Park Sterling (PSTB) 10-Q 2014 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

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

For the quarterly period endedSeptember 30, 2014

or

[ ] 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	(I.R.S. Employer
incorporation or organization)	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. Yes ☒ No☐        

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). Yes  ☒ No ☐ 

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 filer ☐	Accelerated Filer ☒	Non-accelerated filer ☐	Smaller reporting company ☐
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes☐ No ☒ 

As ofNovember 6, 2014, the registrant had outstanding44,849,243 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 September 30, 2014 and December 31, 2013	2
	Condensed Consolidated Statements of Income Three and Nine Months Ended September 30, 2014 and 2013	3
	Condensed Consolidated Statements of Comprehensive Income (Loss) Three and Nine Months Ended September 30, 2014 and 2013	4
	Condensed Consolidated Statements of Changes in Shareholders’ Equity Nine Months Ended September 30, 2014 and 2013	5
	Condensed Consolidated Statements of Cash Flows Nine Months Ended September 30, 2014 and 2013	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	57
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	80
Item 4.	Controls and Procedures	80
Part II.	OTHER INFORMATION
Item 1.	Legal Proceedings	80
Item 1A.	Risk Factors	80
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	81
Item 3.	Defaults Upon Senior Securities	81
Item 4.	Mine Safety Disclosures	81
Item 5.	Other Information	81
Item 6.	Exhibits	81

PARK STERLING CORPORATION

Part I.Financial Information

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Dollars in thousands)

	September 30,			December 31,
	2014			2013*
ASSETS
Cash and due from banks	$	16,505		$	13,087
Interest-earning balances at banks		41,883			41,680
Federal funds sold		465			300
Investment securities available-for-sale, at fair value		367,262			349,491
Investment securities held-to-maturity(fair value of $117,693 and $51,334, respectively)		117,463			51,972
Nonmarketable equity securities		9,731			5,905
Loans held for sale		4,763			2,430
Loans:
Non-covered		1,502,321			1,224,674
Covered		49,834			71,134
Less allowance for loan losses		(9,458	)		(8,831	)
Net loans		1,542,697			1,286,977
Premises and equipment, net		59,334			55,923
Bank-owned life insurance		57,293			47,832
Deferred tax asset		37,869			36,318
Other real estate owned - noncovered		8,631			9,404
Other real estate owned - covered		4,703			5,088
Goodwill		29,992			26,420
FDIC indemnification asset		5,078			10,025
Core deposit intangible		11,307			8,629
Accrued interest receivable		4,540			4,222
Other assets		6,739			5,087
Total assets	$	2,326,255		$	1,960,790
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing	$	322,097		$	255,861
Interest-bearing		1,542,511			1,344,024
Total deposits		1,864,608			1,599,885
Short-term borrowings		-			996
FHLB advances		140,000			55,000
Subordinated debt		23,413			22,052
Accrued interest payable		385			412
Accrued expenses and other liabilities		26,715			20,362
Total liabilities		2,055,121			1,698,707
Shareholders' equity:
Common stock, $1.00 par value200,000,000 shares authorized; 44,850,813 and 44,730,669 shares issuedand outstanding at September 30, 2014 and December 31, 2013, respectively		44,851			44,731
Additional paid-in capital		222,470			222,559
Accumulated earnings (deficit)		6,341			(405	)
Accumulated other comprehensive income (loss)		(2,528	)		(4,802	)
Total shareholders' equity		271,134			262,083
Total liabilities and shareholders' equity	$	2,326,255		$	1,960,790

* Derived from audited financial statements.

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

2

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
Interest income
Loans, including fees	$	19,725		$	17,970		$	55,385		$	54,916
Federal funds sold		1			-			1			24
Taxable investment securities		2,597			1,494			6,720			3,429
Tax-exempt investment securities		138			187			493			571
Nonmarketable equity securities		103			37			254			109
Interest on deposits at banks		22			48			96			154
Total interest income		22,586			19,736			62,949			59,203
Interest expense
Money market, NOW and savings deposits		570			399			1,732			1,186
Time deposits		771			455			2,430			1,590
Short-term borrowings		1			-			3			7
FHLB advances		162			137			416			411
Subordinated debt		350			431			1,282			1,288
Total interest expense		1,854			1,422			5,863			4,482
Net interest income		20,732			18,314			57,086			54,721
Provision for loan losses		(484	)		(419	)		(866	)		(35	)
Net interest income after provision for loan losses		21,216			18,733			57,952			54,756
Noninterest income
Service charges on deposit accounts		1,137			637			2,771			2,016
Income from fiduciary activities		698			795			2,018			2,041
Commissions and fees from investment brokerage		85			115			313			308
Capital markets income		364			-			399			-
Gain (loss) on sale of securities available for sale		(63	)		-			180			104
ATM and card income		631			639			1,905			1,818
Mortgage banking income		822			401			1,719			2,346
Income from bank-owned life insurance		552			537			2,197			1,447
Amortization of indemnification asset		(1,107	)		(118	)		(1,966	)		(73	)
Loss share true-up liability expense		(238	)		73			(599	)		(26	)
Other noninterest income		257			178			1,665			702
Total noninterest income		3,138			3,257			10,602			10,683
Noninterest expense
Salaries and employee benefits		10,240			8,606			29,152			26,185
Occupancy and equipment		3,527			1,861			7,781			5,750
Advertising and promotion		564			186			1,020			556
Legal and professional fees		887			732			2,670			2,486
Deposit charges and FDIC insurance		441			372			1,049			1,268
Data processing and outside service fees		1,907			1,268			4,797			4,561
Communication fees		480			432			1,454			1,312
Core deposit intangible amortization		347			257			921			772
Net cost (earnings) of operation of other real estate owned		343			142			602			(323	)
Loan and collection expense		298			556			890			1,560
Postage and supplies		176			188			521			815
Other noninterest expense		1,438			1,070			3,770			3,433
Total noninterest expense		20,648			15,670			54,627			48,375
Income before income taxes		3,706			6,320			13,927			17,064
Income tax expense		1,254			2,106			4,494			5,798
Net income		2,452			4,214			9,433			11,266
Preferred dividends		-			-			-			353
Net income to common shareholders	$	2,452		$	4,214		$	9,433		$	10,913
Basic earnings per common share	$	0.06		$	0.10		$	0.21		$	0.25
Diluted earnings per common share	$	0.06		$	0.10		$	0.21		$	0.25
Dividends per common share	$	0.02		$	0.02		$	0.02		$	0.02
Weighted-average common shares outstanding
Basic		43,910,365			44,170,964			43,919,481			44,098,417
Diluted		44,233,532			44,273,821			44,224,682			44,172,469

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

3

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

(Dollars in thousands)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
Net income	$	2,452		$	4,214		$	9,433		$	11,266
Securities available for sale and transferred securities:
Change in net unrealized gains (losses) during the period		(1,457	)		(1,286	)		7,565			(11,403	)
Change in net unrealized loss on securities transferred to held to maturity		77			-			(2,132	)		-
Reclassification adjustment for net (gains) losses recognized in net income		63			-			(180	)		(104	)
Total securities available for sale and transferred securities		(1,317	)		(1,286	)		5,253			(11,507	)
Derivatives:
Change in the accumulated gain (loss) on effective cash flow hedge derivatives		215			-			(1,672	)		-
Total derivatives		215			-			(1,672	)		-
Other comprehensive income (loss), before tax		(1,102	)		(1,286	)		3,581			(11,507	)
					.						.
Deferred tax expense (benefit) related to other comprehensive income		(416	)		(478	)		1,307			(4,291	)
					.						.
Other comprehensive income (loss), net of tax		(686	)		(808	)		2,274			(7,216	)
					.						.
Total comprehensive income	$	1,766		$	3,406		$	11,707		$	4,050

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

4

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

Nine Months EndedSeptember 30, 2014 and 2013

(Dollars in thousands)

																			Accumulated
	Preferred Stock						Common Stock						Additional Paid-In			Accumulated  Earnings			Other Comprehensive			Total  Shareholders'
	Shares			Amount			Shares			Amount			Capital			(Deficit)			Income (Loss)			Equity
Balance at December 31, 2012		20,500,000		$	20,500			44,575,853		$	44,576		$	220,996		$	(13,568	)	$	3,198		$	275,702
Redemption of preferred stock		(20,500	)		(20,500	)																	(20,500	)
Issuance of restricted stock grants		-			-			151,500			151			(151	)		-			-			-
Forfeitures of restricted stock grants		-			-			(21,360	)		(21	)		21			-			-			-
Exercise of stock options		-			-			55,391			55			225			-			-			280
Share-based compensation expense		-			-			-			-			1,468			-			-			1,468
Dividends on preferred stock		-			-			-			-			-			(353	)		-			(353	)
Dividends on common stock		-			-			-			-			-			(894	)		-			(894	)
Net income		-			-			-			-			-			11,266			-			11,266
Other comprehensive income (loss)		-			-			-			-			-			-			(7,216	)		(7,216	)
Balance at September 30, 2013		20,479,500		$	-			44,761,384		$	44,761		$	222,559		$	(3,549	)	$	(4,018	)	$	259,753
Balance at December 31, 2013		-		$	-			44,730,669		$	44,731		$	222,559		$	(405	)	$	(4,802	)	$	262,083
Shares issued		-			-			252			-			-			-			-			-
Issuance of restricted stock grants		-			-			236,900			237			(237	)		-			-			-
Forfeitures of restricted stock grants		-			-			(6,000	)		(6	)		6			-			-			-
Exercise of stock options		-			-			43,618			44			154			-			-			198
Share-based compensation expense		-			-			-			-			845			-			-			845
Common stock repurchased		-			-			(154,626	)		(155	)		(857	)		-			-			(1,012	)
Dividends on common stock		-			-			-			-			-			(2,687	)		-			(2,687	)
Net income		-			-			-			-			-			9,433			-			9,433
Other comprehensive income		-			-			-			-			-			-			2,274			2,274
Balance at September 30, 2014		-		$	-			44,850,813		$	44,851		$	222,470		$	6,341		$	(2,528	)	$	271,134

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

5

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	Nine Months Ended September 30,
	2014			2013
Cash flows from operating activities
Net income	$	9,433		$	11,266
Adjustments to reconcile net income to netcash provided by operating activities:
Accretion on acquired loans		(7,169	)		(6,314	)
Net amortization on investments		1,521			1,350
Other depreciation and amortization		7,309			5,848
Provision for loan losses		(866	)		(35	)
Share-based compensation expense		845			1,468
Deferred income taxes		4,823			6,787
Amortization of FDIC indemnification asset		1,966			73
Net gains on sales of investment securities available-for-sale		(180	)		(104	)
Net gains on sales of loans held for sale		(674	)		(1,293	)
Net (gains) losses on sales of fixed assets		398			(18	)
Net gains on sale of other repossessed assets		(96	)		-
Net gains on sales of other real estate owned		(235	)		(1,664	)
Writedowns on other real estate owned		343			1,152
Proceeds from life insurance death benefit		651			-
Income from bank-owned life insurance		(2,197	)		(1,447	)
Proceeds from loans held for sale		43,076			93,800
Disbursements for loans held for sale		(44,344	)		(81,430	)
Change in assets and liabilities:
Decrease in FDIC indemnification asset		(198	)		(1,440	)
(Increase) decrease in accrued interest receivable		427			(185	)
(Increase) decrease in other assets		(357	)		2,388
Decrease in accrued interest payable		(1,588	)		(91	)
Increase in accrued expenses and other liabilities		3,729			1,520
Net cash provided by operating activities		16,617			31,631
Cash flows from investing activities
Net (increase) decrease in loans		(153,168	)		35,245
Purchases of premises and equipment		(3,629	)		(1,988	)
Proceeds from sales of premises and equipment		138			73
Purchases of investment securities available-for-sale		(148,812	)		(154,459	)
Purchases of investment securities held-to-maturity		(10,447	)		(27,284	)
Proceeds from sales of investment securities available-for-sale		160,749			22,815
Proceeds from maturities, calls and paydowns of investment securities available-for-sale		39,007			37,936
Proceeds from maturities, calls and paydowns of investment securities held-to-maturity		3,442			171
FDIC reimbursement of recoverable covered asset losses		3,179			6,104
Proceeds from sale of other real estate owned		10,761			17,642
Net redemptions of nonmarketable equity securities		3,444			617
Purchase of nonmarketable equity securities		(4,322	)		-
Acquisitions, net of cash acquired		59,045			-
Net cash used by investing activities		(40,613	)		(63,128	)
Cash flows from financing activities
Net increase (decrease) in deposits		349			(76,040	)
Repayments of long-term borrowings		(41,415	)		5,000
Proceeds from FHLB advances		85,000			-
Decrease in short-term borrowings		(5,756	)		(7,441	)
Redemption of junior subordinated debt		(6,895	)		-
Redemption of preferred stock		-			(20,500	)
Exercise of stock options		198			280
Repurchase of common stock		(1,012	)		-
Dividends on common stock		(2,687	)		(894	)
Dividends on preferred stock		-			(353	)
Net cash provided (used) by financing activities		27,782			(99,948	)
Net increase (decrease) in cash and cash equivalents		3,786			(131,445	)
Cash and cash equivalents, beginning		55,067			184,142
Cash and cash equivalents, ending	$	58,853		$	52,697
Supplemental disclosures of cash flow information:
Cash paid for interest	$	5,890		$	4,573
Cash paid for income taxes		270			74
Supplemental disclosure of noncash investing and financing activities:
Change in unrealized gain on available-for-sale securities, net of tax	$	5,253		$	(7,216	)
Change in unrealized gain on cash flow hedge, net of tax		(1,672	)		-
Transfer from other assets to investment securities available-for-sale		-			1,393
Loans transferred to other real estate owned		6,651			6,938
Securities available-for-sale transferred to held-to-maturity		58,972			-

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

6

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

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”). At September 30, 2014 and December 31, 2013, the Company’s primary operations and business were that of owning the Bank.

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 “2013 Audited Financial Statements”) included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”) on March 6, 2014 (the “2013 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 September 30, 2014 and December 31, 2013, and the results of its operations and cash flows for the three and nine months ended September 30, 2014 and 2013. Operating results for the three- and nine-month periods ended September 30, 2014 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 purchased credit-impaired (“PCI”) loans, the valuation of the allowance for loan losses, the determination of the need for a deferred tax asset valuation allowance and the fair value of financial instruments and other accounts.

Tabular information, other than share and per share data, is presented in thousands of dollars. Certain amounts reported in prior periods have been reclassified to conform to the current period presentation with no effect on net income or shareholders’ equity as previously reported.

Note 2 - Recent Accounting Pronouncements

In January 2014, the Finanancial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-01, "Investments --Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects". This update revises the criteria required to elect the measurement and presentation alternative under the Accounting Standards Codification ("ASC") 323-740 and simplifies the method of amortization of the investment for entities investing in flow-through limited liability entities that manage or invest in affordable housing projects qualifying for the low-income housing tax credit. The update allows entities that meet the required criteria to qualify to present the investment performance net of income tax expense to better represent the economics of the investment (rather than traditional investment accounting under the equity or cost method). If the entity qualifies for the measurement and presentation alternative, they may amortize the initial cost of the investment in proportion to the related tax credits received (the proportional allocation method). The amendments must be retrospectively applied for all periods presented. For public business entities this update is effective for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted.The Company is currently evaluating the impact of this guidance but does not expect these updates to have a material effect on its financial statements.

7

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

 In January 2014, the FASB issued ASU No. 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)” (“ASU 2014-04”). ASU 2014-04 amended the Receivables—Troubled Debt Restructurings by Creditors subtopic of the ASC to address the reclassification of consumer mortgage loans collateralized by residential real estate upon foreclosure. The amendments clarify the criteria for concluding that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. The amendments also outline interim and annual disclosure requirements. The amendments will be effective for the Company for interim and annual reporting periods beginning after December 15, 2014. Companies are allowed to use either a modified retrospective transition method or a prospective transition method when adopting this update. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). ASU 2014-09 changes the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for interim and annual reporting periods beginning after December 15, 2016. The Company is currently evaluating the impact of this guidance but does not expect these amendments to have a material effect on its financial statements.

In June 2014, the FASB issued ASU 2014-11, “Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures” (“ASU 2014-11”). ASU 2014-11 makes limited amendments to the guidance on accounting for certain repurchase agreements. The new guidance (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) accounted for as secured borrowings. The amendments will be effective for the Company for the first interim or annual period beginning after December 15, 2014. The Company is currently evaluating the impact of this guidance but does not expect these amendments to have a material effect on its financial statements.

In June 2014, the FASB issued ASU 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period—a consensus of the FASB Emerging Issues Task Force” (“ASU 2014-12”). ASU 2014-12 clarifies that performance targets associated with stock compensation should be treated as a performance condition and should not be reflected in the grant date fair value of the stock award. The amendments will be effective for the Company for fiscal years that begin after December 15, 2015. The Company will apply the guidance to all stock awards granted or modified after the amendments are effective. The Company does not expect these amendments to have a material effect on its financial statements.

In August 2014, the FASB issued ASU 2014-14, "Receivables - Troubled Debt Restructurings by Creditors: Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure" ("ASU 2014-14"). This update addresses the diversity in practice regarding the classification and measurement of foreclosed loans which were part of a government-sponsored loan guarantee program. If certain criteria are met, the loan should be derecognized and a separate other receivable should be recorded upon foreclosure at the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. This update is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The update should be adopted either prospectively or on a modified retrospective basis. Early adoption is permitted, provided the entity has adopted ASU 2014-04. The Company is currently evaluating the impact of this guidance but does not expect these updates to have a material effect on its financial statements.

8

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts) 

Note 3– Business Combinations and Goodwill

Business Combinations

Generally, acquisitions are accounted for under the acquisition method of accounting in accordance with ASC 805,Business Combinations. Both the purchased assets and liabilities assumed are recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, especially the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate estimated fair values. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available.

Provident Community Bancshares, Inc.

On May 1, 2014, the Company completed its acquisition of Provident Community Bancshares, Inc. (“Provident Community”) pursuant to the Agreement and Plan of Merger, dated as of March 4, 2014 (the “Agreement”), under which Provident Community, a bank holding company headquartered in Rock Hill, South Carolina, was merged with and into the Company with the Company as the surviving entity. Pursuant to the Agreement, each share of Provident Community common stock was cancelled and converted into the right to receive a cash payment from the Company equal to $0.78 per share, or approximately $1.4 million in the aggregate. In addition, immediately prior to completion of the merger, the Company purchased from the United States Department of the Treasury (“Treasury”) the issued and outstanding shares of Provident Community’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Provident Community Series A Preferred Stock”), and all of the related warrants to purchase shares of Provident Community’s common stock, for an aggregate purchase price of approximately $5.1 million (representing a 45% discount from face value). Thereafter, pursuant to the Agreement, the Provident Community Series A Preferred Stock and related warrants were cancelled in connection with the completion of the merger. Simultaneously with completion of the merger, Provident Community Bank, N.A. merged into the Bank.

The assets acquired and liabilities assumed from Provident Community were recorded at their fair value as of the closing date of the merger. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available.Goodwill of $3.4 million was initially recorded at the time of the acquisition. As a result of refinements to the fair value mark on OREO, other assets and other liabilities, goodwill as indicated below is $0.2 million greater than the goodwill estimated at June 30, 2014. The following table summarizes the consideration paid by the Company in the merger with Provident Community and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date:

9

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

	As Recorded		Fair Value and Other
	by		Merger Related			As Recorded
	Provident		Adjustments			by the Company
Consideration Paid
Cash						$	1,397
Fair value of noncontrolling interest							5,096
Fair Value of Total Consideration Transferred						$	6,493
Recognized amounts of identifiable assets acquired and liabilities assumed:
Cash and cash equivalents	$	65,538	$	-		$	65,538
Securities		124,035		-			124,035
Nonmarketable equity securities		2,948		-			2,948
Loans held for sale		390		-			390
Loans, net of allowance		112,412		(8,034	)		104,378
Premises and equipment		3,150		32			3,182
Core deposit intangibles		-		3,600			3,600
Interest receivable		748		(3	)		745
Other real estate owned		3,666		(702	)		2,964
Bank owned life insurance		8,536		-			8,536
Deferred tax asset		1,628		5,307			6,935
Other assets		1,438		(218	)		1,220
Total assets acquired	$	324,489	$	(18	)	$	324,471
Deposits	$	264,281	$	177		$	264,458
Federal Home Loan Bank advances		37,500		3,915			41,415
Junior Subordinated Debt		12,372		(4,558	)		7,814
Short term borrowings		4,760		-			4,760
Other liabilities		2,087		1,016			3,103
Total liabilities assumed	$	321,000	$	550		$	321,550
Total identifiable assets	$	3,489	$	(568	)	$	2,921
Goodwill resulting from acquisition						$	3,572

The following table discloses certain pro forma information as if Provident Community had been acquired on January 1, 2014 and January 1, 2013, respectively. These results combine the historical results of Provident Community in the Company’s consolidated statement of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2014 and January 1, 2013. Acquisition-related costs of $2.9 million are included in the Company’s consolidated statements of income for the nine months ended September 30, 2014 and are not included in the proforma information below. In particular, no adjustments have been made to eliminate the amount of Provident Community provision for loan losses of $500 thousand in 2013 or the impact of OREO write-downs recognized by Provident Community in 2014 that may not have been necessary had the acquired loans and OREO been recorded at fair value as of the beginning of 2014 or 2013.Furthermore, additional expenses related to systems conversions and other costs of integration are expected to be recorded during 2014. Additionally, the Company expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts below:

10

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

	Pro Forma		Pro Forma
	Nine Months Ended		Nine Months Ended
	September 30, 2014		September 30, 2013
Total revenues(net interest income plus other income)	$	69,668	$	72,937
Net income	$	6,251	$	7,593

Note 4 – Investment Securities

The amortized cost, unrealized gains and losses, and estimated fair value of investment securities at September 30, 2014 and December 31, 2013 are as follows: 

Amortized Cost and Fair Value of Investment Portfolio

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
September 30, 2014
Securities available-for-sale:
U.S. Government agencies	$	510	$	32	$	-		$	542
Municipal securities		11,959		906		-			12,865
Residential agency pass-through securities		143,348		1,148		(414	)		144,082
Residential collateralized mortgage obligations		149,516		320		(2,110	)		147,726
Commercial mortgage-backed securities		5,004		-		(160	)		4,844
Asset-backed securities		53,144		1		(1,214	)		51,931
Corporate and other securities		3,323		252		-			3,575
Equity securities		1,250		447		-			1,697
Total securities available-for-sale	$	368,054	$	3,106	$	(3,898	)	$	367,262
Securities held-to-maturity:
Residential agency pass-through securities	$	44,646	$	602	$	(14	)	$	45,234
Residential collateralized mortgage obligations		8,628		19		(15	)		8,632
Commercial mortgage-backed securities		60,370		-		(2,372	)		57,998
Asset-backed securities		5,951		-		(122	)		5,829
Total securities held-to-maturity	$	119,595	$	621	$	(2,523	)	$	117,693
December 31, 2013
Securities available-for-sale:
U.S. Government agencies	$	513	$	45	$	-		$	558
Municipal securities		15,826		680		-			16,506
Residential agency pass-through securities		90,043		741		(536	)		90,248
Residential collateralized mortgage obligations		105,667		51		(2,369	)		103,349
Commercial mortgage-backed securities		66,396		-		(4,994	)		61,402
Asset-backed securities		73,369		1		(2,293	)		71,077
Corporate and other securities		4,461		-		(16	)		4,445
Equity securities		1,393		513		-			1,906
Total securities available-for-sale	$	357,668	$	2,031	$	(10,208	)	$	349,491
Securities held-to-maturity:
Residential agency pass-through securities	$	41,125	$	-	$	(392	)	$	40,733
Residential collateralized mortgage obligations		4,982		-		(74	)		4,908
Asset-backed securities		5,865		-		(172	)		5,693
Total securities held-to-maturity	$	51,972	$	-	$	(638	)	$	51,334

11

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

At June 1, 2014, commercial mortgage-backed securities (“MBS”) with a fair market value of $58.5 million were transferred from available-for-sale to held-to-maturity. These securities had an aggregate unrealized loss of $2.2 million ($1.5 million, net of tax) on the date of transfer. The net unamortized, unrealized loss on the transferred securities included in accumulated other comprehensive income in the accompanying balance sheet as of September 30, 2014 totaled $2.1 million. This amount will be amortized out of accumulated other comprehensive income over the remaining life of the underlying securities as an adjustment of the yield on those securities. As a result, the amortized cost of these investments of $60.4 million is higher than the $58.2 million carrying value of the securities as of September 30, 2014. There were no other transfers of securities during the three- or nine-month periods ended September 30, 2014.

At September 30, 2014 and December 31, 2013, investment securities with a fair market value of $152.4 million and $99.5 million, respectively, were pledged to secure public and trust deposits, to secure interest rate swaps, and for other purposes as required and permitted by law.

At September 30, 2014 and December 31, 2013, commercial MBS include $56.9 million and $55.7 million, respectively, of delegated underwriting and servicing (“DUS”) bonds collateralized by multi-family properties and backed by an agency of the U.S. government, and $6.0 million and $5.7 million, respectively, of private-label securities collateralized by commercial properties.

At September 30, 2014 and December 31, 2013, asset-backed securities include a $5.8 million and $5.7 million security, respectively, which is approximately 42% collateralized by the Federal Family Education Loan Program and approximately 58% collateralized by private student loan programs.

The amortized cost and fair value of investment securities available-for-sale and held-to-maturity at September 30, 2014 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. All of the Company’s residential agency pass-through securities and residential collateralized mortgage obligations are backed by an agency of the United States government. None of our residential agency pass-through securities or residential collateralized mortgage obligations are private-label securities.

12

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Maturities of Investment Portfolio        

	September 30, 2014
	Amortized		Fair
	Cost		Value
Securities available-for-sale:
U.S. Government agencies
Due after one year through five years	$	510	$	542
Municipal securities
Due after ten years		11,959		12,865
Residential agency pass-through securities
Due after five years through ten years		12,098		12,220
Due after ten years		131,250		131,862
Residential collateralized mortgage obligations
Due after ten years		149,516		147,726
Commercial mortgage-backed securities
Due after five years through ten years		5,004		4,844
Asset-backed securities
Due after ten years		53,144		51,931
Corporate and other securities
Due after ten years		3,323		3,575
Equity securities
Due after ten years		1,250		1,697
Total securities available-for-sale	$	368,054	$	367,262
Securities held-to-maturity:
Residential agency pass-through securities
Due after ten years	$	44,646	$	45,234
Residential collateralized mortgage obligations
Due after ten years		8,628		8,632
Commercial mortgage-backed securities
Due after five years through ten years		60,370		57,998
Asset-backed securities
Due after ten years		5,951		5,829
Total securities held-to-maturity	$	119,595	$	117,693

Securities available-for-sale of $34.5 million were sold in the three months ended September 30, 2014 resulting in a gross loss of $0.01 million. There were no sales of securities available-for-sale during the three months ended September 30, 2013. Securities available-for-sale of $160.7 million and $22.8 million were sold in the nine months ended September 30, 2014 and 2013, respectively, resulting in gross gains of $0.2 million and $0.1 million, respectively. The increase in sales of securities during the nine months ended September 30, 2014 is due to the sale of the majority of the securities acquired in the acquisition of Provident Community.

Management evaluates its investments quarterly 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 securities with unrealized losses at September 30, 2014 and December 31, 2013. 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. At September 30, 2014, thirteen securities have been in a continuous loss position for twelve months or more. At December 31, 2013, five securities had been in a continuous loss position for twelve months or more.

13

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The “Volcker Rule” under the Dodd-Frank Act generally prohibits banks and their affiliates from engaging in proprietary trading and investing in and sponsoring a covered fund (such as a hedge fund or private equity fund). At December 31, 2013, the Company held four investments in senior tranches of collateralized loan obligations (“CLOs”) with a fair value of $23.4 million which were included in asset-backed securities, which could have been impacted by the Volcker Rule. The collateral eligibility language in one of the securities held at December 31, 2013, has been amended to comply with the new bank investment criteria under the Volcker Rule. In addition, the Company sold one of the securities during the nine month period ended September 30, 2014 for a loss of $433 thousand, given expectations that it would not be amended to comply with the Volcker Rule. The Company’s investment in the two remaining securities, which had a net unrealized loss of $179,000 at September 30, 2014 and $274,000 at December 31, 2013, are currently prohibited under the Volcker Rule. The Company will determine any disposition plans for these securities as documentation is, or is not, amended. Under current Federal regulations, banks have until July 21, 2017 to conform their CLO interests to avoid the trading restrictions under the Volcker Rule. Unless the documentation is amended to avoid inclusion within the rule’s prohibitions, the Company would have to recognize other-than-temporary impairment, as applicable, with respect to these securities in conformity with GAAP rules. The Company held no other security types potentially affected by the Volcker Rule at either September 30, 2014 or December 31, 2013.

14

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

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
September 30, 2014
Securities available-for-sale:
Residential agency pass-through securities	$	58,049	$	(261	)	$	7,936	$	(153	)	$	65,985	$	(414	)
Residential collateralized mortgage obligations		54,437		(441	)		49,733		(1,669	)		104,170		(2,110	)
Commercial mortgage-backed securities		-		-			4,844		(160	)		4,844		(160	)
Asset-backed securities		19,810		(184	)		22,119		(1,030	)		41,929		(1,214	)
Total temporarily impairedavailable-for-sale securities	$	132,296	$	(886	)	$	84,632	$	(3,012	)	$	216,928	$	(3,898	)
Securities held-to-maturity:
Residential agency pass-through securities	$	6,156	$	(14	)	$	-	$	-		$	6,156	$	(14	)
Residential collateralized mortgage obligations		3,848		(15	)		-		-			3,848		(15	)
Commercial mortgage-backed securities		-		-			57,998		(2,372	)		57,998		(2,372	)
Asset-backed securities		-		-			5,829		(122	)		5,829		(122	)
Total temporarily impairedheld-to-maturity securities	$	10,004	$	(15	)	$	63,827	$	(2,494	)	$	73,831	$	(2,523	)
December 31, 2013
Securities available-for-sale:
Residential agency pass-through securities	$	32,674	$	(536	)	$	-	$	-		$	32,674	$	(536	)
Residential collateralized mortgage obligations		55,856		(1,687	)		18,167		(682	)		74,023		(2,369	)
Commercial mortgage-backed securities		42,391		(3,247	)		19,011		(1,747	)		61,402		(4,994	)
Asset-backed securities		56,106		(2,236	)		4,986		(57	)		61,092		(2,293	)
Corporate and other securities		3,945		(16	)		-		-			3,945		(16	)
Total temporarily impairedavailable-for-sale securities	$	190,972	$	(7,722	)	$	42,164	$	(2,486	)	$	233,136	$	(10,208	)
Securities held-to-maturity:
Residential agency pass-through securities	$	40,733	$	(392	)	$	-	$	-		$	40,733	$	(392	)
Residential collateralized mortgage obligations		4,908		(74	)		-		-			4,908		(74	)
Asset-backed securities		5,693		(172	)		-		-			5,693		(172	)
Total temporarily impairedheld-to-maturity securities	$	51,334	$	(638	)	$	-	$	-		$	51,334	$	(638	)

The Company has nonmarketable equity securities consisting of investments in several financial institutions and the investments in four statutory trusts. These investments totaled $9.7 million at September 30, 2014 and $5.9 million December 31, 2013. Included in these amounts at September 30, 2014 and December 31, 2013 was $8.3 million and $4.9 million, respectively, of Federal Home Loan Bank (“FHLB”) stock. All nonmarketable equity securities were evaluated for impairment as of September 30, 2014 and December 31, 2013. 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 September 30, 2014 and December 31, 2013, the Company estimated that the fair values of nonmarketable equity securities equaled or exceeded the cost of each of these investments, and, therefore, the investments were not impaired.

15

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Note 5 – Loans and Allowance for Loan Losses

The Company’s loan portfolio was comprised of the following at: 

	September 30, 2014						December 31, 2013
	PCI loans		All other loans		Total		PCI loans		All other loans		Total
Commercial:
Commercial and industrial	$	6,149	$	167,160	$	173,309	$	5,737	$	116,663	$	122,400
Commercial real estate (CRE) - owner-occupied		30,210		301,093		331,303		35,760		231,821		267,581
CRE - investor income producing		51,810		410,621		462,431		56,996		325,191		382,187
AC&D - 1-4 family construction		687		32,245		32,932		-		19,959		19,959
AC&D - lots, land & development		17,967		37,133		55,100		22,699		42,890		65,589
AC&D - CRE		113		53,346		53,459		121		56,638		56,759
Other commercial		1,255		4,026		5,281		137		3,712		3,849
Total commercial loans		108,191		1,005,624		1,113,815		121,450		796,874		918,324
Consumer:
Residential mortgage		30,259		168,714		198,973		32,826		140,550		173,376
Home equity lines of credit (HELOC)		1,709		153,059		154,768		1,402		142,352		143,754
Residential construction		7,601		48,882		56,483		6,920		33,901		40,821
Other loans to individuals		909		25,535		26,444		1,189		17,606		18,795
Total consumer loans		40,478		396,190		436,668		42,337		334,409		376,746
Total loans		148,669		1,401,814		1,550,483		163,787		1,131,283		1,295,070
Deferred costs		-		1,672		1,672		-		738		738
Total loans, net of deferred costs	$	148,669	$	1,403,486	$	1,552,155	$	163,787	$	1,132,021	$	1,295,808

Included in the September 30, 2014 and December 31, 2013 loan totals are $49.8 million and $71.1 million, respectively, of covered loans pursuant to FDIC loss share agreements. Of these amounts, at September 30, 2014, approximately $47.1 million is included in PCI loans and $2.7 million is included in all other loans. At December 31, 2013, approximately $68.0 million is included in PCI loans and $3.2 million is included in all other loans.

At September 30, 2014 and December 31, 2013, the Company had sold participations in loans aggregating $6.6 million and $3.3 million, respectively, to other financial institutions on a nonrecourse basis. Of the $6.6 million in participation loans outstanding at September 30, 3014, $3.5 million were acquired in connection with the Provident Community merger. Collections on loan participations and remittances to participating institutions conform to customary banking practices.

The Bank accepts residential mortgage loan applications and funds loans of qualified borrowers. Funded loans are sold with limited recourse to investors under the terms of pre-existing commitments. The Bank executes all of its loan sales agreements under best efforts contracts with investors. From time to time, the Company may choose to hold certain mortgage loans on balance sheet. In addition, as part of the Provident Community merger, the Company was servicing approximately $4.1 million of residential mortgage loans for the benefit of others as of September 30, 2014.

Loans sold with limited recourse are 1-4 family residential mortgages originated by the Company and sold to various other financial institutions. Various recourse agreements exist, ranging from thirty days to twelve months. The Company’s exposure to credit loss in the event of nonperformance by the other party to the loan is represented by the contractual notional amount of the loan. Since none of the loans has ever been returned to the Company, the amount of total loans sold with limited recourse does not necessarily represent future cash requirements. The Company uses the same credit policies in making loans held for sale as it does  for on-balance sheet instruments. Total loans sold with limited recourse in the three months ended September 30, 2014 and 2013 were $21.3 million and $16.2 million, respectively. Total loans sold with limited recourse in the nine months ended September 30, 2014 and 2013 were $42.4 million and $92.5 million, respectively.

16

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

At September 30, 2014, the carrying value of loans pledged as collateral to the FHLB and to the Federal Reserve for borrowings totaled $515.6 million. At December 31, 2013, the carrying value of loans pledged as collateral to the FHLB and the Federal Reserve totaled $472.4 million.

Concentrations of Credit-Loans are primarily made within the Company’s operating footprint of North Carolina, South Carolina, Virginia and Georgia. 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 September 30, 2014 and December 31, 2013, the Company had no loans outstanding with foreign entities.

17

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Allowance for Loan Losses-The following table presents, by portfolio segment, the activity in the allowance for loan losses for the three and nine months ended September 30, 2014.

	Commercial and industrial			CRE - owner-occupied			CRE - investor income producing			AC&D		AC&D - 1-4 family construction			AC&D - lots, land & development			AC&D - CRE			Other commercial		Residential mortgage			HELOC			Residential construction			Other loans to individuals			Total
For the three months ended September 30, 2014
Allowance for Loan Losses:
Balance, beginning of period	$	1,773		$	473		$	1,425		$	-	$	1,215		$	1,446		$	223		$	51	$	372		$	1,452		$	651		$	97		$	9,178
Provision for loan losses		12			162			(54	)		-		(95	)		(1,086	)		60			2		155			138			240			(18	)		(484	)
Charge-offs		(111	)		-			(20	)		-		-			-			-			-		(25	)		(4	)		-			(15	)		(175	)
Recoveries		262			10			21			-		33			449			-			-		110			15			9			30			939
Net charge-offs		151			10			1			-		33			449			-			-		85			11			9			15			764
Balance, end of period	$	1,936		$	645		$	1,372		$	-	$	1,153		$	809		$	283		$	53	$	612		$	1,601		$	900		$	94		$	9,458
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	-
PCI Impairment charge-offs		-			-			-			-		-			-			-			-		-			-			-			-			-
PCI impairment recoveries		-			-			-			-		-			-			-			-		-			-			-			-			-
Net PCI impairment charge-offs		-			-			-			-		-			-			-			-		-			-			-			-			-
Reversal of PCI loan impairment		-			-			-			-		-			-			-			-		-			-			-			-			-
Benefit attributable to FDIC loss share agreements		-			-			-			-		-			-			-			-		-			-			-			-			-
Total provision for loan losses charged to operations		-			-			-			-		-			-			-			-		-			-			-			-			-
Provision for loan losses recorded through FDIC lossshare receivable		-			-			-			-		-			-			-			-		-			-			-			-			-
Balance, end of period	$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	-
Total Allowance for Loan Losses	$	1,936		$	645		$	1,372		$	-	$	1,153		$	809		$	283		$	53	$	612		$	1,601		$	900		$	94		$	9,458
For the nine months ended September 30, 2014
Allowance for Loan Losses:
Balance, beginning of period	$	1,491		$	399		$	1,797		$	-	$	839		$	1,751		$	299		$	25	$	358		$	1,050		$	390		$	72		$	8,471
Provision for loan losses		88			(16	)		(241	)		-		231			(2,558	)		(16	)		27		159			907			466			18			(935	)
Charge-offs		(111	)		-			(292	)		-		(15	)		(4	)		-			-		(88	)		(402	)		(7	)		(37	)		(956	)
Recoveries		468			262			108			-		98			1,620			-			1		183			46			51			41			2,878
Net charge-offs		357			262			(184	)		-		83			1,616			-			1		95			(356	)		44			4			1,922
Balance, end of period	$	1,936		$	645		$	1,372		$	-	$	1,153		$	809		$	283		$	53	$	612		$	1,601		$	900		$	94		$	9,458
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-		$	-		$	360		$	-	$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	360
PCI Impairment charge-offs		-			-			(5	)		-		-			-			-			-		(1	)		(144	)		-			-			(150	)
PCI impairment recoveries		-			-			-			-		-			-			-			-		-			-			-			-			-
Net PCI impairment charge-offs		-			-			(5	)		-		-			-			-			-		(1	)		(144	)		-			-			(150	)
Reversal of PCI loan impairment		-			-			(354	)		-		-			-			-			-		1			144			-			-			(209	)
Benefit attributable to FDIC loss share agreements		-			-			278			-		-			-			-			-		-			-			-			-			278
Total provision for loan losses charged to operations		-			-			(76	)		-		-			-			-			-		1			144			-			-	��		69
Provision for loan losses recorded through FDIC lossshare receivable		-			-			(279	)		-		-			-			-			-		-			-			-			-			(279	)
Balance, end of period	$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	-
Total Allowance for Loan Losses	$	1,936		$	645		$	1,372		$	-	$	1,153		$	809		$	283		$	53	$	612		$	1,601		$	900		$	94		$	9,458

18

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The following table presents, by portfolio segment, the activity in the allowance for loan losses for the three and nine months ended September 30, 2013.

	Commercial and industrial			CRE - owner-occupied			CRE - investor income producing			AC&D			AC&D - 1-4 family construction		AC&D - lots, land & development		AC&D - CRE		Other commercial			Residential mortgage			HELOC			Residential construction			��	Other loans to individuals			Total
For the three months ended September 30, 2013
Allowance for Loan Losses:
Balance, beginning of period	$	1,585		$	343		$	1,419		$	3,930		$	-	$	-	$	-	$	4		$	267		$	1,311		$	518			$	86		$	9,463
Provision for loan losses		539			57			26			(1,240	)		-		-		-		1			284			357			(44	)			20			-
Charge-offs		(634	)		(12	)		(9	)		(88	)		-		-		-		-			(125	)		(68	)		-				(22	)		(958	)
Recoveries		52			1			26			-			-		-		-		1			32			16			2				11			141
Net charge-offs		(582	)		(11	)		17			(88	)		-		-		-		1			(93	)		(52	)		2				(11	)		(817	)
Balance, end of period	$	1,542		$	389		$	1,462		$	2,602		$	-	$	-	$	-	$	6		$	458		$	1,616		$	476			$	95		$	8,646
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	216		$	-		$	1		$	445		$	-	$	-	$	-	$	-		$	394		$	3		$	289			$	36		$	1,384
PCI Impairment charge-offs		(216	)		-			-			(163	)		-		-		-		-			(311	)		-			(233	)			(36	)		(959	)
PCI impairment recoveries		-			-			-			-			-		-		-		-			-			-			-				-			-
Net PCI impairment charge-offs		(216	)		-			-			(163	)		-		-		-		-			(311	)		-			(233	)			(36	)		(959	)
Reversal of PCI loan impairment		-			-			(1	)		(282	)		-		-		-		-			(77	)		(3	)		(56	)			-			(419	)
Benefit attributable to FDIC loss share agreements		-			-			-			-			-		-		-		-			-			-			-				-			-
Total provision for loan losses charged to operations		-			-			(1	)		(282	)		-		-		-		-			(77	)		(3	)		(56	)			-			(419	)
Provision for loan losses recorded through FDIC lossshare receivable		-			-			-			-			-		-		-		-			-			-			-				-			-
Balance, end of period	$	-		$	-		$	-		$	-		$	-	$	-	$	-	$	-		$	6		$	-		$	-			$	-		$	6
Total Allowance for Loan Losses	$	1,542		$	389		$	1,462		$	2,602		$	-	$	-	$	-	$	6		$	464		$	1,616		$	476			$	95		$	8,652
For the nine months ended September 30, 2013
Allowance for Loan Losses:
Balance, beginning of period	$	849		$	496		$	1,102		$	4,157		$	-	$	-	$	-	$	8		$	454		$	1,463		$	1,046			$	49		$	9,624
Provision for loan losses		1,740			(64	)		131			(2,206	)		-		-		-		(3	)		69			756			(616	)			66			(127	)
Charge-offs		(1,190	)		(52	)		(230	)		(94	)		-		-		-		-			(128	)		(660	)		(49	)			(52	)		(2,455	)
Recoveries		143			9			459			745			-		-		-		1			63			57			95				32			1,604
Net charge-offs		(1,047	)		(43	)		229			651			-		-		-		1			(65	)		(603	)		46				(20	)		(851	)
Balance, end of period	$	1,542		$	389		$	1,462		$	2,602		$	-	$	-	$	-	$	6		$	458		$	1,616		$	476			$	95		$	8,646
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	225		$	-		$	-		$	542		$	-	$	-	$	-	$	-		$	200		$	-		$	-			$	-		$	967
PCI Impairment charge-offs		(216	)		-			(16	)		(177	)		-		-		-		(386	)		(311	)		-			(233	)			(36	)		(1,375	)
PCI impairment recoveries		-			-			-			25			-		-		-		-			-			-			-				-			25
Net PCI impairment charge-offs		(216	)		-			(16	)		(152	)		-		-		-		(386	)		(311	)		-			(233	)			(36	)		(1,350	)
Reversal of PCI loan impairment		(9	)		-			16			(390	)		-		-		-		386			117			-			233				36			389
Benefit attributable to FDIC loss share agreements		(104	)		-			(1	)		(192	)		-		-		-		-			-			-			-				-			(297	)
Total provision for loan losses charged to operations		(113	)		-			15			(582	)		-		-		-		386			117			-			233				36			92
Provision for loan losses recorded through FDIC lossshare receivable		104			-			1			192			-		-		-		-			-			-			-				-			297
Balance, end of period	$	-		$	-		$	-		$	-		$	-	$	-	$	-	$	-		$	6		$	-		$	-			$	-		$	6
Total Allowance for Loan Losses	$	1,542		$	389		$	1,462		$	2,602		$	-	$	-	$	-	$	6		$	464		$	1,616		$	476			$	95		$	8,652

19

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The following table presents, by portfolio segment, the balance in the allowance for loan losses disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans at September 30, 2014 and December 31, 2013.

	Commercial and industrial		CRE - owner-occupied		CRE - investor income producing		AC&D		AC&D - 1-4 family construction		AC&D - lots, land & development		AC&D - CRE		Other commercial		Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total
At September 30, 2014
Allowance for Loan Losses:
Individually evaluated for impairment	$	239	$	28	$	52	$	-	$	-	$	8	$	-	$	43	$	320	$	444	$	195	$	8	$	1,337
Collectively evaluated for impairment		1,697		617		1,320		-		1,153		801		283		10		292		1,157		705		86		8,121
		1,936		645		1,372		-		1,153		809		283		53		612		1,601		900		94		9,458
Purchased credit-impaired		-		-		-		-		-		-		-		-		-		-		-		-		-
Total	$	1,936	$	645	$	1,372	$	-	$	1,153	$	809	$	283	$	53	$	612	$	1,601	$	900	$	94	$	9,458
Recorded Investment in Loans:
Individually evaluated for impairment	$	785	$	3,041	$	1,497	$	-	$	-	$	1,126	$	-	$	257	$	2,918	$	3,272	$	622	$	50	$	13,568
Collectively evaluated for impairment		166,375		298,052		409,124		-		32,245		36,007		53,346		3,769		165,796		149,787		48,260		25,485		1,388,246
		167,160		301,093		410,621		-		32,245		37,133		53,346		4,026		168,714		153,059		48,882		25,535		1,401,814
Purchased credit-impaired		6,149		30,210		51,810		-		687		17,967		113		1,255		30,259		1,709		7,601		909		148,669
Total	$	173,309	$	331,303	$	462,431	$	-	$	32,932	$	55,100	$	53,459	$	5,281	$	198,973	$	154,768	$	56,483	$	26,444	$	1,550,483
At December 31, 2013
Allowance for Loan Losses:
Individually evaluated for impairment	$	14	$	14	$	527	$	-	$	-	$	-	$	-	$	18	$	167	$	137	$	7	$	-	$	884
Collectively evaluated for impairment		1,477		385		1,270		-		839		1,751		299		7		191		913		383		72		7,587
		1,491		399		1,797		-		839		1,751		299		25		358		1,050		390		72		8,471
Purchased credit-impaired		-		-		360		-		-		-		-		-		-		-		-		-		360
Total	$	1,491	$	399	$	2,157	$	-	$	839	$	1,751	$	299	$	25	$	358	$	1,050	$	390	$	72	$	8,831
Recorded Investment in Loans:
Individually evaluated for impairment	$	265	$	1,902	$	3,216	$	-	$	-	$	1,888	$	-	$	262	$	4,513	$	3,014	$	66	$	60	$	15,186
Collectively evaluated for impairment		116,398		229,919		321,975		-		19,959		41,002		56,638		3,450		136,037		139,338		33,835		17,546		1,116,097
		116,663		231,821		325,191		-		19,959		42,890		56,638		3,712		140,550		142,352		33,901		17,606		1,131,283
Purchased credit-impaired		5,737		35,760		56,996		-		-		22,699		121		137		32,826		1,402		6,920		1,189		163,787
Total	$	122,400	$	267,581	$	382,187	$	-	$	19,959	$	65,589	$	56,759	$	3,849	$	173,376	$	143,754	$	40,821	$	18,795	$	1,295,070

20

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The Company’s loan loss allowance methodology includes four components, as described below:

1)       Specific Reserve Component. Specific reserves represent the current impairment estimate on specific loans, for which it is probable that the Company will be unable to collect all amounts due according to contractual terms based on current information and events. Impairment measurement reflects only a deterioration of credit quality and not changes in market rates that may cause a change in the fair value of the impaired loan. The amount of impairment may be measured in one of three ways, including (i) calculating the present value of expected future cash flows, discounted at the loan’s interest rate implicit in the original document and deducting estimated selling costs, if any; (ii) observing quoted market prices for identical or similar instruments traded in active markets, or employing model-based valuation techniques for which all significant assumptions are observable in the market; and (iii) determining the fair value of collateral, which is utilized for both collateral dependent loans and for loans when foreclosure is probable.

Impaired loans with a balance less than or equal to $150 thousand are viewed in two groups: those which have experienced charge-offs and those recorded at legal balance. Those loans which have experienced charge-offs have no additional reserve applied unless specifically calculated at a point in time when the loan balance exceeded $150 thousand. Those loans recorded at their legal balance are reserved for based on a pooled probability of default and loss given default calculation.

2)       Quantitative Reserve Component. Quantitative reserves represent the current loss contingency estimate on pools of loans, which is an estimate of the amount for which it is probable that the Company will be unable to collect all amounts due on homogeneous groups of loans according to contractual terms should one or more events occur, excluding those loans specifically identified above.

The historical loss experience of the Company is collected quarterly by evaluating internal loss data. The estimated historical loss rates are grouped by loan product type. The Company utilizes average historical losses to represent management’s estimate of losses inherent in a particular portfolio. The historical look back period is estimated by loan type, and the Company applies the appropriate historical loss period which best reflects the inherent loss in the applicable portfolio considering prevailing market conditions.

In the past, the Company has recorded a minimum reserve as part of the quantitative component. A minimum reserve is utilized when the Company has insufficient internal loss history or when internal loss history falls below the minimum reserve percentage. Minimums are determined by analyzing Federal Reserve Bank charge-off data for all insured federal- and state-chartered commercial banks. During the second quarter of 2014, the Company determined that it would use the calculated average historical loss rates and adjust to the minimum reserve amounts in its qualitative component. This change represented a reclassification between components of the allowance and had no impact on the calculation in total.

During the third quarter of 2013, the Company segregated the AC&D portfolio into three collateral types: (i) 1-4 family construction, (ii) lots, land and development and (iii) CRE construction. These enhancements strengthen the granularity of the allowance methodology and are reflective of the distinctions in credit quality indicators for the three collateral types as well as the Company’s present origination activities.

21

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The following look back periods were utilized by management in determining the quantitative reserve component at September 30, 2014 and December 31, 2013:

	September 30,	December 31,
	2014	2013
Look back periods (in calendar quarters)
Commercial:
Commercial and industrial	15	15
CRE - owner-occupied	15	Minimum
CRE - investor income producing	15	15
AC&D - 1-4 family construction	15	15
AC&D - lots, land, & development	15	15
AC&D - CRE	15	Minimum
Other commercial	15	Minimum
Residential mortgage	15	12
HELOC	15	12
Residential construction	15	12
Other loans to individuals	15	Minimum

The changes in the look back periods noted above were made to provide a better estimate of the loss inherent in the portfolio for each loan category and to reflect the availability of loss history. The Company also performs a quantitative calculation on the acquired purchased performing loan portfolio. There is no allowance for loan losses established at the acquisition date for purchased performing loans. The historical loss experience discussed above is applied to the acquired purchased performing loan portfolio and the result is compared to the remaining fair value mark on this portfolio. A provision for loan losses is recorded for any further deterioration in these loans subsequent to the acquisition. At September 30, 2014 and December 31, 2013, this analysis did not indicate a need for a provision for loan losses for the acquired purchased performing portfolio. The remaining mark on the acquired purchased performing loan portfolio was $3.7 million and $4.5 million at September 30, 2014 and December 31, 2013, respectively.

3)      Qualitative Reserve Component. Qualitative reserves represent an estimate of the amount for which it is probable that environmental or other relevant factors will cause the aforementioned loss contingency estimate to differ from the Company’s historical loss experience or other assumptions. The Company has historically focused directly on five specific environmental factors. These five factors include portfolio trends, portfolio concentrations, economic and market conditions, changes in lending practices and other factors. During the second quarter of 2014, the Company introduced two new environmental factors – changes in loan review system and geographical considerations – that are discussed below. Management believes these additional categories provide more clarity in the determination of the allowance. Each of the factors, except other factors, can range from 0.00% (not applicable) to 0.15% (very high). Other factors are reviewed on a situational basis and are adjusted in 5 basis point increments, up or down, with a maximum of 0.50%. Details of the seven environmental factors for inclusion in the allowance methodology are as follows:

i. Portfolio trends, which may relate to such factors as type or level of loan origination activity, changes in asset quality (i.e., past due, special mention, non-performing) and/or changes in collateral values;

ii. Portfolio concentrations, which may relate to individual borrowers and/or guarantors, industry sectors, loan types and/or other factors;

22

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

iii. Economic and market trends, which may relate to trends and/or levels of gross domestic production, unemployment, bankruptcies, foreclosures, housing starts, housing prices, equity prices, competitor activities and/or other factors;

iv. Changes in lending practices, which may relate to changes in credit policies, procedures, systems or staff;

v. Changes in loan review system, which may introduce variation in loan grading, collateral adequacy and valuation and impairment classification;

vi. Geographical considerations, which may relate to economic and/or environmental issues unique to a geographical area including but not limited to elimination of a major employer, natural disaster, or long-term states of emergency; and

vii. Other factors, which is intended to capture the incremental adjustment, by loan type, to internally calculated minimum reserves (as discussed above) as well as environmental factors not specifically identified above.

In addition, qualitative reserves on purchased performing loans are based on the Company’s judgment around the timing difference expected to occur between accretion of the fair market value credit adjustment and realization of actual loan losses.

4)       Reserve on Purchased-Credit Impaired Loans.In determining the acquisition date fair value of PCI loans, and in subsequent accounting, the Company generally aggregates purchased loans into pools of loans with common risk characteristics. Expected cash flows at the acquisition date in excess of the fair value of loans are recorded as interest income over the life of the loans using a level yield method if the timing and amount of the future cash flows of the pool is reasonably estimable. Subsequent to the acquisition date, significant increases in cash flows over those expected at the acquisition date are recognized as interest income prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses. In pools where impairment has already been recognized, an increase in cash flows will result in a reversal of prior impairment. Management analyzes these acquired loan pools using various assessments of risk to determine and calculate an expected loss. The expected loss is derived using an estimate of a loss given default based upon the collateral type and/or specific review by loan officers of loans generally greater than $1.0 million, and the probability of default that was determined based upon management’s review of the loan portfolio. Trends are reviewed in terms of traditional credit metrics such as accrual status, past due status, and weighted-average grade of the loans within each of the accounting pools. In addition, the relationship between the change in the unpaid principal balance and change in the fair value mark is assessed to correlate the directional consistency of the expected loss for each pool.

This analysis resulted in net (recovery) impairment for the nine months ended September 30, 2014 of ($209) thousand. There was no impairment or recovery for the three months ended September 30, 2014. Additionally, $(278) thousand of this recovery of PCI impairment was attributable to covered loans under FDIC loss share agreements. These covered impairments were a function of a decrease in expected losses. See Note 6 – FDIC Loss Share Agreements for further discussion. A full breakdown of the net impairment or recovery is detailed in the allowance by segment table above for the three and nine months ended September 30, 2014 and 2013.

23

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The allowance for loan losses is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. The increase in the allowance for loan losses from December 31, 2013 to September 30, 2014 was a function of the following:

(1) a decrease of $2.0 million in the quantitative component of the allowance due to a decrease in historical loss rates applied to the portfolio as significant charge-offs from 2010 are replaced with low loss periods in 2014. In addition, changes in look-back periods in the residential construction loan type, which better reflect the inherent loss in the portfolio, and the reclassification of the minimum reserve amounts to the qualitative component contributed to the decrease. In the past, we have recorded a minimum reserve as part of the quantitative component. A minimum reserve is utilized when we have insufficient internal loss history or when internal loss history falls below the minimum reserve percentage. Minimums are determined by analyzing Federal Reserve Bank charge-off data for all insured federally and state-chartered commercial banks. For the third quarter of 2014, we calculated the average historical loss rates and adjusted incrementally to the minimum reserve amounts in the qualitative component. This change represented a reclassification between components of the allowance and had no impact on the calculation in total.

(2) An increase of $2.5 million in the qualitative component of the allowance primarily due to the reclassification of minimum reserve amounts noted in item (i) above as well as management’s decision to increase certain factors based on rapid loan growth, including entrance into new markets, and economic uncertainty based on recent market fluctuations.

(3) A decrease of $360 thousand in the reserve on PCI loans due to the reversal of $360 thousand of previously recognized impairments.

(4) An increase of $453 thousand in specific reserves which change periodically as loans move through or out of the impairment process.

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. At both September 30, 2014 and December 31, 2013, $125 thousand was recorded as an other liability for off-balance sheet credit exposure.

Credit Quality Indicators-TheCompany uses several credit quality indicators to manage credit risk in an ongoing manner. The Company's primary credit quality indicatoris 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 ofloans that have significant or unique credit characteristics that benefit from a case-by-caseevaluation. These are typically loans to businesses or individuals in the classes thatcomprise 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 theconsumer portfolio segment.

24

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

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. PCI loans that were recorded at estimated fair value on the acquisition date are generally assigned a “pass” loan grade because their net financial statement value is based on the present value of expected cash flows. 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 and consumer portfolio segments that are inadequately protected by the sound worth and paying capacity of the borrower or of the collateral pledged, if any. 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.

25

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

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 September 30, 2014 and December 31, 2013, by loan class and by credit quality indicator.

	As of September 30, 2014
	Commercial and industrial		CRE - owner-occupied		CRE - investor income producing		AC&D - 1-4 family construction		AC&D - lots, land & development		AC&D - CRE		Other commercial		Total Commercial
Pass	$	171,024	$	326,551	$	451,622	$	32,932	$	51,747	$	53,459	$	5,024	$	1,092,359
Special mention		780		1,457		6,943		-		1,627		-		145		10,952
Classified		1,505		3,295		3,866		-		1,726		-		112		10,504
Total	$	173,309	$	331,303	$	462,431	$	32,932	$	55,100	$	53,459	$	5,281	$	1,113,815

	Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total Consumer
Pass	$	195,210	$	149,183	$	55,741	$	26,316	$	426,450
Special mention		1,536		3,604		119		126		5,385
Classified		2,227		1,981		623		2		4,833
Total	$	198,973	$	154,768	$	56,483	$	26,444	$	436,668
Total Loans									$	1,550,483

	As of December 31, 2013
	Commercial and industrial		CRE - owner-occupied		CRE - investor income producing		AC&D - 1-4 family construction		AC&D - lots, land & development		AC&D - CRE		Other commercial		Total Commercial
Pass	$	120,037	$	260,472	$	373,464	$	19,959	$	60,332	$	56,759	$	3,587	$	894,610
Special mention		1,692		6,126		3,628		-		2,802		-		150		14,398
Classified		671		983		5,095		-		2,455		-		112		9,316
Total	$	122,400	$	267,581	$	382,187	$	19,959	$	65,589	$	56,759	$	3,849	$	918,324

	Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total Consumer
Pass	$	169,519	$	137,626	$	39,824	$	18,301	$	365,270
Special mention		1,864		2,893		766		488		6,011
Classified		1,993		3,235		231		6		5,465
Total	$	173,376	$	143,754	$	40,821	$	18,795	$	376,746
Total Loans									$	1,295,070

26

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Aging Analysis of Accruing and Non-Accruing Loans –The Company considers a loan to be past due or delinquent when the terms of the contractual obligation are not met by the borrower. PCI loans are included as a single category in the table below as management believes, regardless of their age, there is a lower likelihood of aggregate loss related to these loan pools. Additionally, PCI loans are discounted to allow for the accretion of income on a level yield basis over the life of the loan based on expected cash flows. Regardless of accruing status, the associated discount on these loan pools results in income recognition. The following presents, by class, an aging analysis of the Company’s accruing and non-accruing loans as of September 30, 2014 and December 31, 2013.

	30-59		60-89		Past Due
	Days		Days		90 Days		PCI
	Past Due		Past Due		or More		Loans		Current		Total Loans
As of September 30, 2014
Commercial:
Commercial and industrial	$	131	$	883	$	491	$	6,149	$	165,655	$	173,309
CRE - owner-occupied		-		-		1,725		30,210		299,368		331,303
CRE - investor income producing		39		611		2,446		51,810		407,525		462,431
AC&D - 1-4 family construction		-		-		-		687		32,245		32,932
AC&D - lots, land & development		-		-		143		17,967		36,990		55,100
AC&D - CRE		-		-		-		113		53,346		53,459
Other commercial		47		146		112		1,255		3,721		5,281
Total commercial loans		217		1,640		4,917		108,191		998,850		1,113,815
Consumer:
Residential mortgage		125		177		367		30,259		168,045		198,973
HELOC		683		593		388		1,709		151,395		154,768
Residential construction		871		-		424		7,601		47,587		56,483
Other loans to individuals		99		9		266		909		25,161		26,444
Total consumer loans		1,778		779		1,445		40,478		392,188		436,668
Total loans	$	1,995	$	2,419	$	6,362	$	148,669	$	1,391,038	$	1,550,483
As of December 31, 2013
Commercial:
Commercial and industrial	$	96	$	52	$	149	$	5,737	$	116,366	$	122,400
CRE - owner-occupied		418		-		209		35,760		231,194		267,581
CRE - investor income producing		655		-		3,161		56,996		321,375		382,187
AC&D - 1-4 family construction		-		-		-		-		19,959		19,959
AC&D - lots, land & development		48		-		292		22,699		42,550		65,589
AC&D - CRE		-		-		-		121		56,638		56,759
Other commercial		-		112		-		137		3,600		3,849
Total commercial loans		1,217		164		3,811		121,450		791,682		918,324
Consumer:
Residential mortgage		-		32		1,340		32,826		139,178		173,376
HELOC		248		160		698		1,402		141,246		143,754
Residential construction		25		-		66		6,920		33,810		40,821
Other loans to individuals		14		11		-		1,189		17,581		18,795
Total consumer loans		287		203		2,104		42,337		331,815		376,746
Total loans	$	1,504	$	367	$	5,915	$	163,787	$	1,123,497	$	1,295,070

27

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Impaired Loans - Allclasses of loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect allamounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impaired loans may include all classesofnonaccrual 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 presentvalue of estimated future cash flows using the rate implicit in the original loan agreement or at the fair value of collateral if repayment is expected solely from the collateral.

Additionally, a portion of the Company’s qualitative factors accounts for potential impairment on loans generally less than $150 thousand. 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.

The Company’s quarterly cash flow analyses of PCI loan pools indicated no additional impairment for the three months ended September 30, 2014. The Company’s cash flow analyses of PCI loan pools indicated a net release of previous impairment of $209 thousand for the nine months ended September 30, 2014 as the pools affected showed improved expected cash flows. The following tables do not include information regarding impairment of the Company’s PCI loans. Additional information regarding these impairments and reversals are shown in the tables and discussion above.

28

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The table below presents impaired loans, by class, and the corresponding allowance for loan losses at September 30, 2014 and December 31, 2013:

	September 30, 2014						December 31, 2013
			Unpaid		Related				Unpaid		Related
	Recorded		Principal		Allowance For		Recorded		Principal		Allowance For
	Investment		Balance		Loan Losses		Investment		Balance		Loan Losses
Impaired Loans with No RelatedAllowance Recorded:
Commercial:
Commercial and industrial		348	$	426	$	-	$	183	$	473	$	-
CRE - owner-occupied		2,873		2,961		-		1,815		1,955		-
CRE - investor income producing		1,179		1,196		-		30		47		-
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		1,078		1,191		-		1,888		4,475
AC&D - CRE		-		-		-		-		-
Other commercial		-		-		-		150		167		-
Total commercial loans		5,478		5,774		-		4,066		7,117		-
Consumer:
Residential mortgage		338		437		-		3,080		3,926		-
HELOC		1,348		1,990		-		2,478		2,855		-
Residential construction		18		39		-		26		39		-
Other loans to individuals		-		-		-		58		62		-
Total consumer loans		1,704		2,466		-		5,642		6,882		-
Total impaired loans with no relatedallowance recorded	$	7,182	$	8,240	$	-	$	9,708	$	13,999	$	-
Impaired Loans with anAllowance Recorded:
Commercial:
Commercial and industrial	$	437	$	452	$	239	$	82	$	90	$	14
CRE - owner-occupied		168		175		28		87		88		14
CRE - investor income producing		318		330		52		3,186		3,673		527
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		48		49		8		-		-		-
AC&D - CRE		-		-		-		-		-		-
Other commercial		257		274		43		112		112		18
Total commercial loans		1,228		1,280		370		3,467		3,963		573
Consumer:
Residential mortgage		2,580		2,647		320		1,433		1,485		167
HELOC		1,924		1,997		444		536		587		137
Residential construction		604		613		195		40		42		7
Other loans to individuals		50		53		8		2		4		-
Total consumer loans		5,158		5,310		967		2,011		2,118		311
Total impaired loans with anallowance recorded	$	6,386	$	6,590	$	1,337	$	5,478	$	6,081	$	884
Total Impaired Loans:
Commercial:
Commercial and industrial	$	785	$	878	$	239	$	265	$	563	$	14
CRE - owner-occupied		3,041		3,136		28		1,902		2,043		14
CRE - investor income producing		1,497		1,526		52		3,216		3,720		527
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		1,126		1,240		8		1,888		4,475		-
AC&D - CRE		-		-		-		-		-		-
Other commercial		257		274		43		262		279		18
Total commercial loans		6,706		7,054		370		7,533		11,080		573
Consumer:
Residential mortgage		2,918		3,084		320		4,513		5,411		167
HELOC		3,272		3,987		444		3,014		3,442		137
Residential construction		622		652		195		66		81		7
Other loans to individuals		50		53		8		60		66		-
Total consumer loans		6,862		7,776		967		7,653		9,000		311
Total impaired loans	$	13,568	$	14,830	$	1,337	$	15,186	$	20,080	$	884

29

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The average recorded investment and interest income recognized on impaired loans, by class, for the three and nine months ended September 30, 2014 and 2013 are shown in the table below.

	Three Months Ended September 30,								Nine Months Ended September 30,
	2014				2013				2014				2013
	Average		Interest		Average		Interest		Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized		Investment		Recognized
Impaired Loans with No RelatedAllowance Recorded:
Commercial:
Commercial and industrial	$	507	$	4	$	219	$	4	$	418	$	14	$	345	$	4
CRE - owner-occupied		2,876		8		2,033		93		2,513		34		1,903		93
CRE - investor income producing		1,060		7		180		-		656		23		1,816		-
AC&D		-		-		2,300		58		-		-		3,982		181
AC&D - 1-4 family construction		-		-		-		-		-		-		-		-
AC&D - lots, land & development		1,086		20		-		-		1,489		98		-		-
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		-		-		154		-		90		-		160		-
Total commercial loans		5,529		39		4,886		155		5,166		169		8,206		278
Consumer:
Residential mortgage		1,172		-		2,876		14		2,348		-		2,207		46
Home equity lines of credit		1,380		6		1,139		16		1,525		19		1,183		16
Residential construction		18		-		-		-		16		-		24		-
Other loans to individuals		-		-		62		1		35		-		68		3
Total consumer loans		2,570		6		4,077		31		3,924		19		3,482		65
Total impaired loans with no relatedallowance recorded	$	8,099	$	45	$	8,963	$	186	$	9,090	$	188	$	11,688	$	343
Impaired Loans with anAllowance Recorded:
Commercial:
Commercial and industrial	$	281	$	-	$	437	$	-	$	178	$	1	$	516	$	1
CRE - owner-occupied		175		4		74		-		147		7		30		-
CRE - investor income producing		366		-		3,675		37		1,532		-		2,192		112
AC&D		-		-		125		-		-		-		50		-
AC&D - 1-4 family construction		-		-		-		-		19		-		-		-
AC&D - lots, land & development		48		-		-		-		29		-		-		-
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		257		-		-		-		147		5		-		-
Total commercial loans		1,127		4		4,311		37		2,052		13		2,788		113
Consumer:
Residential mortgage		1,963		16		1,283		10		1,651		55		1,241		26
Home equity lines of credit		1,836		12		1,431		1		1,624		35		876		2
Residential construction		607		-		40		1		273		-		16		1
Other loans to individuals		57		1		3		-		24		2		1		-
Total consumer loans		4,463		29		2,757		12		3,572		92		2,134		29
Total impaired loans with anallowance recorded	$	5,590	$	33	$	7,068	$	49	$	5,624	$	105	$	4,922	$	142
Total Impaired Loans:
Commercial:
Commercial and industrial	$	788	$	4	$	656	$	4	$	596	$	15	$	861	$	5
CRE - owner-occupied		3,051		12		2,107		93		2,660		41		1,933		93
CRE - investor income producing		1,426		7		3,855		37		2,188		23		4,008		112
AC&D		-		-		2,425		58		-		-		4,032		181
AC&D - 1-4 family construction		-		-		-		-		19		-		-		-
AC&D - lots, land & development		1,134		20		-		-		1,518		98		-		-
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		257		-		154		-		237		5		160		-
Total commercial loans		6,656		43		9,197		192		7,218		182		10,994		391
Consumer:
Residential mortgage		3,135		16		4,159		24		3,999		55		3,448		72
Home equity lines of credit		3,216		18		2,570		17		3,149		54		2,059		18
Residential construction		625		-		40		1		289		-		40		1
Other loans to individuals		57		1		65		1		59		2		69		3
Total consumer loans		7,033		35		6,834		43		7,496		111		5,616		94
Total impaired loans	$	13,689	$	78	$	16,031	$	235	$	14,714	$	293	$	16,610	$	485

30

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

During the three and nine months ended September 30, 2014, the Company recognized $78 thousand and $293 thousand, respectively, in interest income with respect to impaired loans, primarily accruing TDRs, within the period the loans were impaired. During the three and nine months ended September 30, 2013, the Company recognized $235 thousand and $485 thousand, respectively, in interest income with respect to impaired loans, primarily accruing TDRs, within the period the loans were impaired.

Nonaccrual and Past Due Loans -It is the general policy of the Company to place a loan on nonaccrual status when there is probable loss or when there is reasonable doubt that all principal will be collected, or when it is over 90 days past due. At September 30, 2014, there were $3.1 million in loans past due 90 days or more and accruing interest of which $1.8 million was a single relationship that repaid in full on October 1, 2014. At December 31, 2013, there were $17 thousand in loans past due 90 days or more and accruing interest. These loans were considered fully collectible at September 30, 2014 and December 31, 2013. The recorded investment in nonaccrual loans at September 30, 2014 and December 31, 2013 follows:

	September 30,		December 31,
	2014		2013
Commercial:
Commercial and industrial	$	430	$	200
CRE - owner-occupied		1,752		209
CRE - investor income producing		1,017		3,192
AC&D - 1-4 family construction		-		-
AC&D - lots, land & development		47		292
AC&D - CRE		-		-
Other commercial		112		112
Total commercial loans		3,358		4,005
Consumer:
Residential mortgage		742		2,007
HELOC		1,171		2,348
Residential construction		623		66
Other loans to individuals		-		2
Total consumer loans		2,536		4,423
Total nonaccrual loans	$	5,894	$	8,428

Purchased Credit-Impaired Loans–PCI loans had an unpaid principal balance of $184.0 million and $197.0 million and a carrying value of $148.7 million and $163.8 million at September 30, 2014 and December 31, 2013, respectively. PCI loans represented 6.4% and 8.4% of total assets at September 30, 2014 and December 31, 2013, respectively. Determining the fair value of the PCI loans at the time of acquisition required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called the accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and is called the nonaccretable difference. In accordance with GAAP, there was no carryover of previously established allowance for loan losses from acquired companies.

31

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The PCI loan portfolio acquired in connection with the Provident Community acquisition was accounted for at fair value as follows:

	May 1, 2014
Contractual principal and interest at acquisition	$	47,572
Nonaccretable difference		(7,480	)
Expected cash flows at acquisition		40,092
Accretable yield		-
Basis in PCI loans at acquisition - estimated fair value	$	40,092

A summary of changes in the accretable yield for all PCI loans for the three and nine months ended September 30, 2014 and 2013 follows:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
Accretable yield, beginning of period	$	45,659		$	42,248		$	39,249		$	42,734
Addition from the Provident Community acquisition		-			-			7,179			-
Interest income		(4,096	)		(3,591	)		(12,056	)		(11,201	)
Reclassification of nonaccretable difference due toimprovement in expected cash flows		1,933			1,699			8,266			7,445
Other changes, net		549			(653	)		1,407			725
Accretable yield, end of period	$	44,045		$	39,703		$	44,045		$	39,703

Troubled Debt Restructuring -In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR. Management strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. All loan modifications are made on a case-by-case basis.

The Company had allocated $638 thousand and $565 thousand, respectively, of specific reserves to customers whose loan terms have been modified in a TDR as of September 30, 2014 and December 31, 2013. As of September 30, 2014, the Company had 12 TDR loans totaling $4.7 million, of which $410 thousand are nonaccrual loans. As of December 31, 2013, the Company had 11 TDR loans totaling $8.2 million, of which $4.4 million are nonaccrual loans.

32

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The following tables represent a breakdown of the types of concessions made by loan class for the nine-month periods ended September 30, 2014 and 2013. There were no concessions made during the three months ended September 30, 2014 and 2013. 

	Nine months ended September 30, 2014
	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Extended payment terms
Commercial and industrial		1	$	14	$	14
CRE - investor income producing		1		94		94
Other commercial		1		165		165
HELOC		1		299		299
Residential construction		1		173		173
		5	$	745	$	745

	Nine months ended September 30, 2013
	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Below market interest rate
Residential mortgage		1	$	43	$	43
Total		1		43		43
Extended payment terms
AC&D		1		962		962
		1		962		962
Total		2	$	1,005	$	1,005

There were no loans that were modified as TDRs within the 12 months ended September 30, 2014 and September 30, 2013 for which there was a payment default during the three or nine months ended September 30, 2014 or September 30, 2013, respectively.

33

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The Company does not deem a TDR to be successful until it has been re-established as an accruing loan. The following table presents the successes and failures of the types of modifications indicated within the 12 months ended September 30, 2014 and 2013

Twelve Months Ended September 30, 2014
	Paid in full				Paying as restructured				Foreclosure/Default
	Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment
Below market interest rate		-	$	-		5	$	1,733		-	$	-
Extended payment terms		1		94		1		40		-	$	-
Total		1	$	94		6	$	1,773		-	$	-

Twelve Months Ended September 30, 2013
	Paid in full				Paying as restructured				Foreclosure/Default
	Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment
Below market interest rate		2	$	164		1	$	42		-	$	-
Extended payment terms		1		329		1		109		-	$	-
Total		3	$	493		2	$	151		-	$	-

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 arms length 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:

	Nine Months Ended
	September 30,
	2014			2013
Beginning balance	$	17,247		$	4,184
Disbursements		1,784			12,830
Repayments		(4,961	)		(1,928	)
Ending balance	$	14,070		$	15,086

At September 30, 2014 and December 31, 2013, the Company had pre-approved but unused lines of credit totaling $2.1 million and $3.0 million, respectively, to related parties.

34

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Note 6 – FDIC Loss Share Agreements

In connection with the Citizens South Banking Corporation (“Citizens South”) acquisition, the Bank assumed two purchase and assumption agreements with the Federal Deposit Insurance Corporation (“FDIC”) that cover approximately $49.8 million and $71.1 million of covered loans as of September 30, 2014 and December 31, 2013, respectively, and $4.7 million and $5.1 million of covered other real estate owned (“OREO”) as of September 30, 2014 and December 31, 2013, respectively. Citizens South acquired these assets in prior transactions with the FDIC.

Within the first purchase and assumption agreement are two loss share agreements that originated in March 2010, related to Citizen South’s acquisition of Bank of Hiawassee, a Georgia state-chartered bank headquartered in Hiawassee, Georgia. Under these loss share agreements, the FDIC will cover 80% of net loan losses up to $102 million and 95% of net loan losses that exceed $102 million. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans, five years for losses on all other loans and eight years for recoveries on all other loans. At September 30, 2014 and December 31, 2013, the Bank recorded an estimated receivable from the FDIC in the amount of $3.4 million and $6.6 million, respectively, related to these loss share agreements.

Within the second purchase and assumption agreement are two loss share agreements that originated in April 2011, related to Citizens South’s acquisition of New Horizons Bank, a Georgia state-chartered bank headquartered in East Ellijay, Georgia. The first loss share agreement covers certain residential loans and OREO for a period of ten years. The other loss share agreement covers all remaining covered assets for a period of five years. Pursuant to the terms of these loss share agreements, the FDIC is obligated to reimburse the Bank for 80% of all eligible losses, which begins with the first dollar of loss occurred, and certain collection and disposition expenses with respect to covered assets. The Bank has a corresponding obligation to reimburse the FDIC for 80% of eligible recoveries with respect to covered assets for a period of ten years for residential properties and eight years for all other covered assets. At September 30, 2014 and December 31, 2013, the Bank recorded an estimated receivable from the FDIC in the amount of $1.7 million and $3.4 million, respectively, related to these loss share agreements.

The following table provides changes in the estimated receivable from the FDIC for the nine months ended September 30, 2014 and 2013:

	September 30,
	2014			2013
Balance, beginning of period	$	10,025		$	18,697
Increase (decrease) in expected losses on loans		(278	)		297
Additional (gains) losses to OREO		96			438
Reimbursable expenses		380			321
Amortization discounts and premiums, net		(1,966	)		(209	)
Reimbursements from the FDIC		(3,179	)		(6,104	)
Other changes, net		-			519
Balance, end of period	$	5,078		$	13,959

The estimated receivable from the FDIC is measured separately from the related covered assets.. At September 30, 2014 and December 31, 2013, the projected cash flows related to the FDIC receivable for losses and reimbursable expenses on covered loans and assets were approximately $4.0 million and $11.5 million, respectively. Included in the estimated receivable above is a component of amortization which will be recognized over the life of the agreement, with increases or decreases based on estimated performance of the underlying loans.

35

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

In relation to the FDIC indemnification asset is an expected true-up with the FDIC related to the loss share agreements described above. The loss share agreements between the Bank and the FDIC with respect to New Horizons Bank and Bank of Hiawassee each contain a provision that obligates the Company to make a true-up payment to the FDIC if the realized losses of each of these acquired banks are less than expected. An estimate of this amount is determined each reporting period. At September 30, 2014 and December 31, 2013, the true-up amount was estimated to be approximately $5.6 million and $5.0 million, respectively, at the end of the loss share agreements. These amounts are recorded in other liabilities on the balance sheet. The actual payment will be determined at the end of the term of the loss sharing agreements and is based on the negative bid, expected losses, intrinsic loss estimate, and assets covered under the loss share agreements.

Note 7 – Other Real Estate Owned

The Company owned $13.3 million and $14.5 million in OREO at September 30, 2014 and December 31, 2013, respectively. The portion of OREO covered under the loss share agreements with the FDIC at September 30, 2014 and December 31, 2013 totaled $4.7 million and $5.1 million, respectively.

Transactions in OREO for the three and nine months ended September 30, 2014 and 2013 are summarized below:

	Three months ended						Nine months ended
	September 30,			September 30,			September 30,			September 30,
Non-Covered OREO	2014			2013			2014			2013
Beginning balance	$	10,773		$	9,741		$	9,404		$	18,427
Additions		190			772			1,701			1,735
Acquired through merger		-			-			2,964			-
Sales		(2,280	)		(1,667	)		(5,248	)		(11,009	)
Writedowns		(52	)		(138	)		(190	)		(445	)
Ending balance	$	8,631		$	8,708		$	8,631		$	8,708

	Three months ended						Nine months ended
	September 30,			September 30,			September 30,			September 30,
Covered OREO	2014			2013			2014			2013
Beginning balance	$	5,234		$	6,542		$	5,088		$	6,646
Additions		1,181			1,887			4,950			5,203
Sales		(1,457	)		(2,255	)		(5,036	)		(4,969	)
Writedowns		(255	)		(1	)		(299	)		(707	)
Ending balance	$	4,703		$	6,173		$	4,703		$	6,173

36

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The following is a summary of information relating to analysis of OREO at September 30, 2014 and December 31, 2013:

	September 30,		December 31,
	2014		2013
Non-covered OREO:
Commercial and industrial	$	654	$	-
CRE - owner-occupied		616		591
CRE - investor income producing		1,987		2,933
AC&D - 1-4 family construction		1,511		2,811
AC&D - lots, land & development		2,058		1,448
Other commercial		257		195
Residential mortgage		873		704
HELOC		196		124
Residential construction		439		598
Other loans to individuals		40		-
OREO covered by FDIC loss share agreements		4,703		5,088
	$	13,334	$	14,492

Note 8 – Subordinated Debt

In September 2009, the Bank issued $6.9 million in aggregate principal amount of its 11% Subordinated Notes, due June 30, 2019 (the “Notes”). On June 30, 2014, the Bank redeemed these Notes in full at a price equal to 100% of the principal amount of the Notes redeemed plus accrued but unpaid interest.

As a result of the mergers with Community Capital, Citizens South and Provident Community, the Company’s capital structure includes trust preferred securities previously issued by the predecessor companies through specially formed trusts. The combined total amount outstanding of the acquired trusts as of September 30, 2014 and December 31, 2013 was $38.1 million ($23.4 million, net of mark to market) and $25.8 million ($15.2 million, net of mark to market), respectively.

Community Capital previously had formed Community Capital Corporation Statutory Trust I, an unconsolidated statutory business trust, which issued $10.3 million ($6.1 million, net of mark to market) of trust preferred securities that were sold to third parties. The rate on the trust preferred securities acquired through the Community Capital merger adjusts quarterly to three-month LIBOR plus 1.55%. Citizens South previously had formed CSBC Statutory Trust I, an unconsolidated statutory business trust, which issued $15.5 million ($9.4 million, net of mark to market) of trust preferred securities that were sold to third parties. The rate on the trust preferred securities acquired through the Citizens South merger adjusts quarterly to three-month LIBOR plus 1.57%. Provident Community previously had formed Provident Community Bancshares Capital Trust I and Provident Community Bancshares Capital Trust II. Each trust is an unconsolidated statutory business trust, which issued $4.1 million ($2.6 million, net of mark to market) and $8.2 million ($5.3 million, net of mark to market), respectively, of trust preferred securities that were sold to third parties. The rate on each of the trust preferred securities acquired through the Provident Community merger adjusts quarterly to three-month LIBOR plus 1.74%.

The amounts presented are after related acquisition accounting fair market value adjustments. The proceeds of the sales of the trust preferred securities were used to purchase junior subordinated debt from the predecessor companies, which are presented as subordinated debt in the condensed consolidated balance sheets of the Company and qualify for inclusion in Tier 1 Capital for regulatory capital purposes, subject to certain limitations.

37

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Note 9 – Income Taxes

Income taxes are provided based on the asset-liability method of accounting, which includes the recognition of deferred tax assets (“DTAs”) and liabilities for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. In general, the Company records a DTA when the event giving rise to the tax benefit has been recognized in the consolidated financial statements.

As of September 30, 2014 and December 31, 2013, the Company had a net DTA in the amount of approximately $37.9 million and $36.3 million, respectively. The increase is primarily a function of fair market value adjustments related to the Provident Community merger, partially offset by earnings of $9.4 million during the first nine months of 2014. The Company evaluates the carrying amount of the DTA on a quarterly basis in accordance with the guidance provided in FASB ASC Topic 740, in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e., a likelihood of more than 50%) that some portion, or all, of the DTA will not be realized within its life cycle, based on the weight of available evidence. In most cases, the realization of the DTA is dependent upon generating a sufficient level of taxable income in future periods, which can be difficult to predict. In addition to projected earnings, the Company also considers projected asset quality, liquidity, its strong capital position, which could be leveraged to increase earning assets and generate taxable income, its growth plans and other relevant factors. Based on the weight of available evidence, the Company determined that as of September 30, 2014 and December 31, 2013 that it is more likely than not that it will be able to fully realize the existing DTA and therefore considered it appropriate not to establish a DTA valuation allowance at either September 30, 2014 or December 31, 2013.

Note10 - Per Share Results

Basic earnings per share represent income available to common shareholders divided by the weighted-average number of shares outstanding during the relevant period. Diluted earnings per share reflect additional shares that would have been outstanding if dilutive potential shares had been issued. Potential shares that may be issued by the Company relate solely to outstanding stock options and restricted shares (unvested shares), and are determined using the treasury stock method. Under the treasury stock method, the number of incremental shares is determined by assuming the issuance of stock for the outstanding stock options reduced by the number of shares assumed to be repurchased from the issuance proceeds, using the average market price for the period of the Company's stock. Weighted-average shares for the basic and diluted EPS calculations have been reduced by the average number of unvested restricted shares. 

Weighted-Average Shares for Earnings Per Share Calculation

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2014		2013		2014		2013
Weighted-average number of commonshares outstanding excluding unvested restricted shares		43,910,365		44,170,964		43,919,481		44,098,417
Effect of dilutive stock optionsand unvested shares		323,167		102,857		305,201		74,052
Weighted-average number of commonshares and dilutive potential commonshares outstanding		44,233,532		44,273,821		44,224,682		44,172,469

38

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

There were 1,940,740 outstanding options and 853,208 outstanding unvested restricted shares that were anti-dilutive for the three months ended September 30, 2014. There were 244,910 dilutive stock options and 78,257 dilutive unvested restricted shares outstanding for the three months ended September 30, 2014.

There were 2,664,625 outstanding options and 554,400 outstanding unvested restricted shares that were anti-dilutive for the three months ended September 30, 2013. There were 58,037 dilutive stock options and 44,820 dilutive unvested restricted shares outstanding for the three months ended September 30, 2013.

There were 1,948,108 outstanding options and 863,805 outstanding unvested restricted shares that were anti-dilutive for the nine months ended September 30, 2014. There were 237,542 dilutive stock options and 67,660 dilutive unvested restricted shares outstanding for the nine months ended September 30, 2014.

There were 2,678,958 outstanding options and 554,400 outstanding unvested restricted shares that were anti-dilutive for the nine months ended September 30, 2013. There were 42,231 dilutive stock options and 31,820 dilutive unvested restricted shares outstanding for the nine months ended September 30, 2013.

At September 30, 2014, 554,400 of the outstanding restricted shares had performance conditions, which 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. These anti-dilutive restricted shares are issued (and thereby have voting rights), but are not included in basic earnings per share calculations until they vest (and thereby have economic rights).

Note 11 – Preferred Stock

In connection with the Citizens South acquisition, the Company issued 20,500 shares of its Non-Cumulative Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”) upon conversion of Citizens South’s preferred stock that previously was issued to the Treasury pursuant to a Securities Purchase Agreement between Citizens South and the Treasury in connection with Citizens South’s participation in the Small Business Lending Fund (“SBLF”) program. On September 30, 2013, the Company fully redeemed the 20,500 shares of the Series C Preferred Stock and exited the SBLF program. The Series C Preferred Stock, which had a liquidation value of $1,000 per share, was entitled to receive noncumulative dividends, payable quarterly, at a rate determined by reference to the level of “Qualified Small Business Lending”.

Note 12 - 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 September 30, 2014, we had $369.6 million of pre-approved but unused lines of credit, $7.4 million of standby letters of credit and $487 thousand of commercial letters of credit. At December 31, 2013, we had $279.5 million of pre-approved but unused lines of credit, $3.6 million of standby letters of credit and $1.9 million of commercial letters of credit. 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.

39

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Note 13 - Derivative Financial Instruments and Hedging Activities

The following table presents information on the Company’s swaps at September 30, 2014:

									Floating
Original		Current							Rate
Notional		Notional		Termination	Fixed			Floating	Payer			Hedge	Type of
Amount		Amount		Date	Rate			Rate	Spread			Treatment	Hedge
$	2,555	$	2,345	10/10/15		5.50	%	USD-LIBOR-BBA		2.88	%	Yes	Fair Value
	3,595		3,108	04/27/17		5.25	%	USD-LIBOR-BBA		2.73	%	Yes	Fair Value
	3,269		3,133	04/01/19		4.45	%	USD-LIBOR-BBA		2.90	%	Yes	Fair Value
	2,365		2,304	06/27/22		4.50	%	USD-LIBOR-BBA		2.25	%	Yes	Fair Value
	8,000		7,960	08/13/19		4.81	%	USD-LIBOR-BBA		3.10	%	Yes	Fair Value
	12,500		12,500	12/31/18		1.688	%	USD-Federal Funds-H15		0.25	%	Yes	Cash Flow
	12,500		12,500	12/31/20		2.341	%	USD-Federal Funds-H15		0.25	%	Yes	Cash Flow
	25,000		25,000	12/31/20		3.104	%	USD-Federal Funds-H15		0.25	%	Yes	Cash Flow
	20,000		20,000	10/21/21		3.439	%	USD-LIBOR-BBA		0.00	%	Yes	Cash Flow
	1,338		1,315	06/15/19		4.95	%	USD-LIBOR-BBA		2.75	%	No	N/A
	2,600		2,552	03/15/21		4.34	%	USD-LIBOR-BBA		2.15	%	No	N/A
	489		3,422	03/15/21		4.64	%	USD-LIBOR-BBA		2.15	%	No	N/A
	1,122		1,119	10/05/18		4.25	%	USD-LIBOR-BBA		2.00	%	No	N/A
	1,273		1,273	09/05/19		4.00	%	USD-LIBOR-BBA		1.75	%	No	N/A
	21,000		21,000	09/15/24		4.60	%	USD-LIBOR-BBA		2.16	%	No	N/A
$	117,606	$	119,531

At September 30, 2014, the Company had five loan swaps accounted for as fair value hedges in accordance with ASC 815,Derivatives and Hedging. The aggregate original notional amount of these loan swaps was $19.8 million. These derivative instruments are used to protect the Company from interest rate risk caused by changes in the London Interbank Offered Rate (“LIBOR”) curve in relation to certain designated fixed rate loans. 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 $(262) thousand and $(258) thousand at September 30, 2014 and December 31, 2013, respectively, and are included in other liabilities. The loans being hedged are also recorded at fair value. These fair value hedges had no indications of ineffectiveness for any of the periods presented. The Company recorded interest expense on these loan swaps of $68 thousand and $148 thousand in the three and nine months ended September 30, 2014, respectively, and $35 thousand and $200 thousand in the three and nine months ended September 30, 2013, respectively.

The Company entered into an interest rate swap agreement during October 2013 with a notional amount of $20.0 million. This derivative instrument is used to protect the Company from future interest rate risk on a portion of its floating rate FHLB borrowings. This derivative instrument is a $20.0 million three-year forward starting, five-year interest rate swap with an effective date of October 21, 2016. The instrument carries a fixed rate of 3.439% with quarterly payments commencing in January 2017. This derivative instrument is accounted for as a cash flow hedge with effective changes in fair market value recorded in other comprehensive income net of tax. This derivative instrument is carried at a fair market value of $(479) thousand and $298 thousand at September 30, 2014 and December 31, 2013, respectively, and is included in other liabilities at September 30, 2014 and other assets at December 31, 2013. As a result of the unfavorable position of the instrument at September 30, 2014, the Company posted collateral of approximately $480 thousand with the counterparty.

40

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The Company entered into three interest rate swap agreements during December 2013 with an aggregate notional amount of $50.0 million. These derivative instruments are used to protect the Company from future interest rate risk related to a seven-year commitment of floating rate broker-dealer sweep accounts through a brokered deposit program. These derivative instruments are a combination of a $12.5 million forward starting, five-year interest rate swap; a $12.5 million forward starting, seven-year interest rate swap; and a $25.0 million two-year forward starting swap. Effective dates for these derivative instruments are January 2, 2014, January 2, 2014 and January 4, 2016, respectively. These instruments carry a fixed rate of 1.688% with monthly payments commencing February 3, 2014, a fixed rate of 2.341% with monthly payments commencing February 3, 2014, and a fixed rate of 3.104% with monthly payments commencing February 1, 2016, respectively. These derivative instruments are accounted for as cash flow hedges with effective changes in fair market value recorded in other comprehensive income net of tax. These derivative instruments are carried at a fair market value of $(649) thousand and $247 thousand at September 30, 2014 and December 31, 2013, respectively, and are included in other liabilities at September 30, 2014 and other assets at December 31, 2013. As a result of the unfavorable position of the instruments at September 30, 2014, the Company posted collateral of approximately $650 thousand with the counterparty.

The Company has entered into six interest rate swap agreements to convert certain fixed-rate receivables to floating rates and certain fixed-rate obligations to floating rates. To meet the needs of the Company’s customers, the Company has entered into certain swap agreements to convert variable rate loans receivable into fixed rates for the customer’s cash flow management needs. To offset this interest rate risk, the Company has entered into substantially identical agreements with a third party to swap these fixed rate agreements into variable rates. The interest rate swaps are used to provide fixed rate financing while managing interest rate risk and were not designated as hedges. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR, with payments being calculated on the notional amount. The interest rate swaps are settled monthly, with varying maturities. The interest rate swaps had a notional amount of $30.8 million at September 30, 2014, representing the amount of fixed-rate receivables outstanding and liabilities outstanding, and are included in other assets and other liabilities at their fair values of $449 thousand. All changes in fair value are recorded as other income within non-interest income. Fair values for interest rate swap agreements are based upon the amounts required to settle the contracts. At September 30, 2014, there was no impact to earnings as the changes in the fair value of both the fixed and variable legs of the swap completely offset each other.

41

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Note 14 – Accumulated Other Comprehensive Income

The before and after tax amounts allocated to each component of other comprehensive income (loss) are presented in the following table. Reclassification adjustments related to securities available for sale are included in gain (loss) on sale of securities available for sale in the accompanying consolidated statements of income. Amortization of net unrealized losses on securities transferred to held to maturity are included in interest income on taxable investment securities in the accompanying consolidated statements of income.

	Three Months Ended									Three Months Ended
	September 30, 2014									September 30, 2013
	Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount			Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
Securities available for sale and transferred securities:
Change in net unrealized gains (losses) during the period	$	(1,457	)	$	(549	)	$	(908	)	$	(1,286	)	$	(478	)	$	(808	)
Change in net unrealized gains (losses) on securities transferred to held to maturity		77			29			48			-			-			-
Reclassification adjustment for net (gains) losses recognized in net income		63			23			40			-			-			-
Total securities available for sale and transferred securities		(1,317	)		(497	)		(820	)		(1,286	)		(478	)		(808	)
Derivatives:
Change in the accumulated loss on effective cash flow hedge derivatives		215			81			134			-			-			-
Total derivatives		215			81			134			-			-			-
Total other comprehensive income (loss)	$	(1,102	)	$	(416	)	$	(686	)	$	(1,286	)	$	(478	)	$	(808	)

	Nine Months Ended									Nine Months Ended
	September 30, 2014									September 30, 2013
	Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount			Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
Securities available for sale and transferred securities:
Change in net unrealized gains (losses) during the period	$	7,565		$	2,803		$	4,762		$	(11,403	)	$	(4,242	)	$	(7,161	)
Change in net unrealized loss on securities transferred to held to maturity		(2,132	)		(801	)		(1,331	)		-			-			-
Reclassification adjustment for net (gains) losses recognized in net income		(180	)		(68	)		(112	)		(104	)		(49	)		(55	)
Total securities available for sale and transferred securities		5,253			1,934			3,319			(11,507	)		(4,291	)		(7,216	)
Derivatives:
Change in the accumulated loss on effective cash flow hedge derivatives		(1,672	)		(627	)		(1,045	)		-			-			-
Total derivatives		(1,672	)		(627	)		(1,045	)		-			-			-
Total other comprehensive income (loss)	$	3,581		$	1,307		$	2,274		$	(11,507	)	$	(4,291	)	$	(7,216	)

The following table presents activity in accumulated other comprehensive income (loss), net of tax, by component for the periods indicated.

	Securities Available for Sale			Derivatives			Accumulated Other Comprehensive Income (Loss)
Balance, January 1, 2014	$	(5,145	)	$	343		$	(4,802	)
Other comprehensive income (loss) before reclassifications		3,431			(1,045	)		2,386
Amounts reclassified from accumulated other comprehensive income (loss)		(112	)		-			(112	)
Net other comprehensive income (loss) during the period		3,319			(1,045	)		2,274
Balance, September 30, 2014	$	(1,826	)	$	(702	)	$	(2,528	)
Balance, January 1, 2013	$	3,198		$	-		$	3,198
Other comprehensive income (loss) before reclassifications		(7,161	)		-			(7,161	)
Amounts reclassified from accumulated other comprehensive income (loss)		(55	)		-			(55	)
Net other comprehensive income (loss) during the period		(7,216	)		-			(7,216	)
Balance, September 30, 2013	$	(4,018	)	$	-		$	(4,018	)

42

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Note 15 - 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–Cash and cash equivalents, which are comprised of cash and due from banks, interest-earning balances at banks and Federal funds sold, approximate their fair value.

Investment Securities Available-for-sale and Investment Securities Held-to-Maturity-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.

Nonmarketable Equity Securities–Cost is a reasonable estimate of fair value for nonmarketable equity securities because no quoted market prices are available and the securities are not readily marketable. The carrying amount is adjusted for any other than temporary declines in value.

Loans Held for Sale-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.

Loans, net of allowance -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.

FDIC Indemnification Asset –The fair values for the FDIC indemnification asset are estimated based on discounted future cash flows using current discount rates.

Accrued Interest Receivable-The carrying amount is a reasonable estimate of fair value.

Deposits-The fair value of deposits with 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 maturities, 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.

Subordinated Debt –The fair value of the fixed rate subordinated debt is estimated using a discounted cash flow calculation that applies the Company’s current borrowing rate. The carrying amounts of variable rate borrowings are reasonable estimates of fair value because they can reprice frequently.

43

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

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, it is not practicable to estimate the fair value of future financing commitments.

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 and derivative instruments 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.

Level1 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.

44

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The carrying amounts and estimated fair values of the Company’s financial instruments, none of which are held for trading purposes, at September 30, 2014 and December 31, 2013 are as follows: 

					Fair Value Measurements
	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets or Liabilities		Significant Other Observable Inputs		Significant Unobservable Inputs
	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2014
Financial assets:
Cash and cash equivalents	$	58,853	$	58,853	$	58,853	$	-	$	-
Investment securities available-for-sale		367,262		367,262		1,697		365,565		-
Investment securities held-to-maturity		117,463		117,693		-		117,693		-
Nonmarketable equity securities		9,731		9,731		-		9,731		-
Loans held for sale		4,763		4,763		-		4,763		-
Loans, net of allowance		1,542,697		1,471,901		-		19,159		1,452,742
FDIC indemnification asset		5,078		5,078		-		-		5,078
Accrued interest receivable		4,540		4,540		-		4,540		-
Financial liabilities:
Deposits with no stated maturity		1,242,407		1,242,407		-		1,242,407		-
Deposits with stated maturities		622,201		560,476		-		560,476		-
Swap fair value hedge		309		309		-		309		-
Interest rate swaps		1,643		1,643		-		1,643		-
Borrowings		163,413		162,938		-		162,938		-
Accrued interest payable		385		385		-		385		-
December 31, 2013:
Financial assets:
Cash and cash equivalents	$	55,067	$	55,067	$	55,067	$	-	$	-
Investment securities available-for-sale		349,491		349,491		1,906		347,585		-
Investment securities held-to-maturity		51,972		51,334		-		51,334		-
Nonmarketable equity securities		5,905		5,905		-		5,905		-
Loans held for sale		2,430		2,430		-		2,430		-
Loans, net of allowance		1,286,977		1,267,349		-		5,884		1,261,465
FDIC indemnification asset		10,025		10,025		-		-		10,025
Interest rate swaps		545		545		-		545		-
Accrued interest receivable		4,222		4,222		-		4,222		-
Financial liabilities:
Deposits with no stated maturity		1,055,457		1,055,457		-		1,055,457		-
Deposits with stated maturities		544,428		545,111		-		545,111		-
Swap fair value hedge		258		258		-		258		-
Borrowings		78,048		77,899		-		77,899		-
Accrued interest payable		412		412		-		412		-

45

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

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

Investment Securities-Investment securities available-for-sale are recorded at fair value on a recurring basis. Investment securities held-to-maturity are valued at quoted market prices or dealer quotes similar to securities available for sale. 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, United States Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include MBS issued by government-sponsored entities or private label entities, municipal bonds and corporate debt securities that are valued using quoted prices for similar instruments in active markets.

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 on a recurring basis. The Company classifies derivative instruments held or issued for risk management purposes as Level 2. As of September 30, 2014 and December 31, 2013, the Company’s derivative instruments consist of interest rate swaps and swap fair value hedges.

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, discounted cash flows or a pooled probability of default and loss given default calculation. 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. The Company records such impaired loans as nonrecurring Level 3.

At September 30, 2014 and December 31, 2013, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. The Company records the five 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.

Loans held for sale –Loans held for sale are adjusted to lower of cost or market upon transfer from the loan portfolio to loans held for sale. Subsequently, loans held for sale are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral, management’s estimation of the value of the collateral or commitments on hand from investors within the secondary market for loans with similar characteristics. The fair value adjustments for loans held for sale are recorded as nonrecurring Level 2.

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 less costs to sell. 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 measured due to further deterioration in the value of the OREO since initial recognition, the Company records the foreclosed asset as nonrecurring Level 3.

46

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

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 September 30, 2014 and December 31, 2013 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
September 30, 2014
U.S. Government agencies	$	-	$	542		$	-	$	542
Municipal securities		-		12,865			-		12,865
Residential agency pass-through securities		-		144,082			-		144,082
Residential collateralized mortgage obligations		-		147,726			-		147,726
Commercial mortgage-backed obligations		-		4,844			-		4,844
Asset-backed securities		-		51,931			-		51,931
Corporate and other securities		-		3,575			-		3,575
All other equity securities		1,697		-			-		1,697
Interest rate swaps		-		(1,643	)		-		(1,643	)
Fair value loans		-		19,159			-		19,159
Swap fair value hedge		-		(309	)		-		(309	)
December 31, 2013
U.S. Government agencies	$	-	$	558		$	-	$	558
Municipal securities		-		16,506			-		16,506
Residential agency pass-through securities		-		90,248			-		90,248
Residential collateralized mortgage obligations		-		103,349			-		103,349
Commercial mortgage-backed obligations		-		61,402			-		61,402
Asset-backed securities		-		71,077			-		71,077
Corporate and other securities		-		4,445			-		4,445
All other equity securities		1,906		-			-		1,906
Interest rate swaps		-		545			-		545
Fair value loans		-		5,884			-		5,884
Swap fair value hedge		-		(258	)		-		(258	)

There were no transfers between valuation levels for any accounts during the nine months ended September 30, 2014. At December 31, 2013, the Company transferred its corporate debt security investment from Level 3 to Level 2. In December 2013, the Company received notice that this corporate debt security would be satisfied at its book value in January 2014. The full book value of this security was received on January 31, 2014. At September 30, 2014, the Company had no Level 3 assets measured at fair value on a recurring basis. If different valuation techniques are deemed necessary, the Company would consider those transfers to occur at the end of the period that the accounts are valued.

47

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Assets Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower of cost or market accounting or impairment charges of individual assets. Processes are in place for overseeing the valuation procedures for Level 3 measurements of OREO and impaired loans. The assets are reviewed on a quarterly basis to determine the accuracy of the observable inputs, generally third party appraisals, auction values, values derived from trade publications and data submitted by the borrower, and the appropriateness of the unobservable inputs, generally discounts due to current market conditions and collection issues. Discounts are based on asset type and valuation source; deviations from the standard are documented. The discounts are periodically reviewed to determine whether they remain appropriate. Consideration is given to current trends in market values for the asset categories and gain and losses on sales of similar assets.

Discounts range from 0% to 100% depending on the nature of the assets and source of value. Real estate is valued based on appraisals or evaluations, discounted by 8% at a minimum with higher discounts for property in poor condition or property with characteristics that may make it more difficult to market. Commercial loans secured by receivables or non-real estate collateral are generally valued using the discounted cash flow method. Inputs are determined on a borrower-by-borrower basis.

Impaired loans and related write-downs are based on the fair value of the underlying collateral if repayment is expected solely from the collateral or using a pooled probability of default and loss given default calculation. Collateral values are reviewed quarterly and estimated using customized discounting criteria and appraisals.

Other real estate owned is based on the lower of the cost or fair value of the underlying collateral less expected selling costs. Collateral values are estimated primarily using appraisals and reflect a market value approach. Fair values are reviewed quarterly and new appraisals are generally obtained annually.

48

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The following table sets forth by level, within the fair value hierarchy, the Company’s assets at fair value on a nonrecurring basis at September 30, 2014 and December 31, 2013:

 

	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
September 30, 2014
OREO	$	-	$	-	$	5,284	$	5,284
Impaired loans:
Commercial and industrial		-		-		141		141
CRE - owner-occupied		-		-		77		77
CRE - investor income producing		-		-		242		242
AC&D - lots, land & development		-		-		40		40
Other commercial		-		-		121		121
Residential mortgage		-		-		125		125
HELOC		-		-		1,252		1,252
Residential construction		-		-		385		385
Other loans to individuals		-		-		42		42
December 31, 2013
OREO	$	-	$	-	$	9,085	$	9,085
Impaired loans:
Commercial and industrial		-		-		69		69
CRE - owner-occupied		-		-		73		73
CRE - investor income producing		-		-		2,659		2,659
Other commercial		-		-		93		93
Residential mortgage		-		-		510		510
HELOC		-		-		184		184
Residential construction		-		-		34		34
Other loans to individuals		-		-		1		1

The table below presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a nonrecurring basis at September 30, 2014.

								Weighted
	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs			Average Discount
OREO	$	5,284	Appraisals	Discount to reflect currentmarket conditions		0% - 55	%		3.73	%
Impaired loans		33	Discounted cash flows	Percent of total contractualcash flows not expected to be collected		0% - 50	%		18.07	%
		1,086	Probability of defaultmodel	Discount to reflect probabilityand loss given default		0% - 100	%		16.15	%
		1,306	Collateral basedmeasurements	Discount to reflect current market conditions and ultimate collectability		0% - 60	%		37.27	%
	$	7,709

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 September 30, 2014, OREO with a carrying value of $1.0 million was written down by $161 thousand to $0.8 million. During the nine months ended September 30, 2014, OREO with a carrying value of $3.0 million was written down by $343 thousand to $2.7 million. During the three months ended September 30, 2013, OREO with a carrying value of $0.7 million was written down by $0.1 million to $0.6 million. During the nine months ended September 30, 2013, OREO with a carrying value of $7.3 million was written down by $1.2 million to $6.1 million.

49

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Note 16 – Shareholders’ Equity

Share-Based Plans

The Company maintains share-based 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 Option Plans”), which provided for an aggregate of 1,859,550 shares of Common Stock reserved for the granting of options. The 2010 Plans were substantially similar to the 2006 option plans for directors and employees, which provided for an aggregate of 990,000 of shares of Common Stock reserved for options. Upon effectiveness of the holding company reorganization on January 1, 2011, 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. As a result, there will be no further awards under the 2010 Plans. At September 30, 2014, there were options to purchase 1,891,609 shares of Common Stock outstanding under the 2010 Option Plans and the 2006 option 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 “2010 LTIP”), which was effective upon the holding company reorganization and replaced the 2010 Plans. The 2010 LTIP provided for an aggregate of 1,016,400 of shares of Common Stock reserved for issuance to employees and directors in connection with stock options, restricted stock awards, and other stock-based awards. At September 30, 2014, there were options to purchase 106,340 shares of Common Stock and 215,999 unvested restricted stock awards outstanding under the 2010 LTIP. The 2010 LTIP was frozen upon effectiveness of the Company’s 2014 Long Term Incentive Plan (described below), and no future awards may be made thereunder.

In March 2014, the Board of Directors of the Company adopted and in May 2014 shareholders approved the Park Sterling Corporation 2014 Long-Term Incentive Plan for directors and employees (the “2014 LTIP”), which replaced the 2010 LTIP. An aggregate of 1,000,000 of shares of Common Stock, plus any shares subject to an award granted under the 2010 LTIP that was outstanding on March 26, 2014 that may expire, be forfeited or otherwise terminate unexercised, have been reserved for issuance to employees and directors under the 2014 LTIP in connection with stock options, restricted stock awards, and other stock-based awards. The 2014 LTIP will expire on May 23, 2024 and no awards may be made after that date. At September 30, 2014, there 161,066 unvested restricted stock awards outstanding under the 2014 LTIP.

As a result of the Citizens South merger, the Company assumed the Citizens South Bank 1999 Stock Option Plan (the “1999 Citizens South Plan”), the Citizens South Banking Corporation 2003 Stock Option Plan (the “2003 Citizens South Plan”) and the Citizens South Banking Corporation 2008 Equity Incentive Plan ( the “2008 Citizens South Plan”), each of which has been renamed as a Park Sterling Corporation plan, and the obligations of awards outstanding under the plans at the effective date of the merger.

Under the 2008 Citizens South Plan, the Company could grant non-qualified stock options and stock appreciation rights (“SARs”) to eligible employees and directors of, or service providers to, the Company or the Bank who were not employees or directors of or service providers to the Company or the Bank at the effective time of the merger. Stock options and SARS are evidenced by an award agreement that specifies, as applicable, the number of shares, date of grant, exercise price, vesting period and expiration date, and other information. Awards under the 2008 Citizens South Plan have an exercise price at least equal to the fair market value of the Common Stock on the grant date, cannot be exercised more than 10 years after the grant date and generally expire or are forfeited upon termination of employment prior to the end of the award term, except in limited circumstances such as death, disability, retirement or change in control. At September 30, 2014, there were options to purchase 148,161 shares of Common Stock outstanding under the 2008 Citizens South Plan. The 2008 Citizens South Plan was frozen upon effectiveness of the 2014 LTIP, and no future awards may be made thereunder.

50

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

The 2003 Citizens South Plan and the 1999 Citizens South Plan are no longer active plans and no future awards can be granted thereunder. At September 30, 2014, there were options to purchase 12,431 shares of Common Stock outstanding under the 2003 Citizens South Plan, and there were options to purchase 942 shares of Common Stock outstanding under the 1999 Citizens South Plan.

The exercise price of each option under these plans is not less than the market price of the Company’s Common Stock on the date of the grant. The exercise price of all options outstanding at September 30, 2014 under these plans ranges from $3.04 to $15.45 and the average exercise price was $7.41. The Company funds the option shares from authorized but unissued shares. The Company does not typically purchase shares to fulfill the obligations of the stock benefit plans. Options granted become exercisable in accordance with the plans’ vesting schedules, which are generally three years. All unexercised options expire ten years after the date of the grant. 

As contemplated during the Bank’s 2010 public offering, the Company awarded 568,260 of stock price performance-based restricted shares to officers and directors following the holding company reorganization. During 2013 and 2014, 13,860 stock price performance-based restricted shares were forfeited, and there were 554,400 stock price performance-based restricted shares outstanding at September 30, 2014. These 554,400 shares vest one-third each when the Company’s stock price per share reaches the following performance thresholds for 30 consecutive trading days: (i) 125% of offer price ($8.13); (ii) 140% of offer price ($9.10); and (iii) 160% of offer price ($10.40). These anti-dilutive restricted shares are issued (and thereby have voting rights), but are not included in earnings per share calculations until they vest (and thereby have economic rights).

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

	Outstanding Options									Unvested Restricted Shares
				Weighted		Weighted							Weighted
				Average		Average							Average		Aggregate
	Number			Exercise		Contractual		Intrinsic		Number			Grant Date		Intrinsic
	Outstanding			Price		Term (Years)		Value		Outstanding			Fair Value		Value
At December 31, 2013		2,225,551		$	7.35		5.65	$	-		770,399		$	4.35	$	5,315
Options granted		17,500			6.70		-		-		-			-		-
Restricted shares granted		-			-		-		-		236,900			6.52		1,571
Options exercised		(43,618	)		4.54		-		-		-			-		-
Restricted shares vested		-			-		-		-		(69,834	)		5.33		463
Expired and forfeited		(13,783	)		9.06		-		-		(6,000	)		5.53		40
At September 30, 2014		2,185,650		$	7.39		4.94	$	551		931,465		$	4.82	$	6,176
Exercisable at September 30, 2014		2,156,983		$	7.41		4.89

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The average fair value per share of options granted in the first nine months of 2014 was $6.70. Assumptions used for grants were as follows. There were no stock options granted during the nine-month period ended September 30, 2013.

51

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

Assumptions in Estimating Option Values
Weighted-average volatility	38.6% - 39.0	%
Expected dividend yield	1.21	%
Risk-free interest rate	2.22	%
Expected life (years)	7

At September 30, 2014, unrecognized compensation cost related to outstanding stock options of $48 thousand is expected to be recognized over a weighted-average period of 1.10 years. Total compensation expense for stock options was $8 thousand and $157 thousand for the three months ended September 30, 2014 and 2013, respectively, and $34 thousand and $801 thousand for the nine months ended September 30, 2014 and 2013, respectively.

At September 30, 2014, unrecognized compensation cost related to unvested restricted shares of $1.9 million is expected to be recognized over a weighted-average period of 1.10 years. Total compensation expense for restricted shares was $306 thousand and $249 thousand for the three months ended September 30, 2014 and 2013, respectively, and $811 thousand and $667 thousand for the nine months ended September 30, 2014 and 2013, respectively.

Note 17 – Subsequent Events

DividendDeclaration

On October 29, 2014, the Company announced that its Board of Directors has declared a quarterly dividend of $0.02 per common share, payable on November 26, 2014 to all common shareholders of record as of the close of business on November 12, 2014.

Share Repurchase Agreement

On October 30, 2014, the Company’s Board of Directors approved a new share repurchase program whereby the Company may purchase up to 2.2 million common shares, or approximately 5% of the Company's 44,850,813 outstanding dilutive common shares. The share repurchase authorization, which is effective immediately and extends through November 1, 2016, permits the Company to effect the repurchases from time to time through a combination of open market repurchases, privately negotiated transactions, accelerated share repurchase transactions and other derivative transactions.

52

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 or forecasts of future events, results and conditions, including financial and other estimates and expectations regarding the effects of the merger with Provident Community Bancshares, Inc. (“Provident Community”), the general business strategy of engaging in bank mergers, organic growth, branch openings and closings, expansion in new markets, hiring of additional personnel, expansion or addition of product capabilities, expected footprint of the banking franchise and anticipated asset size; anticipated loan growth; changes in loan mix and deposit mix; capital and liquidity levels; net interest income; provision expense; noninterest income and noninterest expenses; realization of deferred tax asset; credit trends and conditions, including loan losses, allowance for loan loss, charge-offs, delinquency trends and nonperforming asset levels; the amount, timing and prices of share repurchases; the payment of common stock dividends; and other similar matters. These forward-looking 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 Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”) on March 6, 2014 (the “2013 Form 10-K”) and in any of the Company’s subsequent filings with the SEC: failure to realize synergies and other financial benefits from the Provident Community merger within the expected time frames; increases in expected costs or decreases in expected savings or difficulties related to merger integration matters; inability to identify and successfully negotiate and complete additional combinations with other potential merger partners or to successfully integrate such businesses into the Company, including the Company’s ability to adequately estimate or to realize the benefits and cost savings from and limit any unexpected liabilities acquired as a result of any such business combination; failure to generate an adequate return on investment related to the Richmond branches office or other hiring initiatives; inability to generate future organic growth in loan balances, retail banking, wealth management, capital markets or mortgage banking results through the hiring of new personnel, development of new products, opening of de novo branches, or otherwise; variability in the performance of covered loans and associated loss share related expenses; the effects of negative or soft economic conditions, including stress in the commercial real estate markets or failure of continued 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 allowances for loan losses; deterioration in the credit quality of the loan portfolio or in the value of the collateral securing those loans; deterioration in the value of securities held in the investment securities portfolio; the possibility of recognizing other than temporary impairments on holdings of collateralized loan obligation securities as a result of the Volcker Rule; the impacts on the Company of a potential increasing rate environment; the potential impacts of any government shutdown or debt ceiling impasses, including the risk of a United States credit rating downgrade or default, or continued global economic instability, which could cause disruptions in the financial markets, impact interest rates, and cause other potential unforeseen consequences; fluctuations in the market price of the common stock, regulatory, legal and contractual requirements, other uses of capital, the Company’s financial performance, market conditions generally, and future actions by the board of directors, in each case impacting repurchases of common stock or declaration of dividends; legal and regulatory developments including changes in the federal risk-based capital rules; increased competition from both banks and nonbanks; changes in accounting standards, rules and interpretations, inaccurate estimates or assumptions in accounting, including acquisition accounting fair market value assumptions and accounting for purchased credit-impaired loans, and the impact on the Company’s financial statements; 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.

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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- and nine-month periods ended September 30, 2014. 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 (the “Unaudited Financial Statements”).

Executive Overview

The Company reported net income available to common shareholders of $9.4 million, or $0.21 per share, for the nine months ended September 30, 2014 compared to $10.9 million, or $0.25 per share, for the nine months ended September 30, 2013. The Company reported adjusted net income available to common shareholders, which excludes merger-related expenses and gain or loss on sale of securities, of $11.0 million, or $0.25 per share, for the nine months ended September 30, 2014 compared to $12.0 million, or $0.27 per share, for the nine months ended September 30, 2013.

Net interest margin was 3.97% for the nine-month period ended September 30, 2014, representing a 27 basis point decrease from 4.20% for the nine-month period ended September 30, 2013. The reduction in net interest margin from September 30, 2013 resulted primarily from a 24 basis point decrease in average yield on loans, reflecting both a lower mix of higher yielding PCI loans and lower accelerated accretion, and an 8 basis point increase in the cost of interest-bearing liabilities, driven primarily by the expiration of accounting-related fair market value adjustments on acquired deposits in the fourth quarter of 2013.

Total assets increased $365.5 million, or 18.6%, to $2.33 billion at September 30, 2014, compared to total assets of $1.96 billion at December 31, 2013, driven both by organic growth and the Provident Community acquisition. Cash and cash equivalents increased $3.8 million, or 6.9%, to $58.9 million, and total securities, including non-marketable securities, increased $87.1 million, or 21%, to $494.5 million, compared to December 31, 2013. These increases were primarily the result of the merger with Provident Community. Total loans, excluding loans held for sale, increased $256.3 million, or 19.8%, to $1.6 billion at September 30, 2014, compared to total loans, excluding loans held for sale, of $1.3 billion at December 31, 2013. The increase resulted from $152.0 million of organic loan growth, representing a 16% annual growth rate, and the Provident Community acquisition, net of acquisition accounting fair market value adjustments.

Asset quality remained strong during the first nine months of 2014. Nonperforming loans increased $395 thousand, or 3%, to $12.7 million at September 30, 2014, or 0.82% of total loans, compared to $12.3 million at December 31, 2013, or 0.95% of total loans. Nonperforming assets decreased $763 thousand, or 3%, to $26.0 million at September 30, 2014, or 1.12% of total assets, compared to $26.8 million at December 31, 2013, or 1.37% of total assets. The Company currently expects 80% of losses and associated expenses on covered OREO to be reimbursed under its FDIC loss share agreements.

Total deposits increased $264.7 million, or 16.6%, to $1.86 billion at September 30, 2014, compared to $1.60 billion at December 31, 2013, reflecting both the Provident Community acquisition and strong results in retail and commercial banking.Total borrowings increased $85.4 million, or 110%, to $163.4 million at September 30, 2014 compared to $78.0 million at December 31, 2013. The Company borrowed an additional $85 million in FHLB advances during the third quarter of 2014 which was used to fund loan growth and fully repay $8.6 million in short-term repurchase agreements. Total shareholders’ equity increased $9.1 million, or 3.5%, to $271.1 million at September 30, 2014 compared to $262.1 million at December 31, 2013, driven primarily by net income of $9.4 million for the nine months ended September and a $2.3 million increase in accumulated other comprehensive income from unrealized securities gains. These increases were offset primarily by $2.7 million in dividends on common stock and the repurchase of 136,743 shares of common stock for a total of $892 thousand. The Company’s ratio of tangible common equity to tangible assets decreased to 10.06% at September 30, 2014 from 11.79% at December 31, 2013. The Company’s Tier 1 leverage ratio decreased to 10.09% in September 30, 2014 from 11.63% at December 31, 2013.

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Adjusted net income and related per share measures, as well as tangible common equity and tangible assets, and related ratios, are non-GAAP financial measures. For reconciliations to the most comparable GAAP measure, see “Non-GAAP Financial Measures” below. 

Business Overview

The Company, a North Carolina corporation, was formed in October 2010 to serve as the holding company for the Bank and is a bank holding company registered with the Federal Reserve Board. The Bank was incorporated in September 2006 as a North Carolina-chartered commercial nonmember bank. On January 1, 2011, the Company acquired all of the outstanding common stock of the Bank in exchange for shares of the Company’s Common Stock, on a one-for-one basis, in a statutory share exchange transaction effected under North Carolina law pursuant to which the Company became the bank holding company for the Bank.

Consistent with our growth strategy, in January 2014, the Bank opened a loan production office in Richmond, Virginia and in May 2014, received regulatory approval to open a full-service branch in Richmond, Virginia. In addition, on May 1, 2014, the Company completed its acquisition of Provident Community pursuant to the Agreement and Plan of Merger, dated as of March 4, 2014 (the “Agreement”), under which Provident Community, a bank holding company headquartered in Rock Hill, South Carolina, was merged with and into the Company with the Company as the surviving entity. Pursuant to the Agreement, each share of Provident Community common stock was cancelled and converted into the right to receive a cash payment from the Company equal to $0.78 per share, or approximately $1.4 million in the aggregate. In addition, immediately prior to completion of the merger, the Company purchased from the United States Department of the Treasury (“Treasury”) the issued and outstanding shares of Provident Community’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Provident Community Series A Preferred Stock”), and all of the related warrants to purchase shares of Provident Community’s common stock, for an aggregate purchase price of approximately $5.1 million (representing a 45% discount from face value). Thereafter, pursuant to the Agreement, the Provident Community Series A Preferred Stock and related warrants were cancelled in connection with the completion of the merger. Simultaneously with completion of the merger, Provident Community Bank, N.A. merged into the Bank. The merger strengthens our position in the Charlotte metro market, improves our branch density in South Carolina’s Upstate and Midlands regions, provides an attractive source of core deposits to help fund organic loan growth, and creates efficiencies which are expected to enhance financial returns to shareholders.

The Company provides a full array of retail and commercial banking services, including wealth management and capital markets, through its offices located in North Carolina, South Carolina, Virginia and Georgia. Our 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.

Non-GAAP Financial Measures

In addition to traditional measures, management uses tangible assets, tangible common equity, tangible book value, adjusted allowance for loan losses, adjusted net income, adjusted net interest margin and adjusted noninterest expenses, and related ratios and per-share measures, each of which is a non-GAAP financial measure. Management uses (i) tangible assets, tangible common equity and tangible book value (which exclude goodwill and other intangibles from equity and assets) and related ratios to evaluate the adequacy of shareholders' equity and to facilitate comparisons with peers; (ii) adjusted allowance for loan losses (which includes net fair market value adjustments related to acquired loans) as supplemental information for comparing the combined allowance and fair market value adjustments to the combined acquired and non-acquired loan portfolios (fair market value adjustments are available only for losses on acquired loans); and (iii) adjusted net income and adjusted noninterest expense (which exclude merger-related expenses and gain or loss on sale of securities, as applicable) and adjusted net interest margin (which excludes accelerated accretion of net acquisition accounting fair market value adjustments) to evaluate its core earnings and to facilitate comparisons with peers.

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The following table presents these non-GAAP financial measures and provides a reconciliation of these non-GAAP measures to the most directly comparable GAAP measure reported in the Company’s consolidated financial statements:

Reconciliation of Non-GAAP Financial Measures

	September 30,			December 31,
	2014			2013
	(Unaudited)			(Unaudited)
	(dollars in thousands, except per share amounts)
Tangible common equity to tangible assets
Total assets	$	2,326,255		$	1,960,790
Less: intangible assets		(41,299	)		(35,049	)
Tangible assets	$	2,284,956		$	1,925,741
Total common equity	$	271,134		$	262,083
Less: intangible assets		(41,299	)		(35,049	)
Tangible common equity	$	229,835		$	227,034
Tangible common equity		229,835			227,034
Divided by: tangible assets		2,284,956			1,925,741
Tangible common equity to tangible assets		10.06	%		11.79	%
Common equity to assets		11.66	%		13.37	%
Adjusted allowance for loan losses
Allowance for loan losses	$	9,458		$	8,831
Plus: acquisition accounting net FMV adjustments to acquired loans		38,982			37,783
Adjusted allowance for loan losses	$	48,440		$	46,614
Divided by: total loans (excluding LHFS)		1,552,155			1,295,808
Adjusted allowance for loan losses to total loans		3.12	%		3.60	%
Allowance for loan losses to total loans		0.61	%		0.68	%

	Three months ended						Nine months ended
	September 30,			September 30,			September 30,			September 30,
	2014			2013			2014			2013
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
	(dollars in thousands, except per share amounts)
Adjusted net income
Pretax income (as reported)	$	3,706		$	6,320		$	13,927		$	17,064
Plus: merger-related expenses		2,229			167			2,904			1,825
(gain) loss on sale of securities		63			-			(180	)		(104	)
Adjusted pretax income		5,998			6,487			16,651			18,785
Tax expense		2,030			2,162			5,633			6,387
Adjusted net income	$	3,968		$	4,325		$	11,018		$	12,398
Preferred dividends		-			-			-			353
Adjusted net income available to common shareholders	$	3,968		$	4,325		$	11,018		$	12,045
Divided by: weighted average diluted shares		44,233,532			44,273,821			44,224,682			44,172,469
Adjusted net income available to common shareholders per share	$	0.09		$	0.10		$	0.25		$	0.27
Estimated tax rate		33.85	%		33.40	%		33.83	%		34.00	%
Adjusted net interest margin
Net interest income (as reported)	$	20,732		$	18,314		$	57,086		$	54,721
Less: accelerated mark accretion		(173	)		(529	)		(277	)		(1,089	)
Adjusted net interest income		20,559			17,785			56,809			53,632
Divided by: average earning assets		2,066,906			1,747,898			1,924,270			1,740,912
Mutliplied by: annualization factor		3.97			3.97			1.34			1.34
Adjusted net interest margin		3.95	%		4.04	%		3.95	%		4.12	%
Net interest margin		3.98	%		4.16	%		3.97	%		4.20	%
Adjusted noninterest expense
Noninterest expense	$	20,648		$	15,670		$	54,627		$	48,375
Less: merger-related expenses		(2,229	)		(167	)		(2,904	)		(1,825	)
Adjusted noninterest expense	$	18,419		$	15,503		$	51,723		$	46,550

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Recent Accounting Pronouncements

See Note 2 to the Unaudited Financial Statements 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 (“GAAP”) and in accordance with general practices within the banking industry. Our significant accounting policies are described in Note 2 – Summary of Significant Accounting Policies to the Company’s audited consolidated financial statements and accompanying notes (the “2013 Audited Financial Statements”) included in the 2013 Form 10-K. While all of these policies are important to understanding the Unaudited Financial Statements, certain accounting policies described below involve significant judgment and assumptions by management 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.

PCI Loans.Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered credit impaired. Evidence of credit quality deterioration as of the purchase date may include statistics such as internal risk grade, past due and nonaccrual status, recent borrower credit scores and recent loan-to-value (“LTV”) percentages. Purchased credit-impaired (“PCI”) loans are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, the associated allowance for credit losses related to these loans is not carried over at the acquisition date. We estimate the cash flows expected to be collected at acquisition using specific credit review of certain loans, quantitative credit risk, interest rate risk and prepayment risk models, and qualitative economic and environmental assessments, each of which incorporates our best estimate of current key relevant factors, such as property values, default rates, loss severity and prepayment speeds.

Under the accounting guidance for PCI loans, the excess of cash flows expected to be collected over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan, or pool of loans, in situations where there is a reasonable expectation about the timing and amount of cash flows to be collected. The difference between the contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference and is available to absorb future charge-offs.

In addition, subsequent to acquisition, we periodically evaluate our estimate of cash flows expected to be collected. These evaluations, performed quarterly, require the continued usage of key assumptions and estimates, similar to the initial estimate of fair value. In the current economic environment, estimates of cash flows for PCI loans require significant judgment given the impact of home price and property value changes, changing loss severities, prepayment speeds and other relevant factors. Decreases in the expected cash flows will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan losses. Significant increases in the expected cash flows will generally result in an increase in interest income over the remaining life of the loan, or pool of loans. Disposals of loans, which may include sales of loans to third parties, receipt of payments in full or part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount. Trends are reviewed in terms of traditional credit metrics such as accrual status, past due status, and weighted-average grade of the loans within each of the accounting pools. In addition, the relationship between the change in the unpaid principal balance and change in the fair value mark is assessed to correlate the directional consistency of the expected loss for each pool.

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At September 30, 2014, PCI loans represent loans acquired from the acquisitions of Community Capital Corporation (“Community Capital”), Citizens South Banking Corporation (“Citizens South”) and Provident Community that were deemed credit impaired at the time of acquisition. PCI loans that were classified as nonperforming loans by the acquired institutions are no longer classified as nonperforming so long as, at acquisition and quarterly re-estimation periods, we believe we will fully collect the new carrying value of these loans. It is important to note that judgment regarding the timing and amount of cash flows to be collected is required to classify PCI loans as performing, even if the loan is contractually past due.

Allowance for Loan Losses.The allowance for loan losses is based upon management's ongoing evaluation of the loan portfolio and reflects an amount considered by management to be its best estimate of known and inherent losses in the portfolio as of the balance sheet date. The determination of the allowance for loan losses involves a high degree of judgment and complexity. In making the evaluation of the adequacy of the allowance for loan losses, management considers current economic and market conditions, independent loan reviews performed periodically by third parties, portfolio trends and concentrations, delinquency information, management's internal review of the loan portfolio, internal historical loss rates and other relevant factors. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require us to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Although provisions have been established by loan segments based upon management's assessment of their differing inherent loss characteristics, the entire allowance for losses on loans, other than the portion related to PCI loans and specific reserves on impaired loans, is available to absorb further loan losses in any segment.Further information regarding our policies and methodology used to estimate the allowance for possible loan losses is presented in Note 5 – Loans and Allowance for Loan Losses to the 2013 Audited Financial Statements, and Note 5 – Loans and Allowance for Loan Losses to the Unaudited Financial Statements included in this Form 10-Q.

OREO.OREO, consisting of real estate acquired through, or in lieu of, loan foreclosures, is recorded at the lower of cost or fair value less estimated selling costs when acquired. Fair value is determined based on independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Management also considers other factors, including changes in absorption rates, length of time the property has been on the market and anticipated sales values, which have resulted in adjustments to the collateral value estimates indicated in certain appraisals. At the time of foreclosure or initial possession of collateral, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses.

Subsequent declines in the fair value of OREO below the new cost basis are recorded through valuation adjustments. Significant judgments and complex estimates are required in estimating the fair value of other real estate, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. In response to market conditions and other economic factors, management may utilize liquidation sales as part of its problem asset disposition strategy. As a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other real estate. Management reviews the value of other real estate periodically and adjusts the values as appropriate. Revenue and expenses from OREO operations as well as gains or losses on sales and any subsequent adjustments to the value are recorded as net cost (earnings) of operation of other real estate owned, a component of non-interest expense.

FDIC Indemnification Asset.In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, the FDIC indemnification asset was initially recorded at its fair value, and is measured separately from the related covered assets because the indemnification asset is not contractually embedded in the covered assets or transferrable with them in the event of disposal. The FDIC indemnification asset is measured at carrying value subsequent to initial measurement. Improved cash flows of the underlying covered assets will result in impairment of the FDIC indemnification asset and thus amortization through non-interest income. Impairment of the underlying covered assets will increase the cash flows of the FDIC indemnification asset and result in a credit to the provision for loan losses for acquired loans. Impairment and, when applicable, its subsequent reversal are included in the provision for loan losses in the condensed consolidated statements of income.

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The purchase and assumption agreements between the Bank and the FDIC, as discussed in Note 6 – FDIC Loss Share Agreements to the 2013 Audited Financial Statements, and Note 6 – FDIC Loss Share Agreements to the Unaudited Financial Statements included in this Form 10-Q, each contain a provision that obligates the Bank to make a true-up payment to the FDIC if the realized losses of each of the applicable acquired banks are less than expected. Any such true-up payment that is materially higher than current estimates could have a negative effect on our business, financial condition and results of operations. These amounts are recorded in other liabilities on the balance sheet. The actual payment will be determined at the end of the term of the loss sharing agreements and is based on the negative bid, expected losses, intrinsic loss estimate, and assets covered under the loss share agreements.

Income Taxes. Income taxes are provided based on the asset-liability method of accounting, which includes the recognition of deferred tax assets (“DTAs”) and liabilities for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. In general, we record a DTA when the event giving rise to the tax benefit has been recognized in the consolidated financial statements.

As of September 30, 2014 and December 31, 2013, we had a net DTA in the amount of approximately $37.9 million and $36.3 million, respectively. We evaluate the carrying amount of the DTA quarterly in accordance with the guidance provided in ASC 740, in particular applying the criteria set forth therein to determine whether it is more likely than not (i.e., a likelihood of more than 50%) that some portion, or all, of the DTA will not be realized within its life cycle, based on the weight of available evidence. In most cases, the realization of the DTA is dependent upon generating a sufficient level of taxable income in future periods, which can be difficult to predict. In addition to projected earnings, we also consider projected asset quality, liquidity, our strong capital position, which could be leveraged to increase earning assets and generate taxable income, our growth plans and other relevant factors. Based on the weight of available evidence, we determined that as of September 30, 2014 and December 31, 2013 it is more likely than not that we will be able to fully realize the existing DTA and therefore considered it appropriate not to establish a DTA valuation allowance at either September 30, 2014 or December 31, 2013.

Additional information regarding our income taxes is presented in Note 9 —Income Taxes to the 2013 Audited Financial Statements.

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Financial Condition atSeptember 30, 2014 and December 31, 2013

Total assets increased $365.5 million to $2.33 billion at September 30, 2014 compared to total assets of $1.96 billion at December 31, 2013. During the nine months, cash and equivalents increased $3.8 million, or 6.9%. Total loans, excluding loans held for sale, increased $256.3 million, or 19.8%, to $1.6 billion at September 30, 2014. Total securities, including non-marketable securities, increased $87.1 million, or 21%, to $494.5 million at September 30, 2014 from $407.4 million at December 31, 2013. These increases were all driven by the merger with Provident Community as well as approximately $152.0 million in organic loan growth.

Total liabilities of $2.1 billion at September 30, 2014 increased $356.4 million, or 21%, compared to total liabilities of $1.7 billion at December 31, 2013. Total deposits increased $264.7 million, or 16.6%, to $1.9 billion at September 30, 2014, reflecting both the Provident Community acquisition as well as strong results in retail and commercial banking. There were no short-term borrowings at September 30, 2014 as compared to $1.0 million at December 31, 2013.Total borrowings increased $85.4 million, or 110%, to $163.4 million at September 30, 2014 compared to $78.0 million at December 31, 2013, as the Company borrowed an additional $85 million in short-term 30 day FHLB advances with a weighted average rate of 0.17% during the third quarter of 2014 to fund loan growth and to redeem subordinated debt. Repurchase agreements of $5.7 million and $7.8 million in trust preferred subordinated debt, net of acquisition accounting fair market value adjustments, were also assumed in the Provident Community acquisition. Offsetting these increases was the redemption of $6.9 million in 11% Tier 2 eligible subordinated debt at the Bank on June 30, 2014.

Total shareholders’ equity increased $9.1 million, or 3.5%, during the first nine months to $271.1 million at September 30, 2014. The $9.1 million increase was the result of (i) net income of $9.4 million during the first nine months of 2014; (ii) a $2.3 million increase in accumulated other comprehensive income from unrealized securities gains; (iii) $845 thousand of net share based compensation expense; and (iv) $198 thousand in proceeds from the exercise of 43,618 stock options. These increases were offset by $2.7 million in dividends on common stock, the repurchase of 136,743 shares of common stock, at an average cost of $6.52 per share, for a total of $892 thousand during the first nine months of 2014, as part of our previously announced stock repurchase program and the net share settlement of vested shares of restricted stock.

The following table presents selected ratios for the Company for the nine months ended September 30, 2014 and 2013 and for the year ended December 31, 2013:

	Nine months ended						Twelve months
	September 30,						ended
	(annualized)						December 31,
	2014			2013			2013*
Return on Average Assets		0.59	%		0.74	%		0.76	%
Return on Average Equity		4.71	%		5.21	%		5.42	%
Period End Equity to Total Assets		11.66	%		13.39	%		13.37	%

* Derived from audited financial statements.

Investments and Other Interest-earning Assets

We use investment securities to generate interest income through the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral, where required. The composition of our investment portfolio changes from time to time as we consider our liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements.

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Securities available-for-sale are carried at fair market value, with unrealized holding gains and losses reported in accumulated other comprehensive income, net of tax. Securities held-to-maturity are carried at amortized cost. At September 30, 2014, investment securities totaled $484.7 million compared to $401.4 million at December 31, 2013. The increase in investment securities is due primarily to the reinvestment of the proceeds received from the liquidation of securities acquired in the Provident Community acquisition.

During the second quarter of 2014, we re-designated $58.5 million of residential mortgage pass-through and collateralized mortgage obligation securities from available-for-sale to held-to-maturity to mitigate the risk of unrealized mark-to-market losses from rising interest rates. These securities had an aggregate unrealized loss of $2.2 million ($1.5 million, net of tax) on the date of transfer.

Our nonmarketable equity securities increased $3.8 million from December 31, 2013. This increase was due to additional FHLB stock required to be held as a result of the increase in our FHLB advances. See “Deposits and Other Borrowings” below.

The “Volcker Rule” under the Dodd-Frank Act generally prohibits banks and their affiliates from engaging in proprietary trading and investing in and sponsoring a covered fund (such as a hedge fund or private equity fund). At December 31, 2013, the Company held four investments in senior tranches of collateralized loan obligations (“CLOs”) with a fair value of $23.4 million which were included in asset-backed securities, which could have been impacted by the Volcker Rule. The collateral eligibility language in one of the securities held at December 31, 2013, has been amended to comply with the new bank investment criteria under the Volcker Rule. In addition,the Company sold one of the securities during the nine month period ended September 30, 2014 for a loss of $433 thousand given expectations that it would not be amended to comply with the Volcker Rule. The Company’s investment in the remaining two securities, which had a net unrealized loss of $179,000 at September 30, 2014 and $274,000 at December 31, 2013, are currently prohibited under the Volcker Rule. The Company will determine any disposition plans for these securities as documentation is, or is not, amended. Under current Federal regulations, banks have until July 21, 2017 to conform their CLO interests to avoid the trading restrictions under the Volcker Rule. Unless the documentation is amended to avoid inclusion within the rule’s prohibitions, the Company would have to recognize other-than-temporary impairment, as applicable, with respect to these securities in conformity with GAAP rules. The Company held no other security types potentially affected by the Volcker Rule at either September 30, 2014 or December 31, 2013.

At September 30, 2014, we had $41.9 million in interest-bearing deposits at correspondent banks, of which $40.4 million was on deposit with the Federal Reserve Bank, compared to $41.7 million in interest-bearing deposits at correspondent banks at December 31, 2013.

Loans

We consider asset quality to be of primary importance, and employ seasoned credit professionals and documented processes to ensure effective oversight of credit approvals and asset quality monitoring. Our internal loan policy is reviewed by our board of directors’ Loan and Risk Committee on an annual basis and our underwriting guidelines are reviewed and updated on a periodic basis. A formal loan review process is maintained both to ensure adherence to lending policies and to ensure accurate loan grading and is reviewed by our board of directors at least annually. Since inception, we have promoted the separation of loan underwriting from the loan production staff through our credit department. Currently, credit administration analysts are responsible for underwriting and assigning proper risk grades for all loans with an individual, or relationship, exposure in excess of $500 thousand. Underwriting is completed on standardized forms including a loan approval form and separate credit memorandum. The credit memorandum includes a summary of the loan's structure and a detailed analysis of loan purpose, borrower strength (including individual and global cash flow worksheets), repayment sources and, when applicable, collateral positions and guarantor strength. The credit memorandum further identifies exceptions to policy and/or regulatory limits, total exposure, internal risk grades and other relevant credit information. Loans are approved or denied by varying levels of signature authority based on total customer relationship exposure, with a minimum requirement of at least two authorized signatures. A management-level loan committee is responsible for approving all credits in excess of the chief credit officer’s lending authority, which was increased in October 2014 from $3 million to $5 million.

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Our loan underwriting policy contains loan-to-value (“LTV”) limits that are at or below levels required under regulatory guidance, when such guidance is available, including limitations for non-real estate collateral, such as accounts receivable, inventory and marketable securities. When applicable, we compare LTV with loan-to-cost guidelines and ultimately limit loan amounts to the lower of the two ratios. We also consider FICO scores and strive to uphold a high standard when extending loans to individuals. We have not underwritten any subprime, hybrid, no-documentation or low-documentation products.

All acquisition, construction and development (“AC&D”) loans, whether related to commercial or consumer borrowers, are subject to policies, guidelines and procedures specifically designed to properly identify, monitor and mitigate the risk associated with these loans. Loan officers receive and review a cost budget from the borrower at the time an AC&D loan is originated. Loan draws are monitored against the budgeted line items during the development period in order to identify potential cost overruns. Individual draw requests are verified through review of supporting invoices as well as site inspections performed by an external inspector. Additional periodic site inspections are performed by loan officers at times that do not coincide with draw requests in order to keep abreast of ongoing project conditions. Our exposure to AC&D loans has declined significantly since inception of the Bank and current loan origination is focused on 1 – 4 family residential construction for retail customers and 1-4 family residential home construction to selected well-qualified builders, as well as owner-occupied commercial and pre-leased commercial build-to-suit properties. Concentrations as a percent of capital are reported to the board of directors on a quarterly basis. Market conditions for AC&D loans continued to improve in 2014 due to increasing new home sales in our primary markets. As of September 30, 2014, approximately 2% of our AC&D loan portfolio, commercial and consumer, is included on the watch list.

Our second mortgage exposure is primarily attributable to our home equity lines of credit (“HELOC”) portfolio, which totaled approximately $155 million as of September 30, 2014, of which approximately 60% is secured by second mortgages and approximately 40% is secured by first mortgages. HELOCs typically have a draw period of 10 years followed by a 10- or 15- year repayment period. During the draw period, a borrower is only required to make interest payments. Once the draw period has concluded, the line is typically placed on a 1% repayment schedule or is renewed. Management closely monitors HELOCs for end-of-draw periods and works with customers as the end-of-draw approaches. Reviews of all outstanding HELOCs are performed on at least a semi-annual basis.

All loans are assigned an internal risk grade and are reviewed continuously for payment performance and updated through annual portfolio reviews. Loans on the Bank’s watch list are monitored through quarterly watch meetings and monthly impairment meetings. Classified loans are generally managed by a dedicated special asset team who is experienced in various loan rehabilitation and work out practices. Special asset loans are generally managed with a least-loss strategy.

At September 30, 2014, total loans, net of deferred fees, increased $256.4 million compared to December 31, 2013 due to the merger with Provident Community and organic loan growth. The Company’s metropolitan markets, which include Charlotte, Raleigh and Wilmington, North Carolina; Greenville and Charleston, South Carolina and Richmond, Virginia reported organic growth of $152.0 million due to continued success in origination efforts. The composition of the portfolio shifted slightly from December 31, 2013 withthe combination of commercial and industrial and owner-occupied real estate loans increasing from 30% to 33% of total loans. Investor owned commercial real estate remained unchanged at 30% of total loans. Acquisition, construction and development loans decreased from 11% to 9% of total loans. Total consumer loans decreased from 29% to 28% of total loans, with residential mortgages remaining at 13% and home equity lines of credit decreasing to 10% at September 30, 2014 from 11% at December 31, 2014.

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Asset Quality and Allowance for Loan Losses

Our Allowance for Loan Losses Committee is responsible for overseeing our allowance and works with our chief executive officer, senior financial officers, senior risk management officers and the Audit Committee of the board of directors in developing and achieving our allowance methodology and practices. Our allowance for loan loss methodology includes four components – specific reserves, quantitative reserves, qualitative reserves and reserves on PCI loans.

The following table presents a breakdown of our allowance for loan losses, by component and by loan product type, as of September 30, 2014 and December 31, 2013. Details of the seven environmental factors for consideration in the qualitative component of the allowance methodology as well as additional information about the four components and our policies and methodology used to estimate the allowance for loan losses are presented in Note 5 – Loans and Allowance for Loan Losses to the Unaudited Financial Statements included in this Form 10-Q.

Allowance Allocation by Component

	Septmber 30, 2014
	Specific Reserve					Quantitative Reserve						Qualitative Reserve					Reserve on PCI Loans
	$		% of Total Allowance			$			% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance
	(dollars in thousands)
Commercial:
Commercial and industrial	$	239		2.53	%	$	1,012			10.70	%	$	685		7.24	%	$	-		0.00	%
CRE - owner-occupied		28		0.30	%		244			2.58	%		373		3.94	%		-		0.00	%
CRE - investor income producing		52		0.55	%		733			7.75	%		587		6.21	%		-		0.00	%
AC&D - 1-4 family construction		-		0.00	%		716			7.57	%		437		4.62	%		-		0.00	%
AC&D - lots, land & development		8		0.08	%		497			5.25	%		304		3.21	%		-		0.00	%
AC&D - CRE		-		0.00	%		27			0.29	%		256		2.71	%		-		0.00	%
Other commercial		43		0.45	%		3			0.03	%		7		0.07	%		-		0.00	%
Consumer:
Residential mortgage		320		3.38	%		181			1.91	%		111		1.17	%		-		0.00	%
HELOC		444		4.69	%		699			7.39	%		458		4.84	%		-		0.00	%
Residential construction		195		2.06	%		438			4.63	%		267		2.82	%		-		0.00	%
Other loans to individuals		8		0.08	%		(11	)		-0.12	%		97		1.03	%		-		0.00	%
	$	1,337		14.14	%	$	4,539			47.99	%	$	3,582		37.87	%	$	-		0.00	%

	December 31, 2013
	Specific Reserve					Quantitative Reserve					Qualitative Reserve					Reserve on PCI Loans
	$		% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance
	(dollars in thousands)
Commercial:
Commercial and industrial	$	14		0.16	%	$	1,304		14.77	%	$	173		1.96	%	$	-		0.00	%
CRE - owner-occupied		14		0.16	%		319		3.61	%		66		0.75	%		-		0.00	%
CRE - investor income producing		527		5.97	%		1,111		12.58	%		159		1.80	%		360		4.08	%
AC&D - 1-4 family construction		-		0.00	%		755		8.55	%		84		0.95	%		-		0.00	%
AC&D - lots, land, & development		-		0.00	%		1,496		16.94	%		255		2.89	%		-		0.00	%
AC&D - CRE		-		0.00	%		267		3.02	%		32		0.36	%		-		0.00	%
Other commercial		18		0.20	%		5		0.06	%		1		0.01	%		-		0.00	%
Consumer:
Residential mortgage		167		1.89	%		135		1.53	%		56		0.63	%		-		0.00	%
HELOC		137		1.55	%		699		7.92	%		214		2.42	%		-		0.00	%
Residential construction		7		0.08	%		336		3.80	%		48		0.54	%		-		0.00	%
Other loans to individuals		-		0.00	%		64		0.72	%		8		0.09	%		-		0.00	%
Total	$	884		10.01	%	$	6,491		73.50	%	$	1,096		12.41	%	$	360		4.08	%

The allowance for loan losses is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. The increase in the allowance for loan losses from December 31, 2013 to September 30, 2014 was a function of the following:

(i) A decrease of $2.0 million in the quantitative component of the allowance due to a decrease in historical loss rates applied to the portfolio as significant charge-offs from 2010 are replaced with low loss periods in 2014. In addition, changes in look back periods in the residential construction loan type, which better reflect the inherent loss in the portfolio, and the reclassification of the minimum reserve amounts to the qualitative component contributed to the decrease. In the past, we have recorded a minimum reserve as part of the quantitative component. A minimum reserve is utilized when we have insufficient internal loss history or when internal loss history falls below the minimum reserve percentage. Minimums are determined by analyzing Federal Reserve Bank charge-off data for all insured federal- and state-chartered commercial banks. For the third quarter of 2014, we calculated the average historical loss rates and adjusted incrementally to the minimum reserve amounts in the qualitative component. This change represented a reclassification between components of the allowance and had no impact on the calculation in total.

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(ii) An increase of $2.5 million in the qualitative component of the allowance primarily due to the reclassification of minimum reserve amounts noted in item (i) above as well as management’s decision to increase certain factors based on rapid loan growth, including entrance into new markets and economic uncertainty based on recent market fluctuations.

(iii) A decrease of $360 thousand in the reserve on PCI loans due to the reversal of $360 thousand of previously recognized impairments.

(iv) An increase of $453 thousand in specific reserves which change periodically as loans move through or out of the impairment process.

In accordance with GAAP, loans acquired from Community Capital, Citizens South and Provident Community were adjusted at the time of acquisition to reflect the estimated fair market value at acquisition and the associated allowance for loan losses was eliminated. At September 30, 2014, acquired loans comprised 35% of our total loans, compared to 44% at December 31, 2013. The ratio of the allowance for loan losses to total loans was 0.61% at September 30, 2014 and 0.68% at December 31, 2013. The ratio of the adjusted allowance for loan losses to total loans, which includes the remaining acquisition accounting fair market value adjustments for acquired loans, was 3.12% at September 30, 2014 and 3.60% at December 31, 2013. Adjusted allowance for loan losses to loans is a non-GAAP financial measure which is provided as supplemental information for comparing the combined allowance and fair market value adjustments to the combined acquired and non-acquired loan portfolios. Fair market value adjustments are available only for losses on acquired loans. For a reconciliation to the most comparable GAAP measure, see “Non-GAAP Financial Measures” above.

While management believes that it uses the best information available to determine the allowance for loan losses, and that its allowance for loan losses is maintained at a level appropriate in light of the risk inherent in our loan portfolio based on an assessment of various factors affecting the loan portfolio, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. The allowance for loan losses to total loans may increase if our loan portfolio deteriorates due to economic conditions or other factors.

We evaluate and estimate off-balance sheet credit exposure at the same time we estimate credit losses for loans by a similar process, including an estimate of commitment usage levels. 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. At both September 30, 2014 and December 31, 2013, $125 thousand was recorded as an other liability for off-balance sheet credit exposure.

Nonperforming Assets

Nonperforming assets, which consist of nonaccrual loans, accruing troubled debt restructurings (“TDRs”), accruing loans for which payments are 90 days or more past due, and OREO, totaled $26.0 million at September 30, 2014 compared to $26.8 million at December 31, 2013. Nonperforming loans, which consist of nonaccrual loans, accruing TDRs and accruing loans for which payments are 90 days or more past due, increased $395 thousand, or 3%, to $12.7 million, or 0.82% of total loans at September 30, 2014, compared to $12.3 million, or 0.95% of total loans at December 31, 2013. The increase in nonperforming loans was primarily due to a $1.8 million accruing 90 days past due relationship that was repaid in full on October 1, 2014.

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It is our general policy to place a loan on nonaccrual status when it is over 90 days past due and there is reasonable doubt that all principal and interest will be collected. Nonaccrual loans decreased $2.5 million, or 30%, in the first nine months of 2014 from $8.5 million at December 31, 2013. Nonaccrual TDRs are included in the nonaccrual loan amounts noted. At September 30, 2014, nonaccrual TDR loans were $361 thousand and had an allowance of $131 thousand recorded. At December 31, 2013, nonaccrual TDR loans were $4.4 million and had no recorded allowance. Accruing TDRs totaled $4.3 million at September 30, 2014 and $3.9 million at December 31, 2013.

We grade loans with an internal risk grade scale of 10 through 90, with grades 10 through 50 representing “pass” loans, grade 60 representing “special mention” and grades 70 and higher representing “classified” 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 including collateral perfection and outdated or inadequate financial information are also considered in grading loans.

All loans graded 60 or worse are included on our list of “watch loans,” which represent potential problem loans, and are updated and reported to both management and the Loan and Risk Committee of the board of directors quarterly. Additionally, the watch list committee may review other loans with more favorable ratings if there are concerns that the loan may become a problem. Impairment analyses are performed on all loans graded “substandard” (risk grade of 70 or worse) and generally greater than $150 thousand as well as selected other loans as deemed appropriate. At September 30, 2014, we maintained “watch loans”, excluding PCI loans, totaling $31.7 million compared to $35.2 million at December 31, 2013. Approximately $6 million and $7 million of the watch loans at September 30, 2014 and December 31, 2013, respectively, were acquired loans. 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.

We employ one of three potential methods to determine the fair value of impaired loans:

1) Fair value of collateral method. This is the most common method and is used when the loan is collateral dependent. In most cases, we will obtain an “as is” appraisal from a third-party appraisal group. The fair value from that appraisal may be adjusted downward for liquidation discounts for foreclosure or quick sale scenarios, as well as any applicable selling costs.

2) Cash flow method. This method is used when we believe that we will collect the loan primarily from cash flows generated by the borrower.

3) Observable market value method. This is the method used least often by us. Fair value is based on the offering price from a note buyer, in either the local community or a national loan sale advisor.

With respect to nonaccrual commercial and nonaccrual consumer AC&D loans, we typically utilize an “as-is,” or “discounted,” value to determine an appropriate fair value. When appraising projects with an expected cash flow to be received over a period of time, such as acquisition and development/land development loans, fair value is determined using a discounted cash flow methodology. We also account for expected selling and holding costs when determining an appropriate property value.

At September 30, 2014, OREO totaled $13.3 million, all of which is recorded at values based on our most recent appraisals. Included in that total is $4.7 million of OREO covered under the FDIC loss share agreements. At December 31, 2013, OREO totaled $14.5 million, all of which was recorded at values based on the most recent appraisals then available. Included in that total is $5.1 million of OREO covered under the FDIC loss share agreements.

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Deposits and Other Borrowings

We offer a broad range of deposit instruments, including personal and business checking accounts, individual retirement accounts, business and personal money market accounts and certificates of deposit at competitive interest rates. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. We regularly evaluate the internal cost of funds, survey rates offered by competing institutions, review cash flow requirements for lending and liquidity and execute rate changes when deemed appropriate.

Total deposits at September 30, 2014 were $1.86 billion, an increase of $264.7 million, or 16.6%, from December 31, 2013. Noninterest bearing demand deposits increased $66.2 million, or 25.9%, and represented 17% of total deposits at September 30, 2014. Money market, NOW and savings deposits increased $184.6 million, or 25.1%. Non-brokered time deposits increased $40.6 million, or 9.2%. Increases in these deposit types were the result of both the Provident Community acquisition and strong retail and commercial sales efforts. Finally, brokered deposits decreased $26.7 million, or 16.1%. Brokered deposits remain attractive given their relatively lower interest costs and flexible term structures, and will continue to be selectively utilized in our normal funding and interest rate risk management practices. Brokered deposits consist of brokered interest-bearing deposits, brokered money market accounts, and brokered certificates of deposits. Brokered money market and interest-bearing deposits are the result of the brokered money market deposit program initiated in December 2013 in connection with our $50 million investment strategy. The following is a summary of deposits at September 30, 2014 and December 31, 2013:

	September 30,		December 31,
	2014		2013
	(dollars in thousands)
Noninterest bearing demand deposits	$	322,097	$	255,861
Interest-bearing demand deposits		394,506		296,995
Money market deposits		440,334		390,059
Savings		85,470		48,701
Brokered deposits		139,591		166,280
Time deposits - core		482,610		441,989
Total deposits	$	1,864,608	$	1,599,885

Total borrowings increased $85.4 million, or 110%, to $163.4 million at September 30, 2014 compared to $78.0 million at December 31, 2013 as the Company borrowed an additional $85 million in FHLB advances during the third quarter of 2014. Borrowings at September 30, 2014 also include $23.4 million (after acquisition accounting fair market value adjustments) of Tier 1-eligible subordinated debt. Our Tier-2-eligible subordinated debt, which consisted of $6.9 million aggregate principal amount of the Bank’s 11% Subordinated Notes due June 30, 2019, was redeemed in full at the option of the Bank on June 30, 2014. The redemption price was 100% of the principal amount plus accrued but unpaid interest.

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Results of Operations

The following table summarizes components of net income and the changes in those components for the three and nine months ended September 30, 2014 and 2013:

Condensed Consolidated Statements of Income

	Three Months Ended												Nine Months Ended
	September 30,												September 30,
	2014			2013			Change						2014			2013			Change
	(Unaudited)						$			%			(Unaudited)						$			%
	(Dollars in thousands)												(Dollars in thousands)
Gross interest income	$	22,586		$	19,736		$	2,850			14.4	%	$	62,949		$	59,203		$	3,746			6.3	%
Gross interest expense		1,854			1,422			432			30.4	%		5,863			4,482			1,381			30.8	%
Net interest income		20,732			18,314			2,418			13.2	%		57,086			54,721			2,365			4.3	%
Provision for loan losses		(484	)		(419	)		(65	)		15.5	%		(866	)		(35	)		(831	)		2374.3	%
Noninterest income		3,138			3,257			(119	)		-3.7	%		10,602			10,683			(81	)		-0.8	%
Noninterest expense		20,648			15,670			4,978			31.8	%		54,627			48,375			6,252			12.9	%
Net income before taxes		3,706			6,320			(2,614	)		-41.4	%		13,927			17,064			(3,137	)		-18.4	%
Income tax expense		1,254			2,106			(852	)		-40.5	%		4,494			5,798			(1,304	)		-22.5	%
Net income		2,452			4,214			(1,762	)		-41.8	%		9,433			11,266			(1,833	)		-16.3	%
Preferred dividends		-			-			-			0.0	%		-			353			(353	)		-100.0	%
Net income available to common shareholders	$	2,452		$	4,214		$	(1,762	)		-41.8	%	$	9,433		$	10,913		$	(1,480	)		-13.6	%

Net Income available to common shareholders. Net income available to common shareholders for the three months ended September 30, 2014 was $2.5 million compared to $4.2 million for the same period in 2013. This decrease in net income for the three-month period primarily was the result of noninterest expenses which increased $5.0 million, or 31.8%, due to hiring initiatives and the merger with Provident Community, which were partially offset by increased revenues and a reversal of provision expense. Net income available to common shareholders for the nine months ended September 30, 2014, was $9.4 million compared to $10.9 million for the same period in 2013. This decrease in net income is again due to merger expenses and hiring initiatives offset by increased net interest income and reversal of provision for the period. Annualized return on average assets declined to 0.59% during the nine-month period ended September 30, 2014 from 0.74% during the nine-month period ended September 30, 2013. Annualized return on average equity declined to 4.71% during the nine-month period ended September 30, 2014 from 5.21% for the nine-month period ended September 30, 2013.

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 expense 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.   Net interest income increased to $20.7 million for the three-month period ended September 30, 2014 from $18.3 million for the three months ended September 30, 2013. The increase is primarily due to the increase in average earning assets. Net interest income increased to $57.1 million for the nine-month period ended September 30, 2014, as compared to $54.7 million for the nine months ended September 30, 2013.

Total average interest-earning assets increased to $2.1 billion for the three months ended September 30, 2014, from $1.7 billion for the same period in the previous year. Average balances of total interest-bearing liabilities increased to $1.7 billion in the three-month period ended September 30, 2014, compared to $1.4 billion for the same period in 2013. Our net interest margin decreased from 4.16% in the three-month period ended September 30, 2013 to 3.98% in the corresponding period in 2014. The increases in average balances are the result of the Provident Community merger and organic growth for the three-month period. The decrease in net interest margin reflects the lower interest rates on new loans as well as the increase in cost of interest-bearing liabilities.

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Total average interest-earning assets increased to $1.9 billion for the nine months ended September 30, 2014, from $1.7 billion for the same period in the previous year. Average balances of total interest-bearing liabilities increased to $1.6 billion in the nine-month period ended September 30, 2014, compared to $1.4 billion for the same period in 2013. Our net interest margin decreased from 4.20% in the nine-month period ended September 30, 2013 to 3.97% in the corresponding period in 2014. The increases in average balances are the result of the Provident Community merger and organic growth for the nine-month period. The decrease in net interest margin reflects the lower interest rates on new loans, the expiration of accounting-related fair market value adjustments on acquired deposits in the third quarter of 2013, as well as the increase in cost of interest bearing liabilities.

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 September 30,
	2014								2013
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
	(dollars in thousands)
Assets
Interest-earning assets:
Loans, including fees (1)(2)	$	1,515,671		$	19,725		5.16	%	$	1,319,037		$	17,970		5.41	%
Federal funds sold		777			1		0.51	%		532			-		0.00	%
Taxable investment securities		475,779			2,597		2.18	%		327,224			1,494		1.83	%
Tax-exempt investment securities		12,817			138		4.31	%		16,592			187		4.51	%
Nonmarketable equity securities		8,772			103		4.66	%		5,918			37		2.48	%
Other interest-earning assets		53,090			22		0.16	%		78,595			48		0.24	%
Total interest-earning assets		2,066,906			22,586		4.34	%		1,747,898			19,736		4.48	%
Allowance for loan losses		(9,744	)							(10,306	)
Cash and due from banks		18,640								12,730
Premises and equipment		59,644								56,842
Other assets		169,055								160,740
Total assets	$	2,304,501							$	1,967,904
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand	$	372,875		$	81		0.09	%	$	287,096		$	59		0.08	%
Savings and money market		525,456			431		0.33	%		463,309			340		0.29	%
Time deposits - core		496,316			646		0.52	%		477,004			253		0.21	%
Brokered deposits		141,526			183		0.51	%		97,086			202		0.83	%
Total interest-bearing deposits		1,536,173			1,341		0.35	%		1,324,495			854		0.26	%
Federal Home Loan Bank advances		118,609			162		0.54	%		55,217			137		0.98	%
Other borrowings		27,792			351		5.01	%		23,257			431		7.35	%
Total borrowed funds		146,401			513		1.39	%		78,474			568		2.87	%
Total interest-bearing liabilities		1,682,574			1,854		0.44	%		1,402,969			1,422		0.40	%
Net interest rate spread					20,732		3.90	%					18,314		4.08	%
Noninterest-bearing demand deposits		323,716								261,494
Other liabilities		26,358								24,304
Shareholders' equity		271,853								279,137
Total liabilities and shareholders' equity	$	2,304,501							$	1,967,904
Net interest margin							3.98	%							4.16	%

(1) Average loan balances include nonaccrual loans.

(2) Interest income and yields include accretion from acquisition accounting adjustments associated with acquired loans.

(3) Yield/ rate calculated on Actual/Actual day count basis, except for yield on investments which is calculated on a 30/360 day count basis.

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Average Balance Sheets and Net Interest Analysis

	For the Nine Months Ended September 30,
	2014								2013
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
	(dollars in thousands)
Assets
Interest-earning assets:
Loans, including fees (1)(2)	$	1,406,750		$	55,385		5.26	%	$	1,334,216		$	54,916		5.50	%
Federal funds sold		551			1		0.24	%		19,481			24		0.16	%
Taxable investment securities		425,530			6,720		2.11	%		285,933			3,429		1.60	%
Tax-exempt investment securities		13,730			493		4.79	%		17,353			571		4.39	%
Nonmarketable equity securities		6,766			254		5.02	%		6,154			109		2.37	%
Other interest-earning assets		70,943			96		0.18	%		77,775			154		0.26	%
Total interest-earning assets		1,924,270			62,949		4.37	%		1,740,912			59,203		4.55	%
Allowance for loan losses		(9,567	)							(11,244	)
Cash and due from banks		16,974								18,990
Premises and equipment		57,989								57,172
Other assets		161,601								165,363
Total assets	$	2,151,267							$	1,971,193
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand	$	333,087		$	232		0.09	%	$	292,261		$	212		0.10	%
Savings and money market		501,517			1,371		0.37	%		448,237			974		0.29	%
Time deposits - core		474,099			2,024		0.57	%		492,423			880		0.24	%
Brokered deposits		154,054			535		0.46	%		102,325			710		0.93	%
Total interest-bearing deposits		1,462,757			4,162		0.38	%		1,335,246			2,776		0.28	%
Federal Home Loan Bank advances		76,612			417		0.73	%		55,128			411		1.00	%
Other borrowings		27,812			1,284		6.17	%		26,045			1,295		6.65	%
Total borrowed funds		104,424			1,701		2.18	%		81,173			1,706		2.81	%
Total interest-bearing liabilities		1,567,181			5,863		0.50	%		1,416,419			4,482		0.42	%
Net interest rate spread					57,086		3.87	%					54,721		4.12	%
Noninterest-bearing demand deposits		291,891								252,793
Other liabilities		24,229								22,019
Shareholders' equity		267,966								279,962
Total liabilities and shareholders' equity	$	2,151,267							$	1,971,193
Net interest margin							3.97	%							4.20	%

(1) Average loan balances include nonaccrual loans.

(2) Interest income and yields include accretion from acquisition accounting adjustments associated with acquired loans.

(3) Yield/ rate calculated on Actual/Actual day count basis, except for yield on investments which is calculated on a 30/360 day count basis.

Provision forLoan Losses. Our provision for loan losses decreased $65 thousand, or 15.5%, to a release of $484 thousand during the three months ended September 30, 2014, compared to a release of $419 thousand during the corresponding period in 2013. Included in the loan loss provision for the third quarter of 2014 was a net $483 thousand release of provision on our originated portfolio.

Our provision for loan losses decreased $0.8 million to a release of $866 thousand during the nine months ended September 30, 2014, compared to a $35 thousand release during the corresponding period in 2013. Included in the loan loss provision for the first nine months of 2014 was (i) a net impairment reversal of $209 thousand associated with PCI pools, (ii) a $278 thousand reversal of a previous charge attributable to FDIC loss share agreements caused by an increase in expected loss in those acquired loans and (iii) a net $361 thousand release of provision on our originated portfolio.

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We had $764 thousand in net recoveries, excluding charge-offs on PCI loans, during the three months ended September 30, 2014 compared to net charge-offs of $817 thousand during the corresponding period in 2013. We had $1.9 million in net recoveries, excluding charge-offs on PCI loans, during the nine months ended September 30, 2014 compared to net charge-offs of $851 thousand during the corresponding period in 2013. The net recoveries during 2014 reflected the favorable resolution of problem assets from the legacy Park Sterling portfolio, including both disposition of a single troubled debt restructuring that was designated a nonaccrual loan in the fourth quarter of 2013 as well as recoveries from a large residential development nonaccrual loan.

Noninterest Income. The following table presents components of noninterest income for the three and nine months ended September 30, 2014 and 2013:

Noninterest Income

	Three months ended												Nine months ended
	September 30,												September 30,
	2014			2013			Change						2014			2013			Change
	(Unaudited)						$			%			(Unaudited)						$			%
	(dollars in thousands)
Service charges on deposit accounts	$	1,137		$	637		$	500			78.5	%	$	2,771		$	2,016		$	755			37.5	%
Income from fiduciary activities		698			795			(97	)		-12.2	%		2,018			2,041			(23	)		-1.1	%
Commissions and fees from investment brokerage		85			115			(30	)		-26.1	%		313			308			5			1.6	%
Capital markets income		364			-			364			100.0	%		399			-			399			100.0	%
Gain (loss) on sale of securities available for sale		(63	)		-			(63	)		-100.0	%		180			104			76			73.1	%
ATM and card income		631			639			(8	)		-1.3	%		1,905			1,818			87			4.8	%
Mortgage banking income		822			401			421			105.0	%		1,719			2,346			(627	)		-26.7	%
Income from bank-owned life insurance		552			537			15			2.8	%		2,197			1,447			750			51.8	%
Amortization of indemnification asset		(1,107	)		(118	)		(989	)		838.1	%		(1,966	)		(73	)		(1,893	)		2593.2	%
Loss share true-up liability expense		(238	)		73			(311	)		-426.0	%		(599	)		(26	)		(573	)		2203.8	%
Other noninterest income		257			178			79			44.4	%		1,665			702			963			137.2	%
Total noninterest income	$	3,138		$	3,257		$	(119	)		-3.7	%	$	10,602		$	10,683		$	(81	)		-0.8	%

Noninterest income decreased $119 thousand for the three months ended September 30, 2014 when compared to the three months ended September 30, 2013. Noteworthy changes among categories include (i) a $500 thousand increase in service charges on deposit accounts, a direct contribution of the Provident Community merger; (ii) $364 thousand of income from our capital markets area (which includes fee income from interest rate swap and other derivative activities) due to increased hedging activities; (iii) a $421 thousand increase in mortgage banking income due to an increase in the commitments outstanding for the quarter as compared to the third quarter of 2013 which experienced a large decrease in commitments for the period; (iv) a $989 thousand increase in amortization of the indemnification asset related to the loss share agreements with the FDIC; and (v) a $311 thousand decrease related to true-up liability expenses.

The increase in expenses related to the Company’s FDIC loss share agreements, which include amortization of the indemnification asset and true-up liability expense, reflects reductions in the Company’s loss share reimbursement expectations given better than originally forecast performance of the underlying covered loans. The commercial components of the Bank of Hiawassee and New Horizons Bank loss share agreements, which account for approximately 63% of covered loans, expire in March 2015 and April 2016, respectively. The Company currently expects expenses related to loss share agreements to remain elevated through 2014 and then to taper as expiration of the Bank of Hiawassee commercial agreement approaches.

Noninterest income decreased slightly for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. Noteworthy changes among categories include (i) a $755 thousand increase in service charges on deposit accounts, as a direct contribution of the Provident Community merger; (ii) $399 thousand of income from our capital markets area due to increased hedging activities; (iii) a $627 million decrease in mortgage banking income due to lower activity in loan closings and the period end pipeline; (iv) a $750 thousand increase in income from bank-owned life insurance due primarily to death benefit proceeds of $651 thousand received in the first quarter of 2014; (v) a $1.9 million increase in amortization of indemnification assets related to the loss share agreements with the FDIC; (vi) a $573 thousand decrease related to true-up liability expenses; and (vii) a $963 thousand increase in other noninterest income primarily as a result of the sale of MasterCard Class A shares for $936 thousand in the second quarter of 2014.

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Noninterest Expense. The following table presents components of noninterest expense for the three and nine months ended September 30, 2014 and 2013:

Noninterest Expense

	Three months ended										Nine months ended
	September 30,										September 30,
	2014		2013		Change						2014		2013			Change
	(Unaudited)				$			%			(Unaudited)					$			%
	(dollars in thousands)
Salaries and employee benefits	$	10,240	$	8,606	$	1,634			19.0	%	$	29,152	$	26,185		$	2,967			11.3	%
Occupancy and equipment		3,527		1,861		1,666			89.5	%		7,781		5,750			2,031			35.3	%
Advertising and promotion		564		186		378			203.2	%		1,020		556			464			83.5	%
Legal and professional fees		887		732		155			21.2	%		2,670		2,486			184			7.4	%
Deposit charges and FDIC insurance		441		372		69			18.5	%		1,049		1,268			(219	)		-17.3	%
Data processing and outside service fees		1,907		1,268		639			50.4	%		4,797		4,561			236			5.2	%
Communication fees		480		432		48			11.1	%		1,454		1,312			142			10.8	%
Core deposit intangible amortization		347		257		90			35.0	%		921		772			149			19.3	%
Net cost (earnings) of operation of OREO		343		142		201			141.5	%		602		(323	)		925			-286.4	%
Loan and collection expense		298		556		(258	)		-46.4	%		890		1,560			(670	)		-42.9	%
Postage and supplies		176		188		(12	)		-6.4	%		521		815			(294	)		-36.1	%
Other noninterest expense		1,438		1,070		368			34.4	%		3,770		3,433			337			9.8	%
Total noninterest expense	$	20,648	$	15,670	$	4,978			31.8	%	$	54,627	$	48,375		$	6,252			12.9	%

Total noninterest expense increased to $20.6 million for the three months ended September 30, 2014, an increase of 31.8% from $15.7 million for the corresponding period in 2013. Excluding merger-related expenses of $2.2 million and $0.2 million for the three-month periods ended September 30, 2014 and 2013, respectively, noninterest expense increased $2.9 million, or 19%, for the three months ended September 30, 2014, compared to the corresponding period in the prior year. Total noninterest expense increased to $54.6 million for the nine months ended September 30, 2014, an increase of 12.9% from $48.4 million for the corresponding period in 2013. Excluding merger-related expenses of $2.9 million and $1.8 million for the nine-month periods ended September 30, 2014 and 2013, respectively, noninterest expense increased $5.2 million, or 11%, for the nine months ended September 30, 2014, compared to the corresponding period in the prior year. Total full-time equivalents increased to 528 at September 30, 2014 from 452 at September 30, 2013. Adjusted noninterest expenses, which exclude merger-related expenses, is a non-GAAP financial measure. For a reconciliation to the most comparable GAAP measure, see “Non-GAAP Financial Measures” above.

Three-month comparison and analysis

Salaries and employee benefits expensesincreased $1.6 million, or 19.0%, to $10.2 million in the three months ended September 30, 2014 compared to $8.6 million in the comparable period of 2013. These increases are primarily due to hiring initiatives designed to drive future organic growth opportunities and the increase in number of employees resulting from the Provident Community acquisition.

Other notable changes between categories during the three months ended September 30, 2014 when compared to the three months ended September 30, 2013 include (i) an increase in occupancy and equipment expense of $1.7 million, or 89.5%, to $3.5 million primarily due to lease termination expenses of $1.0 million as well as the addition of the Richmond office and the acquisition of Provident Community; (ii) an increase in legal and professional fees of $155 thousand, or 21.2%, to $887 thousand primarily due to the Provident Community acquisition; (iii) a decrease in loan and collection expenses of $258 thousand, or 46.4%, to $298 thousand due to improved asset quality; (iv) an increase in data processing and outside service fees of $639 thousand, or 50.4%, primarily due to the Provident Community acquisition as well as increased deposits; and (v) an increase in advertising and promotion expense of $378 thousand, or 203.2%, as the Company embarked on a new marketing campaign in the third quarter of 2014.

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Additionally, we realized a net loss on operation of OREO during the third quarter of 2014 of $343 thousand. This represents an increase of $201 thousand, or 141.5%, when compared to the cost of operation of OREO of $142 thousand during the comparable period of 2013. We sold 70 properties in the third quarter of 2014 at a net gain of approximately $33 thousand compared to 33 properties in the third quarter of 2013 at a net gain of approximately $191 thousand.

Nine-month comparison andanalysis

Salaries and employee benefits expenses increased $3.0 million, or 11.3%, to $29.2 million in the nine months ended September 30, 2014 compared to $26.2 million in the comparable period of 2013. These increases are primarily due to hiring initiatives designed to drive future organic growth opportunities and the increase in number of employees resulting from the Provident Community acquisition.

Other notable changes between categories during the nine months ended September 30, 2014 when compared to the nine months ended September 30, 2013 include (i) an increase in occupancy and equipment expense of $2.0 million, or 35.3%, to $7.8 million primarily due to the addition of the Richmond office and the acquisition of Provident Community as well as $1.0 million in lease termination costs; (ii) a decrease in FDIC insurance of $219 thousand, or 17.3%, to $1.0 million resulting from a true-up of the estimated assessment; (iii) an increase in data processing and outside service fees of $236 thousand, or 5.2%, to $4.8 million; (iv) a decrease in loan and collection expense of $670 thousand, or 42.9%, to $0.9 million primarily due to improved asset quality; (v) a decrease in postage and supplies of $294 thousand, or 36.1%, to $0.5 million related to 2013 merger costs, from the Citizens South acquisition; (vi) an increase in other tax expense of $250 thousand, or 58.0%, to $681 thousand primarily due to a true-up of franchise taxes; and (v) an increase in advertising and promotion expense of $464 thousand, or 83.5%, as the Company embarked on a new marketing campaign in the third quarter of 2014.

Additionally, we realized a net loss on operation of OREO during the first nine months of 2014 of $602 thousand. This represents an increase of $925 thousand, or 286.4%, when compared to the earnings from operation of OREO of $0.3 million during the comparable period of 2013. We sold 148 properties in the first nine months of 2014 at a net gain of approximately $235 thousand compared to 219 properties in the first nine months of 2013 at a net gain of approximately $1.7 million.

Income Taxes.We generate non-taxable income from tax-exempt investment securities and loans as well as from bank-owned life insurance. Accordingly, the level of such income in relation to income before taxes affects our effective tax rate. For the three months ended September 30, 2014, we recognized income tax expense of $1.3 million compared to income tax expense of $2.1 million for the same period in 2013. The effective tax rate for the three months ended September 30, 2014 is 33.84% compared to 33.32% for the same period in 2013. The change in the effective tax rate for the three-month periods was due to the amount of tax-exempt income on tax-exempt loans and municipal securities and nondeductible merger-related expenses relative to the size of pre-tax income.

For the nine months ended September 30, 2014, we recognized income tax expense of $4.5 million compared to income tax expense of $5.8 million for the same period in 2013. The effective tax rate for the nine months ended September 30, 2014 is 32.27% compared to 33.98% for the same period in 2013. The change in the effective tax rate for the nine-month periods was due to the amount of tax-exempt income on tax-exempt loans and municipal securities, nondeductible merger-related expenses and the death benefits received on bank-owned life insurance relative to the size of pre-tax income.

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. We strive 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 our investment portfolio. In addition, we may have short-term investments at our primary correspondent bank in the form of Federal funds sold. Liquidity is governed by an asset/liability policy approved by the board of directors and administered by an internal Asset-Liability Management Committee (the “ALCO”). The ALCO reports monthly asset/liability-related matters to the Loan and Risk Committee of the board of directors.

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Our internal liquidity ratio (total liquid assets, or cash and cash equivalents, divided by deposits and short-term liabilities) at September 30, 2014 was 14.71% compared to 20.92% at December 31, 2013. The decline in liquidity is due to the deployment of cash into loans and the reclassification of $58 million in available-for-sale investments to the held-to-maturity classification. Both ratios exceeded our minimum internal target of 10%. If we continue to see rapid loan growth as we have seen over the past nine months, we may utilize additional sources of liquidity through the use of available credit lines, additional borrowing capacity through unpledged securities, and brokered deposits. At September 30, 2014, we had $206.8 million of credit available from the FHLB, $168.8 million of credit available from the Federal Reserve Discount Window, other available lines totaling $70.0 million from correspondent banks, and $331.1 million of unpledged securities.

At September 30, 2014, we had $369.6 million of pre-approved but unused lines of credit, $7.4 million of standby letters of credit and $487 thousand of commercial letters of credit. In management's opinion, these commitments represent no more than normal lending risk to us and will be funded from normal sources of liquidity.

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. We continue to remain in a well-capitalized position. Shareholders’ equity on September 30, 2014 was $271.1 million compared to $262.1 million at December 31, 2013. The details of this increase are discussed under “-Financial Condition atSeptember 30, 2014 and December 31, 2013.”

Risk-based capital regulations adopted by the Federal Reserve Board and the FDIC require bank holding companies and banks to achieve and maintain specified ratios of capital to risk-weighted assets. The risk-based capital rules currently in effect are designed to measure “Tier 1” capital (consisting generally of common shareholders’ equity, a limited amount of qualifying perpetual preferred stock and trust preferred securities, and minority interests in consolidated subsidiaries, net of goodwill and other intangible assets, deferred tax assets in excess of certain thresholds and certain other items) and total capital (consisting of Tier 1 capital and Tier 2 capital, which generally includes certain preferred stock, mandatorily convertible debt securities and term subordinated debt) 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. Under current regulations, 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 September 30, 2014, the Company and the Bank both satisfied their minimum regulatory capital requirements and each was “well capitalized” within the meaning of federal regulatory requirements.

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Actual and required capital levels at September 30, 2014 and December 31, 2013 are presented below:

							Regulatory Minimums
										To Be Well
							For Capital			Capitalized Under
							Adequacy			Prompt Corrective
							Purposes			Actions Provisions
	September 30, 2014			December 31, 2013			Ratio			Ratio
	(dollars in thousands)
Park Sterling Corporation
Tier 1 capital	$	225,456		$	218,552
Tier 2 capital		9,660			15,956
Total capital	$	235,116		$	234,508
Risk-weighted assets	$	1,693,196		$	1,424,574
Average assets for Tier 1	$	2,235,267		$	1,879,283
Risk-based capital ratios
Tier 1 capital		13.32	%		15.34	%		4.00	%		6.00	%
Total capital		13.89	%		16.46	%		8.00	%		10.00	%
Tier 1 leverage ratio		10.09	%		11.63	%		4.00	%		5.00	%
Park Sterling Bank
Tier 1 capital	$	210,102		$	193,830
Tier 2 capital		9,659			15,956
Total capital	$	219,761		$	209,786
Risk-weighted assets	$	1,689,538		$	1,420,331
Average assets for Tier 1	$	2,220,706		$	1,861,925
Risk-based capital ratios
Tier 1 capital		12.44	%		13.65	%		4.00	%		6.00	%
Total capital		13.01	%		14.77	%		8.00	%		10.00	%
Tier 1 leverage ratio		9.46	%		10.41	%		4.00	%		5.00	%

In July 2013, the federal banking regulatory agencies approved Final Rules that will replace the existing general risk-based capital and related rules, broadly revising the basic definitions and elements of regulatory capital and making substantial changes to the credit risk weightings for banking and trading book assets. The new regulatory capital rules establish the benchmark capital rules and capital floors that are generally applicable to United States banks under the Dodd-Frank Wall Street Reform and Consumer Protection Act and make the capital rules consistent with heightened international capital standards known as Basel III. These new capital standards will apply to all banks, regardless of size, and to all bank holding companies with consolidated assets greater than $500 million.

Under the Final Rules, Tier 1 capital will consist of two components: common equity Tier 1 capital and additional Tier 1 capital. Total Tier 1 capital, plus Tier 2 capital, will constitute total risk-based capital. The required minimum ratios will be (i) common equity Tier 1 risk-based capital ratio of 4.5%; (ii) Tier 1 risk-based capital ratio of 6%; (iii) total risk-based capital ratio of 8%; and (iv) Tier 1 leverage ratio of average consolidated assets of 4%. Advanced approaches banking organizations (those organizations with either total assets of $250 billion or more, or with foreign exposure of $10 billion or more) also will be subject to a supplementary leverage ratio that incorporates a broader set of exposures in the denominator. The Final Rules also incorporate these changes in regulatory capital into the prompt corrective action framework, under which the thresholds for “adequately capitalized” banking organizations will be equal to the new minimum capital requirements. Under this framework, in order to be considered “well capitalized”, insured depository institutions will be required to maintain a Tier 1 leverage ratio of 5%, a common equity Tier 1 risk-based capital measure of 6.5%, a Tier 1 risked-based capital ratio of 8% and a total risk-based capital ratio of 10%.

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The Final Rules also provide that all covered banking organizations must maintain a new capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. Advanced approaches organizations also will be subject to a countercyclical capital buffer. Failure to satisfy the capital buffer requirements would result in increasingly stringent limitations on various types of capital distributions, including dividends, share buybacks and discretionary payments on Tier 1 instruments, and discretionary bonus payments.

The Final Rules reflect changes from the June 2012 proposals that minimize the impact of the revised capital regulations on community banks. In particular, banking organizations with less than $15 billion in total assets (including the Company and the Bank) will not be subject to the phase-out of non-qualifying Tier 1 capital instruments, such as trust preferred securities (“TruPS”), that were issued and outstanding prior to May 19, 2010. In addition, non-advanced approaches banking organizations will have a one-time option to exclude certain components of accumulated other comprehensive income from inclusion in regulatory capital, comparable to treatment under the current capital rules. The Final Rules also retain the existing treatment for residential mortgage exposures in the current risk-based capital rules, rather than adopt the proposed changes that would have required banking organizations to determine the risk weights based on a complex categorization and loan-to-value assessment.

Although the Final Rules alleviate some of the concerns of community banks with the capital standards as originally proposed, the new capital standards will impose significant changes on the definition of capital, including the inability to include instruments such as TruPS in Tier 1 capital going forward and new constraints on the inclusion of minority interests, mortgage servicing assets, deferred tax assets and certain investments in the capital of unconsolidated financial institutions. In addition, the Final Rules increase the risk-weights of various assets, including certain high volatility commercial real estate and past due asset exposures.

Non-advanced approaches banking organizations, including the Company and the Bank, must begin compliance with the new minimum capital ratios and the standardized approach for risk-weighted assets as of January 1, 2015, and the revised definitions of regulatory capital and the revised regulatory capital deductions and adjustments will be phased in over time for such organizations beginning as of that date. The capital conservation buffer will be phased in for all banking organizations beginning January 1, 2016.

Management does not expect these changes to result in a material difference to its regulatory capital ratios.

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 16 - Off-Balance Sheet Risk of the 2013 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 (“SPE”s), which generally are established for facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of September 30, 2014, we were not involved in any unconsolidated SPE transactions, other than the investments in the four statutory trusts associated with our TruPS.

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Impact of Inflation and Changing Prices

As a financial institution, we have an asset and liability make-up that is distinctly different from that of an entity with substantial investments in plant and inventory because the major portions of a commercial bank’s assets are monetary in nature. As a result, our performance may be significantly influenced by changes in interest rates. Although we, and the banking industry, are 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.

There have been no material changes in our quantitative and qualitative disclosures about market risk as of September 30, 2014 from those disclosed or incorporated in Part II, Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” presented in our 2013 Form 10-K.

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 third fiscal quarter of 2014 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, the Company may be a party to various legal proceedings from time to time. There are no material pending legal proceedings to which the Company is a party or of which any of its property is subject. In addition, the Company is not aware of any threatened litigation, unasserted claims or assessments that could have a material adverse effect on its business, operating results or financial condition.

Item 1A Risk Factors

There have been no material changes in risk factors previously disclosed in the Company’s 2013 Form 10-K.

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

The following table provides information regarding the Company’s purchases of common stock during the three months ended September 30, 2014:

Period	(a) Total Number of Shares Purchased (1)		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (2)
Repurchases from July 1, 2014through July 31, 2014		-	$	-		-		-
Repurchases from August 1, 2014through August 31, 2014		-		-		-		-
Repurchases from September 1, 2014through September 30, 2014		453		6.92		-		-
Total		453	$	6.92		-		-

(1) Represents shares of the Company’s common stock acquired by the Company in connection with satisfaction of tax withholding obligations on vested restricted stock.

(2) On November 2, 2012, we announced a program which expires on November 1, 2014 to repurchase up to 2,200,000 of our common shares from time to time, depending on market conditions and other factors. On October 29, 2014, the board of directors approved a new program, which will expire on November 1, 2016, to repurchase up to 2,200,000 of our common shares from time to time, depending on market conditions and other factors.

During the three months ended September 30, 2014,the Company did not have any unregistered sales of equity securities.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

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
3.1	Articles of Incorporation of the Company, as amended, incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q (File No. 001-35032) filed May 9, 2014
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
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013; (ii) Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2014 and 2013; (iii) Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2014 and 2013; (v) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013; and (vi) Notes to Condensed Consolidated Financial Statements*

*The information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934

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SIGNATURES

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

		PARK STERLING CORPORATION
Date: November 7, 2014	By:	/s/ James C. Cherry
		James C. Cherry
		Chief Executive Officer (authorized officer)
Date: November 7, 2014	By:	/s/ David L. Gaines
		David L. Gaines
		Chief Financial Officer

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Exhibit Index

Exhibit Number	Description of Exhibits
3.1	Articles of Incorporation of the Company, as amended, incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q (File No. 001-35032) filed May 9, 2014
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
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013; (ii) Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2014 and 2013; (iii) Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2014 and 2013; (v) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013; and (vi) Notes to Condensed Consolidated Financial Statements*

*The information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934

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