, earnings, equity structure, capital needs,
regulatory requirements and economic conditions.





The
Company purchased none of its common stock during the three and six months ended
June 30, 2010. Common stock may be purchased through private or open market
transactions pursuant to a stock repurchase plan adopted by the Board. Shares
acquired through repurchase plans are held as treasury stock, at cost. At June
30, 2010, there were 1,510,251 treasury shares totaling $32.1 million, compared
to 1,511,926 shares totaling $32.2 million at December 31,
2009.  Treasury shares are used for general purposes including the
exercise of stock options and providing shares for potential future stock
splits.





From
December 31, 2009 to June 30, 2010, there were 1,675 shares of the Company’s
common stock issued from the exercise of stock options.





Comparison of Operating Results -
Three and Six months ended June 30, 2010 and 2009.Net income
for the three and six months ended June 30, 2010 was $1.6 million and $3.1
million, compared to $1.8 million and $3.8 million for the three and six months
ended June 30, 2009. Diluted earnings per share were $0.16 and $0.32 per share
for the three and six months ended June 30, 2010, compared to $0.18 and $0.39
per share for the three and six months ended June 30, 2009.





Net
earnings during the three and six months ended June 30, 2010 were favorably
impacted by an increase in net interest income, while being partially offset by
the volume of provisions for credit losses to replenish net
charge-offs.  The current economy continues to present a challenging
credit environment for the Bank, for its customers and for the banking
industry.  As the Bank addresses and manages through these challenges,
it remains focused on long-term strategies.  These strategies include
remediating problem assets, maintaining adequate levels of capital and
liquidity, improving efficiency in our operations, building core customer
relationships and improving our franchise value along with shareholder
value.  The Bank remains profitable, continues to maintain a strong
capital position in excess of the well-capitalized regulatory guidelines, and
combined with strengthening of the allowance for credit losses should enhance
future earnings as the current recessionary economic conditions substantially
improve.





Key
performance ratios are return on average assets (ROA), return on average equity
(ROE), and efficiency.  ROA was .8% for both the three and six months
ended June 30, 2010, compared to .8% and .9% for the three and six months ended
June 30, 2009.  ROE was 7.2% and 7.1% for the three and six months
ended June 30, 2010, compared to 8.0% and 9.1% for the three and six months
ended June 30, 2009.  The Company’s efficiency ratio was 59.1% and
57.8% for the three and six months ended June 30, 2010, compared to 58.6% and
57.2% for the three and six months ended June 30, 2009.




13




Interest
Income.Interest income declined to $10.8 million and $22.0
million for the three and six months ended June 30, 2010, from $12.4 million and
$25.0 million for the three and six months ended June 30, 2009. The reduction in
interest income volume is due primarily to the decline in interest rates during
the comparative reporting periods and a decline in the volume of average
interest-earning assets. Average interest-earning assets declined to $738.6
million and $742.6 million for the three and six months ended June 30, 2010,
from $816.2 million and $814.8 million for the three and six months ended June
30, 2009.  The reduction in average interest-earning assets reflects
the net impact of the decrease in loans held for investment, sales and
maturities of investment and mortgage backed securities, the increase in other
real estate owned and the volume of non-performing loans discussed
above.  The yield on average interest-earning assets was 5.9% for both
the three and six months ended June 30, 2010, compared to 6.1% for both the
three and six months ended June 30, 2009.   The yield on average
interest-earning assets has been impacted by the decline in market interest
rates and average interest-earning assets during the comparative reporting
periods as discussed above.





Interest
Expense.Interest expense declined to $2.3 million and $4.6
million for the three and six months ended June 30, 2010, from $4.5 million and
$9.2 million for the three and six months ended June 30, 2009, reflecting a
decline in interest rates between the respective periods and a decline in the
volume of average interest-bearing liabilities.  The effective cost of
funds declined to 1.3% for both the three and six months ended June 30, 2010,
from 2.3% for both the three and six months ended June 30, 2009.  The
Company was able to improve its cost of funds by the combination of deposit
repricing, the rollover of maturing time deposits and the repositioning of
borrowings within the current lower interest rate
environment.  Average deposits and borrowings were $714.4 million and
$717.4 million for the three and six months ended June 30, 2010, compared to
$784.6 million and $783.5 million for the three and six months ended June 30,
2009.





Net Interest Income.Net interest income
increased to $8.6 million and $17.3 million for the three and six months ended
June 30, 2010, from $7.9 million and $15.8 million for the three and six months
ended June 30, 2009.  The interest rate spread (the difference between
the effective yield on average earning assets and the effective cost of average
deposits and borrowings) improved to 4.6% for both the three and six months
ended June 30, 2010, compared to 3.8% for both the three and six months ended
June 30, 2009. The net yield on interest-earning assets (net interest income
divided by average interest-earning assets) improved to 4.6% and 4.7% for the
three and six months ended June 30, 2010, from 3.9% for both the three and six
months ended June 30, 2009. The increase in interest rate spread and net yield
on interest-earning assets is a result of effectively managing the rates earned
and paid and the volume of interest-earning assets and interest-bearing
liabilities.





Provision for Credit
Losses.  The Bank's methodology for determining its provision
for credit losses includes evaluating individual loans for amounts that are
determined to be impaired, evaluating groups of loans that have not been
individually assessed for impairment and historical loss experience. The Bank
recorded $2.1 million and $4.5 million of provisions for credit losses in the
three and six months ended June 30, 2010, compared to $1.7 million and $3.2
million in the three and six months ended June 30, 2009. The provision for
credit losses was necessary to replenish net charge offs of $7.3 million and
$10.1 million recorded in the three and six months ended June 30, 2010, compared
to $894,000 and $3.2 million in the three and six months ended June 30, 2009,
and to strengthen the Bank’s ability to better manage the volume of
non-performing loans, as discussed above. See “Allowance for Credit Losses”
below for additional information.




14




Allowance for Credit
Losses.The Bank maintains allowances for loan and lease
losses and for unfunded loan commitments (collectively the “allowance for credit
losses”) at levels the Bank believes are adequate to absorb probable losses
inherent in the loan and lease portfolio and in unfunded loan
commitments.  The Bank has developed policies and procedures for
assessing the adequacy of the allowance for credit losses that reflect the
assessment of credit risk and impairment analysis.  This assessment
includes an analysis of qualitative and quantitative trends in the levels of
classified loans.  In developing this analysis, the Bank relies on
historical loss experience, estimates and exercises judgment in assessing credit
risk. Future assessments of credit risk may yield different results, depending
on changes in the qualitative and quantitative trends, which may require
increases or decreases in the allowance for credit losses.





The Bank
uses a variety of modeling, calculation methods and estimation tools for
measuring credit risk and performing impairment analysis, which is the basis
used in developing the allowance for credit losses.  The factors
supporting the allowance do not diminish the fact that the entire allowance for
credit losses is available to absorb probable losses in both the loan and leases
portfolio and in unfunded loan commitments.  The Bank’s principal
focus is on the adequacy of the total allowance for credit losses.





During
the three months ended June 30, 2010, the Bank refined its allowance for credit
losses methodology taking into account current generally accepted accounting
principles and regulatory guidance. The refined methodology is focused on
current borrower analysis and loss factors that are more indicative of actual
historical loss experience in recent years pursuant to FAS
5.  Previously, the Bank established specific reserves for certain
impaired loans per FAS 114.  The Bank has elected to write down
substantially all previously calculated specific reserves.  Going
forward, when impairment can be reasonably calculated, the Bank will write down
the affected loan by the level of that impairment.  As a result of
these changes, this leaves the allowance for credit losses with a distinctly
different balance than in previous reporting periods, which contained a mixed
balance between both FAS 5 and FAS 114.  Now essentially all of the
Bank’s calculated allowance for credit losses is under FAS 5.  Where
previous allowance for credit losses carried specific reserves under FAS 114,
the Bank anticipates future reports to more closely approximate this
one.





Based on
the overall credit quality of the loan and lease receivable portfolio, the Bank
believes it has established the allowance for credit losses pursuant to
generally accepted accounting principles, and has taken into account the views
of its regulators and the current economic environment.  Management of
the Bank reassess the information upon which it bases the allowance for credit
losses not greater than quarterly and believes their accounting decisions remain
accurate. However, there can be no assurance in the future that regulators,
increased risks in the loan and lease portfolio, changes in economic conditions
and other factors will not require additional adjustments to the allowance for
credit losses.





The
allowance for credit losses was $8.1 million at June 30, 2010, compared to $13.7
million at December 31, 2009. The ratio of the allowance for credit losses to
loans and leases was 1.2% at June 30, 2010 and 2.0% at December 31,
2009.  See “Note 3. Allowance for Credit Losses” and “Note
6.  Fair Value Hierarchy” of “Notes to Consolidated Financial
Statements (Unaudited)” and “Critical Accounting Policies - Loan Impairment and
Allowance for Credit Losses” below for additional information.





Noninterest
Income.Noninterest income was $2.8 million and $5.5 million
for the three and six months ended June 30, 2010, compared to $3.2 million and
$6.0 million for the three and six months ended June 30,
2009.  Noninterest income consists of fees, service charges and
servicing fees earned on loans, service charges and insufficient funds fees
collected on deposit accounts, gains from loan and securities sales and other
miscellaneous income.




15




The Bank
continues to maintain a consistent level of noninterest income across both loan
and deposit service offerings. Fees, service charges and servicing fees
collected were $2.0 million and $3.8 million for the three and six months ended
June 30, 2010, compared to $2.1 million and $4.0 million for the three and six
months ended June 30, 2009. Fees, service charges earned and insufficient funds
fees collected during each period are attributable to the volume of loan,
deposit account, and insufficient funds transactions processed during each
period, and the collection of related fees and service charges.





The Bank
recorded gains from loan sales of $173,000 and $366,000 during the three and six
months ended June 30, 2010, compared to $430,000 and $688,000 during the three
and six months ended June 30, 2009. Fixed-rate residential mortgage loans are
sold to reduce exposure to interest rate and credit risk, and provide a more
balanced sensitivity to future interest rate changes.





The Bank
recorded gains from investment and mortgage-backed securities sales of $458,000
and $938,000 during the three and six months ended June 30, 2010, compared to
$452,000 and $918,000 during the three and six months ended June 30,
2009.  Proceeds from investment and mortgage-backed securities sales
are used for a variety of purposes, including funding new loan originations,
liquidity management and general banking operations.





Noninterest
Expense.Noninterest expenses were $6.7 million and $13.2
million for the three and six months ended June 30, 2010, compared to $6.5
million and $12.5 million for the three and six months ended June 30,
2009.  The largest component, compensation and fringe benefits,
increased to $4.1 million and $7.8 million for the three and six months ended
June 30, 2010, from $3.6 million and $7.0 million for the three and six months
ended June 30, 2009, reflecting increased staffing levels necessary to enhance
retail banking operations, credit administration and for providing quality
customer service.





FDIC
insurance premiums declined to $286,000 and $584,000 for the three and six
months ended June 30, 2010, from $540,000 and $680,000 for the three and six
months ended June 30, 2009, reflecting the decline in insured deposit account
balances and the impact of the FDIC’s risk-based deposit insurance
assessments.


Expenses
attributable to maintaining the current volume of other real estate owned
declined to $72,000 and $164,000 in the three and six months ended June 30,
2010, from $116,000 and $343,000 in the three and six months ended June 30,
2009.  Other noninterest expenses including premises and equipment,
advertising, data processing, repairs and maintenance, office supplies,
professional fees, taxes and insurance, etc., have remained relatively
consistent during the respective periods.





Income
Taxes.Income tax expense was $1.0 million and $2.0 million
for the three and six months ended June 30, 2010, compared to $1.1 million and
$2.4 million for the three and six months ended June 30,
2009.  Changes in amounts of income tax provisions reflect changes in
pretax income and estimated income tax rates in effect during each
period.  Effective income tax rates were 39.8% and 39.6% for the three
and six months ended June 30, 2010, compared to 39.2% and 38.6% for the three
and six months ended June 30, 2009.  See “Critical Accounting
Policies” below for additional information.





Liquidity and Capital
Resources.  Liquidity generally refers to the Bank's ability to
generate adequate amounts of funds to meet its cash needs.  Adequate
liquidity guarantees that sufficient funds are available to meet deposit
withdrawals, fund future loan commitments, maintain adequate reserve
requirements, pay operating expenses, provide funds for debt service, pay
dividends to stockholders, and meet other general commitments.  The
Bank must maintain certain regulatory liquidity requirements of liquid assets to
deposits and short-term borrowings.  At June 30, 2010, the Bank had
cash, deposits in banks, investment securities, mortgage-backed securities and
loans held for sale totaling $132.8 million, compared to $133.8 million at
December 31, 2009, representing 18.8% and 18.7% of deposits and short-term
borrowings for the respective periods.




16




The Bank
believes it can meet future liquidity needs with existing funding
sources.  The Bank's primary sources of funds are deposits, payments
on loans and mortgage-backed securities, maturities of investment securities,
earnings and funds provided from operations, the ability to borrow from the FHLB
of Atlanta and the availability of loans held for sale.  While
scheduled repayments of loans and mortgage-backed securities are relatively
predictable sources of funds, deposit flows and general market interest rates,
economic conditions and competition substantially influence loan prepayments. In
addition, the Bank manages its deposit pricing in order to maintain a desired
deposit mix.





The FDIC
requires the Bank to meet a minimum leverage capital requirement of Tier 1
capital (consisting of retained earnings and common stockholders’ equity, less
any intangible assets) to assets ratio of 4%.  The FDIC also requires
the Bank to meet a ratio of total capital to risk-weighted assets of 8%, of
which at least 4% must be in the form of Tier 1 capital.  The North
Carolina Office of the Commissioner of Banks requires the Bank to maintain a
capital surplus of not less than 50% of common capital stock.  The
Bank was in compliance with all regulatory capital requirements at June 30, 2010
and December 31, 2009.





Critical Accounting
Policies.  The Company has identified the policies below as
critical to its business operations and the understanding of its results of
operations.  The impact and any associated risks related to these
policies on the Company’s business operations is discussed throughout
Management’s Discussion and Analysis of Financial Condition and Results of
Operations where such policies affect reported and expected financial
results.





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.  Estimates 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.





Loan Impairment and
Allowance for Credit Losses.  A loan or lease 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 or lease agreement.
Uncollateralized loans are measured for impairment based on the present value of
expected future cash flows discounted at the historical effective interest rate,
while all collateral-dependent loans are measured for impairment based on the
fair value of the collateral.  The Bank uses several factors in
determining if a loan or lease is impaired.  The internal asset
classification procedures include a thorough review of significant loans, leases
and lending relationships and include the accumulation of related
data.  This data includes loan and lease payment status, borrowers'
financial data and borrowers' operating factors such as cash flows, operating
income or loss, etc.





The
allowance for credit losses is increased by charges to income and decreased by
charge-offs (net of recoveries).  Management's periodic evaluation of
the adequacy of the allowance for credit losses is based on past loan and lease
loss experience, known and inherent risks in loans and leases and unfunded loan
commitments, 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
allowances for credit losses 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
in the future that regulators or risks in its loans and leases and unfunded loan
commitments will not require additional adjustments to the allowance for credit
losses.




17




Income
Taxes.  Deferred tax asset and liability balances are
determined by application of temporary differences between 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.





Off-Balance Sheet
Arrangements.  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.





Forward Looking
Statements.  The Private Securities Litigation Reform Act of
1995 states that 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 Form 10-Q, including
Management’s Discussion and Analysis of Financial Condition and Results of
Operation, contains forward looking statements that involve risk and
uncertainty.  In order to comply with terms of safe harbor, the
Company notes that a variety of risks and uncertainties could cause its actual
results and experience to differ materially from 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, as actual results may differ
materially from management's expectations.





Accounting Standards
Codification.  In June 2009, the Financial Accounting Standards
Board (the “FASB”) issued Statement of Financial Accounting Standards No. 168
(“SFAS No. 168”), “The FASB Accounting Standards Codification and the
Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB
Statement No. 162.” The FASB Accounting Standards Codification will become the
source of authoritative U.S. GAAP recognized by the FASB to be applied to
nongovernmental entities.





Following
this Statement, the FASB Board will not issue new standards in the form of
Statements, FASB Staff Positions, or Emerging Issues Task Force
Abstracts.  Instead, they will issue Accounting Standards Updates. The
Board will not consider Accounting Standards Updates as authoritative in their
own right.  Accounting Standards Updates will serve only to update the
Codification, provide background information about the guidance and provide the
basis for conclusions on the change(s) in the Codification.





This
statement will replace SFAS No. 162 and modifies the GAAP hierarchy into two
levels: authoritative and non-authoritative. This statement is effective for
financial statements issued for interim and annual periods ending after
September 15, 2009. The Company adopted SFAS No. 168 on September 30, 2009, with
no material impact on its consolidated financial
statements.


18


Going
forward, as the FASB issues Accounting Standards Updates, the Company will
evaluate the impact that such updates may have on its consolidated financial
statements of the Company and will also monitor the effective dates of such
updates.





Item 3.  Quantitative and
Qualitative Disclosures about Market Risk.  Market risk is the
possible chance of loss from unfavorable changes in market prices and
rates.  These changes may result in a reduction of current and future
period net interest income, which is the favorable spread earned from the excess
of interest income on interest-earning assets over interest expense on
interest-bearing liabilities.





The
Company considers interest rate risk to be its most significant market risk,
which could potentially have the greatest impact on operating
earnings.  The structure of the Company's loan and deposit portfolios
is such that a significant decline in interest rates may have a negative impact
on net market values and net interest income.  The Company monitors
whether material changes in market risk have occurred since December 31,
2009.  The Company believes that no material adverse change in market
risk exposure has occurred since December 31, 2009.





The Bank
has experienced intense price competition for both loans and deposits over the
past two years, which presented a net interest margin management
challenge.  Net interest margin management has been significantly
influenced by the Federal Reserve’s 500 basis point rate cuts since September
2007. The Federal Reserve’s aggressive series of rate cuts caused immediate
downward pricing of the Bank’s loan portfolio, while simultaneously outpacing
the ability to reduce its funding cost as rapidly.  With the prime
rate set at 3.25% since December 2008, and the current federal funds rate at 0%
to 0.25%, it is not foreseeable that interest rates can decline
farther.  Over the remainder of 2010, the Bank anticipates little
compression in its net interest margin as maturing time deposits continue to
reprice at lower rates, although there are no guarantees or
assurances.





Item 4.  Controls and
Procedures.As of the end of the period covered by this
report, management of the Company carried out an evaluation, under the
supervision and with the participation of the Company’s principal executive
officer and principal financial officer, of the effectiveness of the Company’s
disclosure controls and procedures. Based on this evaluation, the Company’s
principal executive officer and principal financial officer concluded that the
Company’s disclosure controls and procedures are effective in ensuring that
information required to be disclosed by the Company in reports that it files or
submits under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission’s rules and forms.  It should be
noted that the design of the Company’s disclosure controls and procedures is
based in part upon certain reasonable assumptions about the likelihood of future
events, and there can be no reasonable assurance that any design of disclosure
controls and procedures will succeed in achieving its stated goals under all
potential future conditions, regardless of how remote, but the Company’s
principal executive and financial officers have concluded that the Company’s
disclosure controls and procedures are, in fact, effective at a reasonable
assurance level.





In
addition, there have been no changes in the Company’s internal control over
financial reporting (to the extent that elements of internal control over
financial reporting are subsumed within disclosure controls and procedures)
identified in connection with the evaluation described in the above paragraph
that occurred during the Company’s last fiscal quarter, that has materially
affected, or is reasonably likely to materially affect, the Company’s internal
control over financial reporting.


19


PART
II.  OTHER INFORMATION





Item l.  Legal
Proceedings: The Company is currently not engaged in any material legal
proceedings.  From time to time, the Bank is a party to legal
proceedings within the ordinary course of business wherein it enforces its
security interest in loans, and other matters of similar nature.





Item 1A.  Risk Factors:In addition to the risk factors that were disclosed in response to
Item 1A of Part I of Form 10-K for the year ended December 31,
2009, the following risk factor could impact our operations and financial
results:





The
recently enacted Dodd-Frank Act may adversely impact the Company’s results of
operations, financial condition, or liquidity.





On July
21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (the “Dodd-Frank Act”) into law. The Dodd-Frank Act
represents a comprehensive overhaul of the financial services industry in the
United States. The Dodd-Frank Act includes, among other things:





·
            the
      creation of a Financial Stability Oversight Council to identify emerging
      systemic risks posed by financial firms, activities and practices, and to
      improve cooperation between federal
agencies;


·
            the
      creation of a Bureau of Consumer Financial Protection authorized to
      promulgate and enforce consumer protection regulations relating to
      financial products, which would affect both banks and non-bank financial
      companies;


·
            the
      establishment of strengthened capital and prudential standards for banks
      and bank holding companies;


·
            enhanced
      regulation of financial markets, including derivatives and securitization
      markets;


·
            the
      elimination of certain trading activities by
  banks;


·
            a
      permanent increase of the previously implemented temporary increase of
      FDIC deposit insurance to $250,000 per account, an extension of unlimited
      deposit insurance on qualifying noninterest-bearing transaction accounts,
      and an increase in the minimum deposit insurance fund reserve requirement
      from 1.15% to 1.35%, with assessments to be based on assets as opposed to
      deposits;


·
            amendments
      to the Truth in Lending Act aimed at improving consumer protections with
      respect to mortgage originations, including originator compensation,
      minimum repayment standards, and prepayment considerations;
      and


·
            new
      disclosure and other requirements relating to executive compensation and
      corporate governance.





Although
the Dodd-Frank Act has been signed into law, a number of provisions remain to be
implemented through the rulemaking process at various regulatory agencies. We
are unable to predict the extent to which the Dodd-Frank Act or the forthcoming
rules and regulations will impact the business of the Company and the Bank.
However, we believe that certain aspects of the new legislation, including,
without limitation, the additional cost of higher deposit insurance coverage and
the costs of compliance with disclosure and reporting requirements and
examinations could have a significant impact on our business, financial
condition, and results of operations. Additionally, we cannot predict whether
there will be additional proposed laws or reforms that would affect the U.S.
financial system or financial institutions, whether or when such changes may be
adopted, how such changes may be interpreted and enforced, or how such changes
may affect us.


20




Item 2.  Unregistered Sales
of Equity Securities and Use of Proceeds: The following table sets forth
information regarding the Company's common stock repurchase plan for the quarter
ended June 30, 2010.





Period
                        
                        Total Number
                          of Shares
                          Purchased
                        
                        
                        Average Price
                          Paid
                          per Share
                        
                        
                        Total Number
                          of Shares
                          Purchased as
                          Part of Publicly
                          Announced
                          Plan or
                          Programs (1)
                        
                        
                        Maximum
                          Number of
                          Shares that
                          May Yet Be
                          Purchased
                          Under the Plans
                          or Programs (1)April
      2010Beginning
      date: April 1 Ending date: April 30
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        487,115May
      2010Beginning
      date: May 1 Ending date: May 31
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        487,115June
      2010Beginning
      date: June 1 Ending date: June 30
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        487,115





(1)
            487,115
      shares of common stock may be purchased pursuant to a repurchase program
      announced on January 19, 2010.  This repurchase program will
      expire on January 18, 2011.





Item
3.  Defaults Upon Senior Securities: Not applicable





Item
4.  [Reserved]





Item
5.  Other Information: Not applicable





Item
6.  Exhibits: The following exhibits are filed herewith:





Number
              
              Title31.1
              
              Rule
      13a-14(a) Certification of Chief Executive Officer31.2
              
              Rule
      13a-14(a) Certification of Chief Financial Officer32
              
              Section
      1350 Certification




21


SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





FIRST
      SOUTH BANCORP, INC./s/ William L. Wall
                    
                    /s/ Kristie W. HawkinsWilliam
      L. Wall
                    
                    Kristie
      W. HawkinsExecutive
      Vice President
                    
                    ControllerChief
      Financial Officer
                    
                    Treasurer(Principal
      Financial Officer)
                    
                    (Principal
      Accounting Officer)Date:
      August 6, 2010
                    
                    Date:
      August 6, 2010




22