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 THE****SECURITIES
                EXCHANGE ACT OF 1934**





For
      the
      quarterly period ended March 31, 2008.





OR


**o**
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE****SECURITIES
                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 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 May 7, 2008: 9,753,096








**CONTENTS**





**PAGE****PART
                I. FINANCIAL INFORMATION**Item
                1.
            Financial
                StatementsConsolidated
                Statements of Financial Condition as of March 31, 2008(unaudited)
                and December 31, 2007
            1Consolidated
                Statements of Operations for the Three Months EndedMarch
                31, 2008 and 2007 (unaudited)
            2Consolidated
                Statement of Stockholders' Equity for the Three Months
                EndedMarch
                31, 2008 (unaudited)
            3Consolidated
                Statements of Cash Flows for the Three Months EndedMarch
                31, 2008 and 2007 (unaudited)
            4Notes
                to Consolidated Financial Statements (unaudited)
            5Item
                2.
            Management's
                Discussion and Analysis of Financial Condition and Results of
                Operations
            9Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            17Item
                4.
            Controls
                and Procedures
            18**PART
                II. OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            18Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            18Item
                3.
            Defaults
                Upon Senior Securities
            19Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            19Item
                5.
            Other
                Information
            19Item
                6.
            Exhibits
            19Signatures
            20Exhibits







**First
      South Bancorp, Inc. and Subsidiary**


**Consolidated
      Statements of Financial Condition**




**March
                31**
            
            **December
                31****2008**
            
            **2007****(unaudited)****Assets**Cash
                and due from banks
            
            $
            24,179,684
            
            $
            22,273,592Interest-bearing
                deposits in financial institutions
            
            
            2,071,880
            
            
            1,755,695Investment
                securities - available for sale
            
            
            46,872,318
            
            
            49,064,278Mortgage-backed
                securities - available for sale
            
            
            36,564,663
            
            
            37,828,064Mortgage-backed
                securities - held for investment
            
            
            1,191,418
            
            
            1,291,762Loans
                and leases receivable, net:Held
                for sale
            
            
            7,597,811
            
            
            7,515,626Held
                for investment
            
            
            764,679,685
            
            
            757,567,279Premises
                and equipment, net
            
            
            9,304,673
            
            
            9,433,399Real
                estate owned
            
            
            1,526,023
            
            
            1,601,704Federal
                    Home Loan Bank of Atlanta stock, at cost which approximates
                    market
            
            
            3,658,600
            
            
            3,210,100Accrued
                interest receivable
            
            
            4,877,058
            
            
            5,103,405Goodwill
            
            
            4,218,576
            
            
            4,218,576Mortgage
                servicing rights
            
            
            1,130,695
            
            
            1,150,616Identifiable
                intangible assets
            
            
            188,640
            
            
            196,500Prepaid
                expenses and other assets
            
            
            5,825,531
            
            
            7,077,115Total
                assets
            
            $
            **913,887,255**
            
            $
            **909,287,711****Liabilities
                and Stockholders' Equity**Deposits:Demand
            
            $
            252,153,617
            
            $
            243,647,606Savings
            
            
            17,865,619
            
            
            17,497,763Large
                denomination certificates of deposit
            
            
            214,650,518
            
            
            204,509,581Other
                time
            
            
            269,659,448
            
            
            295,714,633Total
                deposits
            
            
            754,329,202
            
            
            761,369,583Borrowed
                money
            
            
            52,098,547
            
            
            42,067,421Junior
                subordinated debentures
            
            
            10,310,000
            
            
            10,310,000Other
                liabilities
            
            
            10,076,641
            
            
            9,505,385Total
                liabilities
            
            
            826,814,390
            
            
            823,252,389Common
                    stock, $.01 par value, 25,000,000 shares authorized; 11,254,222
                    issued; 9,763,346 and 9,808,655 shares outstanding,
                    respectively
            
            
            97,633
            
            
            98,087Additional
                paid-in capital
            
            
            35,943,807
            
            
            36,761,824Retained
                earnings, substantially restricted
            
            
            81,626,091
            
            
            79,679,027Treasury
                stock at cost
            
            
            (31,734,252
            )
            
            (30,880,120
            )Accumulated
                other comprehensive income, net
            
            
            1,139,586
            
            
            376,504Total
                stockholders' equity
            
            
            87,072,865
            
            
            86,035,322Total
                liabilities and stockholders' equity
            
            $
            **913,887,255**
            
            $
            **909,287,711**





*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****March
                  31****2008**
              
              **2007**Interest
                  income:Interest
                  and fees on loans
              
              $
              15,178,294
              
              $
              15,986,587Interest
                  and dividends on investments and deposits
              
              
              1,204,840
              
              
              1,335,378Total
                  interest income
              
              
              16,383,134
              
              
              17,321,965Interest
                  expense:Interest
                  on deposits
              
              
              6,186,586
              
              
              6,868,826Interest
                  on borrowings
              
              
              399,663
              
              
              143,342Interest
                  on junior subordinated notes
              
              
              196,661
              
              
              207,844Total
                  interest expense
              
              
              6,782,910
              
              
              7,220,012Net
                  interest income
              
              
              9,600,224
              
              
              10,101,953Provision
                  for credit losses
              
              
              -
              
              
              -Net
                  interest income after provision for credit losses
              
              
              9,600,224
              
              
              10,101,953Non-interest
                  income:Fees
                  and service charges
              
              
              1,887,261
              
              
              1,816,737Loan
                  servicing fees
              
              
              163,207
              
              
              162,100Gain
                  (loss) on sale of real estate, net
              
              
              69,515
              
              
              (143
              )Gain
                  on sale of mortgage loans
              
              
              229,530
              
              
              214,644Other
                  income
              
              
              324,691
              
              
              291,170Total
                  non-interest income
              
              
              2,674,204
              
              
              2,484,508Non-interest
                  expense:Compensation
                  and fringe benefits
              
              
              3,587,805
              
              
              3,297,926Federal
                  insurance premiums
              
              
              22,347
              
              
              24,287Premises
                  and equipment
              
              
              499,874
              
              
              473,094Advertising
              
              
              35,016
              
              
              26,495Payroll
                  and other taxes
              
              
              370,260
              
              
              351,965Data
                  processing
              
              
              643,531
              
              
              621,611Amortization
                  of intangible assets
              
              
              102,058
              
              
              96,969Other
              
              
              699,419
              
              
              628,954Total
                  non-interest expense
              
              
              5,960,310
              
              
              5,521,301Income
                  before income taxes
              
              
              6,314,118
              
              
              7,065,160Income
                  taxes
              
              
              2,413,160
              
              
              2,767,163**Net
                  income**
              
              $
              3,900,958
              
              $
              4,297,997Per
                  share data:Basic
                  earnings per share
              
              $
              0.40
              
              $
              0.43Diluted
                  earnings per share
              
              $
              0.40
              
              $
              0.43Dividends
                  per share
              
              $
              0.20
              
              $
              0.19Weighted
                  average shares-Basic
              
              
              9,802,770
              
              
              9,930,732Weighted
                  average shares-Diluted
              
              
              9,833,335
              
              
              10,069,085





*See
      Notes to Consolidated Financial Statements.*




2





**First
      South Bancorp, Inc. and Subsidiary**


**Consolidated
      Statement of Stockholders' Equity**


**Three
      Months Ended March 31, 2008**


**(unaudited)**




**Accumulated****Retained**
              
              
              
              **Other****Additional**
              
              **Earnings,**
              
              
              
              **Comprehensive****Common**
              
              **Paid-in**
              
              **Substantially**
              
              **Treasury**
              
              **Loss,****Stock**
              
              **Capital**
              
              **Restricted**
              
              **Stock**
              
              **Net**
              
              **Total**Balance,
                  December 31, 2007
              
              $
              98,087
              
              $
              36,761,824
              
              $
              79,679,027
              
              $
              (30,880,120
              )
              $
              376,504
              
              $
              86,035,322Net
                  income
              
              
              
              
              
              
              
              
              3,900,958
              
              
              
              
              
              
              
              
              3,900,958Other
                  comprehensive loss, net of taxes
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              763,082
              
              
              763,082Exercise
                  of stock options
              
              
              807
              
              
              (1,639,008
              )
              
              
              
              
              1,719,306
              
              
              
              
              
              81,105Tax
                  benefit of stock options exercised
              
              
              
              
              
              450,394
              
              
              
              
              
              
              
              
              
              
              
              450,394Shares
                  traded to exercise options
              
              
              (208
              )
              
              355,505
              
              
              
              
              
              (449,979
              )
              
              
              
              
              (94,682
              )Acquisition
                  of treasury shares
              
              
              (1,053
              )
              
              
              
              
              
              
              
              (2,123,459
              )
              
              
              
              
              (2,124,512
              )Stock
                  based compensation
              
              
              
              
              
              15,092
              
              
              
              
              
              
              
              
              
              
              
              15,092Dividends
                  ($0.20 per share)
              
              
              
              
              
              
              
              
              (1,953,894
              )
              
              
              
              
              
              
              
              (1,953,894
              )Balance,
                  March 31, 2008
              
              $
              97,633
              
              $
              35,943,807
              
              $
              81,626,091
              
              $
              (31,734,252
              )
              $
              1,139,586
              
              $
              87,072,865





*See
      Notes to Consolidated Financial Statements.*




3





**First
      South Bancorp, Inc. and
      Subsidiary**


**Consolidated
      Statements of Cash Flows**


**(unaudited)**




**Three
                    Months Ended****March
                    31****2008**
                
                **2007**Operating
                    activities:Net
                    income
                
                $
                3,900,958
                
                $
                4,297,997Adjustments
                    to reconcile net income to net cash provided by operating
                    activities:Depreciation
                
                
                217,649
                
                
                204,846Amortization
                    of intangibles
                
                
                102,750
                
                
                96,969Accretion
                    of discounts on securities, net
                
                
                (150
                )
                
                (5,356
                )Gain
                    on disposal of premises and equipment and real estate
                    owned
                
                
                (69,130
                )
                
                (2,857
                )Gain
                    on sale of loans held for sale
                
                
                (229,530
                )
                
                (214,644
                )Stock
                    based compensation expense
                
                
                15,092
                
                
                24,530Originations
                    of loans held for sale, net
                
                
                (12,029,560
                )
                
                (6,428,507
                )Proceeds
                    from sale of loans held for sale
                
                
                12,176,905
                
                
                17,747,565Other
                    operating activities
                
                
                1,386,983
                
                
                592,396Net
                    cash provided by operating activities
                
                
                5,471,967
                
                
                16,312,939Investing
                    activities:Proceeds
                    from maturities of investment securities available for
                    sale
                
                
                3,000,000
                
                
                1,000,000Purchases
                    of investment securities available for sale
                
                
                -
                
                
                (500,000
                )Proceeds
                    from principal repayments of mortgage-backed securities available
                    for
                    sale
                
                
                1,716,803
                
                
                1,480,994Proceeds
                    from principal repayments of mortgage-backed securities held
                    for
                    investment
                
                
                100,344
                
                
                82,919Originations
                    of loans held for investment, net of principal repayments
                
                
                (7,191,349
                )
                
                10,284,685Proceeds
                    from disposal of premises and equipment and real estate
                    owned
                
                
                223,754
                
                
                16,743Sales
                    (purchases) of FHLB stock
                
                
                (448,500
                )
                
                298,200Purchase
                    of premises and equipment
                
                
                (88,923
                )
                
                (480,308
                )Net
                    cash provided by (used in) investing activities
                
                
                (2,687,871
                )
                
                12,183,233Financing
                    activities:Net
                    increase (decrease) in deposit accounts
                
                
                (7,040,381
                )
                
                2,028,229Net
                    increase (decrease) in FHLB borrowings
                
                
                10,000,000
                
                
                (6,000,000
                )Purchase
                    of treasury shares
                
                
                (2,574,699
                )
                
                (1,952,033
                )Proceeds
                    from exercise of stock options, net of tax benefit
                
                
                887,004
                
                
                3,121,213Cash
                    paid for dividends and fractional shares
                
                
                (1,864,869
                )
                
                (1,680,858
                )Net
                    change in repurchase agreements
                
                
                31,126
                
                
                865,201Net
                    cash used in financing activities
                
                
                (561,819
                )
                
                (3,618,248
                )Increase
                    in cash and cash equivalents
                
                
                2,222,277
                
                
                24,877,924Cash
                    and cash equivalents, beginning of period
                
                
                24,029,287
                
                
                25,803,620Cash
                    and cash equivalents, end of period
                
                $
                26,251,564
                
                $
                50,681,544Supplemental
                    disclosures:Real
                    estate acquired in settlement of loans
                
                $
                78,943
                
                $
                439,654Dividends
                    declared, not paid
                
                $
                1,952,669
                
                $
                1,891,737





*See
      Notes to Consolidated Financial Statements.*




4


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**





**Note
      1. Basis of Presentation.** The
      accompanying unaudited consolidated financial statements have been prepared
      in
      accordance with accounting principles generally accepted in the United States
      of
      America and with the instructions to Form 10-Q of 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 a fair presentation of the financial position and results of operations
      for
      the periods presented have been included, none of which were other than normal
      recurring accruals. The financial statements of First South Bancorp, Inc. (the
      “Company”) are presented on a consolidated basis with those of First South Bank
      (the “Bank”). The results of operations for the quarter ended March 31, 2008 are
      not necessarily indicative of the results of operations that may be expected
      for
      the year ended December 31, 2008.





**Note
      2. Earnings Per Share.** Basic
      and
      diluted earnings per share for the quarter ended March 31, 2008 are based on
      weighted average shares of common stock outstanding, excluding treasury shares.
      Diluted earnings per share include the potentially dilutive effects of the
      Company’s stock option plan. For the quarters ended March 31, 2008 and 2007,
      there were 60,000 and 8,750 stock options, respectively, that were antidilutive
      since the exercise price exceeded the average market price of the Company’s
      common stock for the respective periods. These stock options have been omitted
      from the calculation of diluted earnings per share for the quarters ended March
      31, 2008 and 2007.





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




Allowance
            
            Allowance
            
            Allowancefor Loan and
            
            for Unfunded
            
            for CreditLease Losses
            
            Commitments
            
            LossesBalance
                at December 31, 2007
            
            $
            9,486,479
            
            $
            402,643
            
            $
            9,889,122Provision
                for credit losses
            
            
            -
            
            
            -
            
            
            -Reclassifications
            
            
            9,308
            
            
            (9,308
            )
            
            -Loans
                and leases charged-off
            
            
            (123,766
            )
            
            -
            
            
            (123,766
            )Loans
                and leases recovered
            
            
            21,786
            
            
            -
            
            
            21,786Net
                (charge-offs)/recoveries
            
            $
            (101,980
            )
            $
            -
            
            $
            (101,980
            )Balance
                at March 31, 2008
            
            $
            9,393,807
            
            $
            393,335
            
            $
            9,787,142





March 31,
              2008
            
            December 31,
              2007Allowance
                for Credit Losses Ratios:Allowance
                for loan and lease losses/total loans and leases
            
            
            1.20
            %
            
            1.22
            %Allowance
                for unfunded loan commitments/unfunded commitments
            
            
            0.26
            %
            
            0.27
            %Allowance
                for credit losses/total loans and leases
            
            
            1.25
            %
            
            1.27
            %





**Note
      4. Comprehensive Income.** The
      Company applies the provisions of Statement of Financial Accounting Standards
      No. 130, "Reporting 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 relates to unrealized gains and
      losses on available for sale securities. Unrealized gains and losses on
      available for sale securities is primarily impacted by purchases and sales
      of
      available for sale securities and changes in interest rates between the
      respective reporting periods.
      Information concerning the Company's other comprehensive income for the quarters
      ended March 31, 2008 and 2007 is as follows:


5




Quarter Ended March 31,2008
            
            2007Net
                income
            
            $
            3,900,958
            
            $
            4,297,997Gains
                (losses) unrealized, net of income taxes
            
            
            763,082
            
            
            139,240Other
                comprehensive income (loss)
            
            
            763,082
            
            
            139,240Comprehensive
                income
            
            $
            4,664,040
            
            $
            4,437,237





**Note
      5. Stock-Based Compensation.** Effective
      January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
“Share-Based Payment,” (“SFAS No. 123R”) which was issued by the Financial
      Accounting Standards Board (“FASB”) in December 2004. SFAS No. 123R
      revises SFAS No. 123, “Accounting for Stock Based Compensation,” and
      supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”
(“APB 25”), and its related interpretations. SFAS No. 123R requires
      recognition of the cost of employee services received in exchange for an award
      of equity instruments in the financial statements over the period the employee
      is required to perform the services in exchange for the award (presumptively
      the
      vesting period). SFAS No. 123R also requires measurement of the cost of
      employee services received in exchange for an award based on the grant-date
      fair
      value of the award. SFAS No. 123R also amends SFAS No. 95, “Statement
      of Cash Flows,” to require that excess tax benefits be reported as financing
      cash inflows, rather than as a reduction of taxes paid, which is included within
      operating cash flows.





The
      Company adopted SFAS No. 123R using the modified prospective application as
      permitted under SFAS No. 123R. Under this application, the Company records
      compensation expense for all awards granted after the date of adoption and
      for
      the unvested portion of previously granted awards that remain outstanding at
      the
      date of adoption. Prior to the adoption of SFAS No. 123R, the Company used
      the intrinsic value method as prescribed by APB 25 and thus recognized no
      compensation expense for options granted with exercise prices equal to the
      fair
      market value of the Company’s common stock on the date of grant.





The
      Company has one share-based compensation plan. On April 8, 1998, the
      Shareholders of the Company approved the First South Bancorp, Inc. 1997 Stock
      Option Plan (the "Plan"), for a term of ten years. The purpose of this Plan
      is
      to advance the interests of the Company through providing selected key employees
      and Directors of the Bank and the Company with the opportunity to purchase
      shares. At March 31, 2008, the Plan includes 184,170 granted unexercised shares
      and 958,652 shares available to be granted. The Plan matured on April 8, 2008
      and no additional options may be granted under the Plan after the maturity
      date.





The
      option price is required to be 100% of the stock's fair market value as defined,
      with an exception for any shareholder with more than a 10% ownership interest
      in
      the Company. The exercise price is required to be 110% of the stock's fair
      market value for these options holders. Vesting is determined on the date of
      the
      grant. Options have a 10-year life; however, there are additional limitations
      for shareholders with more than a 10% ownership interest in the Company. The
      Plan also has a change of control provision under which all options immediately
      vest if a change of control, as defined, occurs.





A
      summary
      of option activity under the Plan as of March 31, 2008, and changes during
      the quarters ended March 31, 2008 and 2007 is presented
      below:




6





AggregateOptions
            
            Options
            
            
            
            IntrinsicQuarter
                Ended March 31, 2008:
            
            Available
            
            Outstanding
            
            Price
            
            ValueOutstanding
                at December 31, 2007
            
            
            967,652
            
            
            255,919
            
            $
            13.90Granted
            
            
            (13,000
            )
            
            13,000
            
            $
            21.11Forfeited
            
            
            4,000
            
            
            (4,000
            )
            $
            33.00Exercised
            
            
            -
            
            
            (80,749
            )
            $
            5.41Outstanding
                at March 31, 2008
            
            
            958,652
            
            
            184,170
            
            $
            17.72
            
            $
            880,823Vested
                and Exercisable at March 31, 2008
            
            
            
            
            
            125,845
            
            $
            15.22
            
            $
            915,564





AggregateOptions
            
            Options
            
            
            
            IntrinsicQuarter
                Ended March 31, 2007:
            
            Available
            
            Outstanding
            
            Price
            
            ValueOutstanding
                at December 31, 2006
            
            
            988,277
            
            
            538,374
            
            $
            9.65Granted
            
            
            (4,750
            )
            
            4,750
            
            $
            28.18Forfeited
            
            
            1,500
            
            
            (1,500
            )
            $
            23.66Exercised
            
            
            -
            
            
            (260,053
            )
            $
            7.20Outstanding
                at March 31, 2007
            
            
            987,027
            
            
            281,571
            
            $
            12.14
            
            $
            5,221,767Vested
                and Exercisable at March 31, 2007
            
            
            
            
            
            228,821
            
            $
            9.52
            
            $
            4,844,069





A
      summary
      of nonvested option shares as of March 31, 2008, and changes during the
      quarters ended March 31, 2008 and 2007 is presented below:




Quarter
                Ended March 31, 2008:
            
            Shares
            
            PriceNonvested
                at December 30, 2007
            
            
            53,975
            
            $
            24.38Granted
            
            
            13,000
            
            $
            21.11Forfeited
            
            
            (4,000
            )
            $
            33.00Vested
            
            
            (4,650
            )
            $
            20.65Nonvested
                at March 31, 2008
            
            
            58,325
            
            $
            23.10




Quarter
                Ended March 31, 2007:
            
            Shares
            
            PriceNonvested
                at December 31, 2006
            
            
            53,250
            
            $
            22.89Granted
            
            
            4,750
            
            $
            28.18Forfeited
            
            
            (1,500
            )
            $
            23.66Vested
            
            
            (3,750
            )
            $
            20.30Nonvested
                at March 31, 2007
            
            
            52,750
            
            $
            23.53





The
      weighted-average fair value per share of options granted during the quarters
      ended March 31, 2008 and 2007 is estimated on the date of grant using the Black
      Scholes Option Pricing Model, with the following weighted average assumptions:




Year Ended December 31,2008
            
            2007Weighted
                average fair value per share
            
            $
            2.43
            
            $
            5.34Dividend
                growth rate
            
            
            11.8
            %
            
            17.0
            %Expected
                volatility
            
            
            22.6
            %
            
            22.4
            %Average
                risk-free interest rates
            
            
            3.2
            %
            
            4.6
            %Expected
                lives
            
            
            6
                years
            
            
            6
                years





As
      of
      March 31, 2008, there was $158,039 of total unrecognized compensation cost
      related to non-vested share-based compensation arrangements granted under the
      Company’s stock option plans. That cost is expected to be recognized over the
      next 4.25 years. The intrinsic value of options exercised during the quarters
      ended March 31, 2008 and 2007 was $1,314,288 and $6,167,548,
      respectively.


7


The
      amount of cash received and value of shares tendered for payment of option
      exercises for the quarter ended March 31, 2008 was $436,610, compared to
      $1,871,648 for the quarter ended March 31, 2007. The income tax benefits
      realized for the income tax credits arising from option exercise of the
      share-based payment arrangements was $450,394 for the quarter ended
      March 31, 2008, compared to $2,145,076 for the quarter ended March 31,
      2007.





The
      following table summarizes additional information about the Company’s
      outstanding options and exercisable options as of March 31, 2008, 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$5.41 –
                5.50
            
            
            3,375
            
            
            2.2
            
            $
            5.50
            
            
            3,375
            
            $
            5.50$6.87 –
                10.37
            
            
            36,908
            
            
            3.2
            
            $
            8.39
            
            
            36,908
            
            $
            8.39$14.97 –
                16.61
            
            
            44,437
            
            
            4.9
            
            $
            16.19
            
            
            44,437
            
            $
            16.19$16.77 –
                25.22
            
            
            79,700
            
            
            8.1
            
            $
            20.64
            
            
            34,825
            
            $
            19.56$26.17 –
                33.30
            
            
            19,750
            
            
            7.6
            
            $
            28.88
            
            
            6,300
            
            $
            29.76184,170
            
            
            4.6
            
            $
            17.72
            
            
            125,845
            
            $
            15.22





The
      fair
      value compensation cost recognition provisions of SFAS 123R are different from
      the recognition provisions under SFAS 123 and the intrinsic value method for
      compensation cost allowed under APB 25. The following table reflects the impact
      of adopting SFAS 123R by reducing income before income taxes, net income, basic
      earnings per share and diluted earnings per share for the quarters ended March
      31, 2008 and 2007:





Quarter
                Ended March 31,
            
            2008
            
            2007Reduced
                net income before income taxes
            
            $
            15,092
            
            $
            24,530Reduced
                net income
            
            $
            14,087
            
            $
            21,772Reduced
                basic earnings per share
            
            $
            .00
            
            $
            .00Reduced
                diluted earnings per share
            
            $
            .00
            
            $
            .00





**Note
      6. Assets and Liabilities – Fair Value Information.** Assets
      measured at fair value on a recurring basis at March 31, 2008 were as
      follows:





Quoted Prices
            
            SignificantIn Active
            
            Other
            
            SignificantMarkets for
            
            Observable
            
            UnobservableIdentical Assets
            
            Inputs
            
            InputsDescription
            
            3/31/2008
            
            (Level
                1)
            
            (Level
                2)
            
            (Level
                3)Available
                for sale securities:Investment
            
            $
            46,872,318
            
            $
            46,872,318
            
            $
            -
            
            $
            -Mortgage-backed
            
            
            36,564,663
            
            
            36,564,663Other
                real estate owned
            
            
            1,526,023
            
            
            -
            
            
            1,526,023
            
            
            -Total
            
            $
            84,963,004
            
            $
            83,436,981
            
            $
            1,526,023
            
            $
            -





No
      valuation techniques, other than quoted market prices in active markets are
      used
      to determine fair value of available for sale securities. See “Note 4.
      Comprehensive Income” of “Notes to Consolidated Financial Statements
      (Unaudited)” for additional information regarding unrealized gains on available
      for sale securities. The 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.


8


Assets
      acquired through loan foreclosure are recorded as other real estate owned at
      fair value based on the appraised market value of the subject property based
      on
      sales of similar assets. The fair value may be subsequently reduced if the
      estimated fair value declines below the original appraised value. There were
      no
      fair value adjustments to other real estate owned during the quarter ended
      March
      31, 2008.





Gains
      realized and included in earnings for the quarter ended March 31, 2008 are
      reported in other revenues as follows:




OtherRevenuesGain
                on sale of other real estate owned
            
            $
            69,515




No
      liabilities were measured at fair value on a recurring basis during the quarter
      ended March 31, 2008.





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





**General.** First
      South Bancorp, Inc. was formed for the purpose of issuing common stock and
      owning 100% of the stock of First South 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 March 31, 2008 and December 31,
      2007**





Total
      assets increased to $913.9 million at March 31, 2008 from $909.3 million at
      December 31, 2007. Earning assets were $849.8 million at March 31, 2008 compared
      to $857.5 million at December 31, 2007, reflecting the net change in the
      composition of earning assets and an increase in nonperforming loans, as
      discussed below. Earning assets were 93.0% of total assets at March 31, 2008
      compared to 93.6% at December 31, 2007.





Interest-bearing
      overnight deposits in financial institutions were $2.1 million at March 31,
      2008, compared to $1.8 million at December 31, 2007. Short-term overnight
      investments are available to fund loan originations, liquidity management
      activities and daily operations of the Bank.





Investment
      securities available for sale were $46.9 million at March 31, 2008 compared
      to
      $49.1 million at December 31, 2007. Maturities of investment securities
      available for sale were $3.0 million during the quarter ended March 31, 2008,
      and the proceeds were also used to fund liquidity management activities and
      daily operations of the Bank. The Bank sold no securities available for sale
      during the quarter ended March 31, 2008.





Mortgage-backed
      securities available for sale were $36.6 million at March 31, 2008 compared
      to
      $37.8 million at December 31, 2007, reflecting scheduled principal repayments.
      The Bank may sell certain securities during favorable interest rate windows
      and
      securitize certain mortgage loans held for sale into mortgage-backed securities
      to maintain sufficient liquidity levels. The Bank sold no mortgage-backed
      securities available for sale during the quarter ended March 31, 2008, and
      no
      mortgage loans held for sale were securitized into mortgage-backed securities
      available for sale during the quarter ended March 31, 2008. Mortgage-backed
      securities held for investment were $1.2 million at March 31, 2008, compared
      to
      $1.3 million at December 31, 2007, reflecting scheduled principal repayments.


9


As
      a
      result of declining interest rates during the quarter ended March 31, 2008,
      investment and mortgage-backed securities available for sale increased in value
      by a net unrealized gain of $763,000. See “Note 4. Comprehensive Income” of
“Notes to Consolidated Financial Statements (Unaudited)” for additional
      information.





Loans
      held for sale were $7.6 million at March 31, 2008 compared to $7.5 million
      at
      December 31, 2007. Proceeds from loan sales were $12.2 million for the quarter
      ended March 31, 2008, compared to $17.7 million for the quarter ended March
      31,
      2007. The proceeds from loans sold during the quarter ended March 31, 2008
      were
      to fund the net growth in loans and leases held for investment and decline
      in
      time deposits, as discussed below.





Loans
      and
      leases receivable held for investment increased to $764.7 million at March
      31,
      2008 from $757.6 million at December 31, 2007. A portion of the proceeds from
      the sale of loans held for sale, as discussed above, were used to fund the
      net
      growth of loans and leases held for investment. The net growth of loan and
      leases receivable held for investment for the quarter ended March 31, 2008
      was
      at an annualized rate of 3.8%, reflecting continued efforts to grow the
      portfolio.





Nonperforming
      loans increased to $12.8 million at March 31, 2008, from $7.6 million at
      December 31, 2007. Significant nonperforming loans consists primarily of six
      commercial borrowers (residential and commercial real estate developers), with
      total exposure of $10.2 million at March 31, 2008. The Bank believes these
      nonperforming loans will ultimately be resolved in the Bank’s favor, although
      there are no guarantees or assurances.





Deposits
      declined to $754.3 million at March 31, 2008 from $761.4 million at December
      31,
      2007. Checking accounts increased to $252.1 million at March 31, 2008 from
      $243.6 million at December 31, 2007, reflecting continued efforts of attracting
      lower costing core deposits. Time deposits declined to $484.3 million at March
      31, 2008 from $500.2 million at December 31, 2008. During the quarter ended
      March 31, 2008, and amid intense competitive pressure on interest rates, the
      Bank chose to not renew certain maturing time deposits at higher rates, in
      efforts to control its time deposit cost. The Bank also began repricing certain
      new and maturing time deposits at lower rates, and combined with lower costing
      checking accounts, is attempting to effectively managing its deposit cost,
      amid
      the intense competitive market pressure.





Borrowed
      money increased to $52.1 million at March 31, 2008 from $42.1 million at
      December 31, 2007 . FHLB
      advances increased to $45.0 million at March 31, 2008 from $35.0 million at
      December 31, 2007. During the March 2008 quarter, the Bank repaid $35.0 million
      of daily rate credit advances from the Federal Home Loan Bank of Atlanta, and
      borrowed $45.0 million of fixed rated at various terms ranging from 18 to 36
      months at a weighted average cost of 3.01%, in order to reduce its cost of
      funds.





Junior
      subordinated debentures were $10.3 million at both March 31, 2008 and December
      31, 2007. Repurchase agreements were $7.1 million at both March 31, 2008 and
      December 31, 2007, and represent funds held in cash management accounts for
      commercial banking customers.


10


Stockholders'
      equity increased to $87.1 million at March 31, 2008 from $86.0 million at
      December 31, 2007. See "Consolidated Statement of Stockholders' Equity" for
      additional information. The Company's equity to assets ratio was 9.5% at March
      31, 2008 and December 31, 2007, reflecting the combined effect of March 2008
      quarterly earnings, net of increased dividend payments, stock option exercises
      and common stock repurchases.





Accumulated
      other comprehensive income increased to $1.1 million at March 31, 2008 from
      $377,000 at December 31, 2007, reflecting an increase in the net market value
      of
      the investment and mortgage-backed securities, as previously discussed. See
      “Note 4. Comprehensive Income” of “Notes to Consolidated Financial Statements
      (Unaudited)” for additional information.





As
      a
      North Carolina chartered commercial bank, the Bank must meet various capital
      standards required by federal and state banking regulatory agencies. The Bank's
      total capital was $86.0 million at March 31, 2008, substantially in excess
      of
      all regulatory capital requirements. See "Liquidity and Capital Resources"
      below
      for additional information.





On
      March
      27, 2008, the Company declared a cash dividend of $0.20 per share, payable
      April
      24, 2008 to stockholders of record as of April 10, 2008. This dividend payment
      represents a 5.3% payment rate increase over the previous quarterly dividend
      payment, is a payout ratio of 50.0% of basic earnings per share for the quarter
      ended March 31, 2008, and is the Company's 44 th consecutive quarterly cash dividend.





The
      Company acquired 105,241 shares of its common stock during the quarter ended
      March 31, 2008 through private and open market purchases pursuant to a
      repurchase plan adopted by the board of directors. The repurchase of common
      stock allows the Company to minimize the dilutive effect of stock option
      exercises and provides an effective means of leveraging its capital. Repurchased
      shares are held as treasury stock, at cost. At March 31, 2008, 1,490,876
      treasury shares were held totaling $31.7 million, compared to 1,445,567 shares
      held at December 31, 2007 totaling $30.9 million.





During
      the quarter ended March 31, 2008, there were 80,749 shares issued from treasury
      shares for stock option exercises. In addition, during the quarter ended March
      31, 2008, 20,817 shares were tendered by stock option plan participants to
      pay
      the exercise price of stock options being exercised and income taxes incident
      to
      such option exercises.




**Comparison
      of Operating Results – Three Months Ended March 31, 2008 and
      2007**





**General.** Net
      income for the quarter ended March 31, 2008 was $3.9 million compared to $4.3
      million for the quarter ended March 31, 2007. Diluted earnings per share were
      $0.40 the quarter ended March 31, 2008, compared to $0.43 per share for the
      quarter ended March 31, 2007. Net income during the quarter ended March 31,
      2008
      was impacted by a higher than anticipated interest rate compression which has
      been significantly influenced by a series of Federal Reserve rate cuts over
      the
      past six months, and an increase in the amount of non-performing loans.





Many
      banks have been challenged by problems relating to sub-prime lending. First
      South Bank does not have any sub-prime loan exposure. The Bank faces challenges
      due to the weakening real estate market, and it is monitoring and evaluating
      all
      significant loans in its portfolio. The Bank will continue to manage its credit
      risk and exposure while waiting for the stabilization of the real estate market.
      Management believes competition and pricing pressures will continue on both
      deposits and loans during the remainder of 2008. The amount and timing of any
      future Federal Reserve rate cuts remains uncertain, and may further impact
      the
      Bank, particularly if those cuts are significant.


11


The
      Bank
      continues to focus on its key performance ratios and the impact of the economic
      slow down. Efforts continue to be placed on operating efficiency by managing
      net
      interest income, growing non-interest income, and controlling operating
      expenses, resulting in an efficiency ratio 48.5% for the quarter ended March
      31,
      2008, compared to 43.8% for the quarter ended March 31, 2007. The return on
      average assets (ROA) was 1.7% and 1.9%, respectively, for the quarters ended
      March 31, 2008 and March 31. 2007. The return on average equity (ROE) was 18.0%
      21.3%, respectively, for the quarters ended March 31, 2008 and March 31, 2007.





**Interest
      Income.** Interest
      income was $16.4 million for the quarter ended March 31, 2008, compared to
      $17.3
      million for the quarter ended March 31, 2007. This decline is due primarily
      to
      the recent decline in interest rates due to the Federal Reserve rate cuts,
      and
      partially offset by an increase in the volume of average interest-earning assets
      between the respective periods. Average interest-earning assets were $858.7
      million for the quarter ended March 31, 2008, compared to $852.3 million for
      the
      quarter ended March 31, 2007, reflecting growth in loans and leases receivable
      held for investment between the respective periods. The yield on average
      interest-earning assets was 7.6% for the quarter ended March 31, 2008, compared
      to 8.1% for the quarter ended March 31, 2007, also primarily impacted by the
      Federal Reserve rate cuts and the increase in the volume of average
      interest-earning assets and the increase in interest rates between the
      respective periods. As a result of the increase in the amount of nonperforming
      loans, the Bank’s accrued unrecognized interest increased by $248,000 during the
      quarter ended March 31, 2008, compared to a $45,000 decrease during the quarter
      ended March 31, 2007. Total accrued unrecognized interest was $754,000 at March
      31, 2008, compared to $108,000 at March 31, 2007.




**Interest
      Expense.** Interest
      expense on deposits and borrowings was $6.8 million for the quarter ended March
      31, 2008, compared to $7.2 million for the quarter ended March 31, 2007,
      reflecting changes in both the mix and volume of deposits and borrowings, and
      the decline in interest rates between the respective periods. Average deposits
      and borrowings were $822.1 million for the quarter ended March 31, 2008,
      compared to $816.3 million for the quarter ended March 31, 2007. The
      effective cost of average deposits and borrowings was 3.3% for the quarter
      ended
      March 31, 2008, compared to 3.5% for the quarter ended March 31, 2007. See
“Item
      3. Quantitative and Qualitative Disclosures about Market Risk” below for
      additional information.




**Net
      Interest Income.** Net
      interest income was $9.6 million for the quarter ended March 31, 2008, compared
      to $10.1 million for the quarter ended March 31, 2007. The interest rate spread
      (the difference between the effective yield on average earning assets and the
      effective cost of average deposits and borrowings) was 4.3% for the quarter
      ended March 31, 2008, compared to 4.6% for the quarter ended March 31, 2007.
      The
      net yield on interest-earning assets (net interest income divided by average
      interest-earning assets) was 4.5% for the quarter ended March 31, 2008, compared
      to 4.7% for the quarter ended March 31, 2007. The decline in both the interest
      rate spread and net yield on interest-earning assets reflects the impact of
      the
      declining interest rate environment and increase in nonperforming loans during
      the quarter ended March 31, 2008, as previously discussed.





**Provision
      for Credit Losses.** The
      Bank's methodology for determining its provision for credit losses includes
      amounts specifically allocated to credits that are individually determined
      to be
      impaired, as well as general provisions allocated to groups of loans that have
      not been individually assessed for impairment. The Bank recorded no provisions
      for credit losses in the quarters ended March 31, 2008 or March 31, 2007.


12


**Allowance
      for Credit Losses.** The
      Bank
      maintains general and specific allowances for loan and lease losses and unfunded
      loan commitments (collectively the “allowance for credit losses”) at levels the
      Bank believes is 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. This assessment includes
      an
      analysis of qualitative and quantitative trends in the levels of classified
      loans. In developing this analysis, the Bank relies on 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 and estimation tools for measuring its credit risk,
      which are used in developing the allowance for credit losses. The factors
      supporting these allowances 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. 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. However, there can be no assurance in
      the
      future that regulators, increased risks in its loans and leases portfolio,
      changes in economic conditions and other factors will not require additional
      adjustments to the allowance for credit losses.





The
      allowances for loan and lease losses were $9.4 million at March 31, 2008,
      compared to $9.5 million at December 31, 2007. The allowance for unfunded loan
      commitments was $393,000 at March 31, 2008 and $403,000 December 31, 2007.
      The
      ratio of the allowances for loan and lease losses to loans and leases, net
      of
      loans-in-process and deferred loan fees,  was
      1.2%
      at both March 31, 2008 and December 31, 2007. The ratio of the allowance for
      unfunded loan commitments to unfunded loan commitments was .3% at both March
      31,
      2008 and December 31, 2007. See “Note 3. Allowance for Credit Losses” of “Notes
      to Consolidated Financial Statements (Unaudited)” for additional information.





**Noninterest
      Income.** Noninterest
      income increased to $2.7 million for the quarter ended March 31, 2008, from
      $2.5
      million for the quarter ended March 31, 2007. 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 sales
      and
      other miscellaneous income. Fees, service charges and insufficient funds fees
      collected were $1.9 million for the quarter ended March 31, 2008, compared
      to
      $1.8 million for the quarter ended March 31, 2007. Fees, service charges earned
      and insufficient funds fees collected during the respective periods is
      attributable to the volume of loan, deposit account, and insufficient funds
      transactions processed during each period, and the collection of related fees
      and service charges.





The
      Bank
      recorded $230,000 of gains from sales of loans during the quarter ended March
      31, 2008, compared to $215,000 during the quarter ended March 31, 2007. The
      Bank
      sells certain fixed-rate residential mortgage loans to better manage market
      risk
      exposure due to fluctuating interest rates. The Bank also recorded a $70,000
      gain from the sale of an other real estate owned property during the quarter
      ended March 31, 2008.





**Noninterest
      Expense.** Noninterest
      expenses were $6.0 million for the quarter ended March 31, 2008, compared to
      $5.5 million for the quarter ended March 31, 2007. The largest component of
      these expenses, compensation and fringe benefits, increased to $3.6 million
      for
      the quarters ended March 31, 2008, from $3.3 million for the quarter ended
      March
      31, 2007. Fulltime equivalent employees were 279 at March 31, 2008 compared
      to
      272 at March 31, 2007. This increase is due to additional personnel resulting
      from opening new full service offices in Grantsboro and Greenville North
      Carolina, opening a new loan-production office in Durham, North Carolina;
      converting a loan production office in Dunn, North Carolina to a full service
      branch office; and the administrative staff required to support the increase
      in
      customer transaction activity between the respective periods.


13


Premises
      and equipment and data processing expenses have grown proportionately with
      the
      growth in customer accounts and transaction activity, attributable to both
      internal growth and the new offices. Other noninterest expenses including
      premises and equipment, repairs, printing, advertising, and office supplies
      have
      also grown proportionately with the growth in branch office locations.





**Income
      Taxes.** Income
      tax expense was $2.4 million for the quarter ended March 31, 2008, compared
      to
      $2.8 million for the quarter ended March 31, 2007. The changes in the amounts
      of
      income tax provisions reflect the changes in pretax income and the estimated
      income tax rates in effect during the respective periods. The effective income
      tax rates were 38.2% for the quarter ended March 31, 2008, compared to 39.2%
      for
      the quarter ended March 31, 2007.





**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 sufficient funds are
      available to meet deposit withdrawals, fund future loan commitments, maintain
      adequate reserve requirements, pay operating expenses, provide 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 March 31, 2008, the Bank had cash, deposits in
      banks, investment securities, mortgage-backed securities, FHLB stock and loans
      held for sale totaling $122.1 million, compared to $122.9 million at December
      31, 2007, representing 16.0% and 15.3% of deposits and short-term borrowings
      for
      the respective periods.





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 I
      capital (consisting of retained earnings and common stockholder’s 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 I capital. The North Carolina Office of the
      Commissioner of Banks requires the Bank at all times 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 March 31, 2008 and December 31,
      2007.





**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.


14


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.





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





**Off-Balance
      Sheet Arrangements.** The
      Company offers financial instruments with off-balance sheet risk to meet the
      financing needs of customers and to reduce its exposure to fluctuating 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 the disclosure
      of
      forward looking information is desirable for investors and encourages such
      disclosure by providing a safe harbor for forward looking statements by
      corporate management. This Form 10-Q, including Management’s Discussion and
      Analysis of Financial Condition and Results of Operations, contains forward
      looking statements that involve risk and uncertainty. In order to comply with
      the terms of the safe harbor, the Company notes that a variety of risks and
      uncertainties could cause its actual results and experience to differ materially
      from the anticipated results or other expectations expressed in the Company's
      forward looking statements. There are risks and uncertainties that may affect
      the operations, performance, development, growth projections and results of
      the
      Company's business. They include, but are not limited to, economic growth,
      interest rate movements, timely development of technology enhancements for
      products, services and operating systems, the impact of competitive products,
      services and pricing, customer requirements, regulatory changes and similar
      matters. Readers of this report are cautioned not to place undue reliance on
      forward looking statements that are subject to influence by these risk factors
      and unanticipated events, as actual results may differ materially from
      management's expectations.


15


**Recent
      Accounting Pronouncements.**




In
      September 2006, the Financial Accounting Standards Board (the “FASB”) issued
      Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”),
“Fair Value Measurements”. This Statement defines fair value, establishes a
      framework for measuring fair value in generally accepted accounting principles
      (GAAP), and expands disclosures about fair value instruments. This Statement
      applies under other accounting pronouncements that require or permit fair value
      measurements, the FASB having previously concluded in those accounting
      pronouncements that fair value is the relevant measure attribute. Accordingly,
      this statement does not require any new fair value measurements. However, for
      some entities, it will change current practice. It is effective for fiscal
      years
      beginning after November 15, 2007, and interim periods within those fiscal
      years. The Company adopted SFAS No. 157 on January 1, 2008, with no material
      impact on its consolidated financial statements.




In
      February 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      159 (“SFAS No. 159”), “The Fair Value Option for Financial Assets and
      Financial Liabilities – Including an Amendment of FASB Statement No. 115”.
      SFAS No. 159 permits entities to choose measuring many financial instruments
      and
      certain other items at fair value. The objective is to improve financial
      reporting by providing entities with the opportunity to mitigate volatility
      in
      reported earnings caused by measuring related assets and liabilities differently
      without applying complex hedge accounting provisions. This Statement is expected
      to expand the use of fair value measurement, which is consistent with the FASB’s
      long-term measurement objectives for accounting for financial instruments.
      It is
      effective for fiscal years beginning after November 15, 2007. The Company
      adopted SFAS No. 159 on January 1, 2008; however, the Company has not elected
      to
      measure eligible items at fair value, and continues to evaluate the future
      impact SFAS No. 159 may have on its consolidated financial statements.





In
      December 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      160 (“SFAS No. 160”), “Noncontrolling Interests in Consolidated
      Financial Statements – an amendment of ARB No. 51”. The objective of this
      Statement is to improve the relevance, comparability, and transparency of the
      financial information that a reporting entity provides in its consolidated
      financial statements. This Statement requires consolidated net income to be
      reported at amounts that include the amounts attributable to both the parent
      and
      the noncontrolling interest. This Statement establishes a single method of
      accounting for changes in a parent’s ownership interest in a subsidiary that do
      not result in deconsolidation and requires that a parent recognize a gain or
      loss in net income when a subsidiary is deconsolidated. It is effective for
      fiscal years beginning after December 15, 2008. The Company is currently
      evaluating the impact SFAS No. 160 may have on its consolidated financial
      statements.





In
      March
      2008, the FASB issued Statement of Financial Accounting Standards No. 161
      (“SFAS No. 161”), “Disclosures about Derivative Instruments and
      Hedging Activities – an amendment of FASB Statement No. 133”. The objective
      of this Statement is to require enhanced disclosures about an entity’s
      derivative and hedging activities and thereby improve the transparency of
      financial reporting. SFAS No. 161 requires that objectives for using derivative
      instruments be disclosed in terms of underlying risk and accounting designation,
      and disclosing the fair values of derivative instruments and their gains and
      losses in a tabular format. It also requires cross-referencing within the
      footnotes to help users of financial statements locate important information
      about derivative instruments. It is effective for fiscal years beginning after
      November 15, 2008. The Company is currently evaluating the impact SFAS No.
      161 may have on its consolidated financial statements.


16


In
      November 2007, the SEC issued Staff Accounting Bulletin No. 109, “Miscellaneous
      Accounting – Written Loan Commitments Recorded at Fair Value through
      Earnings” (“SAB 109”). SAB 109 addresses written loan commitments that are
      accounted for at fair value through earnings under generally accepted accounting
      principles. This Bulletin supersedes SAB 105, “Accounting for Derivative
      Instruments and Hedging Activities” and concludes that expected net future cash
      flows related to the associated servicing of the loan should be included in
      the
      measurement of all written loan commitments that are accounted for at fair
      value
      through earnings. SAB 105 indicated that the SEC staff believed that internally
      developed intangible assets should not be recorded as part of the fair value
      of
      a derivative loan commitment. SAB 109 retains that staff view and broadens
      its
      application to all written loan commitments that are accounted for as fair
      value
      through earnings. The SEC expects registrants to apply the views in Question
      1
      of SAB 109 on a prospective basis to derivative loan commitments issued or
      modified in fiscal quarters beginning after December 15, 2007. The Company
      is
      currently evaluating the impact SAB 109 may have on its consolidated financial
      statements.





In
      December 2007, the SEC issued Staff Accounting Bulletin No. 110, “Share-Based
      Payment – Certain Assumptions Used in Valuation Methods – Expected
      Term” (“SAB 110”). SAB 110 provides guidance on developing an estimated term of
“plain vanilla” share options in accordance with SFAS No. 123(r), Share-Based
      Payment. Due to the fact that detailed external information about employees
      exercise behavior may not, as originally thought, be readily available by
      December 31, 2007, the SEC staff will continue to accept, under certain
      circumstances, the use of the simplified method beyond December 31, 2007. The
      Company is currently evaluating the impact SAB 110 may have on its consolidated
      financial statements.





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





**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, 2007. The Company believes that
      an
      adverse change in market risk exposure has occurred since December 31, 2007.


17


As
      has
      most of the banking industry, the Bank has experienced intense price competition
      for both loans and deposits. This has been a contributing factor to net interest
      margin compression in the March 31, 2008 quarter, which has been significantly
      influenced by the Federal Reserve’s 300 basis point rate cuts over the past six
      months. The Bank is an asset-sensitive bank and consequently, the Federal
      Reserve’s aggressive series of rate cuts has caused an immediate downward
      pricing of its loan portfolio, while outpacing the ability to reduce its funding
      cost as rapidly. Over the remainder of 2008, the Bank anticipates some
      improvement in its net interest margin as maturing time deposits begin 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.





**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
      2. Unregistered Sales of Equity Securities and Use of Proceeds:** The
      following table sets forth information regarding the Company's repurchases
      of
      its Common Stock during the quarter ended March 31, 2008.




18




**Number****of Shares****Purchased**
            
            **Maximum****as Part of**
            
            **Number of Shares****Number of**
            
            **Average**
            
            **Publicly**
            
            **Yet to Be****Shares**
            
            **Price Paid**
            
            **Announced**
            
            **Purchased Under****Period**
            
            **Purchased**
            
            **per Share**
            
            **Plan**
            
            **the Plan**January
                2008 (1)Beginning
                date: January 1
            
            
            21,498
            
            $
            22.38
            
            
            21,498
            
            
            228,674Ending
                date: January 31February
                2008 (2)Beginning
                date: February 1
            
            
            59,091
            
            $
            19.76
            
            
            59,091
            
            
            431,664Ending
                date: February 29March
                2008 (2)Beginning
                date: March 1
            
            
            24,652
            
            $
            19.30
            
            
            24,652
            
            
            407,012Ending
                date: March 31





(1)
            Shares
                were purchased pursuant to a stock repurchase program announced on
                January
                9, 2007. This repurchase program expired on January 8, 2008.


(2)
            Shares
                were purchased pursuant to a stock repurchase program announced on
                January
                15, 2008. This repurchase program will expire on January 14, 2009.





**Item
      3. Defaults Upon Senior Securities:** Not
      applicable





**Item
      4. Submission of Matters to a Vote of Security Holders:** Not
      applicable





**Item
      5. Other Information:** Not
      applicable





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





Number
            
            Title10.12
            
            Change-in-Control
                Protective Agreement between First South Bank, First South Bancorp,
                Inc.
                and William L. Wall, as amended, dated April 24, 200831.1
            
            Rule
                13a-14(a) Certification of Chief Executive Officer31.2
            
            Rule
                13a-14(a) Certification of Chief Financial Officer32
            
            Section
                1350 Certification




19




**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:
                May 8, 2008
            Date:May
                8, 2008




20