First South Bancorp, Inc. Reports Increase in March 31, 2013 Quarterly Operating Results

Washington, North Carolina - First South Bancorp, Inc. (NASDAQ: FSBK) (the “Company”), the parent holding company of First South Bank (the “Bank”), reports its unaudited operating results for the quarter ended March 31, 2013.

For the 2013 first quarter, net income increased 239.1% to $1.6 million, or $0.16 per diluted common share, compared to net income of $462,000, or $0.05 per diluted common share, earned for the comparative 2012 first quarter.

The improvement in earnings is primarily attributed to a $1.4 million reduction in the provision for credit losses, coupled with a $1.5 million decrease in non-interest expenses as costs associated with our other real estate owned portfolio (OREO) fell significantly. These improvements were partially offset by net decreases in non-interest income and net interest income due to our lower level of earning assets.

Bruce Elder, President and CEO, commented, “As was previously disclosed, the Bank executed a bulk sale of problem loans and took a significant valuation adjustment on OREO reflected in our 2012 fourth quarter results. The 2013 first quarter operating results begin to reflect the positive impact of those actions. Although the lower average volume of earning assets resulted in a decline in net interest income when compared with the 2012 first quarter, improvement in provisions for loan losses, recurring non-interest income and non-interest expenses specifically related to the maintenance and valuation charges of OREO have driven earnings higher. As we continue to shift our focus from asset remediation and disposition to activities which will grow earning assets, we anticipate further earnings enhancement.”

Net Interest Income

Net interest income declined to $7.0 million for the 2013 first quarter, from $7.5 million earned for the comparative 2012 first quarter. The net interest margin experienced a modest 5 basis points decline to 4.37% for the 2013 first quarter, from 4.42% for the first quarter of 2012. The net interest margin decline for the 2013 first quarter is due to reductions in the level and yield on earning assets, which was partially offset by a reduction in the Company’s cost of funds due to the maturity of longer-term, higher priced CD’s. While a portion of these funds left the Company, the residual renewed into lower priced CD’s or migrated to non-maturity deposit products within the Bank. We anticipate our margin to experience further reductions as our mix of earning assets continues to change and as we take steps to protect our balance sheet from exposure to rising interest rates.

Asset Quality and Provisions for Loan Losses

Total nonperforming assets, including all loans held for investment and for sale in non-accrual status and OREO, declined to $16.7 million or 2.41% of total assets at March 31, 2013, from $34.2 million or 4.84% of total assets at December 31, 2012. All loans held for investment and for sale in non-accrual status totaled $5.3 million at March 31, 2013, versus $21.3 million at December 31, 2012, reflecting the net impact of the bulk sale transaction and management’s efforts focused on improving asset quality. Our level of OREO properties dropped to $11.3 million at March 31, 2013, from $12.9 million at December 31, 2012. During the 2013 first quarter, the Bank had $341,000 of OREO additions and $1.9 million of OREO disposals.

The allowance for loan and lease losses (ALLL) increased to $8.6 million at March 31, 2013, and represented 1.96% of loans held for investment, compared to $7.9 million at December 31, 2012, or 1.78% of loans held for investment. The Bank recorded $400,000 of provision for credit losses in the 2013 first quarter, compared to $1.8 million in the 2012 first quarter. The ALLL benefited from $308,000 of net recoveries during the first quarter of 2013, compared to $2.6 million of net charge offs experienced in the first quarter of 2012. Management believes the ALLL remains adequate.

Non-Interest Income

Total non-interest income was $2.6 million for the 2013 first quarter, compared to $3.2 million for the first quarter of 2012. The higher level of non-interest income in the first quarter of 2012 was primarily due to $1.0 million of gains recorded on the sale of available for sale securities. Non-interest income in the first quarter of 2013 benefitted from increased gains on the sale of mortgage loans as well as services charges and fees on loan and deposit accounts.

Net gains recorded from the sales of mortgage loan held for sale increased to $550,000 for the 2013 first quarter, from $305,000 for the comparative 2012 first quarter. Fees and service charges on loans and deposits, as well as loan servicing fees totaled $1.8 million for first quarter of 2013, a $156,000 increase over the amount generated during the same three month period of 2012.

Non-Interest Expense

Total non-interest expense for the first quarter of 2013 declined to $6.8 million from $8.2 million for the comparative quarter of 2012. The decline was primarily attributable to a significant reduction in expenses related to our OREO portfolio and lower compensation and employee benefits expenses.

Expenses attributable to valuation adjustments, ongoing maintenance and property taxes for OREO properties for the first quarter of 2013 declined by $1.1 million from the $1.3 million incurred during the comparative 2012 first quarter. There were no valuation adjustments recorded during the first quarter of 2013, compared to $903,000 of valuation adjustments recorded during the 2012 first quarter. In addition the costs of maintenance and other related expenses associated with carrying OREO properties fell 54.1% to $172,000 for the first quarter of 2013, from $375,000 in the first quarter of 2012.

Compensation and benefit expenses, the largest component of non-interest expenses, fell to $3.6 million for the 2013 first quarter, from $4.2 million for the comparative 2012 first quarter. The 2012 first quarter included a $470,000 accrual of retirement benefits for the previous CEO. The Bank will continue to manage staffing levels to ensure we meet the ongoing needs of our customers and support the future growth of our institution.

Balance Sheet

Total assets were $691.0 million at March 31, 2013, compared to $707.7 million at December 31, 2012. Our total assets were reduced and our asset mix changed as proceeds from the bulk loan transaction and the sale of mortgage loans held for sale were used to pay off maturing FHLB advances and to increase our level of interest-earning deposits and investment securities.

Loans and leases held for investment decreased to $436.5 million at March 31, 2013, from $441.8 million at December 31, 2012. This decrease is primarily attributable to the net impact of current quarter origination and repayment activity.

Investment securities and interest-earning deposits in banks increased to $203.6 million at March 31, 2013, from $168.2 million at December 31, 2012, reflecting the investment of a portion of the proceeds of the bulk loan sale. The quarter-over-quarter growth in the level of investments and interest-earning deposits reflects a strategy to diversify the portfolio. The Bank utilized this opportunity to add defensive investments to the portfolio. While these bonds have a lower current yield than our legacy portfolio, they will help insulate earnings in a rising rate environment.

The loss associated with the bulk sale of problem loans and the valuation adjustment on OREO reflected in our 2012 fourth quarter results created a $10.8 million tax net operating loss carryover for the Company. The accounting entries to capture this change impacted our net income tax receivable and net deferred income tax accounts and have been reflected in our first quarter 2013 balance sheet. Booking of these entries had no effect on net income, total assets, or shareholders’ equity for the periods presented.

Total deposits decreased to $599.6 million at March 31, 2013, from $600.9 million at December 31, 2012. The Bank’s level of non-maturity deposits increased to $316.8 million at March 31, 2013, from $305.2 million at December 31, 2012; while certificates of deposit declined to $282.8 million, or 47.2% of total deposits, at March 31, 2013, from $295.7 million, or 49.2% of total deposits, at December 31, 2012.

All of the $16.5 million of short-term FHLB advances outstanding at December 31, 2012, matured and were repaid during the first quarter of 2013. These funds were used to fund the mortgage loans held for sale portfolio at year-end. These borrowings were repaid as proceeds were received from the bulk loan transaction as well as the sale of mortgage loans.

Stockholders' equity increased to $75.5 million at March 31, 2013, from $74.7 million at December 31, 2012, reflecting the net income earned for the 2013 first quarter, and changes in accumulated other comprehensive income. The tangible equity to assets ratio increased to 10.31% at March 31, 2013, from 9.95% at December 31, 2012. There were 9,751,271 common shares outstanding at March 31, 2013 and December 31, 2012, respectively. Tangible book value per common share increased to $7.30 at March 31, 2013, from $7.22 at December 31, 2012.

Key Performance Ratios

Key performance ratios are the return on average assets (ROA), the return on average equity (ROE) and the efficiency ratio. The ROA increased to 0.91% for the 2013 first quarter, from 0.25% for the 2012 first quarter. The ROE increased to 8.02% for the 2013 first quarter, from 2.18% for the comparative 2012 first quarter. The efficiency ratio (noninterest expenses as a percentage of net interest income plus noninterest income) measures the proportion of net operating revenues that are absorbed by overhead expenses. The efficiency ratio improved to 70.34% for the 2013 first quarter, from 76.63% for the comparative 2012 first quarter, reflecting the improvement in OREO related and other expenses noted above.

First South Bank has been serving the citizens of eastern North Carolina since 1902 and offers a variety of financial products and services, including a leasing company. Securities brokerage services are made available through an affiliation with an independent broker/dealer. The Bank operates through its main office headquartered in Washington, North Carolina, and has 26 full service branch offices located throughout central and eastern North Carolina.

First South Bancorp, Inc. may be accessed on its website at www.firstsouthnc.com. The Company’s common stock symbol as traded on the NASDAQ Global Select Market is “FSBK”.

Statements contained in this release, which are not historical facts, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those currently anticipated due to a number of factors which include the effects of future economic conditions, governmental fiscal and monetary policies, legislative and regulatory changes, the risks of changes in interest rates, the effects of competition, and including without limitation to other factors that could cause actual results to differ materially as discussed in documents filed by the Company with the Securities and Exchange Commission from time to time.

(More)

(NASDAQ: FSBK)

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Financial Condition

(*) Derived from audited consolidated financial statements

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Operations

(unaudited)