Park Sterling (PSTB) 10-Q 2011 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

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 001-35032

PARK STERLING CORPORATION

(Exact name of registrant as specified in its charter)

NORTH CAROLINA	27-4107242
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
1043 E. Morehead Street, Suite 201
Charlotte, North Carolina	28204
(Address of principal executive offices)	(Zip Code)

(704) 716-2134
(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. Yesþ Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filero Accelerated Filero Non-accelerated filero
(Do not check if a smaller reporting company) Smaller reporting companyþ

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

As of May 12, 2011, the registrant had outstanding 28,619,358 shares of common stock, $1.00 par value per share.

PARK STERLING CORPORATION

Table of Contents

	Page No.
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets March 31, 2011 and December 31, 2010		2
Condensed Consolidated Statements of Income (Loss) Three Months Ended March 31, 2011 and 2010		3
Condensed Consolidated Statements of Changes in Shareholders’ Equity Three Months Ended March 31, 2011 and 2010		4
Condensed Consolidated Statements of Cash Flows Three Months Ended March 31, 2011 and 2010		5
Notes to Condensed Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		29
Item 3. Quantitative and Qualitative Disclosures about Market Risk		44
Item 4. Controls and Procedures		44
Part II. OTHER INFORMATION
Item 1. Legal Proceedings		44
Item 1A. Risk Factors		44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		45
Item 3. Defaults Upon Senior Securities		45
Item 4. [Removed and Reserved]		45
Item 5. Other Information		45
Item 6. Exhibits		46
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PARK STERLING CORPORATION

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

	March 31,			December 31,
	2011			2010 *
	(Dollars in thousands)
ASSETS
Cash and due from banks	$	54,192		$	2,433
Interest-earning balances at banks		3,796			5,040
Federal funds sold		57,525			57,905
Investment securities available-for-sale, at fair value		112,273			140,590
Loans		388,187			399,829
Allowance for loan losses		(11,768	)		(12,424	)
Net loans		376,419			387,405
Federal Home Loan Bank stock		1,910			1,757
Premises and equipment, net		4,525			4,477
Accrued interest receivable		1,469			1,640
Other real estate owned		1,565			1,246
Other assets		14,742			13,615
Total assets	$	628,416		$	616,108
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand deposits	$	37,098		$	36,333
Money market, NOW and savings deposits		107,186			71,666
Time deposits of less than $100,000		70,026			78,242
Time deposits of $100,000 through $250,000		73,949			79,020
Time deposits of more than $250,000		133,253			142,559
Total deposits		421,512			407,820
Short-term borrowings		1,213			874
Long-term borrowings		20,000			20,000
Subordinated debt		6,895			6,895
Accrued interest payable		245			290
Accrued expenses and other liabilities		3,781			3,128
Total liabilities		453,646			439,007
Shareholders’ equity:
Preferred stock, no par value 5,000,000 shares authorized; -0- issued and outdstanding at March 31, 2011 and December 31, 2010, respectively		—			—
Common stock, $1.00 par value 200,000,000 shares authorized at March 31, 2011 and December 31, 2010; 28,619,358 and 28,051,098 shares outstanding at March 31, 2011 and December 31, 2010, respectively		28,619			28,051
Additional paid-in capital		159,367			159,489
Accumulated deficit		(12,388	)		(9,501	)
Accumulated other comprehensive loss		(828	)		(938	)
Total shareholders’ equity		174,770			177,101
Total liabilities and shareholders’ equity	$	628,416		$	616,108

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

2

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS) (Unaudited)
(Dollars in thousands, except per share data)

	Three Months Ended
	March 31,
	2011			2010
Interest income
Loans, including fees	$	4,758		$	5,143
Federal funds sold		30			9
Taxable investment securities		681			326
Tax-exempt investment securities		171			160
Interest on deposits at banks		14			13
Total interest income		5,654			5,651
Interest expense
Money market, NOW and savings deposits		141			83
Time deposits		1,226			1,484
Short-term borrowings		—			5
Long-term borrowings		141			138
Subordinated debt		190			190
Total interest expense		1,698			1,900
Net interest income		3,956			3,751
Provision for loan losses		4,462			1,531
Net interest income (loss) after provision for loan losses		(506	)		2,220
Noninterest income
Service charges on deposit accounts		26			14
Gain on sale of securities available-for-sale		19			18
Other noninterest income		27			6
Total noninterest income		72			38
Noninterest expense
Salaries and employee benefits		2,507			1,252
Occupancy and equipment		256			206
Advertising and promotion		38			57
Legal and professional fees		307			76
Deposit charges and FDIC insurance		287			176
Data processing and outside service fees		123			93
Director fees		41			—
Net cost of operation of other real estate		235			36
Other noninterest expense		440			146
Total noninterest expense		4,234			2,042
Income (loss) before income taxes		(4,668	)		216
Income tax expense (benefit)		(1,781	)		59
Net income (loss)	$	(2,887	)	$	157
Basic earnings (loss) per common share	$	(0.10	)	$	0.03
Diluted earnings (loss) per common share	$	(0.10	)	$	0.03
Weighted-average common shares outstanding
Basic		28,051,098			4,951,098
Diluted		28,051,098			4,951,098

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

3

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
Three Months Ended March 31, 2011 and 2010
(Dollars in thousands)

											Accumulated
					Additional						Other			Total
	Common Stock				Paid-In			Accumulated			Comprehensive			Stockholders’
	Shares		Amount		Capital			Deficit			Income (Loss)			Equity
Balance at December 31, 2009		4,951,098	$	23,023	$	23,496		$	(1,642	)	$	1,218		$	46,095
Share-based compensation expense		—		—		104			—			—			104
Comprehensive income (loss):
Net income		—		—		—			157			—			157
Unrealized holding gains on available-for-sale securities, net of taxes		—		—		—			—			289			289
Unrealized holding losses on interest rate swaps, net of taxes		—		—		—			—			(224	)		(224	)
Total comprehensive income (loss)		—		—		—			—			—			222
Balance at March 31, 2010		4,951,098	$	23,023	$	23,600		$	(1,485	)	$	1,283		$	46,421
Balance at December 31, 2010		28,051,098	$	28,051	$	159,489		$	(9,501	)	$	(938	)	$	177,101
Issuance of restricted stock grants		568,260		568		(568	)		—			—			—
Share-based compensation expense		—		—		446			—			—			446
Comprehensive income (loss):
Net loss		—		—		—			(2,887	)		—			(2,887	)
Unrealized holding gains on available-for-sale securities, net of taxes		—		—		—			—			275			275
Unrealized holding losses on interest rate swaps, net of taxes		—		—		—			—			(165	)		(165	)
Total comprehensive income (loss)		—		—		—			—			—			(2,777	)
Balance at March 31, 2011		28,619,358	$	28,619	$	159,367		$	(12,388	)	$	(828	)	$	174,770

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

4

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)

	Three Months Ended
	March 31,
	2011			2010
Cash flows from operating activities
Net income (loss)	$	(2,887	)	$	157
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		394			98
Provision for loan losses		4,462			1,531
Stock option expense		446			104
Income on termination of swap		—			(210	)
Gain on sales of investment securities available-for-sale		(19	)		(18	)
Gain on sales of other real estate		(24	)		—
Change in assets and liabilities:
Decrease in accrued interest receivable		171			76
(Increase) decrease in other assets		(1,465	)		127
Decrease in accrued interest payable		(45	)		(4	)
Increase in accrued expenses and other liabilities		653			142
Net cash provided by operating activities		1,686			2,003
Cash flows from investing activities
Net decrease in loans		5,480			1,109
Purchases of bank premises and equipment		(139	)		(24	)
Purchases of investment securities available-for-sale		(1,746	)		(4,225	)
Proceeds from sales of investment securities available-for-sale		24,314			2,161
Proceeds from maturities and call of investment securities available-for-sale		5,887			1,892
Writedowns (improvements) to other real estate		241			(92	)
Proceeds from sale of other real estate		534			—
Purchase of Federal Home Loan Bank stock		(153	)		—
Net cash provided by investing activities		34,418			821
Cash flows from financing activities
Net increase in deposits		13,692			533
Decrease in short-term borrowings		339			157
Net cash provided by financing activities		14,031			690
Net increase in cash and cash equivalents		50,135			3,514
Cash and cash equivalents, beginning		65,378			23,237
Cash and cash equivalents, ending	$	115,513		$	26,751
Supplemental disclosures of cash flow information:
Cash paid for interest	$	1,743		$	1,904
Cash paid for income taxes		—			64
Supplemental disclosure of noncash investing and financing activities:
Change in unrealized gain on available-for-sale securities, net of tax	$	275		$	289
Change in unrealized loss on swap, net of tax		(165	)		(224	)
Loans transferred to other real estate owned		1,070			1,424

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

5

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1 — Basis of Presentation

Park Sterling Corporation (the “Company”) was formed on October 6, 2010 to serve as the holding company for Park Sterling Bank (the “Bank”) and is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the Bank Holding Company Act (the “BHC Act”). On January 1, 2011, the Company acquired all of the outstanding stock of the Bank in a statutory exchange transaction (the “Reorganization”). Prior to January 1, 2011, the Company conducted no operations other than obtaining regulatory approval for the Reorganization. The information in the unaudited condensed consolidated financial statements and accompanying notes for all periods prior to January 1, 2011 is that of the Bank on a stand-alone basis.

The Bank was incorporated on September 8, 2006, as a North Carolina-chartered commercial bank and began operations in October 2006. The Bank’s primary focus is to provide banking services to small and mid-sized businesses, owner-occupied and income producing real estate owners, professionals and other clients doing business or residing within its target markets. The Bank operates under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”) and the State of North Carolina Office of the Commissioner of Banks (the “NC Commissioner”). The Bank undergoes periodic examinations by those regulatory authorities.

On March 30, 2011, the Company and Community Capital Corporation (“Community Capital”) entered into an Agreement and Plan of Merger, pursuant to which Community Capital will be merged with and into the Company, with the Company as the surviving entity. The merger has been unanimously approved by the board of directors of each company and is subject to customary closing conditions, including regulatory approval and Community Capital shareholder approval. If the merger is completed, each outstanding share of Community Capital common stock will be exchanged for either 0.6667 of a share of Company common stock or $3.30 in cash, subject to the limitation that the total consideration will consist of 40.0% in cash and 60.0% in shares of Company common stock.

The accompanying unaudited condensed consolidated financial statements and notes have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with GAAP. Because the accompanying unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP, they should be read in conjunction with the Company’s audited consolidated financial statements and accompanying footnotes (the “2010 Audited Financial Statements”) included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 filed with the Securities and Exchange Commission (“SEC”) on March 31, 2011 (the “2010 Form 10-K”).

In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all normal, recurring adjustments necessary to present fairly the financial position of the Company as of March 31, 2011, and the results of operations and cash flows for the three months ended March 31, 2011 and 2010. Operating results for the three-month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year or for other interim periods.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are susceptible to significant change in the near term are the valuation of the allowance for loan losses and the fair value of financial instruments and other accounts.

Certain amounts reported in prior periods have been reclassified to conform to the current period presentation.

6

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 2 — Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards UpdateFair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurement(“ASU No. 2010-06”). ASU No. 2010-06 requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in FASB Accounting Standards Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase transparency in financial reporting.

Specifically, ASU No. 2010-06 amends Codification Subtopic 820-10 to now require that: (1) a reporting entity disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and (2) a reporting entity present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3). In addition, ASU No. 2010-06 clarifies the requirements for purposes of reporting fair value measurement for each class of assets and liabilities, and that a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities and should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. ASU No. 2010-06 became effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted the fair value disclosures guidance on January 1, 2010, except for the gross presentation of the Level 3 rollforward information, which was adopted by the Company on January 1, 2011. The adoption of the gross presentation disclosures did not have an impact on the Company’s financial position or results of operations.

In July 2010, the FASB issued ASU No. 2010-20,Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (Topic 310)(“ASU No. 2010-20”). ASU No. 2010-20 will require the Company to provide a greater level of disaggregated information about the credit quality of the Company’s loans and the Allowance for Loan Losses (the “Allowance”). ASU No. 2010-20 requires the Company to disclose additional information related to credit quality indicators, past due information, and information related to loans modified in a troubled debt restructuring. The provisions of ASU No. 2010-20 are effective for the Company’s reporting period ending December 31, 2010. As this ASU amends only the disclosure requirements for loans and the Allowance, the adoption will have no material impact on the Company’s financial condition or results of operations.

In April 2011, the FASB issued ASU No. 2011-02,A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (Topic 310)(“ASU No. 2011-02”). ASU No. 2011-02 provides greater clarity and guidance to assist creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. As a result of applying these amendments, the Company may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, the amendments will be applied prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company will be required to disclose the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired under Section 310-10-35 (FAS 114) for which impairment was previously measured under Subtopic 450-20, Contingencies: Loss Contingencies (FAS 5). The provisions of ASU No. 2011-02 are effective for the Company’s reporting period ending September 30, 2011. Management is still evaluating the impact of this ASU on the Company’s financial condition.

7

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 3 — Shareholders’ Equity

Common Stock

On May 4, 2010, the Bank’s shareholders approved an amendment to the Articles of Incorporation of the Bank to increase the number of authorized shares of common stock to 200,000,000.

On August 18, 2010, in connection with its public offering of common stock (the “Public Offering”), the Bank consummated the issuance and sale of 23,100,000 shares of common stock at $6.50 per share, for a gross aggregate offering price of $150.2 million. The Bank incurred underwriting fees of $6.0 million and related expenses of $0.9 million resulting in net proceeds of $143.2 million being received by the Bank of which $140.2 was recorded in shareholders’ equity. Additional underwriting fees equal to $3.0 million will be payable in the future if the common stock price closes at a price equal to or above 125% of the offering price, or $8.125 per share, for a period of 30 consecutive days. A liability for the $3.0 million contingent underwriting fee has been accrued and is included in other liabilities in the accompanying balance sheet at March 31, 2011.

On January 1, 2011, in conjunction with the Company’s acquisition of the Bank in a statutory exchange transaction, the par value of authorized common stock of the Company, which was established in the Company’s Articles of Incorporation at $1.00 per share, replaced the previously reported par value of $4.65 per share of common stock of the Bank. This transaction was given retroactive effect in the financial statements. As such, the par value of the common stock reflected in the audited consolidated balance sheet as of December 31, 2010 reflects a $102.8 million reclassification from common stock to additional paid-in capital because of the Reorganization.

Share-Based Plans

The Company may grant share-based compensation to employees and non-employee directors in the form of stock options, restricted stock or other stock-based awards. Share-based compensation expense is measured based on the fair value of the award at the date of grant and is charged to earnings on a straight-line basis over the requisite service period, which is currently up to seven years. The fair value of stock options is estimated at the date of grant using a Black-Scholes option-pricing model and related assumptions. The amortization of share-based compensation reflects estimated forfeitures, adjusted for actual forfeiture experience. The fair value of restricted stock awards is estimated using a Monte Carlo simulation and related estimated assumptions for volatility and a risk free interest rate.

The Company maintains equity-based compensation plans for directors and employees. During 2010, the Board of Directors of the Bank adopted and shareholders approved, the Park Sterling Bank 2010 Stock Option Plan for Directors and the Park Sterling Bank 2010 Employee Stock Option Plan (the “2010 Plans”). The 2010 Plans are substantially similar to the Bank’s 2006 option plans for directors and employees, which provided for an aggregate of 990,000 of common shares reserved for options. The 2010 Plans provide for an aggregate of 1,859,550 of common shares reserved for options. Upon effectiveness of the Reorganization, the Company assumed all outstanding options under the 2010 plans and the 2006 plans, and the Company’s common stock was substituted as the stock issuable upon the exercise of options under these plans.

Also during 2010, the Board of Directors of the Company adopted and shareholders approved, the Park Sterling Corporation 2010 Long-Term Incentive Plan for directors and employees (the “LTIP”), which was effective upon the Reorganization. The LTIP provides for an aggregate of 1,016,400 of common shares reserved for issuance to employees and directors in connection with stock options, stock appreciation rights and other stock-based awards (including, without limitation, restricted stock awards).

8

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Activity in the Company’s shared based plans is summarized in the following table:

				Outstanding Options									Nonvested Restricted Shares
	Options						Weighted		Weighted						Weighted
	Available						Average		Average						Average		Aggregate
	for Future			Number			Exercise		Contractual		Intrinsic		Number		Grant Date		Intrinsic
	Grants			Outstanding			Price		Term (Years)		Value		Outstanding		Fair Value		Value
At December 31, 2010		525,918			2,323,632		$	7.83		8.50	$	—		—	$	—	$	—
Approved for issuance		1,016,400			—			—		—		—		—		—		—
Options Granted		(82,340	)		82,340			5.74		—		—		—		—		—
Restricted Shares Granted		(568,260	)		—			—		—		—		568,260		3.91		2,756,061
Exercised		—			—			—		—		—		—		—		—
Expired and forfeited		176,083			(176,083	)		6.50		2.62		—		—		—		—
At March 31, 2011		1,067,801			2,229,889		$	7.86		8.23	$	—		568,260	$	3.91	$	2,756,061
Exercisable at March 31, 2011					785,902		$	10.38		6.01	$	—

The fair value of options is estimated at the date of the grant using the Black-Scholes option-pricing model and expensed over the options’ vesting periods. The following weighted-average assumptions were used in valuing options issued during the three months ended March 31, 2011.

Assumptions in Estimating Option Values

Weighted-average volatility		36.86	%
Expected dividend yield		0	%
Risk-free interest rate		4.40	%
Expected life	7 years

No options vested during the three months ended March 31, 2011 and 2010. The compensation expense for stock option plans was $310 thousand and $104 thousand for the three months ended March 31, 2011 and 2010, respectively. At March 31, 2011, unrecognized compensation cost related to nonvested stock options of $3.0 million is expected to be recognized over a weighted-average period of 1.43 years.

No shares of restricted stock vested during the three months ended March 31, 2011 and 2010. The compensation expense for restricted shares was $136 thousand for the three months ended March 31, 2011. At March 31, 2011, unrecognized compensation cost related to nonvested restricted shares of $2.7 million is expected to be recognized over a weighted-average period of 3.48 years.

9

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 4 — Investment Securities

The amortized cost, unrealized gains, losses, and estimated fair value of securities available-for-sale at March 31, 2011 and December 31, 2010 are as follows:

Amortized Cost and Fair Value of Investment Portfolio

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)
March 31, 2011
Securities available-for-sale:
U.S. Government agencies	$	10,526	$	44	$	(152	)	$	10,418
Residential mortgage-backed securities		30,960		447		(408	)		30,999
Collateralized agency mortgage obligations		55,285		120		(1,879	)		53,526
Municipal securities		15,515		439		(23	)		15,931
Corporate and other securities		1,523		24		(148	)		1,399
Total investment securities	$	113,809	$	1,074	$	(2,610	)	$	112,273
December 31, 2010
Securities available-for-sale:
U.S. Government agencies	$	13,075	$	181	$	(96	)	$	13,160
Residential mortgage-backed securities		52,342		495		(438	)		52,399
Collateralized agency mortgage obligations		60,711		111		(2,103	)		58,719
Municipal securities		13,771		183		(146	)		13,808
Corporate and other securities		2,675		5		(176	)		2,504
Total investment securities	$	142,574	$	975	$	(2,959	)	$	140,590

The amortized cost and fair values of securities available-for-sale at March 31, 2011 and December 31, 2010 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Maturities of Investment Portfolio

	March 31, 2011
	Amortized		Fair
	Cost		Value
	(Dollars in thousands)
U.S. Government agencies
Due after one year through five years	$	10,000	$	9,848
Due after five years through ten years		526		570
Residential mortgage-backed securities
Due after five years through ten years		1,341		1,351
Due after ten years		29,619		29,648
Collateralized agency mortgage obligations
Due after ten years		55,285		53,526
Municipal securities
Due after ten years		15,515		15,931
Corporate and other securities
Due after five years through ten years		500		352
Due after ten years		1,023		1,047
Total investment securites	$	113,809	$	112,273

10

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Management periodically evaluates each investment security for other than temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. The following table shows gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, for investment securities with unrealized losses at March 31, 2011 and December 31, 2010. The unrealized losses relate to debt securities that have incurred fair value reductions due to market volatility and uncertainty since the securities were purchased. Management believes that the unrealized losses are more likely than not to reverse as confidence returns to investment markets. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, and it is more likely than not that the Company will not have to sell the investments before recovery of their amortized cost basis, none of the securities are deemed to be other than temporarily impaired. One corporate debt security has been in a loss position for twelve months or more at March 31, 2011. At December 31, 2010, two corporate debt securities were in a loss position for twelve months or more.

Investment Portfolio Gross Unrealized Losses and Fair Value

	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
	(Dollars in thousands)
March 31, 2011
Securities available-for-sale:
U.S. Government agencies	$	9,848	$	(152	)	$	—	$	—		$	9,848	$	(152	)
Residential Mortgage-backed securities		19,607		(408	)		—		—			19,607		(408	)
Collateralized mortgage obligations		49,541		(1,879	)		—		—			49,541		(1,879	)
Municipal securities		814		(23	)		—		—			814		(23	)
Corporate and other securities		—		—			353		(148	)		353		(148	)
Total temporarily impaired securities	$	79,810	$	(2,462	)	$	353	$	(148	)	$	80,163	$	(2,610	)
December 31, 2010
Securities available-for-sale:
U.S. Government agencies	$	9,904	$	(96	)	$	—	$	—		$	9,904	$	(96	)
Residential Mortgage-backed securities		37,052		(438	)		—		—			37,052		(438	)
Collateralized mortgage obligations		53,232		(2,103	)		—		—			53,232		(2,103	)
Municipal securities		6,215		(146	)		—		—			6,215		(146	)
Corporate and other securities		—		—			1,475		(176	)		1,475		(176	)
Total temporarily impaired securities	$	106,403	$	(2,783	)	$	1,475	$	(176	)	$	107,878	$	(2,959	)

Securities with a fair value of $4.8 million and $4.2 million at March 31, 2011 and December 31, 2010, respectively, were pledged to secure an interest rate swap and securities sold under agreements to repurchase. During the three months ended March 31, 2011, the Company sold $24.3 million of securities available-for-sale, resulting in a gross gain of $0.02 million. Securities available-for-sale with a book value of $2.1 million were sold in the three months ended March 31, 2010 resulting in a gross gain of $0.02 million.

11

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

The aggregate cost of the Company’s cost method investments totaled $2.0 million at March 31, 2011 and $2.3 million at December 31, 2010. Cost method investments at March 31, 2011 included $1.9 million in Federal Home Loan Bank (“FHLB”) stock and $0.1 million of other investments which are included in other assets. All cost method investments were evaluated for impairment as of March 31, 2011 and December 31, 2010. The following factors have been considered in determining the carrying amount of FHLB stock: 1) management’s current belief that the Company has sufficient liquidity to meet all operational needs in the foreseeable future and would not need to dispose of the stock below recorded amounts, 2) management’s belief that the FHLB has the ability to absorb economic losses given the expectation that the FHLB has a high degree of government support and 3) redemptions and purchases of the stock are at the discretion of the FHLB. At March 31, 2011 and December 31, 2010, the Company estimated that the fair values of cost method investments equaled or exceeded the cost of each of these investments, and, therefore, the investments were not impaired.

Note 5 — Loans and Allowance for Loan Losses

The following is a summary of the loan portfolio at March 31, 2011 and December 31, 2010:

	2011			2010
Commercial:
Commercial and industrial	$	48,107		$	48,401
Commercial real estate — owner-occupied		52,764			55,089
Commercial real estate — investor income producing		113,612			110,407
Acquisition, construction and development		75,977			87,846
Other commercial		5,232			3,225
Total commercial loans		295,692			304,968
Consumer:
Residential mortgage		25,034			21,716
Home equity lines of credit		53,725			56,968
Residential construction		7,018			9,051
Other loans to individuals		6,811			7,245
Total consumer loans		92,588			94,980
Total loans		388,280			399,948
Deferred fees		(93	)		(119	)
Total loans, net of deferred fees	$	388,187		$	399,829

At March 31, 2011 and December 31, 2010, the carrying value of loans pledged as collateral on FHLB borrowings totaled $43.8 million.

Concentrations of Credit—Loans are primarily made in the Charlotte and Wilmington regions of North Carolina. Real estate loans can be affected by the condition of the local real estate market. Commercial and industrial loans can be affected by the local economic conditions. The commercial loan portfolio has concentrations in business loans secured by real estate and real estate development loans. Primary concentrations in the consumer loan portfolio include home equity lines of credit and residential mortgages. At March 31, 2011 and December 31, 2010, we had no loans outstanding with non-U.S. entities.

12

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Allowance for Loan Losses— The following table presents, by portfolio segment, the activity in the allowance for loan losses for the quarter ended March 31, 2011. The following table also presents, by portfolio segment, the balance in the allowance for loan losses disaggregated based on the Company’s impairment measurement method and the related recorded investment in loans at March 31, 2011 and December 31, 2010.

	Commercial			Consumer			Unallocated			Total
For the quarter ended March 31, 2011
Allowance for Loan Losses:
Balance, beginning of period	$	9,165		$	1,375		$	1,884		$	12,424
Provision for loan losses		2,705			1,782			(25	)		4,462
Charge-offs		(4,296	)		(1,285	)		—			(5,581	)
Recoveries		460			3			—			463
Net charge-offs		(3,836	)		(1,282	)		—			(5,118	)
Ending balance	$	8,034		$	1,875		$	1,859		$	11,768
At March 31, 2011
Allowance for Loan Losses:
Individually evaluated for impairment	$	1,410		$	450		$	—		$	1,860
Collectively evaluated for impairment		6,624			1,425			1,859			9,908
Total	$	8,034		$	1,875		$	1,859		$	11,768
Recorded Investment in Loans:
Individually evaluated for impairment	$	29,832		$	4,195		$	—		$	34,027
Collectively evaluated for impairment		265,860			88,393			—			354,253
Total	$	295,692		$	92,588		$	—		$	388,280
At December 31, 2010
Allowance for Loan Losses:
Individually evaluated for impairment	$	4,092		$	115		$	—		$	4,207
Collectively evaluated for impairment		5,073			1,260			1,884			8,217
Total	$	9,165		$	1,375		$	1,884		$	12,424
Recorded Investment in Loans:
Individually evaluated for impairment	$	37,451		$	3,460		$	—		$	40,911
Collectively evaluated for impairment		267,517			91,520			—			359,037
Total	$	304,968		$	94,980		$	—		$	399,948

A summary of the activity in the allowance for loan losses for the three-month periods ended March 31, 2011 and 2010 follows:

	Three Months Ended
	March 31,
	2011			2010
Balance, beginning of period	$	12,424		$	7,402
Provision for loan losses		4,462			1,531
Charge-offs		(5,581	)		(554	)
Recoveries		463			1
Net charge-offs		(5,118	)		(553	)
Balance, end of period	$	11,768		$	8,380

The Company introduced refinements to its loan loss allowance methodology in the third quarter of 2010. The principal refinement was the addition of a more comprehensive qualitative component. Qualitative reserves represent an estimate of the amount for which it is probable that environmental factors will cause the quantitatively determined loss contingency estimate to differ from historical results or other assumptions. The Company has identified six environmental factors for inclusion in our allowance methodology at this time, aggregating $1.8 million at March 31, 2011 and December 31, 2010, including (i) portfolio trends, (ii) portfolio concentrations, (iii) economic and market trends, (iv) changes in lending practices, (v) regulatory environment, and (vi) other factors. The first three factors are believed by management to present the most significant risk to the portfolio, and are therefore associated with both higher absolute and range of potential reserve percentages. The reserve percentages for each of the six factors are derived from available industry information combined with management judgment. The Company may consider both trends and absolute levels of such factors, if applicable.

13

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

The Company evaluates and estimates off-balance sheet credit exposure at the same time it estimates credit losses for loans by a similar process. These estimated credit losses are not recorded as part of the allowance for loan losses, but are recorded to a separate liability account by a charge to income, if material. Loan commitments, unused lines of credit and standby letters of credit make up the off-balance sheet items reviewed for potential credit losses. These estimated credit losses were not material at March 31, 2011 and December 31, 2010.

Credit Quality Indicators—The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company’s primary credit quality indicator is an internal credit risk rating system that categorizes loans into pass, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans to businesses or individuals in the classes that comprise the commercial portfolio segment. Groups of loans that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk rated and monitored collectively. These are typically loans to individuals in the classes that comprise the consumer portfolio segment.

The following are the definitions of the Company’s credit quality indicators:

Pass:	Loans in classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes there is a low likelihood of loss related to those loans that are considered pass.
Special Mention:	Loans in classes that comprise the commercial and consumer portfolio segments that have potential weaknesses that deserve management’s close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan. Management believes there is a moderate likelihood of some loss related to those loans that are considered special mention.
Classified:	Loans in the classes that comprise the commercial portfolio segment that are inadequately protected by the sound worth and paying capacity of the borrower or of the collateral pledged, if any. Classified loans are also those in the classes that comprise the consumer portfolio segment that are past due 90 days or more as to principal or interest. Residential mortgage and home equity loans may be current as to principal and interest, but may be considered classified for a period of up to six months. Following a period of demonstrated performance in accordance with contractual terms, the loan may be removed from classified status. Management believes that there is a distinct possibility that the Company will sustain some loss if the deficiencies related to classified loans are not corrected in a timely manner.

14

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

The Company’s credit quality indicators are periodically updated on a case-by-case basis. The following tables present the recorded investment in the Company’s loans as of March 31, 2011 and December 31, 2010, by loan class and by credit quality indicator.

	As of March 31, 2011
			Commercial
	Commercial		Real Estate		CRE-Investor		Acquisition,
	and		(CRE)-Owner		Income		Construction		Other		Total
	Industrial		Occupied		Producing		and Development		Commercial		Commercial
Pass	$	44,718	$	46,542	$	99,857	$	26,277	$	5,232	$	222,626
Special mention		2,767		1,892		4,893		18,016		—		27,568
Classified		622		4,330		8,862		31,684		—		45,498
Total	$	48,107	$	52,764	$	113,612	$	75,977	$	5,232	$	295,692
	Residential		Home Equity		Residential		Other Loans to				Total
	Mortgage		Lines of Credit		Construction		Individuals				Consumer
Pass	$	20,002	$	51,050	$	6,077	$	6,723			$	83,852
Special mention		1,368		1,081		—		—				2,449
Classified		3,664		1,594		941		88				6,287
Total	$	25,034	$	53,725	$	7,018	$	6,811			$	92,588
Total Recorded Investment in Loans											$	388,280
	As of December 31, 2010
			Commercial
	Commercial		Real Estate		CRE-Investor		Acquisition,
	and		(CRE)-Owner		Income		Construction		Other		Total
	Industrial		Occupied		Producing		and Development		Commercial		Commercial
Pass	$	46,888	$	52,746	$	98,195	$	37,435	$	3,225	$	238,489
Special mention		262		—		9,520		14,289		—		24,071
Classified		1,251		2,343		2,692		36,122		—		42,408
Total	$	48,401	$	55,089	$	110,407	$	87,846	$	3,225	$	304,968
	Residential		Home Equity		Residential		Other Loans to				Total
	Mortgage		Lines of Credit		Construction		Individuals				Consumer
Pass	$	19,160	$	53,839	$	7,951	$	7,245			$	88,195
Special mention		1,359		1,607		—		—				2,966
Classified		1,197		1,522		1,100		—				3,819
Total	$	21,716	$	56,968	$	9,051	$	7,245			$	94,980
Total Recorded Investment in Loans											$	399,948

15

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Aging Analysis of Accruing and Non-Accruing Loans—The following presents by class, an aging analysis of the Company’s accruing and non-accruing loans as of March 31, 2011 and December 31, 2010.

	30-59		60-89		Past Due
	Days		Days		90 Days
(dollars in thousands)	Past Due		Past Due		or More		Current		Total Loans
As of March 31, 2011
Commercial:
Commercial and industrial	$	—	$	—	$	327	$	47,780	$	48,107
Commercial real estate — owner-occupied		—		—		581		52,183		52,764
Commercial real estate — investor income producing		—		—		—		113,612		113,612
Acquisition, construction and development		5,264		524		11,036		59,153		75,977
Other commercial		—		—		—		5,232		5,232
Total commercial loans		5,264		524		11,944		277,960		295,692
Consumer:
Residential mortgage		—		—		—		25,034		25,034
Home equity lines of credit		—		—		—		53,725		53,725
Residential construction		—		—		843		6,175		7,018
Other loans to individuals		—		—		—		6,811		6,811
Total consumer loans		—		—		843		91,745		92,588
Total loans	$	5,264	$	524	$	12,787	$	369,705	$	388,280
As of December 31, 2010
Commercial:
Commercial and industrial	$	—	$	593	$	111	$	47,697	$	48,401
Commercial real estate — owner-occupied		717		—		—		54,372		55,089
Commercial real estate — investor income producing		—		—		261		110,146		110,407
Acquisition, construction and development		4,025		4,188		5,676		73,957		87,846
Other commercial		—		—		—		3,225		3,225
Total commercial loans		4,742		4,781		6,048		289,397		304,968
Consumer:
Residential mortgage		—		—		374		21,342		21,716
Home equity lines of credit		1,000		—		—		55,968		56,968
Residential construction		—		1,000		—		8,051		9,051
Other loans to individuals		—		—		—		7,245		7,245
Total consumer loans		1,000		1,000		374		92,606		94,980
Total loans	$	5,742	$	5,781	$	6,422	$	382,003	$	399,948

Impaired Loans— All classes of loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impaired loans may include all classes of nonaccruing loans and loans modified in a troubled debt restructuring (“TDR”). If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

16

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Information for impaired loans, none of which are accruing interest, at and for the period ended March 31, 2011 is set forth in the following table:

			Unpaid		Related		Average		Interest
	Recorded		Principal		Allowance For		Recorded		Income
	Investment		Balance		Loan Losses		Investment		Recognized
Impaired Loans with No Related Allowance Recorded:
Commercial:
Commercial and industrial	$	30	$	821	$	—	$	144	$	—
CRE — owner-occupied		581		741		—		705		—
CRE — investor income producing		575		841		—		531		—
Acquisition, construction and development		22,575		32,088		—		25,475		—
Other commercial		—		—		—		—		—
Total commercial loans		23,761		34,491		—		26,855		—
Consumer:
Residential mortgage		811		823		—		819		—
Home equity lines of credit		—		1,700		—		—		—
Residential construction		941		2,175		—		1,092		—
Other loans to individuals		—		10		—		—		—
Total consumer loans		1,752		4,708		—		1,911		—
Total impaired loans with no related allowance recorded	$	25,513	$	39,199	$	—	$	28,766	$	—
Impaired Loans with an Allowance Recorded:
Commercial:
Commercial and industrial	$	500	$	625	$	152	$	501	$	—
CRE — owner-occupied		—		—		—		—		—
CRE — investor income producing		783		792		137		577		—
Acquisition, construction and development		4,788		4,828		1,121		2,662		—
Other commercial		—		—		—		—		—
Total commercial loans		6,071		6,245		1,410		3,740		—
Consumer:
Residential mortgage		2,443		2,560		450		1,609		—
Home equity lines of credit		—		—		—		—		—
Residential construction		—		—		—		—		—
Other loans to individuals		—		—		—		—		—
Total consumer loans		2,443		2,560		450		1,609		—
Total impaired loans with an allowance recorded	$	8,514	$	8,805	$	1,860	$	5,349	$	—
Impaired Loans:
Commercial	$	29,832	$	40,736	$	1,410	$	30,595	$	—
Consumer		4,195		7,268		450		3,520		—
Total impaired loans	$	34,027	$	48,004	$	1,860	$	34,115	$	—

17

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Information for impaired loans, none of which are accruing interest, at and for the year ended December 31, 2010 is set forth in the following table:

			Unpaid		Related		Average		Interest
	Recorded		Principal		Allowance For		Recorded		Income
	Investment		Balance		Loan Losses		Investment		Recognized
Impaired Loans with No Related Allowance Recorded:
Commercial:
Commercial and industrial	$	722	$	913	$	—	$	69	$	—
CRE — owner-occupied		—		—		—		—		—
CRE — investor income producing		583		841		—		15		—
Acquisition, construction and development		19,054		25,909		—		3,753		—
Other commercial		—		—		—		—		—
Total commercial loans		20,359		27,663		—		3,837		—
Consumer:
Residential mortgage		1,197		1,255		—		111		—
Home equity lines of credit		164		165		—		3		—
Residential construction		1,100		2,174		—		27		—
Other loans to individuals		—		—		—				—
Total consumer loans		2,461		3,594		—		141		—
Total impaired loans with no related allowance recorded	$	22,820	$	31,257	$	—	$	3,978	$	—
Impaired Loans with an Allowance Recorded:
Commercial:
Commercial and industrial	$	437	$	437	$	280	$	2	$	—
CRE — owner-occupied		717		741		136		393		—
CRE — investor income producing		1,119		1,209		277		404		—
Acquisition, construction and development		14,818		14,828		3,399		328		—
Other commercial		—		—		—				—
Total commercial loans		17,091		17,215		4,092		1,127		—
Consumer:
Residential mortgage		—		—		—		—		—
Home equity lines of credit		1,000		1,000		115		22		—
Residential construction		—		—		—		—		—
Other loans to individuals		—		—		—		—		—
Total consumer loans		1,000		1,000		115		22		—
Total impaired loans with an allowance recorded	$	18,091	$	18,215	$	4,207	$	1,149	$	—
Impaired Loans:
Commercial	$	37,450	$	44,878	$	4,092	$	4,964	$	—
Consumer		3,461		4,594		115		163		—
Total impaired loans	$	40,911	$	49,472	$	4,207	$	5,127	$	—

During the three months ended March 31, 2011 and 2010, the Company did not recognize any interest income, including interest income recognized on a cash basis, within the period that loans were impaired.

18

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Nonaccrual and Past Due Loans—It is the general policy of the Company to stop accruing interest income when a loan is placed on nonaccrual status and any interest previously accrued but not collected is reversed against current income. Generally, a loan is placed on nonaccrual status when it is over 90 days past due and there is reasonable doubt that all principal will be collected. The recorded investment in nonaccrual loans at March 31, 2011 and December 31, 2010 follows:

	March 31,		December 31,
	2011		2010
Commercial:
Commercial and industrial	$	530	$	1,159
CRE — owner-occupied		581		717
CRE — investor income producing		1,358		1,702
Acquisition, construction and development		27,363		33,872
Other commercial		—		—
Total commercial loans		29,832		37,450
Consumer:
Residential mortgage		3,254		1,197
Home equity lines of credit		—		1,164
Residential construction		941		1,100
Other loans to individuals		—		—
Total consumer loans		4,195		3,461
Total nonaccrual loans	$	34,027	$	40,911

Nonaccrual loans at March 31, 2011 include $19.7 million of TDR loans of which $17.2 million is in the acquisition, construction and development portfolio. The March 31, 2011 recorded allowance for these loans was $0.4 million. Nonaccrual loans at December 31, 2010 include $24.9 million of TDR loans of which $23.7 million is in the acquisition, construction and development portfolio. The December 31, 2010 recorded allowance for these loans was $2.4 million.

At March 31, 2011 and December 31, 2010, there were no loans 90 days or more past due and accruing interest.

Related Party Loans—From time to time, the Company engages in loan transactions with its directors, executive officers and their related interests (collectively referred to as “related parties”). Such loans are made in the ordinary course of business and on substantially the same terms and collateral as those for comparable transactions prevailing at the time and do not involve more than the normal risk of collectability or present other unfavorable features. A summary of activity in loans to related parties is as follows:

	Three Months Ended
	March 31,
	2011
	(Dollars in thousands)
Beginning balance	$	5,075
Disbursements		368
Repayments		(719	)
Ending balance	$	4,724

At March 31, 2011 and December 31, 2010, the Company had pre-approved but unused lines of credit totaling $2.0 million to related parties.

19

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 6 — Per Share Results

Basic and diluted net earnings (loss) per common share are computed based on the weighted-average number of shares outstanding during each period. Diluted net earnings (loss) per common share reflect the potential dilution that could occur if all dilutive stock options were exercised and all restricted shares were vested.

Basic and diluted net earnings (loss) per common share have been computed based upon net income (loss) as presented in the accompanying consolidated statements of income (loss) divided by the weighted-average number of common shares outstanding or assumed to be outstanding as summarized below:

Weighted-Average Shares for Earnings Per Share Calculation

	Three Months Ended
	March 31
	2011		2010
Weighted-average number of common shares outstanding		28,051,098		4,951,098
Effect of dilutive stock options and restricted shares		—		—
Weighted-average number of common shares and dilutive potential common shares outstanding		28,051,098		4,951,098

For the three-month period ended March 31, 2011, 2,229,889 outstanding options were anti-dilutive due to the loss for the first quarter of 2011 and 568,260 outstanding restricted shares were anti-dilutive due to the vesting price exceeding the average market price for the period, and were omitted from the calculation. The restricted shares will vest one-third each when the Company’s share price achieves, for 30 consecutive trading days, $8.125, $9.10 and $10.40, respectively.

For the three-month period ended March 31, 2010, 788,652 outstanding options were anti-dilutive due to the exercise price exceeding the average market price for the period and were omitted from the calculation. There were outstanding restricted shares for the three-month period ended March 31, 2010.

20

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 7 — Total Comprehensive Income (Loss)

The components of comprehensive income (loss) and related tax effects for the three-month periods ended March 31, 2011 and 2010 are as follows:

Comprehensive Income (Loss)

	Three Months Ended
	March 31,
	2011			2010
	(Dollars in thousands)
Net income (loss)		(2,887	)		157
Unrealized holding gains on available-for-sale securities	$	467		$	488
Tax effect		(180	)		(188	)
Reclassification of gain recognized in net income		(19	)		(18	)
Tax effect		7			7
		275			289
Unrealized holding loss on swaps		(270	)		(155	)
Tax effect		105			(69	)
		(165	)		(224	)
					.
Total comprehensive income (loss)	$	(2,777	)	$	222

Note 8 — Derivative Financial Instruments and Hedging Activities

During May 2008, the Company entered into an interest rate swap agreement with a notional amount of $40.0 million. The derivative instrument is used to protect certain designated variable rate loans from the downward effects of their repricing in the event of a decreasing rate environment for a period of three years ending May 16, 2011 and is accounted for as a cash flow hedge. If the USD-Prime-H.15 rate (“Prime Rate”) remains below 6.22%, the Company receives the difference between 6.22% and the daily weighted-average Prime Rate for each period. If the Prime Rate increases above 6.22% during the term of the contract, the Company will pay the difference between 6.22% and the daily weighted-average Prime Rate for each period. At March 31, 2011, the derivative instrument is carried at the fair market value of $0.2 million and is included in other assets. The fair market value of this swap at December 31, 2010 was $0.5 million. Changes in fair value of the swap that are deemed effective are recorded in other comprehensive income net of tax. Changes in fair value for the ineffective portion of the swap are recorded in interest income; such amounts were insignificant for each of the three months ended March 31, 2011 and 2010. The Company recorded interest income on the swap of $0.3 million for the three months ended March 31, 2011 and 2010, respectively.

At March 31, 2011, the Company had six loan swaps. The total original notional amount of these loan swaps was $13.8 million. These derivative instruments are used to protect the Company from interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans and are accounted for as fair value hedges. The derivative instruments are used to convert these fixed rate loans to an effective floating rate. If the LIBOR rate is below the stated fixed rate of the loan for a given period, the Company will owe the floating rate payer the notional amount times the difference between LIBOR and the stated fixed rate. If LIBOR is above the stated rate for any given period during the term of the contract, the Company will receive payments based on the notional amount times the difference between LIBOR and the stated fixed rate. These derivative instruments are carried at a fair market value of $(0.5) million and $(0.5) million and are included in loans at March 31, 2011 and December 31, 2010, respectively. The loans being hedged are also recorded at fair value. The Company recorded interest expense on these loan swaps of $0.1 million in each of the three months ended March 31, 2011 and 2010.

21

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

See table below for the information on the individual loan swaps at March 31, 2011:

Individual Loan Swap Information
(Dollars in thousands)

										Floating
Original		Current								Rate
Notional		Notional		Termination		Fixed			Floating	Payer
Amount		Amount		Date		Rate			Rate	Spread
$	2,670	$	2,447		04/10/13		5.85	%	USD-LIBOR-BBA		0.238	%
	1,800		437		04/09/13		5.80	%	USD-LIBOR-BBA		0.233	%
	1,100		1,010		05/11/13		6.04	%	USD-LIBOR-BBA		0.227	%
	3,775		3,552		02/15/13		5.90	%	USD-LIBOR-BBA		0.220	%
	1,870		1,608		02/15/13		5.85	%	USD-LIBOR-BBA		0.225	%
	2,555		2,555		10/15/15		5.50	%	USD-LIBOR-BBA		0.288	%
$	13,770	$	11,609

Note 9 — Fair Value Measurements

The Company is required to disclose the estimated fair value of financial instruments, both assets and liabilities on and off the balance sheet, for which it is practicable to estimate fair value. These fair value estimates are made at each balance sheet date, based on relevant market information and information about the financial instruments. Fair value estimates are intended to represent the price at which an asset could be sold or the price for which a liability could be settled in an orderly transaction between market participants at the measurement date. However, given there is no active market or observable market transactions for many of the Company’s financial instruments, the Company has made estimates of many of these fair values which are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimated values. The methodologies used for estimating the fair value of financial assets and financial liabilities are discussed below:

Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments including due from banks and federal funds sold approximate their fair value.

Investment Securities

Fair value for investment securities is based on the quoted market price if such information is available. If a quoted market price is not available, fair values are based on quoted market prices of comparable instruments.

FHLB Stock

The Bank, as a member of the FHLB, is required to maintain an investment in FHLB capital stock and the carrying amount is estimated to be fair value.

22

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Loans, net of allowance

For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Further adjustments are made to reflect current market conditions. There is no discount for liquidity included in the expected cash flow assumptions.

Accrued Interest Receivable

The carrying amount is a reasonable estimate of fair value.

Deposits

The fair value of deposits that have no stated maturities, including demand deposits, savings, money market and NOW accounts, is the amount payable on demand at the reporting date. The fair value of deposits that have stated maturity dates, primarily time deposits, is estimated by discounting expected cash flows using the rates currently offered for instruments of similar remaining maturities.

Borrowings

The fair values of short-term and long-term borrowings are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements.

Accrued Interest Payable

The carrying amount is a reasonable estimate of fair value.

Derivative Instruments

Derivative instruments, including interest rate swaps and swap fair value hedges, are recorded at fair value on a recurring basis. Fair value measurement is based on discounted cash flow models. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.

Financial Instruments with Off-Balance Sheet Risk

With regard to financial instruments with off-balance sheet risk discussed in Note K of the 2010 Audited Financial Statements, it is not practicable to estimate the fair value of future financing commitments.

The carrying amounts and estimated fair values of the Company’s financial instruments, none of which are held for trading purposes, at March 31, 2011 and December 31, 2010 are as follows:

Financial Instruments Carrying Amounts and Estimated Fair Values

	March 31, 2011				December 31, 2010
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	115,513	$	115,513	$	65,378	$	65,378
Investment securities		112,273		112,273		140,590		140,590
FHLB stock		1,910		1,910		1,757		1,757
Loans, net of allowance		376,419		372,183		387,405		382,854
Interest rate swap		188		188		459		459
Accrued interest receivable		1,469		1,469		1,640		1,640
Financial liabilities:
Deposits with no stated maturity	$	144,284	$	144,284	$	107,999	$	107,999
Deposits with stated maturities		277,228		278,067		299,821		300,393
Swap fair value hedge		491		491		569		569
Borrowings		28,108		27,365		27,769		26,913
Accrued interest payable		245		245		290		290

23

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record other assets at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include the use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government-sponsored entities, municipal bonds and corporate debt securities that are valued using quoted prices for similar instruments in active markets. Securities classified as Level 3 include a corporate debt security in a less liquid market whose value is determined by reference to the going rate of a similar debt security if it were to enter the market at period end. The derived market value requires significant management judgment and is further substantiated by discounted cash flow methodologies.

Derivative Instruments

Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company uses a third party to measure the fair value. The Company classifies derivatives instruments held or issued for risk management purposes as Level 2. As of March 31, 2011 and December 31, 2010, the Company’s derivative instruments consist of interest rate swaps and swap fair value hedges.

24

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Loans

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures it for the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, a loan’s observable market price and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value exceeds the recorded investments in such loans. Impaired loans where a specific allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price for the collateral, the Company records the impaired loan as nonrecurring Level 3.

At March 31, 2011 and December 31, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. The Company recorded the six loans involved in fair value hedges at fair market value on a recurring basis. The Company does not record other loans at fair value on a recurring basis.

Other real estate owned

Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is not an observable market price for the collateral, the Company records the OREO as nonrecurring Level 3.

25

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below presents, by level, the recorded amount of assets and liabilities at March 31, 2011 and December 31, 2010 measured at fair value on a recurring basis:

Fair Value on a Recurring Basis

	Quoted Prices in		Significant
	Active Markets for		Other				Significant
	Identical Assets		Observable Inputs				Unobservable Inputs		Assets/Liabilities
Description	(Level 1)		(Level 2)				(Level 3)		at Fair Value
	(Dollars in thousands)
March 31, 2011
U.S. Government agencies	$	—	$	10,418			$	—	$	10,418
Residential mortgage-backed securities		—		30,999				—		30,999
Collateralized agency mortgage obligations		—		53,526				—		53,526
Municipal securities		—		15,931				—		15,931
Debt Securities		—		—				353		353
Corporate and other Securities		—		1,046				—		1,046
Interest rate swap		—		188				—		188
Fair value loans		—		12,100				—		12,100
Swap fair value hedge		—		(491	)			—		(491	)
						��
December 31, 2010
U.S. Government agencies	$	—	$	13,160			$	—	$	13,160
Residential mortgage-backed securities		—		52,399				—		52,399
Collateralized agency mortgage obligations		—		58,719				—		58,719
Municipal securities		—		13,808				—		13,808
Debt Securities		—		—				350		350
Corporate and other Securities		—		2,154				—		2,154
Interest rate swap		—		459				—		459
Fair value loans		—		9,702				—		9,702
Swap fair value hedge		—		(569	)					(569	)

There were no transfers between valuation levels during the three months ended March 31, 2011.

The following are reconciliations of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months ended March 31, 2011 and March 31, 2010. The ending balances for Level 3 assets during the three months ended March 31, 2010 remained unchanged from December 31, 2009 at $0.4 million.

Level 3 Assets Reconciliation
(Dollars in thousands)

	Three Months Ended
	March 31,
	2011		2010
Debt Securities:
Balance, beginning of period	$	350	$	400
Decrease in unrealized loss		3		—
Balance, end of period	$	353	$	400

26

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

Assets Recorded at Fair Value on a Nonrecurring Basis

Assets measured at fair value on a nonrecurring basis at March 31, 2011 and December 31, 2010 are included in the table below by level:

Fair Value on a Nonrecurring Basis

	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable		Assets/
	Assets		Inputs		Inputs		(Liabilities)
Description	(Level 1)		(Level 2)		(Level 3)		at Fair Value
	(Dollars in thousands)
March 31, 2011
OREO	$	—	$	1,565	$	—	$	1,565
Impaired loans	$	—	$	—	$	25,832	$	25,832
December 31, 2010
OREO	$	—	$	1,246	$	—	$	1,246
Impaired loans	$	—	$	—	$	37,724	$	37,724

In accordance with accounting for foreclosed property, the carrying value of OREO is periodically reviewed and written down to fair value and any loss is included in earnings. During the three months ended March 31, 2011, OREO with a carrying value of $0.9 million was written down by $0.3 million to $0.6 million.

There were no transfers between valuation levels for any accounts for the quarter ended March 31, 2011. If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period that the accounts are valued.

Note 10 — Commitments and Contingencies

In the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit, which are not reflected in the accompanying unaudited condensed consolidated financial statements. At March 31, 2011, we had $11.5 million of loan commitments outstanding, $62.4 million of pre-approved but unused lines of credit and $2.9 million of standby letters of credit and financial guarantees. At December 31, 2010, we had $3.8 million of loan commitments outstanding, $69.6 million of pre-approved but unused lines of credit and $2.9 million of standby letters of credit and financial guarantees. In management’s opinion, these commitments represent no more than normal lending risk to us and will be funded from normal sources of liquidity.

As of March 31, 2011 and December 31, 2010, the Company has a commitment to fund $0.6 million related to an agreement with the Small Business Investment Corporation.

27

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains, and Park Sterling Corporation (the “Company”) and its management may make, certain statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “may,” “plan,” “contemplate,” “anticipate,” “believe,” “intend,” “continue,” “expect,” “project,” “predict,” “estimate,” “could,” “should,” “would,” “will,” “goal,” “target” and similar expressions. The forward-looking statements express management’s current expectations, plans or forecasts of future events, results and condition, including expectations regarding the proposed merger with Community Capital, the general business strategy of engaging in bank mergers, organic growth and anticipated asset size, additional branch openings, refinement of the loan loss allowance methodology, recruiting of key leadership positions, decreases in construction and development loans and other changes in loan mix, changes in deposit mix, capital and liquidity levels, net interest income, credit trends and conditions, including loan losses, allowance, charge-offs, delinquency trends and nonperforming loan and asset levels, and other similar matters. These statements are not guarantees of future results or performance and by their nature involve certain risks and uncertainties that are based on management’s beliefs and assumptions and on the information available to management at the time that these disclosures were prepared. Actual outcomes and results may differ materially from those expressed in, or implied by, any of these forward-looking statements.

You should not place undue reliance on any forward-looking statement and should consider all of the following uncertainties and risks, as well as those more fully discussed in the 2010 Form 10-K and in any of the Company’s subsequent filings with the SEC: inability to obtain regulatory approvals of the Community Capital merger on the proposed terms and schedule; failure of Community Capital’s shareholders to approve the merger; failure to realize synergies and other financial benefits from the proposed Community Capital merger within the expected time frame; increases in expected costs or difficulties related to integration of the Community Capital merger; fluctuation in the trading price of the Company’s stock prior to the closing of the proposed Community Capital merger, which would affect the total value of the proposed merger transaction; inability to successfully open new branches or loan production offices, including the Company’s inability to attract and maintain customers; inability to identify and successfully negotiate and complete additional combinations with potential merger partners or to successfully integrate such businesses into the Company, including the Company’s ability to realize the benefits and cost savings from and limit any unexpected liabilities acquired as a result of any such business combination; the effects of negative economic conditions, including stress in the commercial real estate markets or delay or failure of recovery in the residential real estate markets; changes in consumer and investor confidence and the related impact on financial markets and institutions; changes in interest rates; failure of assumptions underlying the establishment of our allowance; deterioration in the credit quality of our loan portfolios or in the value of the collateral securing those loans; deterioration in the value of securities held in our investment securities portfolio; legal and regulatory developments; increased competition from both banks and nonbanks; changes in accounting standards, rules and interpretations, inaccurate estimates or assumptions in accounting and the impact on the Company’s financial statements; the Company’s ability to attract new employees; and management’s ability to effectively manage credit risk, market risk, operational risk, legal risk, and regulatory and compliance risk.

Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update any forward-looking statement to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made.

28

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

The purpose of this discussion and analysis is to focus on significant changes in our financial condition as of and results of operations during the three month period ended March 31, 2011. This discussion and analysis highlights and supplements information contained elsewhere in this Quarterly Report on Form 10-Q, particularly the preceding unaudited condensed consolidated financial statements and accompanying notes.

Overview

The Company was formed on October 6, 2010 to serve as the holding company for the Bank and is a bank holding company registered with the Federal Reserve Board under the BHC Act. At present, the Company’s primary operations and business are that of owning the Bank, its sole subsidiary. The Company’s offices are located at 1043 E. Morehead Street, Suite 201, Charlotte, North Carolina, 28204 and its phone number is (704) 716-2134.

The Bank was incorporated on September 8, 2006 as a North Carolina-chartered commercial bank and is the wholly-owned subsidiary of the Company. The Bank opened for business on October 25, 2006 at 1043 E. Morehead Street, Suite 201, Charlotte, North Carolina. The Bank opened a branch in Wilmington, North Carolina, in October 2007 and in the SouthPark neighborhood of Charlotte in July 2008, and received approval from the NC Commissioner in March 2011 to open a branch in Charleston, South Carolina. The Bank currently anticipates that it will open additional branch offices and/or loan production offices in its target markets this year.

On January 1, 2011, the Company acquired all of the outstanding common stock of the Bank in the Reorganization, which was effected under North Carolina law and in accordance with the terms of an Agreement and Plan of Reorganization and Share Exchange dated October 22, 2010. This agreement and the Reorganization were approved by the Bank’s shareholders at a special meeting of the Bank’s shareholders held on November 23, 2010. Pursuant to the Reorganization, shares of the Bank’s common stock were exchanged for shares of the Company’s common stock on a one-for-one basis. As a result, the Bank became the sole subsidiary of the Company, the Company became the holding company for the Bank and the shareholders of the Bank became shareholders of the Company. The unaudited condensed consolidated financial statements, discussions of those statements, market data and all other operating data presented herein for periods prior to January 1, 2011 are those of the Bank on a stand-alone basis.

In August 2010, the Bank conducted the Public Offering, which raised gross proceeds of $150.2 million to facilitate a change in its business plan from primarily organic growth at a moderate pace over the next few years to seeking to acquire regional and community banks in the Carolinas and Virginia. The Company intends to become a regional-sized multi-state banking franchise through acquisitions and organic growth, seeking to reach a consolidated asset size of between $8 billion and $10 billion over the next several years. The Company is committed to building a banking franchise that is noted for sound risk management, superior client service and exceptional client relationships.

As part of the Bank’s change in strategy, immediately following the Public Offering, the Bank reduced the size of its board of directors from thirteen members to six members, maintaining two of the sitting directors, Larry W. Carroll and Thomas B. Henson, and adding four new directors, Walter C. Ayers, Leslie M. (Bud) Baker, James C. Cherry and Jeffrey S. Kane. Mr. Baker was named Chairman of the board of directors upon becoming a member. In March 2011, the board of directors of the Company, which mirrors that of the Bank, approved expanding its membership to seven and appointed Jean E. Davis as a director.

The Bank also reorganized its management team following the Public Offering. The new executive management team includes James C. Cherry, who became the Chief Executive Officer; David L. Gaines, who became the Chief Financial Officer; Nancy J. Foster, who became the Chief Risk Officer; and Bryan F. Kennedy, III, who was the President and Chief Executive Officer and remains the President.

29

As part of its operations, the Company regularly evaluates the potential acquisition of, and holds discussions with, various financial institutions eligible for bank holding company ownership or control. As a rule, the Company expects to publicly announce material transactions when a definitive agreement has been reached.

On March 30, 2011, the Company and Community Capital entered into an Agreement and Plan of Merger, pursuant to which Community Capital will be merged with and into the Company, with the Company as the surviving entity. The merger has been unanimously approved by the board of directors of each company and is subject to customary closing conditions, including regulatory approval and Community Capital shareholder approval. If the merger is completed, each outstanding share of Community Capital common stock will be exchanged for either 0.6667 of a share of Company common stock or $3.30 in cash, subject to the limitation that the total consideration will consist of 40.0% in cash and 60.0% in shares of Company common stock. As of March 31, 2011, Community Capital, which is headquartered in Greenwood, South Carolina, had $649.1 million in assets and operated 17 full service branches and one drive-through facility throughout South Carolina. For additional information, please see the Company’s Current Report on Form 8-K filed on March 31, 2011.

The Company provides banking services to small and mid-sized businesses, owner-occupied and income producing real estate owners, real estate developers and builders, professionals and consumers doing business or residing within its target markets. Through its branches, the Bank provides a wide range of banking products, including personal and business checking accounts, individual retirement accounts, business and personal money market accounts, certificates of deposit, overdraft protection, safe deposit boxes and online banking. The Company’s lending activities include a range of short to medium-term commercial, real estate, residential mortgage and home equity and personal loans. Its objective since inception has been to provide the strength and product diversity of a larger bank and the service and relationship attention that characterizes a community bank. The Company strives to develop a personal relationship with its clients while at the same time offering traditional deposit and loan banking services.

Our primary market area consists of the Charlotte and Wilmington, North Carolina metropolitan statistical areas (“MSAs”). The Charlotte-Gastonia-Concord MSA consists of five counties in North Carolina (Anson, Cabarrus, Gaston, Mecklenburg and Union) and one county in South Carolina (York). The Wilmington MSA consists of New Hanover, Brunswick, and Pender counties in Southeast North Carolina.

Commercial banking in the Charlotte and Wilmington markets and in the Carolinas and Virginia generally is extremely competitive. We compete for deposits in our banking markets with other commercial banks, savings banks and other thrift institutions, credit unions, brokerage firms and all other organizations and institutions engaged in money market transactions. In our lending activities, the Company competes with all other financial institutions, as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit.

Interest rates, both on loans and deposits, and prices of fee-based services, are significant competitive factors among financial institutions. Other important competitive factors include office location, office hours, the quality of customer service, community reputation, continuity of personnel and services, and in the case of larger commercial customers, relative lending limits and the ability to offer sophisticated cash management and other commercial banking services. Many of our competitors have greater resources, broader geographic markets and higher lending limits. To counter these competitive disadvantages, we depend on our reputation as a community bank in our local markets, our direct customer contact, our ability to make credit and other business decisions locally, and personalized customer service.

30

Recent Accounting Pronouncements

See Note 2 to the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

Critical Accounting Policies and Estimates

In the preparation of our financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and in accordance with general practices within the banking industry. Our significant accounting policies are described in the notes to the 2010 Audited Financial Statements.

Certain accounting policies involve significant judgment and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and assumptions that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

We believe our critical accounting policies and estimates include the allowance for loan losses and the fair value of financial instruments and other accounts. Based on management’s calculation, an allowance of $11.8 million, or 3.03% of total loans, net of unearned interest, was an adequate estimate of potential losses within the loan portfolio at March 31, 2011. If the mix and amount of future charge-off percentages differ significantly from those assumptions used by management in making its determination, the allowance for loan losses and provision for loan losses on the income statement could be significantly affected and could have a material adverse impact on our results of operations and financial condition.

Financial Condition at March 31, 2011 and December 31, 2010

Total assets grew by $12.3 million, or 2.0%, from $616.1 million at December 31, 2010 to $628.4 million at March 31, 2011. At March 31, 2011, interest-earning assets were $561.8 million, which included $388.2 million in gross loans, $112.3 million in investment securities available-for-sale, $57.5 million in overnight investments and $3.8 million in interest-bearing deposits in other banks. Interest-earning assets at December 31, 2010 totaled $603.3 million and consisted of $399.8 million in gross loans, $140.6 million in investment securities available-for-sale, $57.9 million in overnight investments and $5.0 million in interest-bearing deposits in other banks.

Shareholders’ equity equaled $174.8 million at March 31, 2011 compared to $177.1 million at December 31, 2010. This decrease of $2.3 million was a result of the first quarter loss of $2.9 million offset by a $0.1 million decrease, net of taxes, in accumulated other comprehensive loss relating to unrealized gains on investments available-for-sale and swaps and $0.5 million of additional paid in capital relating to the share-based compensation expense.

The following table reflects selected ratios for the Company for the three months ended March 31, 2011 and 2010:

Selected Ratios

	Three months ended
	March 31,
	(annualized and unaudited)						At December 31,
	2011			2010			2010*
Return on Average Assets		-1.93	%		0.13	%		-2.81	%
Return on Average Equity		-6.60	%		1.36	%		-9.75	%
Period End Equity to Total Assets		27.81	%		9.77	%		28.75	%

* Derived from audited financial statements.

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Loans

At March 31, 2011, total loans were $388.2 million compared to $399.8 million at December 31, 2010. This decrease included a $13.9 million reduction in the construction and development portfolio, consistent with our general intention to reduce residential construction and development exposure in our portfolio.

Substantially all of our loans are to clients in our immediate markets. In the Charlotte market, we have a diversified mix of commercial real estate, owner-occupied commercial real estate, commercial and small business loans, and a significant portfolio of home equity lines of credit. Our Wilmington operation has a heavier concentration of real estate related loans with a smaller proportion of construction and development loans than Charlotte. Wilmington, like most coastal markets, is heavily dependent on real estate and tourism to drive its economy. We believe we are not dependent on any single customer or group of customers whose insolvency would have a material adverse effect on our financial condition or results of operations.

Asset Quality and Allowance for Loan Losses

Due to unprecedented asset quality challenges and the global economic recession, the U.S. banking industry has been experiencing significant financial challenges. Our senior management works closely with credit administration, third-party credit review specialists, and lending staff to ensure that adequate resources are in place to proactively manage through the current slowdown in the real estate market and overall economy. When a problem is identified, management is committed to assessing the situation and moving quickly to minimize losses, while being sensitive to the borrower’s effectiveness as an operator, the long-term viability of the business or project and the borrower’s commitment to working with the Company to achieve an acceptable resolution of the credit.

We consider asset quality to be of primary importance, and employ a formal internal loan review process to ensure adherence to the lending policy as approved by our board of directors. It is the responsibility of each loan officer to assign an appropriate risk grade to loans when originated. Our credit administration function, through the loan review process with periodic assistance from third party credit review specialists, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality changes, it is the responsibility of our credit administration department to change the borrower’s risk grade accordingly. The process of determining the allowance for loan losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses, and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to historical loan loss experience, the value and adequacy of collateral, economic conditions in our market areas and other factors. During the third quarter of 2010, the Company introduced refinements to its loan loss allowance methodology. The principal change was the addition of a more comprehensive qualitative component, which evaluates six environmental factors, including portfolio trends, portfolio concentrations, general economic and market trends, changes in lending practices, regulatory environment and other factors. These refinements are intended to help management recognize expected losses that may not be identified through the quantitative analysis of our historical loss experience. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses represents management’s estimate of the appropriate level of reserve to provide for the risk inherent in our loan portfolio.

Our policy regarding past due loans normally requires a nonaccrual at 90 days past due. Charge-off to the allowance for loan losses may ensue following timely collection efforts and a thorough review of payment sources. Further efforts are then pursued through various means available. Loans carried in a nonaccrual status are generally secured by collateral, which is considered in the determination of the allowance for loan losses, through the impaired loan process.

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The allowance for loan losses as a percentage of total loans increased to 3.03% at March 31, 2011 from 2.12% at March 31, 2010. The increase related to a refinement in allowance methodology to incorporate a more comprehensive qualitative component, the effects of extended economic weakness on portfolio trends, and specific reserves related to impaired loans. The allowance for loan losses as a percentage of total loans decreased from 3.11% at December 31, 2010, due to the recognition of loss on loans. We had net charge-offs of $5.1 million in the first three months of 2011 compared to $0.6 million in the same period of 2010 and $8.9 million for the three months ended December 31, 2010.

Nonperforming Assets

Nonperforming assets, which consist of accruing loans for which payments are 90 days or more past due, accruing troubled debt restructurings (“TDRs”), nonaccrual loans, and OREO decreased $6.6 million, or 15.1%, to $36.8 million at March 31, 2011 from $43.4 million at December 31, 2010.

There were no loans past due 90 days or more and still accruing interest at March 31, 2011 and December 31, 2010. Loans past due 90 days or more and still accruing interest totaled $0.6 million at March 31, 2010. Accruing TDRs totaled $1.2 million at March 31, 2011 and December 31, 2010, compared to $2.8 million at March 31, 2010.

Nonaccrual loans were $34.0 million at March 31, 2011, a decrease of $6.9 million, or 16.9%, from nonaccrual loans of $40.9 million at December 31, 2010. These nonaccrual loans consisted primarily of loans involving acquisition, construction and development activity, which totaled $28.3 million, or 83.2%, of total nonaccrual loans at March 31, 2011 compared to $35.0 million, or 85.5%, of total nonaccrual loans at December 31, 2010. Nonaccrual loans increased significantly in 2010 compared to prior years as a result of the negative impact on our loan portfolio from increased unemployment, the slow-down in housing, depressed real estate values in our markets, and other similar factors. At March 31, 2010, nonaccrual loans were $1.7 million.

We grade loans with a risk grade scale of 1-9, with grades 1-5 representing pass credits, and grades 6, 7, 8, and 9 representing “special mention,” “substandard,” “doubtful,” and “loss” credit grades, respectively. Loans are reviewed on a regular basis internally and at least annually by an external loan review group to ensure loans are graded appropriately. Credits are reviewed for past due trends, declining cash flows, significant decline in collateral value, weakened guarantor financial strength, management concerns, market conditions, and other factors that could jeopardize the repayment performance of the loan. Documentation deficiencies, to include collateral perfection and outdated or inadequate financial information, are also considered in grading loans.

All loans graded 6 or worse, as well as those graded 5 and with a balance of $250 thousand or more, are included on our list of “watch loans”, which is updated and reported to both the management and Board of Directors committees and the full board of directors on a monthly basis. Additionally, other loans with more favorable ratings may be placed on the watch list if there are concerns that the loan may become a problem in the future. Impairment analysis has been performed on all loans graded “substandard” and selected other loans as deemed appropriate. At March 31, 2011, we maintained “watch loans” totaling $108.1 million compared to $102.9 million at December 31, 2010. Currently all loans on our watch list carry a risk grade of 6 or worse. The future level of watch loans cannot be predicted, but rather will be determined by several factors, including overall economic conditions in the markets served.

At March 31, 2011, OREO totaled $1.6 million, which represented two residential lots, six residential properties and one nonresidential property, all of which are recorded at values based on our most recent appraisals. At December 31, 2010, OREO was $1.2 million. All OREO properties have been written down to their respective fair values.

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Investments and Other Interest-earning Assets

Investment securities were $112.3 million at March 31, 2011. This was a $28.3 million decrease from the $140.6 million balance at December 31, 2010 and is a result of the sale of $24.4 million of securities available for sale related to the upstream of capital from the Bank to the Company as well as to normal amortization of residential mortgage-backed securities. Our investment portfolio consists of U.S. government agency securities, residential mortgage-backed securities, municipal securities and other debt instruments. At the end of the first quarter of 2011, our portfolio had a net unrealized loss of $1.5 million compared to a $2.0 million net unrealized loss at December 31, 2010. We have no securities with an unrealized loss deemed to be other than temporary at March 31, 2011. In addition, there were no securities with an unrealized loss deemed to be other than temporary at December 31, 2010.

At March 31, 2011, we had $57.5 million in federal funds sold, and $3.8 million in interest-bearing deposits with other FDIC-insured financial institutions. This compares with $57.9 million in federal funds and $5.0 million in interest-bearing deposits at other FDIC-insured financial institutions at December 31, 2010.

Deposits and Other Borrowings

Total deposits increased by $13.7 million, or 3.4%, from December 31, 2010 to March 31, 2011. Core deposits (excluding brokered time deposits) increased $28.0 million, or 15.0%, while brokered time deposits decreased by $5.1 million, or 4.8%. The increase in core deposits resulted from a continued effort by management to obtain additional deposits from existing relationships and shareholders along with targeted calling efforts by associates and board members.

Borrowed funds totaled $28.1 million at March 31, 2011, compared to $28.0 million at December 31, 2010.

Results of Operations

Comparison of Results of Operations for the Three Months Ended March 31, 2011 and March 31, 2010

The following table summarizes components of income and expense and the changes in those components for the three months ended March 31, 2011 and 2010:

Condensed Consolidated Statements of Income (Loss)

	Three Months Ended
	March 31,
	2011			2010		Change
	(Unaudited)					$			%
	(Dollars in thousands)
Gross interest income	$	5,654		$	5,651	$	3			0.1	%
Gross interest expense		1,698			1,900		(202	)		-10.6	%
Net interest income		3,956			3,751		205			5.5	%
Provision for loan losses		4,462			1,531		2,931			191.4	%
Noninterest income		72			38		34			89.5	%
Noninterest expense		4,234			2,042		2,192			107.3	%
Net income (loss) before taxes		(4,668	)		216		(4,884	)		-2261.1	%
Income tax expense (benefit)		(1,781	)		59		(1,840	)		-3118.6	%
Net income (loss)	$	(2,887	)	$	157	$	(3,044	)		-1938.9	%

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Net Income (Loss). The net loss for the three months ended March 31, 2011 was $2.9 million compared to net income of $0.2 million for the same period in 2010. This decrease of $3.0 million resulted primarily from a $2.9 million increase in provision for loan losses and an increase in noninterest expense of $2.2 million, partially offset by a $1.8 million tax benefit. Annualized return on average assets decreased during the three-month period ended March 31, 2011 to (1.93)% from .13% for the same period ended March 31, 2010. Annualized return on average equity also decreased from 1.36% for the three-month period ended March 31, 2010 to (6.60)% for the same period in 2011.

Net Interest Income. Our largest source of earnings is net interest income, which is the difference between interest income on interest-earning assets and interest paid on deposits and other interest-bearing liabilities. The primary factors that affect net interest income are changes in volume and yields of earning assets and interest-bearing liabilities, which are affected, in part, by management’s responses to changes in interest rates through asset/liability management. During the three-month period ended March 31, 2011, net interest income was $4.0 million as compared to $3.8 million in 2010, an increase of $0.2 million, or 5.5%.

Total average interest-earning assets increased by $134.5 million, or 29.5%, to $590.5 million for the three months ended March 31, 2011 from $456.0 million for the same period in the previous year. We experienced growth in the average balances of interest-earning assets, specifically federal funds sold and investment securities available-for-sale, due to the investment of the net proceeds from the Public Offering. The average balance of federal funds sold increased $37.5 million along with an increase in average balance of investment securities available-for-sale of $93.6 million.

Average balances of total interest-bearing liabilities decreased in the first three months of 2011, with average total interest-bearing deposit balances decreasing by $1.5 million, or 0.4%, to $364.3 million in 2011 from $365.8 million for the same period in 2010. Average brokered deposits declined by $31.3 million from the previous year as management reduced the Company’s wholesale funding. This decline in brokered deposits was more than offset by an increase in other average deposits of $41.0 million in the first three months of 2011 as compared to the same period in 2010. This increase in other average deposits includes an increase in average noninterest-bearing deposits of $11.1 million, or 43.0%, to $37.0 million at March 31, 2011. Our net interest margin decreased from 3.29% in the three-month period ended March 31, 2010 to 2.68% in the same period in 2011 as a result of lower yields on investments and the loss of income on nonaccrual loans. Interest paid on funding sources for the three months ended March 31, 2011 totaled $1.7 million, reflecting a 1.73% cost of interest-bearing liabilities. For the same period in 2010, interest of $1.9 million was paid at a cost of interest-bearing liabilities of 1.90%.

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The following tables summarize net interest income and average yields and rates paid for the periods indicated:

Average Balance Sheets and Net Interest Analysis

	For the Three Months Ended March 31,
	2011								2010
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
	(Dollars in thousands)
Assets
Interest-earning assets:
Loans, including fees (1)	$	397,066		$	4,758		4.79	%	$	395,441		$	5,143		5.20	%
Federal funds sold		52,726			30		0.23	%		15,267			9		0.24	%
Taxable investment securities		121,424			681		2.24	%		28,441			326		4.58	%
Tax-exempt investment securities		14,698			171		4.65	%		14,082			160		4.54	%
Other interest-earning assets		4,572			14		1.22	%		2,759			13		1.88	%
Total interest-earning assets		590,486			5,654		3.83	%		455,990			5,651		4.96	%
Allowance for loan losses		(12,343	)							(7,686	)
Cash and due from banks		8,530								7,683
Premises and equipment		4,474								4,641
Other assets		18,829								12,468
Total assets	$	609,976							$	473,096
Liabilities and stockholders’ equity
Interest-bearing liabilities:
Interest-bearing demand	$	55,393		$	3		0.02	%	$	36,609		$	2		0.02	%
Savings and money market		24,778			138		2.23	%		11,659			81		2.78	%
Time deposits — core		182,405			739		1.62	%		184,487			935		2.03	%
Time deposits — brokered		101,696			487		1.92	%		133,028			549		1.65	%
Total interest-bearing deposits		364,272			1,367		1.50	%		365,783			1,567		1.71	%
Federal Home Loan Bank advances		20,000			141		2.82	%		25,000			143		2.29	%
Other borrowings		8,029			190		9.47	%		9,108			190		8.34	%
Total borrowed funds		28,029			331		4.72	%		34,108			333		3.91	%
Total interest-bearing liabilities		392,301			1,698		1.73	%		399,891			1,900		1.90	%
Net interest rate spread					3,956		2.10	%					3,751		3.06	%
Noninterest-bearing demand deposits		37,048								25,904
Other liabilities		3,612								572
Stockholders’ equity		177,015								46,729
Total liabilities and stockholders’ equity	$	609,976							$	473,096
Net interest margin							2.68	%							3.29	%

(1) Average loan balances include nonaccrual loans.

Provision for Loan Losses. Our provision for loan losses increased $2.9 million, or 191.4%, to $4.5 million during the three months ended March 31, 2011, from $1.5 million during the corresponding period in 2010. The increase in the provision resulted from the credit deterioration due to the continuing softening economy, significant decline in real estate values and a refinement to our allowance for loan loss methodology, which introduced a more comprehensive qualitative component. We had $5.2 million in net charge-offs during the first three months of 2011, compared to $0.6 million during the corresponding period in 2010. Nonperforming loans to total assets were 5.61% at March 31, 2011, compared to 0.95% at March 31, 2010.

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The ratio of the allowance for loan losses to total loans was 3.03% and 2.12% at March 31, 2011 and 2010, respectively. Management periodically evaluates our credit policies and procedures to confirm that they effectively manage risk and facilitate appropriate internal controls.

Noninterest Income. Noninterest income has not historically been a major component of our earnings. We have a minimal amount of noninterest income from service charges. Noninterest income increased from $38 thousand for the three months ended March 31, 2010 to $72 thousand for the same period in 2011. The growth in non-interest income was primarily related to gains on the sale of OREO totaling $24,000 and on sale of securities available for sale totaling $19,000.

Noninterest Expense. The level of noninterest expense substantially affects our profitability. Total noninterest expense was $4.2 million for the three months ended March 31, 2011 compared to $2.0 million for the same period in 2010. The increase of $2.2 million, or 107.4%, in the three months ended March 31, 2011 compared to 2010 includes an increase in salaries and benefits in the amount of $1.3 million as a result of an increase in full time equivalent employees (“FTEs”), reflecting our change in strategy. We employed 67 FTEs at March 31, 2011 compared to 46 at March 31, 2010. Additionally, OREO expense increased $0.2 million due to additional write-downs on properties, legal and professional fees increased by $0.2 million as a result of the Company becoming a public entity, and FDIC insurance and director fees increased.

The following table presents components of noninterest expense for the three months ended March 31, 2011 and 2010:

Noninterest Expense

	Three months ended
	March 31,
	2011		2010		Change
	(Unaudited)				$			%
	(Dollars in thousands)
Salaries and benefits	$	2,507	$	1,252	$	1,255			100.2	%
Occupancy and equipment		256		206		50			24.3	%
Advertising and promotion		38		57		(19	)		-33.3	%
Legal and professional fees		307		76		231			303.9	%
Deposit charges and FDIC insurance		287		176		111			63.1	%
Data processing and outside service fees		123		93		30			32.3	%
Directors fees		41		—		41			100.0	%
Other real estate owned expense		235		36		199			552.8	%
Other expenses		440		146		294			201.4	%
Total noninterest expense	$	4,234	$	2,042	$	2,192			107.3	%

Income Taxes. We generate significant amounts of non-taxable income from tax-exempt investment securities. Accordingly, the level of such income in relation to income before taxes significantly affects our effective tax rate. For the three months ended March 31, 2011, we recognized an income tax benefit of $1.8 million compared to an income tax expense of $0.06 million for the same period in 2010. The effective tax rate for the three months ended March 31, 2011 is 38.20% compared to 27.30% for the same period in 2010. The change in the effective tax rate was due to the amount of tax- exempt income relative to the size of pre-tax income. A tax benefit is recorded if non-taxable income exceeds income before taxes, resulting in a reduction of total income subject to income taxes.

37

In evaluating whether we will realize the full benefit of our net deferred tax asset, we considered projected earnings, asset quality, liquidity, capital position, which will enable us to deploy capital to generate taxable income, growth plans, etc. In addition, we also considered the previous twelve quarters of income (loss) before income taxes in determining the need for a valuation allowance, which is called the cumulative loss test. In the first quarter of 2011 and for the year ended 2010, we incurred a loss, primarily as a result of the increased provision for loan losses, which resulted in the failure of the cumulative loss test. Significant negative trends in credit quality, losses from operations, etc. could impact the realizability of the deferred tax asset in the future. After considering the above factors, both positive and negative, management believes that our deferred assets are more likely than not to be realized.

Liquidity and Capital Resources

Liquidity refers to the ability to manage future cash flows to meet the needs of depositors and borrowers and to fund operations. Management strives to maintain sufficient liquidity to fund future loan demand and to satisfy fluctuations in deposit levels. This is achieved primarily in the form of available lines of credit from various correspondent banks, the FHLB, the Federal Reserve Discount Window, and through an investment portfolio. In addition, we occasionally have short-term investments at our primary correspondent bank in the form of federal funds sold. Liquidity is governed by a board of directors approved Asset Liability Policy, administered by an internal Senior Management Risk Committee. The Committee reports on a monthly basis asset/liability related matters to the Board of Directors Loan and Risk Committee.

Our internal liquidity ratio was 49.2% at March 31, 2011 compared to 50.5% at December 31, 2010, in each case exceeding our minimum internal target of 10%. In addition, at March 31, 2011, we had an additional $20.1 million of credit available from the FHLB, $43.8 million from the Federal Reserve Discount Window, and available lines of credit totaling $70.0 million from correspondent banks.

At March 31, 2011, we had $11.5 million of loan commitments outstanding and had pre-approved but unused lines of credit totaling $76.8 million. In management’s opinion, these commitments represent no more than normal lending risk to the Company and will be funded from normal sources of liquidity. At December 31, 2010, we had $3.8 million of loan commitments outstanding, $69.6 million of pre-approved but unused lines of credit and $2.9 million of standby letters of credit and financial guarantees.

Our capital position is reflected in our shareholders’ equity, subject to certain adjustments for regulatory purposes. Shareholders’ equity, or capital, is a measure of our net worth, soundness and viability. Shareholders’ equity on March 31, 2011 was $174.8 million compared to the December 31, 2010 balance of $177.1 million. In August 2010, we completed our public offering of 23,100,000 shares of common stock at an initial purchase price of $6.50 per share for an aggregate offering price of approximately $150.2 million. As a result of the offering, we received net proceeds of approximately $140.2 million, after $9.0 million in underwriting fees, including the $3.0 million in contingent fees (described in Note 3 to the unaudited condensed consolidated financial statements included in this Form 10-Q), and approximately $0.9 million in related expenses. Remaining proceeds have been invested in accordance with the Company’s investment policies.

Risk based capital regulations adopted by the FDIC require banks to achieve and maintain specified ratios of capital to risk weighted assets. The risk based capital rules are designed to measure “Tier 1” capital (consisting of common equity, retained earnings and a limited amount of qualifying perpetual preferred stock and trust preferred securities, net of goodwill and other intangible assets and accumulated other comprehensive income) and total capital in relation to the credit risk of both on- and off-balance sheet items. Under the guidelines, one of four risk weights is applied to the different on-balance sheet items. Off-balance sheet items, such as loan commitments, are also subject to risk weighting after conversion to balance sheet equivalent amounts. All banks must maintain a minimum total capital to total risk weighted assets ratio of 8.00%, at least half of which must be in the form of core, or Tier 1, capital. These guidelines also specify that banks that are experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels. At March 31, 2011, we satisfied the respective minimum regulatory capital requirements, and we were “well capitalized” within the meaning of federal regulatory requirements. Our risk-weighted assets at March 31, 2011 and December 31, 2010 were $411.7 million and $431.3 million, respectively. Actual capital levels and minimum levels at March 31, 2011 and December 31, 2010 were:

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Capital Ratios

											To Be Well
						For Capital					Capitalized Under
						Adequacy					Prompt Corrective
	Actual					Purposes					Actions Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
Park Sterling Corporation
March 31, 2011
Total Risk-Based Capital Ratio	$	182,243		44.27	%	$	32,935		8.00	%	$	41,169		10.00	%
Tier 1 Capital Ratio		170,120		41.32	%		16,468		4.00	%		24,701		6.00	%
Tier 1 Leverage Ratio		170,120		28.14	%		24,180		4.00	%		30,225		5.00	%
December 31, 2010
Total Risk-Based Capital Ratio	$	185,768		43.06	%	$	34,035		8.00	%	$	42,543		10.00	%
Tier 1 Capital Ratio		173,395		40.20	%		17,017		4.00	%		25,525		6.00	%
Tier 1 Leverage Ratio		173,395		27.39	%		22,227		4.00	%		27,784		5.00	%
Park Sterling Bank
March 31, 2011
Total Risk-Based Capital Ratio	$	106,280		25.74	%	$	33,037		8.00	%	$	41,297		10.00	%
Tier 1 Capital Ratio		94,141		22.80	%		16,519		4.00	%		24,778		6.00	%
Tier 1 Leverage Ratio		94,141		15.78	%		23,862		4.00	%		29,828		5.00	%
December 31, 2010
Total Risk-Based Capital Ratio	$	185,768		43.06	%	$	34,035		8.00	%	$	42,543		10.00	%
Tier 1 Capital Ratio		173,395		40.20	%		17,017		4.00	%		25,525		6.00	%
Tier 1 Leverage Ratio		173,395		27.39	%		22,227		4.00	%		27,784		5.00	%

The Company has committed to our regulators to maintain a Tier 1 Leverage Ratio of at least 10.00% for the three years following the Public Offering.

Disclosure of Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

In the ordinary course of operations, we enter into certain contractual obligations. Such obligations include the funding of operations through debt issuances as well as leases for premises and equipment.

Information about our off-balance sheet risk exposure is presented in Note K of the 2010 Audited Financial Statements. As part of ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities (SPEs), which generally are established for facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of March 31, 2011, we were not involved in any unconsolidated SPE transactions.

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Interest Rate Sensitivity

Our Asset Liability Committee (“ALCO”) actively measures and manages interest rate risk using a process developed by the Company. The Committee is also responsible for approving our asset/liability management policies, overseeing the formulation and implementation of strategies to improve balance sheet positioning and earnings, and reviewing our interest rate sensitivity position.

The primary tool that management uses to measure short-term interest rate risk is a net interest income simulation model prepared by an independent correspondent bank. These simulations estimate the impact that various changes in the overall level of interest rates over a one- and two- year time horizon would have on net interest income. The results help us develop strategies for managing exposure to interest rate risk.

Like any forecasting technique, interest rate simulation modeling is based on a large number of assumptions. In this case, the assumptions relate primarily to loan and deposit growth, asset and liability prepayments, interest rates and balance sheet management strategies. Management believes that both individually and taken together the assumptions are reasonable. Nevertheless, the simulation modeling process produces only a sophisticated estimate, not a precise calculation of exposure. In addition, the overall interest rate risk management process is subject to annual review by an outside professional services firm to ascertain its effectiveness as required by federal regulations.

Our current guidelines for risk management call for preventive measures if a 300 basis point shock or immediate increase or decrease in short term rates over the next 12 months would affect net interest income over the same period by more than 30.0%. We currently are operating well within these guidelines. As of March 31, 2011, based on the results of the simulation model, we could expect net interest income to decrease by approximately 7.1% over 12 months if short-term interest rates immediately decreased by 300 basis points, which is unlikely based on current rate levels. If short-term interest rates increased by 300 basis points, net interest income could be expected to increase by approximately 6.5% over 12 months. At December 31, 2010, the simulation model results showed that we could expect net interest income to decrease by approximately 4.8% over 12 months if short-term interest rates decreased by 300 basis points, and if short-term interest rates increased by 300 basis points, net interest income could be expected to increase by approximately 6.6% over 12 months.

We use multiple interest rate swap agreements, accounted for as either cash flow or fair value hedges, as part of the management of interest rate risk. At March 31, 2011, we had an interest rate swap, accounted for as a cash flow hedge, with a notional amount of $40.0 million that was purchased on May 16, 2008 to protect the Company from falling rates. We receive 6.22% fixed for a period of three years, and pay prime rate for the same period, currently at 3.25%. During the three months ended March 31, 2011 and 2010, we recorded $0.3 million of income from this instrument. The unrealized gain on this instrument at December 31, 2010 was $0.3 million.

During the year ended December 31, 2008, we entered into five loan swaps accounted for as fair value hedges. The total original notional amount of these swaps was $11.2 million. These derivative instruments are used to protect the Company from interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. These derivative instruments are carried at a fair market value of $0.5 million at March 31, 2011. We recorded interest expense on these loan swaps of $0.1 million for the three months ended March 31, 2011 and 2010.

For cash flow hedges, we use the dollar-offset method for assessing effectiveness using the cumulative approach. The dollar-offset method compares the dollar amount of the change in anticipated future cash flows of the hedging instrument with the dollar amount of the changes in anticipated future cash flows of the risk being hedged over the assessment period. The cumulative approach involves comparing the cumulative changes in the hedging instrument’s anticipated future cash flows to the cumulative changes in the hedged transaction’s anticipated future cash flows. Because the floating index and reset dates are based on identical terms, management believes that the hedge relationship of the cumulative changes in expected future cash flow from the hedging derivative and the cumulative changes in expected interest cash flows from the hedged exposure will be highly effective.

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Consistent with the risk management objective and the hedge accounting designation, management measures the degree of hedge effectiveness by comparing the cumulative change in anticipated interest cash flows from the hedged exposure over the hedging period to the cumulative change in anticipated cash flows from the hedging derivative. Any difference between these two measures will be deemed hedge ineffectiveness and recorded in current earnings. Management utilizes the “Hypothetical Derivative Method” to compute the cumulative change in anticipated interest cash flows from the hedged exposure. To the extent that the cumulative change in anticipated cash flows from the hedging derivative offsets from 80% to 125% of the cumulative change in anticipated interest cash flows from the hedged exposure, the hedge is deemed effective.

For fair value hedges, Accounting Standards Codification (“ASC”) Topic 815 requires that the method selected for assessing hedge effectiveness must be reasonable, be defined at the inception of the hedging relationship and be applied consistently throughout the hedging relationship. We use the dollar-offset method for assessing effectiveness using the cumulative approach. The dollar-offset method compares the fair value of the hedging derivative with the fair value of the hedged exposure. The cumulative approach involves comparing the cumulative changes in the hedging derivative’s fair value to the cumulative changes in the hedged exposure’s fair value. The calculation of dollar offset is the change in clean fair value of hedging derivative, divided by the change in fair value of the hedged exposure attributable to changes in the LIBOR curve. To the extent that the cumulative change in fair value of the hedging derivative offsets from 80% to 125% of the cumulative change in fair value of the hedged exposure, the hedge will be deemed effective. The change in fair value of the hedging derivative and the change in fair value of the hedged exposure are recorded in earnings. Any hedge ineffectiveness is also reflected in current earnings.

Fair value hedges (pay floating, received fixed) are recorded on the balance sheet in other assets or liabilities at fair market value. Loan swaps (pay fixed, receive floating) are carried at fair market value and are included in loans. Changes in fair value of the hedged loans have been completely offset by the fair value changes in the derivatives, which are in contra asset accounts included in loans.

See Note L of the 2010 Audited Financial Statements and Note 8 of our unaudited condensed financial statements included in this Quarterly Report on Form 10-Q for further discussion on our derivative financial instruments and hedging activities.

Financial institutions are subject to interest rate risk to the degree that their interest-bearing liabilities, primarily deposits, mature or reprice more or less frequently, or on a different basis, than their interest-earning assets, primarily loans and investment securities. The match between the scheduled repricing and maturities of our interest-earning assets and liabilities within defined periods is referred to as “gap” analysis. At March 31, 2011, our cumulative one-year gap was a positive, or asset sensitive, $66.9 million, or 10.7% of total assets, well within our ALCO policy guideline of 35%. Our cumulative one-year gap at December 31, 2010 was $42.9 million, or 7.0%, of total assets.

The following table reflects our rate sensitive assets and liabilities by maturity as of March 31, 2011. Variable rate loans are shown in the category of due “within three months” because they reprice with changes in the prime lending rate. Fixed rate loans are presented assuming the entire loan matures on the final due date, although payments are actually made at regular intervals and are not reflected in this schedule.

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Interest Rate Gap Sensitivity

	Within			Three			One Year
	Three			Months to			to Five			After
	Months			One Year			Years			Five Years			Total
	(Dollars in thousands)
At March 31, 2011:
Interest-earning assets:
Interest-bearing deposits	$	3,796		$	—		$	—		$	—		$	3,796
Federal funds sold		57,525			—			—			—			57,525
Securities		2,407			17,405			46,953			45,508			112,273
Loans		240,816			26,428			120,913			30			388,187
Other interest-earning assets		—			—			—			—			—
Total interest-earning assets		304,544			43,833			167,866			45,538			561,781
Interest-bearing liabilities:
Demand deposits		2,722			—			6,224			4,666			13,612
MMDA and savings		93,574			—			—			—			93,574
Time deposits		73,484			123,668			80,076			—			277,228
Short term borrowings		1,213			—			—			—			1,213
Long term borrowings		—			—			20,000			6,895			26,895
Total interest-bearing liabilities		170,993			123,668			106,300			11,561			412,522
Derivatives		10,684			2,555			(13,239	)		—			—
Interest sensitivity gap	$	144,235		$	(77,280	)	$	48,327		$	33,977		$	149,259
Cummulative interest sensitivity gap	$	144,235		$	66,955		$	115,282		$	149,259
Percentage of total assets					10.65	%
At December 31, 2010:
Interest-earning assets:
Interest bearing deposits	$	5,040		$	—		$	—		$	—		$	5,040
Federal funds sold		57,905			—			—			—			57,905
Securities		—			—			12,590			128,000			140,590
Loans		245,364			16,532			133,416			4,517			399,829
Other interest-earning assets		—			—			—			2,275			2,275
Total interest-earning assets		308,309			16,532			146,006			134,792			605,639
Interest-bearing liabilities:
Demand deposits		9,372			—			—			—			9,372
MMDA and savings		62,293			—			—			—			62,293
Time deposits		74,505			145,549			79,767			—			299,821
Short term borrowings		874			—			—			—			874
Long term borrowings		—			—			20,000			6,895			26,895
Total interest-bearing liabilities		147,044			145,549			99,767			6,895			399,255
Derivatives		(29,316	)		40,000			(7,036	)		(3,648	)		—
Interest sensitivity gap	$	131,949		$	(89,017	)	$	39,203		$	124,249		$	206,384
Cummulative interest sensitivity gap	$	131,949		$	42,932		$	82,135		$	206,384
Percentage of total assets					6.97	%

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Impact of Inflation and Changing Prices

A commercial bank has an asset and liability make-up that is distinctly different from that of a company with substantial investments in plant and inventory because the major portions of a commercial bank’s assets are monetary in nature. As a result, a bank’s performance may be significantly influenced by changes in interest rates. Although the banking industry is more affected by changes in interest rates than by inflation in the prices of goods and services, inflation is a factor that may influence interest rates. However, the frequency and magnitude of interest rate fluctuations do not necessarily coincide with changes in the general inflation rate. Inflation does affect operating expenses in that personnel expenses and the cost of supplies and outside services tend to increase more during periods of high inflation.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

See “Interest Rate Sensitivity” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2 for disclosures about market risk.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, the management of the Company, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of such date.

Changes in Internal Control over Financial Reporting

There was no change in the Company’s internal control over financial reporting that occurred during the first fiscal quarter of 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

In the ordinary course of business, we may be a party to various legal proceedings from time to time. In the opinion of management, we are not a party to, nor is any of our property the subject of, any pending or to our knowledge threatened proceeding, the outcome of which would have a material impact on the Company’s financial condition or results of operations.

Item 1A Risk Factors

As previously discussed in this report, on March 30, 2011, the Company and Community Capital entered into an Agreement and Plan of Merger, pursuant to which Community Capital will be merged with and into the Company, with the Company as the surviving entity. The merger remains subject to various conditions, including the approval by Community Capital shareholders and the receipt of customary bank regulatory approvals. The following risk factors are being provided in addition to the risk factors previously disclosed in the 2010 Form 10-K.

The Community Capital merger will not be completed unless important conditions to the merger are satisfied, including the receipt of regulatory approvals.

Completion of the Community Capital merger is subject to certain conditions, including regulatory approvals and approval of the Community Capital shareholders. If these conditions are not satisfied or waived (to the extent permitted by law), the merger may be delayed or may not occur, and we could lose some or all of the intended benefits of the merger. We may not receive the applicable regulatory approvals, or governmental authorities may impose conditions upon the completion of the merger or require changes in the terms of the merger. These conditions or changes could result in the termination of the merger agreement or could have the effect of delaying the completion of the merger or imposing additional costs or limiting the possible revenues of the combined company.

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We expect to incur significant transaction and merger-related integration costs in connection with the merger with Community Capital and, even if completed, we may not realize all of the anticipated benefits of the merger.

We expect to incur significant costs associated with completing the Community Capital merger and integrating the businesses. It is possible that the integration process could result in the loss of key employees, the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, depositors and employees or to achieve the anticipated benefits of the merger. Integration efforts will also divert management attention and resources. These integration issues could have an adverse effect on the Company during the transition period. Accordingly, the anticipated benefits and cost savings of the merger may not be realized fully or at all or may take longer to realize than expected.

The Community Capital merger may distract our management from other responsibilities.

The Community Capital merger could cause our management to focus its time and energies on matters related to the transaction that otherwise would be directed to our business and operations. Any such distraction, if significant, could affect our ability to fully realize the expected financial benefits from this transaction if the merger takes place. Additionally, our strategic plan is, in part, to grow through acquisitions of other financial institutions and/or the assets of other financial institutions, such as branches or lines of business. If we announce another acquisition before the completion of the Community Capital merger, that merger may be more difficult to complete due to potential delays in obtaining regulatory or shareholder approval and our focus on a new acquisition may limit our ability to fully realize the expected benefits from the merger, if the merger takes place.

Sales of substantial amounts of our common stock in the open market by former Community Capital shareholders could depress the stock price.

Shares of the Company’s common stock that are issued to Community Capital shareholders will be freely tradable without restrictions or further registration under the Securities Act of 1933, as amended, except for shares issued to any shareholder who may be deemed to be an affiliate of the Company. We currently expect to issue approximately 4,024,550 shares of the Company’s common stock in connection with the merger. If the merger is completed and if Community Capital’s shareholders sell substantial amounts of our common stock in the public market following completion of the merger, the market price of our common stock may decrease.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the three months ended March 31, 2011,the Company did not have any unregistered sales of equity securities or repurchases of its common stock.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. [Removed and Reserved]

Item 5. Other Information

Not applicable.

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Item 6. Exhibits

The following documents are filed or furnished as exhibits to this report:

Exhibit
Number		Description of Exhibits
	2.1	Agreement and Plan of Merger dated March 31, 2011 by and between Park Sterling Corporation and Community Capital Corporation, incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed April 5, 2011
	3.1	Articles of Incorporation of the Company, incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
	3.2	Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
	31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

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

	PARK STERLING CORPORATION
Date: May 13, 2011	By:	/s/ James C. Cherry
		James C. Cherry
		Chief Executive Officer (authorized officer)
Date: May 13, 2011	By:	/s/ David L. Gaines
		David L. Gaines
		Chief Financial Officer

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Exhibit Index

Exhibit
Number		Description of Exhibits
	2.1	Agreement and Plan of Merger dated March 31, 2011 by and between Park Sterling Corporation and Community Capital Corporation, incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed April 5, 2011
	3.1	Articles of Incorporation of the Company, incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
	3.2	Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
	31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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