Park Sterling 10Q 2016 Q2 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 ended June 30, 2016

[ ] 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 of August 8, 2016, the registrant had outstanding 53,361,119 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 June 30, 2016 and December 31, 2015	2

	Condensed Consolidated Statements of Income Three and Six Months Ended June 30, 2016 and 2015	3

	Condensed Consolidated Statements of Comprehensive Income Three and Six Months Ended June 30, 2016 and 2015	4

	Condensed Consolidated Statements of Changes in Shareholders’ Equity Six Months Ended June 30, 2016 and 2015	5

	Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2016 and 2015	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	46

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	67

Item 4.	Controls and Procedures	67

Part II.	Other Information

Item 1.	Legal Proceedings	67

Item 1A.	Risk Factors	67

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	68

Item 3.	Defaults Upon Senior Securities	68

Item 4.	Mine Safety Disclosures	68

Item 5.	Other Information	68

Item 6.	Exhibits	69

PARK STERLING CORPORATION

Part I.Financial Information

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Dollars in thousands)

	June 30, 2016			December 31, 2015 *

ASSETS

Cash and due from banks	$	33,348		$	53,840
Interest-earning balances at banks		34,955			16,451
Federal funds sold		1,570			235
Investment securities available-for-sale, at fair value		393,131			384,934
Investment securities held-to-maturity (fair value of $106,763 and $107,629 at June 30, 2016 and December 31, 2015, respectively)		102,125			106,458
Nonmarketable equity securities		14,420			11,366
Loans held for sale		11,967			4,943
Loans:
Non-covered		2,311,775			1,724,164
Covered		15,122			17,651
Less allowance for loan losses		(10,873	)		(9,064	)
Net loans		2,316,024			1,732,751

Premises and equipment, net		65,711			55,658
Bank-owned life insurance		69,695			58,633
Deferred tax asset		28,985			28,971
Other real estate owned - noncovered		2,866			4,211
Other real estate owned - covered		380			1,240
Goodwill		63,197			29,197
FDIC indemnification asset		1,165			943
Core deposit intangible		12,354			9,571
Accrued interest receivable		6,842			5,082
Other assets		15,340			9,776

Total assets	$	3,174,075		$	2,514,260


LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing	$	496,195		$	350,836
Interest-bearing		1,977,228			1,601,826
Total deposits		2,473,423			1,952,662

Short-term borrowings		200,000			185,000
Long-term borrowings		64,714			29,996
Subordinated debt		33,176			24,262
Accrued interest payable		568			515
Accrued expenses and other liabilities		47,744			37,121
Total liabilities		2,819,625			2,229,556


Shareholders' equity:
Common stock, $1.00 par value 200,000,000 shares authorized; 53,332,369 and 44,854,509 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively		53,332			44,854
Additional paid-in capital		275,246			222,596
Retained earnings		25,219			20,117
Accumulated other comprehensive income (loss)		653			(2,863	)
Total shareholders' equity		354,450			284,704

Total liabilities and shareholders' equity	$	3,174,075		$	2,514,260

* Derived from audited financial statements.

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

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Interest income
Loans, including fees	$	26,729		$	19,667		$	53,853		$	38,778
Federal funds sold		5			-			13			-
Taxable investment securities		2,640			2,508			5,327			5,299
Tax-exempt investment securities		137			143			284			281
Nonmarketable equity securities		153			122			307			249
Interest on deposits at banks		34			18			76			36
Total interest income		29,698			22,458			59,860			44,643

Interest expense
Money market, NOW and savings deposits		1,014			532			2,032			1,052
Time deposits		1,449			752			2,847			1,459
Short-term borrowings		251			76			545			152
Long-term borrowings		440			131			850			259
Subordinated debt		494			351			940			679
Total interest expense		3,648			1,842			7,214			3,601
Net interest income		26,050			20,616			52,646			41,042

Provision for loan losses		882			134			1,438			314
Net interest income after provision for loan losses		25,168			20,482			51,208			40,728

Noninterest income
Service charges on deposit accounts		1,528			1,107			3,017			2,126
Income from fiduciary activities		580			774			1,244			1,506
Commissions and fees from investment brokerage		283			132			422			262
Income from capital markets		767			394			835			792
Loss on sale of securities available for sale		(87	)		-			(93	)		-
ATM and card income		776			629			1,349			1,323
Mortgage banking income		873			956			1,648			1,907
Income from bank-owned life insurance		526			553			1,514			1,321
Amortization of indemnification asset and true-up liability expense		(25	)		(165	)		(172	)		(559	)
Other noninterest income		154			(88	)		338			115
Total noninterest income		5,375			4,292			10,102			8,793

Noninterest expense
Salaries and employee benefits		11,774			10,021			24,792			20,452
Occupancy and equipment		3,041			2,491			6,166			5,046
Advertising and promotion		367			304			788			678
Legal and professional fees		950			660			1,675			1,458
Deposit charges and FDIC insurance		478			433			910			825
Data processing and outside service fees		2,224			1,640			7,747			3,288
Communication fees		505			541			988			1,119
Core deposit intangible amortization		458			347			916			695
Net cost of operation of other real estate owned		70			232			336			267
Loan and collection expense		273			242			310			396
Postage and supplies		191			116			364			265
Other noninterest expense		1,615			1,205			3,107			2,882
Total noninterest expense		21,946			18,232			48,099			37,371

Income before income taxes		8,597			6,542			13,211			12,150

Income tax expense		3,045			2,273			4,919			4,098

Net income	$	5,552		$	4,269		$	8,292		$	8,052

Basic earnings per common share	$	0.11		$	0.10		$	0.16		$	0.18

Diluted earnings per common share	$	0.11		$	0.10		$	0.16		$	0.18

Dividends per common share	$	0.03		$	0.03		$	0.06		$	0.06

Weighted-average common shares outstanding
Basic		52,394,397			43,971,007			52,340,772			43,944,638
Diluted		52,704,537			44,301,895			52,650,886			44,287,424

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

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(Dollars in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015

Net income	$	5,552		$	4,269		$	8,292		$	8,052

Securities available for sale and transferred securities:
Change in net unrealized gains (losses) during the period		2,118			(3,150	)		6,809			(165	)
Change in net unrealized gain on securities transferred to held to maturity		26			73			52			209
Reclassification adjustment for net losses recognized in net income		87			-			93			-
Total securities available for sale and transferred securities		2,231			(3,077	)		6,954			44

Derivatives:
Change in the accumulated gain (loss) on effective cash flow hedge derivatives		(475	)		646			(1,700	)		(610	)
Change in the accumulated loss on terminated cash flow hedge derivatives		93			-			186			-
Reclassification adjustment for interest payments		88			103			177			206
Total derivatives		(294	)		749			(1,337	)		(404	)

Other comprehensive income (loss), before tax		1,937			(2,328	)		5,617			(360	)

Deferred tax expense (benefit) related to other comprehensive income (loss)		729			(864	)		2,101			(135	)

Other comprehensive income (loss), net of tax		1,208			(1,464	)		3,516			(225	)

Total comprehensive income	$	6,760		$	2,805		$	11,808		$	7,827

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

PARK STERLING CORPORATION

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

(Dollars in thousands)

	Six Months Ended June 30, 2016 and 2015
	Common Stock						Additional Paid-In			Accumulated			Accumulated Other Comprehensive			Total Shareholders'
	Shares			Amount			Capital			Earnings			Income (Loss)			Equity


Balance at December 31, 2014		44,859,798		$	44,860		$	222,819		$	8,901		$	(1,475	)	$	275,105

Issuance of restricted stock grants		212,300			212			(212	)		-			-			-

Forfeitures of restricted stock grants		(8,917	)		(9	)		9			-			-			-

Exercise of stock options		28,963			29			112			-			-			141

Share-based compensation expense		1,182			1			589			-			-			590

Common stock repurchased or reacquired		(182,640	)		(182	)		(1,046	)		-			-			(1,228	)

Dividends on common stock		-			-			-			(2,692	)		-			(2,692	)

Net income		-			-			-			8,052			-			8,052

Other comprehensive loss		-			-			-			-			(225	)		(225	)

Balance at June 30, 2015		44,910,686		$	44,911		$	222,271		$	14,261		$	(1,700	)	$	279,743

Balance at December 31, 2015		44,854,509		$	44,854		$	222,596		$	20,117		$	(2,863	)	$	284,704

Shares issued for First Capital merger		8,376,094			8,376			52,937			-			-			61,313

Issuance of restricted stock grants		236,534			236			(236	)		-			-			-

Forfeitures of restricted stock grants		(38,783	)		(39	)		39			-			-			-

Exercise of stock options		274,890			275			1,512			-			-			1,787

Share-based compensation expense		1,300			1			682			-			-			683

Common stock repurchased or reacquired		(372,175	)		(371	)		(2,284	)		-			-			(2,655	)

Dividends on common stock		-			-			-			(3,190	)		-			(3,190	)

Net income		-			-			-			8,292			-			8,292

Other comprehensive income		-			-			-			-			3,516			3,516

Balance at June 30, 2016		53,332,369		$	53,332		$	275,246		$	25,219		$	653		$	354,450

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

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	Six Months Ended
	June 30,
	2016			2015
Cash flows from operating activities
Net income	$	8,292		$	8,052
Adjustments to reconcile net income to netcash provided by operating activities:
Accretion on acquired loans		(4,902	)		(3,720	)
Net amortization on investments		1,258			1,209
Other depreciation and amortization		5,045			5,433
Provision for loan losses		1,438			314
Share-based compensation expense		683			590
Deferred income taxes		(171	)		3,695
Amortization of FDIC indemnification asset		142			514
Net losses on sales of investment securities available-for-sale		93			-
Net gains on sales of loans held for sale		(846	)		(830	)
Net losses on sales of fixed assets		274			349
Net gains on sales of other real estate owned		(171	)		(307	)
Writedowns on other real estate owned		294			485
Income from bank-owned life insurance		(1,514	)		(1,321	)
Proceeds from loans held for sale		44,460			54,326
Disbursements for loans held for sale		(50,638	)		(52,595	)
Change in assets and liabilities:
Decrease in FDIC indemnification asset		333			90
Decrease (increase) in accrued interest receivable		96			(385	)
Increase in other assets		(1,460	)		(352	)
Increase (decrease) in accrued interest payable		12			(23	)
Increase in accrued expenses and other liabilities		4,374			746
Net cash provided by operating activities		7,092			16,270

Cash flows from investing activities
Net increase in loans		(81,816	)		(79,027	)
Purchases of premises and equipment		(2,558	)		(2,401	)
Proceeds from sales of premises and equipment		-			169
Purchases of investment securities available-for-sale		(76,247	)		(56,061	)
Purchases of investment securities held-to-maturity		-			(4,958	)
Proceeds from sales of investment securities available-for-sale		124,381			-
Proceeds from maturities, calls and paydowns of investment securities available-for-sale		26,929			28,115
Proceeds from maturities, calls and paydowns of investment securities held-to-maturity		4,292			9,040
Proceeds from life insurance death benefit		534			1,054
FDIC payment (reimbursement) of recoverable covered asset losses		(697	)		2,151
Proceeds from sale of other real estate owned		3,674			5,701
Net (purchases) redemptions of nonmarketable equity securities		1,289			(1,968	)
Termination of cash flow hedge		(1,855	)		-
Acquisitions, net of cash acquired		(12,067	)		-
Net cash used by investing activities		(14,141	)		(98,185	)

Cash flows from financing activities
Net increase in deposits		13,627			23,646
Advances of long-term borrowings		35,000			-
Repayments of long-term borrowings		(45,503	)		-
Net advances in short-term borrowings		7,379			55,000
Repayments of junior subordinated debt		(49	)		-
Exercise of stock options		1,787			141
Repurchase of common stock		(2,655	)		(1,228	)
Dividends on common stock		(3,190	)		(2,692	)
Net cash provided by financing activities		6,396			74,867

Net decrease in cash and cash equivalents		(653	)		(7,048	)

Cash and cash equivalents, beginning		70,526			51,390

Cash and cash equivalents, ending	$	69,873		$	44,342

Supplemental disclosures of cash flow information:
Cash paid for interest	$	7,161		$	3,624
Cash paid for income taxes		760			338

Supplemental disclosure of noncash investing and financing activities:
Change in unrealized gain on available-for-sale securities, net of tax	$	6,935		$	27
Change in unrealized loss on cash flow hedge, net of tax		(429	)		(252	)
Loans transferred to other real estate owned		1,592			3,677

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

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 June 30, 2016 and December 31, 2015, 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 “2015 Audited Financial Statements”) included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 filed with the Securities and Exchange Commission (“SEC”) on March 6, 2016 (the “2015 Form 10-K”).

In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which consist of normal, recurring adjustments, necessary to present fairly the financial position of the Company as of June 30, 2016 and December 31, 2015, the results of its operations for the three and six months ended June 30, 2016 and 2015, and cash flows for the six months ended June 30, 2016 and 2015. Operating results for the six-month period ended June 30, 2016 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, the fair value of financial instruments and other accounts and the fair value of assets and liabilities acquired in the acquisition of First Capital Bancorp, Inc. (“First Capital”).

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.

Note 2 - Recent Accounting Pronouncements

During the first quarter of 2016, the Company adopted Accounting Standards Update (“ASU”) 2015-16, “Simplifying the Accounting for Measurement Period Adjustments” (“ASU 2015-16”). ASU 2015-16 simplifies the accounting for adjustments made to provisional amounts recognized in a business combination by eliminating the requirement to retrospectively account for those adjustments. The amendments in ASU 2015-16 were effective for fiscal years beginning after December 15, 2015. This guidance did not have a material effect on the Company’s financial statements.

During the first quarter of 2016, the Company also adopted ASU 2015-03, “Interest- Imputation of Interest (Subtopic 835-300: Simplifying the Presentation of Debt Issuance Costs)” (“ASU 2015-03”). The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The guidance was effective for fiscal years beginning after December 31, 2015 and interim periods within that year. This guidance did not have a material effect on the Company’s financial statements.

On January 5, 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-01, “Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). Changes to the current GAAP model primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The guidance will be effective in fiscal years beginning after December 15, 2017, including interim periods within that fiscal year. The Company is evaluating the impact of this update on its financial statements.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

In February 2016, the FASB issued ASU 2016-02, “Leases” (“ASU 2016-02”), which is intended to improve financial reporting about leasing transactions. ASU 2016-02 will require organizations (“lessees”) that lease assets with lease terms of more than twelve months to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Financial reporting for organizations that own the assets leased by lessees (“lessors”) will remain largely unchanged from current GAAP. In addition, the ASU will require disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases. The effective date of this ASU is for fiscal years beginning after December 31, 2018 and interim periods within that year. The Company is evaluating the impact of this standard on its financial statements.

In February 2016, the FASB issued ASU 2016-09, “Compensation- Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”), which is intended to improve accounting for share-based payment award transactions. ASU 2016-09 will simplify share-based transactions including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The effective date of this ASU is for fiscal years beginning after December 31, 2017, including interim periods within those fiscal years. The Company is evaluating the impact of this update on its financial statements.

In June 2016, the FASB issued ASU 2016-13 “Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”) as part of its project on financial instruments. ASU 2016-13 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale (AFS) debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The effective date of this ASU is for reporting periods beginning after December 15, 2019. The implementation of ASU 2016-13 will have a significant impact on both the method of estimating credit losses as well as the amount of credit losses reflected in the financial statements. The Company is currently in a planning phase for implementation of the new standard and its expected impact on its financial statements.

Note 3– Business Combinations andGoodwill

Business Combinations

Generally, acquisitions are accounted for under the acquisition method of accounting in accordance with Accounting Standards Codification (“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.

First Capital

On January 1, 2016, the Company acquired First Capital pursuant to the merger agreement dated September 30, 2015. Upon completion of the merger, First Capital common shareholders received either $5.54 in cash or 0.7748 Park Sterling shares for each First Capital share they held, subject to the limitation that the total consideration for shareholders consisted of 30.0% in cash and 70.0% in Park Sterling shares; First Capital warrant holders received either $1.77 in cash or 0.24755 Park Sterling shares for each First Capital warrant they held, subject to the limitation that the total consideration for warrant holders consisted of 30.0% in cash and 70.0% in Park Sterling shares; and each outstanding option to purchase shares of First Capital common stock was converted into the right to receive cash equal to the product of (a) $5.54 minus the per share exercise price of such option, and (b) the number of shares of First Capital common stock subject to the option. After application of the elections made by the holders of First Capital’s common stock and warrants and the allocation procedures contained in the merger agreement, the aggregate merger consideration consisted of approximately 8,376,094 shares of the Company’s common stock and approximately $25.8 million in cash. Based upon the $7.32 per share closing price of the Company’s common stock on December 31, 2015, the transaction value was approximately $87.1 million.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The assets acquired and liabilities assumed from First Capital 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 $34.5 million was initially recorded at the time of the acquisition. As a result of refinements to the fair value mark on nonmarketable equity securities, deferred tax asset, other assets and other liabilities, goodwill as indicated below is $0.5 million less than the goodwill estimated at the time of acquisition. The following table summarizes the consideration paid by the Company in the merger with First Capital and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date:

	As Recorded by First Capital		Fair Value and Other Merger Related Adjustments			As Recorded by the Company
Consideration Paid
Cash						$	25,834
Common shares issued							61,313

Fair Value of Total Consideration Transferred						$	87,147

Recognized amounts of identifiable assets acquired and liabilities assumed:

Cash and cash equivalents	$	13,767	$	-		$	13,767
Securities		77,404		69			77,473
Nonmarketable equity securities		4,161		27			4,188
Loans, net of allowance		500,265		(56	)		500,209
Premises and equipment		11,699		(393	)		11,306
Core deposit intangibles		-		3,700			3,700
Interest receivable		1,856		-			1,856
Bank owned life insurance		10,216		-			10,216
Deferred tax asset		3,956		(722	)		3,234
Other assets		2,962		(124	)		2,838

Total assets acquired		626,286		2,501			628,787

Deposits		506,060		1,683			507,743
Federal Home Loan Bank advances		45,000		503			45,503
Junior Subordinated Debt		9,963		(1,372	)		8,591
Short term borrowings		7,621		-			7,621
Other liabilities		5,994		188			6,182

Total liabilities assumed	$	574,638	$	1,002		$	575,640

Total identifiable assets	$	51,648	$	1,499		$	53,147

Goodwill resulting from acquisition						$	34,000

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 certain proforma information as if First Capital had been acquired on January 1, 2015. These results combine the historical results of First Capital 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, 2015. Acquisition-related costs of $6.5 million are included in the Company’s consolidated statements of income for the six months ended June 30, 2016 and are not included in the proforma information below. In particular, no adjustments have been made to eliminate the amount of First Capital recovery of loan losses of $145 thousand for the six months ended June 30, 2015. Furthermore, additional expenses related to systems conversions and other costs of integration are expected to be recorded during 2016. 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 proforma amounts below:

	Proforma Results for the Six Months Ended June 30, 2015						Actual Results Six Months Ended
	Park Sterling		First Capital		Combined		June 30, 2016
Total revenues(net interest income plus noninterest income)	$	49,835	$	11,035	$	60,870	$	62,748
Net income		8,052		2,231		10,283		8,292
Basic earnings per common share	$	0.18	$	0.18	$	0.19	$	0.16

Note 4 – Investment Securities

The amortized cost, unrealized gains and losses, and estimated fair value of securities available-for-sale at June 30, 2016 and December 31, 2015 are as follows:

Amortized Cost and Fair Value of Investment Portfolio

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
June 30, 2016
Securities available-for-sale:
U.S. Government agencies	$	501	$	3	$	-		$	504
Municipal securities		13,244		974		-			14,218
Residential agency pass-through securities		177,979		4,366		-			182,345
Residential collateralized mortgage obligations		104,412		2,454		-			106,866
Asset-backed securities		86,417		811		(731	)		86,497
Corporate and other securities		1,471		-		(111	)		1,360
Equity securities		1,250		91		-			1,341
Total securities available-for-sale	$	385,274	$	8,699	$	(842	)	$	393,131

Securities held-to-maturity:
Residential agency pass-through securities	$	38,196	$	1,577	$	-		$	39,773
Residential collateralized mortgage obligations		7,305		316		-			7,621
Commercial mortgage-backed obligations		53,425		1,226		-			54,651
Asset-backed securities		4,757		-		(40	)		4,717
Total securities held-to-maturity	$	103,683	$	3,119	$	(40	)	$	106,762

December 31, 2015
Securities available-for-sale:
U.S. Government agencies	$	503	$	11	$	-		$	514
Municipal securities		14,049		747		-			14,796
Residential agency pass-through securities		130,041		1,500		(81	)		131,460
Residential collateralized mortgage obligations		151,928		646		(943	)		151,631
Commercial mortgage-backed securities		4,856		-		(100	)		4,756
Asset-backed securities		79,941		104		(925	)		79,120
Corporate and other securities		1,463		37		-			1,500
Equity securities		1,250		-		(93	)		1,157
Total securities available-for-sale	$	384,031	$	3,045	$	(2,142	)	$	384,934

Securities held-to-maturity:
Residential agency pass-through securities	$	41,012	$	831	$	(53	)	$	41,790
Residential collateralized mortgage obligations		7,723		69		-			7,792
Commercial mortgage-backed obligations		54,028		-		(1,367	)		52,661
Asset-backed securities		5,394		-		(8	)		5,386
Total securities held-to-maturity	$	108,157	$	900	$	(1,428	)	$	107,629

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

In the second quarter of 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 June 30, 2016 and December 31, 2015 totaled $1.6 million and $1.7 million, respectively. 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 $53.4 million is higher than the $51.9 million carrying value of the securities as of June 30, 2016. There were no transfers of securities from available-for-sale to held-to-maturity during the three and six months ended June 30, 2016 or 2015.

At June 30, 2016 and December 31, 2015, investment securities with a fair market value of $171.9 million and $154.9 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 June 30, 2016 and December 31, 2015, commercial MBS include $45.8 million and $51.1 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 of private-label securities collateralized by commercial properties.

At June 30, 2016 and December 31, 2015, asset-backed securities include a $4.8 million security that is approximately 45% collateralized by the Federal family education loan program and 55% collateralized by a private student loan program.

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

The amortized cost and fair value of investment securities available-for-sale and held-to-maturity at June 30, 2016 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.

	June 30, 2016
	Amortized Cost		Fair Value
Securities available-for-sale:
U.S. Government agencies
Due after one year through five years	$	501	$	504
Municipal securities
Due after five years through ten years		4,376		4,663
Due after ten years		8,868		9,555
Residential agency pass-through securities
Due after five years through ten years		7,732		8,072
Due after ten years		170,247		174,273
Residential collateralized mortgage obligations
Due after five years through ten years		15,558		16,037
Due after ten years		88,854		90,829
Commercial mortgage-backed obligations
Due after one year through five years		-		-
Asset-backed securities
Due after five years through ten years		59,004		58,975
Due after ten years		27,413		27,522
Corporate and other securities
Due after ten years		1,471		1,360
Equity securities
No maturity		1,250		1,341
Total securities available-for-sale	$	385,274	$	393,131

Securities held-to-maturity:
Residential agency pass-through securities
Due after ten years	$	38,196	$	39,773
Residential collateralized mortgage obligations
Due after ten years		7,305		7,621
Commercial mortgage-backed obligations
Due after five years through ten years		53,425		54,651
Asset-backed securities
Due after ten years		4,757		4,717
Total securities held-to-maturity	$	103,683	$	106,762

Securities available-for-sale of $24.3 million and $124.4 million were sold in the three months and six months ended June 30, 2016, respectively. Gross realized losses on the sale of securities for the three months ended June 30, 2016 were $87 thousand. Gross realized losses on the sale of securities for the six months ended June 30, 2016 were $187 thousand. Gross realized gains on the sale of securities for the six months ended June 30, 2016 were $94 thousand. There were no sales of securities in the three and six months ended June 30, 2015. The significant amount of sales of securities during the first quarter of 2016 is due to the sale of securities held by First Capital immediately following the acquisition.

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 June 30, 2016 and December 31, 2015. None of the securities are deemed to be other than temporarily impaired since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, as all but one of the bonds are issued by United States government agencies with the remaining bond being partially guaranteed by a government agency, and it is more likely than not that the Company will not have to sell the investments before recovery of their amortized cost basis. At June 30, 2016, there were six securities in a loss position for twelve months or more. At December 31, 2015, there were 18 securities in a loss position for twelve months or more.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Pursuant to the “Volcker Rule” adopted by the federal banking regulatory agencies effective April, 2014, banks and their affiliates are prohibited from engaging in proprietary trading and investing in and sponsoring a covered fund (such as a hedge fund or private equity fund). Banking entities have until July 21, 2017 to conform their activities to the requirements of the rule. At June 30, 2016 and December 31, 2015, the Company held a collateralized loan obligation (“CLO”) with a fair value of $5.0 million, which was included in asset-backed securities, which currently would be prohibited under the Volcker Rule. The net unrealized loss of the prohibited CLO was $68,250 and $57,300 at June 30, 2016 and December 31, 2015, respectively. The Company will determine any disposition plans for this security as the documentation is, or is not, amended. Unless the documentation is amended to avoid inclusion within the rule’s prohibitions, the Company would have to recognize other-than-temporary-impairment with respect to this security in conformity with GAAP rules and dispose of the security by July 21, 2017. The Company held no other security types potentially affected by the Volcker Rule at June 30, 2016.

Investment Portfolio Gross Unrealized Losses and Fair Value

	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2016
Securities available-for-sale:
Asset-backed securities	$	15,492	$	(356	)	$	27,622	$	(375	)	$	43,114	$	(731	)
Corporate and other securities		1,360		(111	)		-		-			1,360		(111	)

Total temporarily impaired available-for-sale securities	$	16,852	$	(467	)	$	27,622	$	(375	)	$	44,474	$	(842	)

Securities held-to-maturity:
Asset-backed securities	$	-	$	-		$	4,717	$	(40	)	$	4,717	$	(40	)

Total temporarily impaired held-to-maturity securities	$	-	$	-		$	4,717	$	(40	)	$	4,717	$	(40	)

December 31, 2015
Securities available-for-sale:
Residential agency pass-through securities	$	14,785	$	(37	)	$	3,489	$	(44	)	$	18,274	$	(81	)
Residential collateralized mortgage obligations		43,563		(306	)		27,718		(637	)		71,281		(943	)
Commercial mortgage-backed securities		4,756		(100	)		-		-			4,756		(100	)
Asset-backed securities		18,651		(190	)		45,263		(735	)		63,914		(925	)
Equity Securities		1,157		(93	)		-		-			1,157		(93	)
Total temporarily impaired available-for-sale securities	$	82,912	$	(726	)	$	76,470	$	(1,416	)	$	159,382	$	(2,142	)

Securities held-to-maturity:
Residential collateralized mortgage obligations	$	4,456	$	(53	)	$	-	$	-		$	4,456	$	(53	)
Commercial mortgage-backed securities		18,736		(370	)		33,925		(997	)		52,661		(1,367	)
Asset-backed securities		-		-			5,386		(8	)		5,386		(8	)

Total temporarily impaired held-to-maturity securities	$	23,192	$	(423	)	$	39,311	$	(1,005	)	$	62,503	$	(1,428	)

The Company has nonmarketable equity securities consisting of investments in several unaffiliated financial institutions, as well as investments in five statutory trusts related to trust preferred securities issued by predecessor companies. These investments totaled $14.4 million at June 30, 2016 and $11.4 million at December 31, 2015. Included in these amounts at June 30, 2016 and December 31, 2015 was $12.8 million and $10.0 million, respectively, of Federal Home Loan Bank (“FHLB”) stock. All nonmarketable equity securities were evaluated for impairment as of June 30, 2016 and December 31, 2015. At June 30, 2016 and December 31, 2015, 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.

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:

	June 30, 2016						December 31, 2015
	PCI loans		All other loans		Total		PCI loans		All other loans		Total
Commercial:
Commercial and industrial	$	4,340	$	330,304	$	334,644	$	4,825	$	242,082	$	246,907
Commercial real estate (CRE) - owner-occupied		20,179		356,261		376,440		21,388		309,834		331,222
CRE - investor income producing		33,003		731,165		764,168		32,371		473,739		506,110
AC&D - 1-4 family construction		813		99,791		100,604		465		31,797		32,262
AC&D - lots, land & development		9,584		85,102		94,686		4,797		39,614		44,411
AC&D - CRE		220		125,246		125,466		-		87,452		87,452
Other commercial		1,727		8,683		10,410		1,870		6,731		8,601
Total commercial loans		69,866		1,736,552		1,806,418		65,716		1,191,249		1,256,965

Consumer:
Residential mortgage		23,396		220,667		244,063		23,420		200,464		223,884
Home equity lines of credit (HELOC)		1,783		179,237		181,020		1,580		155,798		157,378
Residential construction		3,137		62,730		65,867		3,685		68,486		72,171
Other loans to individuals		488		26,087		26,575		516		28,300		28,816
Total consumer loans		28,804		488,721		517,525		29,201		453,048		482,249
Total loans		98,670		2,225,273		2,323,943		94,917		1,644,297		1,739,214
Deferred costs		-		2,954		2,954		-		2,601		2,601
Total loans, net of deferred costs	$	98,670	$	2,228,227	$	2,326,897	$	94,917	$	1,646,898	$	1,741,815

Included in the June 30, 2016 and December 31, 2015 loan totals are $15.1 million and $17.7 million, respectively, of covered loans pursuant to Federal Deposit Insurance Corporation (“FDIC”) loss share agreements. Of these amounts, at June 30, 2016, approximately $13.2 million is included in PCI loans and $1.9 million is included in all other loans. At December 31, 2015, $15.6 million is included in PCI loans and $2.1 million is included in all other loans.

At June 30, 2016 and December 31, 2015, the Company had sold participations in loans aggregating $24.1 million and $12.5 million, respectively, to other financial institutions on a nonrecourse basis. Of the $24.1 million in participation loans outstanding at June 30, 2016, approximately half were acquired in connection with the First Capital 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. The Company serviced $2.5 million and $2.8 million of residential mortgage loans for the benefit of others as of June 30, 2016 and December 31, 2015, respectively.

Loans sold are 1-4 family residential mortgages originated by the Company and sold to various other financial institutions. 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 only a few of the loans have ever been returned to the Company, the amount of total loans sold does not necessarily represent future cash requirements. Total loans sold in the three and six months ended June 30, 2016 were $26.0 million and $43.6 million, respectively. Total loans sold in the three and six months ended June 30, 2015 were $27.9 million and $53.5 million, respectively.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

At June 30, 2016, the carrying value of loans pledged as collateral to the FHLB on borrowings and to the Federal Reserve totaled $880.7 million. At December 31, 2015, the carrying value of loans pledged as collateral to the FHLB and the Federal Reserve totaled $693.0 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 June 30, 2016 and December 31, 2015, the Company had no loans outstanding with foreign entities.

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 six months ended June 30, 2016 and 2015.

	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			Residential mortgage			HELOC			Residential construction			Other loans to individuals			Total
For the three months ended June 30, 2016
Allowance for Loan Losses:
Balance, beginning of period	$	2,047		$	1,108	$	2,217	$	381	$	398		$	808	$	67		$	724		$	1,393		$	449		$	240		$	9,832
Provision for loan losses		66			123		348		91		(70	)		28		3			104			130			(12	)		71			882
Charge-offs		(1	)		-		-		-		-			-		-			(15	)		(56	)		-			(21	)		(93	)
Recoveries		16			-		7		13		121			-		-			8			66			2			19			252
Net (charge-offs) recoveries		15			-		7		13		121			-		-			(7	)		10			2			(2	)		159

Total Allowance for Loan Losses	$	2,128		$	1,231	$	2,572	$	485	$	449		$	836	$	70		$	821		$	1,533		$	439		$	309		$	10,873

For the six months ended June 30, 2016
Allowance for Loan Losses:
Balance, beginning of period	$	1,821		$	1,135	$	2,099	$	247	$	278		$	679	$	69		$	672		$	1,337		$	461		$	266		$	9,064
Provision for loan losses		283			96		451		221		16			157		(37	)		129			95			(39	)		66			1,438
Charge-offs		(15	)		-		-		-		-			-		-			(32	)		(56	)		(11	)		(61	)		(175	)
Recoveries		39			-		22		17		155			-		38			52			157			28			38			546
Net (charge-offs) recoveries		24			-		22		17		155			-		38			20			101			17			(23	)		371

Total Allowance for Loan Losses	$	2,128		$	1,231	$	2,572	$	485	$	449		$	836	$	70		$	821		$	1,533		$	439		$	309		$	10,873

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

	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		Residential mortgage			HELOC			Residential construction			Other loans to individuals			Total
For the three months ended June 30, 2015
Allowance for Loan Losses:
Balance, beginning of period	$	2,045		$	781		$	1,988		$	141		$	179		$	475	$	38	$	531		$	1,843		$	458		$	111		$	8,590
Provision for loan losses		(597	)		519			42			99			(31	)		195		22		145			(478	)		(77	)		161			-
Charge-offs		(67	)		(220	)		-			-			-			-		-		(46	)		(67	)		(3	)		(15	)		(418	)
Recoveries		13			-			7			-			119			-		-		22			62			3			21			247
Net (charge-offs) recoveries		(54	)		(220	)		7			-			119			-		-		(24	)		(5	)		-			6			(171	)
Balance, end of period	$	1,394		$	1,080		$	2,037		$	240		$	267		$	670	$	60	$	652		$	1,360		$	381		$	278		$	8,419

PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-		$	-		$	-		$	-		$	-		$	-	$	-	$	-		$	-		$	-		$	-		$	-
PCI Impairment charge-offs		(51	)		-			(39	)		-			-			-		-		(66	)		-			-			-		$	(156	)
PCI impairment recoveries		-			-			-			-			-			-		-		-			-			-			-			-
Net PCI impairment charge-offs		(51	)		-			(39	)		-			-			-		-		(66	)		-			-			-			(156	)
PCI provision for loan losses		51			-			88			-			-			-		-		66			-			-			-			205
Benefit attributable to FDIC loss share agreements		-			-			(71	)		-			-			-		-		-			-			-			-			(71	)
Total provision for loan losses charged to operations		51			-			17			-			-			-		-		66			-			-			-			134
Provision for loan losses recorded through FDIC loss share receivable		-			-			71											-		-			-			-			-			71
Balance, end of period	$	-		$	-		$	49		$	-		$	-		$	-	$	-	$	-		$	-		$	-		$	-		$	49

Total Allowance for Loan Losses	$	1,394		$	1,080		$	2,086		$	240		$	267		$	670	$	60	$	652		$	1,360		$	381		$	278		$	8,468

For the six months ended June 30, 2015
Allowance for Loan Losses:
Balance, beginning of period	$	1,563		$	721		$	1,751		$	458		$	591		$	395	$	32	$	443		$	1,651		$	542		$	115		$	8,262
Provision for loan losses		(78	)		578			80			(218	)		(567	)		275		28		296			(285	)		(87	)		158			180
Charge-offs		(154	)		(220	)		-			-			-			-		-		(117	)		(80	)		(78	)		(34	)		(683	)
Recoveries		63			1			206			-			243			-		-		30			74			4			39			660
Net (charge-offs) recoveries		(91	)		(219	)		206			-			243			-		-		(87	)		(6	)		(74	)		5			(23	)
Balance, end of period	$	1,394		$	1,080		$	2,037		$	240		$	267		$	670	$	60	$	652		$	1,360		$	381		$	278		$	8,419

PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-		$	-		$	-		$	-		$	-		$	-	$	-	$	-		$	-		$	-		$	-		$	-
PCI Impairment charge-offs		(51	)		-			(39	)		-			-			-		-		(66	)		-			-			-			(156	)
PCI impairment recoveries		-			-			-			-			-			-		-		-			-			-			-			-
Net PCI impairment charge-offs		(51	)		-			(39	)		-			-			-		-		(66	)		-			-			-			(156	)
PCI provision for loan losses		51			-			88			-			-			-		-		66			-			-			-			205
Benefit attributable to FDIC loss share agreements		-			-			(71	)		-			-			-		-		-			-			-			-			(71	)
Total provision for loan losses charged to operations		51			-			17			-			-			-		-		66			-			-			-			134
Provision for loan losses recorded through FDIC loss share receivable		-			-			71											-		-			-			-			-			71
Balance, end of period	$	0		$	-		$	49		$	-		$	-		$	-	$	-	$	0		$	-		$	-		$	-		$	49

Total Allowance for Loan Losses	$	1,394		$	1,080		$	2,086		$	240		$	267		$	670	$	60	$	652		$	1,360		$	381		$	278		$	8,468

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 June 30, 2016 and December 31, 2015.

	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		Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total
At June 30, 2016
Allowance for Loan Losses:
Individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	194	$	20	$	-	$	214
Collectively evaluated for impairment		2,128		1,231		2,572		485		449		836		70		821		1,339		419		309		10,659
		2,128		1,231		2,572		485		449		836		70		821		1,533		439		309		10,873
Purchased credit-impaired		-		-		-		-		-		-		-		-		-		-		-		-
Total	$	2,128	$	1,231	$	2,572	$	485	$	449	$	836	$	70	$	821	$	1,533	$	439	$	309	$	10,873

Recorded Investment in Loans:
Individually evaluated for impairment	$	-	$	866	$	883	$	-	$	677	$	-	$	211	$	2,071	$	1,224	$	242	$	-	$	6,174
Collectively evaluated for impairment		330,304		355,395		730,282		99,791		84,425		125,246		8,472		218,596		178,013		62,488		26,087		2,219,099
		330,304		356,261		731,165		99,791		85,102		125,246		8,683		220,667		179,237		62,730		26,087		2,225,273
Purchased credit-impaired		4,340		20,179		33,003		813		9,584		220		1,727		23,396		1,783		3,137		488		98,670
Total	$	334,644	$	376,440	$	764,168	$	100,604	$	94,686	$	125,466	$	10,410	$	244,063	$	181,020	$	65,867	$	26,575	$	2,323,943

At December 31, 2015
Allowance for Loan Losses:
Individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	192	$	-	$	-	$	192
Collectively evaluated for impairment		1,821		1,135		2,099		247		278		679		69		672		1,145		461		266		8,872
		1,821		1,135		2,099		247		278		679		69		672		1,337		461		266		9,064
Purchased credit-impaired		-		-		-		-		-		-		-		-		-		-		-		-
Total	$	1,821	$	1,135	$	2,099	$	247	$	278	$	679	$	69	$	672	$	1,337	$	461	$	266	$	9,064

Recorded Investment in Loans:
Individually evaluated for impairment	$	-	$	1,266	$	440	$	-	$	723	$	-	$	-	$	1,304	$	1,381	$	238	$	-	$	5,352
Collectively evaluated for impairment		242,082		308,568		473,299		31,797		38,891		87,452		6,731		199,160		154,417		68,248		28,300		1,638,945
		242,082		309,834		473,739		31,797		39,614		87,452		6,731		200,464		155,798		68,486		28,300		1,644,297
Purchased credit-impaired		4,825		21,388		32,371		465		4,797		-		1,870		23,420		1,580		3,685		516		94,917
Total	$	246,907	$	331,222	$	506,110	$	32,262	$	44,411	$	87,452	$	8,601	$	223,884	$	157,378	$	72,171	$	28,816	$	1,739,214

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:

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.

In the second quarter of 2015 as part of management’s annual review of the allowance for loan loss methodology, management modified the methodology used for the determination of allowance for loan losses to collectively review impaired loans with a balance of less than or equal to $150 thousand. These loans are no longer individually reviewed for specific impairment but rather are reviewed on a pooled basis in a manner consistent with unimpaired loans with additional qualitative factors applied when necessary to reflect the additional risk characteristics of these loans.

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. The historic look back periods utilized by management for all loan types was 15 quarters at both June 30, 2016 and December 31, 2015.

The Company also performs a quantitative calculation on the 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 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. This analysis indicated a need for a $262 thousand and $178 thousand provision for loan losses for the purchased performing portfolio at June 30, 2016 and December 31, 2015, respectively. The remaining mark on the purchased performing loan portfolio was $5.0 million and $2.1 million at June 30, 2016 and December 31, 2015, respectively. Approximately $3.4 million of the remaining mark at June 30, 2016 on the purchased performing loan portfolio was associated with the First Capital merger.

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. These factors include portfolio trends, portfolio concentrations, economic and market conditions, changes in lending practices, changes in loan review systems, geographical considerations and other factors. 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:

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;

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

ii.

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

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;

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.

Reserve on PCI 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. There were no outstanding reserves on PCI loans as of June 30, 2016 and December 31, 2015.

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, 2015 to June 30, 2016 was a function of the following:

(1)

a decrease of $1.0 million in the quantitative component of the allowance due to a decrease in historical loss rates applied to the portfolio as older periods with higher rates of net charge-offs are replaced with more recent periods with higher rates of net recoveries;

(2)

an increase of $2.8 million in the qualitative component of the allowance primarily due to an increase in the economic and market trends factor in light of market volatility and heightened uncertainty which emerged at the end of the quarter, organic loan growth and additional provision recorded for the purchased performing loans; and

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

(3)

an increase of $22 thousand in specific reserves on a single residential construction loan relationship.

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 June 30, 2016 and December 31, 2015, $125 thousand was recorded as an other liability for off-balance sheet credit exposure.

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

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

	Pass:		Loans in classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. 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.

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 June 30, 2016 and December 31, 2015, by loan class and by credit quality indicator.

	As of June 30, 2016
	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	$	331,214	$	365,653	$	759,337	$	100,604	$	93,644	$	125,466	$	10,072	$	1,785,990
Special mention		3,314		9,658		2,862		-		443		-		-		16,277
Classified		116		1,129		1,969		-		599		-		338		4,151
Total	$	334,644	$	376,440	$	764,168	$	100,604	$	94,686	$	125,466	$	10,410	$	1,806,418

	Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total Consumer
Pass	$	237,729	$	172,605	$	65,123	$	26,415	$	501,872
Special mention		3,816		7,165		448		16		11,445
Classified		2,518		1,250		296		144		4,208
Total	$	244,063	$	181,020	$	65,867	$	26,575	$	517,525

Total Loans									$	2,323,943

	As of December 31, 2015
	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	$	243,228	$	316,706	$	500,964	$	32,262	$	43,454	$	87,452	$	8,467	$	1,232,533
Special mention		3,571		11,986		3,824		-		404		-		-		19,785
Classified		108		2,530		1,322		-		553		-		134		4,647
Total	$	246,907	$	331,222	$	506,110	$	32,262	$	44,411	$	87,452	$	8,601	$	1,256,965

	Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total Consumer
Pass	$	217,463	$	150,217	$	71,225	$	28,762	$	467,667
Special mention		4,690		6,213		457		23		11,383
Classified		1,731		948		489		31		3,199
Total	$	223,884	$	157,378	$	72,171	$	28,816	$	482,249

Total Loans									$	1,739,214

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 payment status, the associated discount on these loan pools results in income recognition. The increase in loans 60-89 days past due is primarily the result of two relationships that are fully collateralized and for which full repayment is currently expected. The following presents, by class, an aging analysis of the Company’s accruing and non-accruing loans as of June 30, 2016 and December 31, 2015.

	30-59 Days Past Due		60-89 Days Past Due		Past Due 90 Days or More		PCI Loans		Current		Total Loans
As of June 30, 2016
Commercial:
Commercial and industrial	$	212	$	772	$	66	$	4,340	$	329,254	$	334,644
CRE - owner-occupied		-		1,809		271		20,179		354,181		376,440
CRE - investor income producing		-		246		608		33,003		730,311		764,168
AC&D - 1-4 family construction		-		-		-		813		99,791		100,604
AC&D - lots, land & development		-		-		-		9,584		85,102		94,686
AC&D - CRE		-		-		-		220		125,246		125,466
Other commercial		-		-		211		1,727		8,472		10,410
Total commercial loans		212		2,827		1,156		69,866		1,732,357		1,806,418

Consumer:
Residential mortgage		-		628		1,623		23,396		218,416		244,063
HELOC		628		1,215		443		1,783		176,951		181,020
Residential construction		-		1,166		276		3,137		61,288		65,867
Other loans to individuals		5		51		25		488		26,006		26,575
Total consumer loans		633		3,060		2,367		28,804		482,661		517,525
Total loans	$	845	$	5,887	$	3,523	$	98,670	$	2,215,018	$	2,323,943

As of December 31, 2015
Commercial:
Commercial and industrial	$	18	$	28	$	78	$	4,825	$	241,958	$	246,907
CRE - owner-occupied		1,273		-		176		21,388		308,385		331,222
CRE - investor income producing		-		-		1,369		32,371		472,370		506,110
AC&D - 1-4 family construction		-		-		-		465		31,797		32,262
AC&D - lots, land & development		-		-		-		4,797		39,614		44,411
AC&D - CRE		-		-		-		-		87,452		87,452
Other commercial		-		212		-		1,870		6,519		8,601
Total commercial loans		1,291		240		1,623		65,716		1,188,095		1,256,965

Consumer:
Residential mortgage		48		1,037		1,023		23,420		198,356		223,884
HELOC		132		139		204		1,580		155,323		157,378
Residential construction		12		-		306		3,685		68,168		72,171
Other loans to individuals		284		51		-		516		27,965		28,816
Total consumer loans		476		1,227		1,533		29,201		449,812		482,249
Total loans	$	1,767	$	1,467	$	3,156	$	94,917	$	1,637,907	$	1,739,214

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Impaired Loans - All classes of loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impaired loans may include all classes of nonaccrual loans and loans modified in a troubled debt restructuring (“TDR”). If a loan greater than $150 thousand is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the 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. There was no impairment of PCI loans as of June 30, 2016 and December 31, 2015.

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 June 30, 2016 and December 31, 2015:

	June 30, 2016						December 31, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance For Loan Losses		Recorded Investment		Unpaid Principal Balance		Related Allowance For Loan Losses
Impaired Loans with No Related Allowance Recorded:
Commercial:
Commercial and industrial	$	-	$	-	$	-	$	-	$	-	$	-
CRE - owner-occupied		866		927		-		1,266		1,312		-
CRE - investor income producing		883		925		-		440		440		-
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		677		799		-		723		842		-
AC&D - CRE		-		-		-		-		-		-
Other commercial		211		211		-		-		-		-
Total commercial loans		2,637		2,862		-		2,429		2,594		-
Consumer:
Residential mortgage		2,071		2,084		-		1,304		1,339		-
HELOC		-		-		-		157		278		-
Residential construction		-		-		-		238		376		-
Other loans to individuals		-		-		-		-		-		-
Total consumer loans		2,071		2,084		-		1,699		1,993		-
Total impaired loans with no related allowance recorded	$	4,708	$	4,946	$	-	$	4,128	$	4,587	$	-

Impaired Loans with an Allowance Recorded:
Commercial:
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 loans		-		-		-		-		-		-
Consumer:
Residential mortgage		-		-		-		-		-		-
HELOC		1,224		1,247		194		1,224		1,248		192
Residential construction		242		242		20		-		-		-
Other loans to individuals		-		-		-		-		-		-
Total consumer loans		1,466		1,489		214		1,224		1,248		192
Total impaired loans with an allowance recorded	$	1,466	$	1,489	$	214	$	1,224	$	1,248	$	192

Total Impaired Loans Individually Reviewed for Impairment
Commercial:
Commercial and industrial	$	-	$	-	$	-	$	-	$	-	$	-
CRE - owner-occupied		866		927		-		1,266		1,312		-
CRE - investor income producing		883		925		-		440		440		-
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		677		799		-		723		842		-
AC&D - CRE		-		-		-		-		-		-
Other commercial		211		211		-		-		-		-
Total commercial loans		2,637		2,862		-		2,429		2,594		-
Consumer:
Residential mortgage		2,071		2,084		-		1,304		1,339		-
HELOC		1,224		1,247		194		1,381		1,526		192
Residential construction		242		242		20		238		376		-
Other loans to individuals		-		-		-		-		-		-
Total consumer loans		3,537		3,573		214		2,923		3,241		192

Total Impaired Loans Individually Reviewed for Impairment	$	6,174	$	6,435	$	214	$	5,352	$	5,835	$	192


Total Impaired Loans Collectively Reviewed for Impairment	$	2,241	$	2,580	$	10	$	2,429	$	2,863	$	368

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 six months ended June 30, 2016 , the Company recognized $33 thousand and $76 thousand, respectively, of interest income with respect to impaired loans, specifically accruing TDRs, within the period the loans were impaired. During the three and six months ended June 30, 2015, the Company recognized $47 thousand and $103 thousand, respectively, of interest income with respect to impaired loans. The average recorded investment and interest income recognized on impaired loans, by class, for the three and six months ended June 30, 2016 and 2015 are shown in the table below.

	Three Months Ended June 30,								Six Months Ended June 30,
	2016				2015				2016				2015
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Impaired Loans with No Related Allowance Recorded:
Commercial:
Commercial and industrial	$	449	$	-	$	-	$	-	$	299	$	-	$	-	$	-
CRE - owner-occupied		1,256		-		2,163		-		1,259		-		2,360		-
CRE - investor income producing		888		6		599		5		738		13		650		13
AC&D - 1-4 family construction		-		-		-		-		-		-		-		-
AC&D - lots, land & development		691		9		940		14		701		20		920		26
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		211		-		-		-		141		-		-		-
Total commercial loans		3,495		15		3,702		19		3,138		33		3,930		39
Consumer:
Residential mortgage		1,929		5		850		-		1,720		10		922		-
Home equity lines of credit		78		-		434		-		104		-		468		2
Residential construction		121		-		247		-		160		4		272		-
Other loans to individuals		-		-		-		-		-		-		-		-
Total consumer loans		2,128		5		1,531		-		1,984		14		1,662		2
Total impaired loans with no related allowance recorded	$	5,623	$	20	$	5,233	$	19	$	5,122	$	47	$	5,592	$	41

Impaired Loans with an Allowance Recorded:
Commercial:
Commercial and industrial	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
CRE - owner-occupied		-		-		-		-		-		-		-		-
CRE - investor income producing		-		-		-		-		-		-		-		-
AC&D - 1-4 family construction		-		-		-		-		-		-		-		-
AC&D - lots, land & development		-		-		91		-		-		-		122		3
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		-		-		-		-		-		-		-		-
Total commercial loans		-		-		91		-		-		-		122		3
Consumer:
Residential mortgage		139		-		677		8		92		-		691		14
Home equity lines of credit		1,224		10		1,226		10		1,224		19		1,226		21
Residential construction		121		-		-		-		81		-		-		-
Other loans to individuals		-		-		-		-		-		-		-		-
Total consumer loans		1,484		10		1,903		18		1,397		19		1,917		35
Total impaired loans with an allowance recorded	$	1,484	$	10	$	1,994	$	18	$	1,397	$	19	$	2,039	$	38

Total Impaired Loans Individually Reviewed for Impairment
Commercial:
Commercial and industrial	$	449	$	-	$	-	$	-	$	299	$	-	$	-	$	-
CRE - owner-occupied		1,256		-		2,163		-		1,259		-		2,360		-
CRE - investor income producing		888		6		599		5		738		13		650		13
AC&D - 1-4 family construction		-		-		-		-		-		-		-		-
AC&D - lots, land & development		691		9		1,031		14		701		20		1,042		29
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		211		-		-		-		141		-		-		-
Total commercial loans		3,495		15		3,793		19		3,138		33		4,052		42
Consumer:
Residential mortgage		2,068		5		1,527		8		1,812		10		1,613		14
Home equity lines of credit		1,302		10		1,660		10		1,328		19		1,694		23
Residential construction		242		-		247		-		241		4		272		-
Other loans to individuals		-		-		-		-		-		-		-		-
Total consumer loans		3,612		15		3,434		18		3,381		33		3,579		37

Total Impaired Loans Individually Reviewed for Impairment	$	7,107	$	30	$	7,227	$	37	$	6,519	$	66	$	7,631	$	79

Total Impaired Loans Collectively Reviewed for Impairment	$	2,211	$	3	$	2,953	$	10	$	2,283	$	10	$	2,894	$	24

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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 June 30, 2016, there were no loans past due 90 days or more and accruing interest. At December 31, 2015, there was $1.2 million in loans past due 90 days or more and accruing interest. These loans were considered fully collectible at December 31, 2015. The recorded investment in nonaccrual loans at June 30, 2016 and December 31, 2015 was as follows:

	June 30, 2016		December 31, 2015
Commercial:
Commercial and industrial	$	107	$	97
CRE - owner-occupied		961		1,266
CRE - investor income producing		795		318
AC&D - lots, land & development		5		6
Other commercial		211		-
Total commercial loans		2,079		1,687
Consumer:
Residential mortgage		2,107		1,333
HELOC		651		762
Residential construction		276		467
Other loans to individuals		71		77
Total consumer loans		3,105		2,639
Total nonaccrual loans	$	5,184	$	4,326

Purchased Credit-Impaired Loans–PCI loans had an unpaid principal balance of $125.0 million and $121.0 million and a carrying value of $98.7 million and $94.9 million at June 30, 2016 and December 31, 2015, respectively. PCI loans represented 3.1% and 3.8% of total assets at June 30, 2016 and December 31, 2015, 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 and taking into account prepayment assumptions. 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. The servicing income and accretion to interest income shown in the table below are both reported in the interest income on loans line of the income statement. In accordance with GAAP, there was no carryover of previously established allowance for loan losses from acquired companies.

The PCI loan portfolio attributable to the First Capital acquisition was accounted for at fair value as follows:

	January 1, 2016

Contractual principal and interest at acquisition	$	23,023
Nonaccretable difference		(3,120	)
Expected cash flows at acquisition		19,903
Accretable yield		(1,663	)

Basis in PCI loans at acquisition - estimated fair value	$	18,240

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

A summary of changes in the accretable yield for PCI loans for the six months ended June 30, 2016 and 2015 follows:

	Six Months Ended June 30,
	2016			2015

Accretable yield, beginning of period	$	32,509		$	40,540
Addition from the First Capital acquisition		1,663			-
Servicing income		(2,985	)		(3,351	)
Accretion to interest income		(2,814	)		(3,300	)
Reclassification of nonaccretable difference due toimprovement in expected cash flows		1,515			2,808
Other changes, net		489			76
Accretable yield, end of period	$	30,377		$	36,773

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.

As of June 30, 2016, the Company had 12 TDR loans totaling $3.1 million, of which $560 thousand were nonaccrual loans. As of December 31, 2015, the Company had 14 TDR loans totaling $3.3 million, of which $466 thousand were nonaccrual loans. The Company had allocated $194 thousand and $192 thousand, respectively, of specific reserves to customers whose loan terms have been modified in a TDR as of June 30, 2016 and December 31, 2015.

The following tables represent a breakdown of the types of concessions made by loan class for the three and six months ended June 30, 2016 and 2015.

	Three months ended June 30, 2016						Six months ended June 30, 2016
	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Extended payment terms
CRE - investor income producing		1	$	91	$	91		1	$	91	$	91
Total		1	$	91	$	91		1	$	91	$	91

	Three months ended June 30, 2015						Six months ended June 30, 2015
	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Extended payment terms
Commercial and industrial		1	$	15	$	15		1	$	15	$	15
CRE - owner occupied		-		-		-		1		84		84
CRE - investor income producing		-		-		-		1		209		209
Residential mortgage		-		-		-		1		12		12
Total		1	$	15	$	15		4	$	320	$	320

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

There were no loans modified as TDRs within the 12 months ended June 30, 2016 for which there was a payment default during the six months ended June 30, 2016. One loan was modified as a commercial TDR within the 12 months ended June 30, 2015 for which there was a payment default during the six months ended June 30, 2015, as listed below.

	Six months ended June 30, 2015
	Number of loans		Recorded Investment
Extended payment terms
CRE - investor income producing		1	$	84
Total		1	$	84

The Company does not deem a TDR 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 June 30, 2016 and 2015:

	Twelve Months Ended June 30, 2016
	Paid in full				Paying as restructured				Foreclosure/Default
	Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment

Extended payment terms		-	$	-		1	$	91		-	$	-
Total		-	$	-		1	$	91		-	$	-

	Twelve Months Ended June 30, 2015
	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		-	$	-		1	$	180		-	$	-
Extended payment terms		1		636		3		236		1		84
Total		1	$	636		4	$	416		1	$	84

Note 6 – FDIC Loss Share Agreements

In connection with the acquisition of Citizens South Banking Corporation (“Citizens South”) in 2012, the Bank assumed two purchase and assumption agreements with the FDIC that cover approximately $15.1 million and $17.7 million of covered loans as of June 30, 2016 and December 31, 2015, respectively, and $0.4 million and $1.2 million of covered OREO as of June 30, 2016 and December 31, 2015, 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, and five years for losses and eight years for recoveries on all other loans. The agreement related to Bank of Hiawassee’s non-single family assets expired on March 31, 2015. On April 1, 2015, the remaining balance of $19.6 million associated with the Bank of Hiawassee non-single family loans and $816,000 associated with non-single family foreclosed assets were transferred from the covered portfolio to the non-covered portfolio. At June 30, 2016 and December 31, 2015, the Bank recorded an estimated receivable from the FDIC in the amount of $1.0 million and $551 thousand, respectively, related to the remaining single-family loss share agreement.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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. The agreement related to New Horizon’s non-single family assets expired on June 30, 2016. On July 1, 2016, the remaining balance of $8.0 million associated with the New Horizon non-single family loans and $836,000 associated with non-single family foreclosed assets were transferred from the covered portfolio to the non-covered portfolio. 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 incurred, 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 June 30, 2016 and December 31, 2015, the Bank recorded an estimated receivable from the FDIC in the amount of $161 thousand and $392 thousand, respectively, related to these loss share agreements.

The following table provides changes in the estimated receivable from the FDIC:

	For the six months ended June 30,
	2016			2015

Balance, beginning of period	$	943		$	3,964
Increase (decrease) in expected losses on loans		35			71
Additional losses to OREO		-			(6	)
Reimbursable expenses (income)		(368	)		(154	)
Amortization discounts and premiums, net		(142	)		(515	)
Payments to (reimbursements from) the FDIC		697			(2,151	)
Balance, end of period	$	1,165		$	1,209

The estimated receivable from the FDIC is measured separately from the related covered assets and is recorded at carrying value. At June 30, 2016 and December 31, 2015, the projected cash flows related to the FDIC receivable for losses on covered loans and assets were approximately $1.4 million and $925 thousand, 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.

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 both June 30, 2016 and December 31, 2015, the “true-up” amount was estimated to be approximately $5.8 million 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, including any recovery period, of the loss sharing agreements and will be based on the negative bid, expected losses, intrinsic loss estimate, and assets covered under the loss share agreements.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 7 – Other Real Estate Owned

The Company owned $3.2 million and $5.5 million in OREO at June 30, 2016 and December 31, 2015, respectively. The portion of OREO covered under the loss share agreements with the FDIC at June 30, 2016 and December 31, 2015 totaled $0.4 million and $1.2 million, respectively. The Company’s loss share agreement related to New Horizon’s non-single family assets expired on June 30, 2016, and on July 1, 2015, the remaining balance of $836,000 associated with the New Horizon non-single family foreclosed assets was transferred from the covered portfolio to the non-covered portfolio. Therefore, after June 30, 2016, the Company bears all future losses on that portfolio of foreclosed properties. The Company’s loss share agreement related to Bank of Hiawassee’s non-single family assets expired on March 31, 2015, and on April 1, 2015, the remaining balance of $816,000 associated with the Bank of Hiawassee non-single family foreclosed assets was transferred from the covered portfolio to the non-covered portfolio. Therefore, after March 31, 2015, the Company bears all future losses on that portfolio of foreclosed properties.

Transactions in OREO for the three and six months ended June 30, 2016 and 2015 are summarized below:

	Three months ended June 30,						Six months ended June 30,
Non-Covered OREO	2016			2015			2016			2015

Beginning balance	$	3,425		$	8,570		$	4,211		$	8,979
Additions		36			1,413			1,593			3,001
Transfers from covered to non-covered		-			812			-			812
Sales		(503	)		(1,510	)		(2,666	)		(3,404	)
Writedowns		(92	)		(381	)		(272	)		(484	)
Ending balance	$	2,866		$	8,904		$	2,866		$	8,904

Covered OREO	2016			2015			2016			2015

Beginning balance	$	985		$	1,713		$	1,240		$	3,011
Additions		-			197			-			676
Transfers from covered to non-covered		-			(812	)		-			(812	)
Sales		(562	)		(214	)		(782	)		(1,990	)
Writedowns		(43	)		-			(78	)		(1	)
Ending balance	$	380		$	884		$	380		$	884

As of June 30, 2016, the Company has $3.3 million of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process.

Note 8 – 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 both June 30, 2016 and December 31, 2015, the Company had a net DTA in the amount of approximately $29.0 million. The unchanged balance reflects the increase in deferred tax assets related to the merger with First Capital in the first quarter, which was offset by 2016 earnings. 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 as of June 30, 2016 and December 31, 2015 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 June 30, 2016 or December 31, 2015.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 9 - 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 or vested. Potential shares that may be issued by the Company or vested relate solely to outstanding stock options and restricted shares (non-vested 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 and vesting of restricted shares 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. Anti-dilutive shares represent those options whose weighted average exercise price is less than the closing stock price at the reporting date and those restricted stock awards that are unvested and not dilutive, as described above, as of the reporting date.

For the three months ended June 30, 2016, the Company issued 212,434 restricted stock awards, repurchased 150,000 shares in open market transactions and acquired 31,207 shares in connection with satisfaction of tax withholding obligations on vested restricted stock. For the three months ended June 30, 2015, the Company issued 205,800 restricted stock awards, issued 3,885 shares pursuant to the exercise of stock options, repurchased 145,809 shares in open market transactions and acquired 23,366 shares in connection with satisfaction of tax withholding obligations on vested restricted stock.

For the six months ended June 30, 2016, the Company issued 236,544 restricted stock awards and 1,300 shares of common stock to employees under the 2014 Long-term Incentive Plan, repurchased 248,349 shares of Common Stock in open market transactions and acquired 123,826 shares in connection with satisfaction of tax withholding obligations on vested restricted stock. For the six months ended June 30, 2015, the Company issued 212,300 restricted stock awards, issued 28,963 shares pursuant to the exercise of stock options, issued 1,182 shares of common stock to employees under the 2014 Long-term Incentive Plan, repurchased 149,609 shares in open market transactions and acquired 33,031 shares in connection with satisfaction of tax withholding obligations on vested restricted stock.

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

Weighted-Average Shares for Earnings Per Share Calculation

	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015

Weighted-average number of common shares outstandingexcluding unvestedrestricted shares		52,394,397		43,971,007		52,340,772		43,944,638

Effect of dilutive stock options and unvested restricted shares		310,140		330,888		310,114		342,786

Weighted-average number of common shares and dilutive potential common shares outstanding		52,704,537		44,301,895		52,650,886		44,287,424

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

There were 1,579,453 outstanding options and 889,409 outstanding unvested restricted shares that were anti-dilutive for the three months ended June 30, 2016. There were 237,650 dilutive stock options and 72,489 dilutive unvested restricted shares outstanding for the three months ended June 30, 2016.

There were 1,863,294 outstanding options and 911,281 outstanding unvested restricted shares that were anti-dilutive for the three months ended June 30, 2015. There were 256,825 dilutive stock options and 74,063 dilutive unvested restricted shares outstanding for the three months ended June 30, 2015.

There were 1,593,556 outstanding options and 875,331 outstanding unvested restricted shares that were anti-dilutive for the six months ended June 30, 2016. There were 223,547 dilutive stock options and 86,567 dilutive unvested restricted shares outstanding for the six months ended June 30, 2016.

There were 1,867,290 outstanding options and 895,387 outstanding unvested restricted shares that were anti-dilutive for the six months ended June 30, 2015. There were 252,829 dilutive stock options and 89,957 dilutive unvested restricted shares outstanding for the six months ended June 30, 2015.

At June 30, 2016, 436,590 of the outstanding unvested restricted shares had stock price-based 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.

Note 10 - Commitments and Contingencies

In the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit, which are not reflected in the accompanying unaudited condensed consolidated financial statements. At June 30, 2016, the Company had $754.3 million of pre-approved but unused lines of credit, $10.0 million of standby letters of credit and $12.2 million of commercial letters of credit. At December 31, 2015, the Company had $514.8 million of pre-approved but unused lines of credit, $9.1 million of standby letters of credit and $267 thousand 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.

Note 11 - Derivative Financial Instruments and Hedging Activities

The Company uses certain derivative instruments, including interest rate floors and swaps, to meet the needs of its customers as well as to manage the interest rate risk associated with certain transactions. The following table summarizes the derivative financial instruments utilized by the Company:

		June 30, 2016						December 31, 2015

				Estimated Fair Value						Estimated Fair Value
	Balance Sheet Location	Notional Amount		Gain		Loss		Notional Amount		Gain		Loss

Cash flow hedges:
Interest rate contracts:	Other assets and
Pay fixed swaps with counterparty	other liabilities	$	45,000	$	-	$	3,597	$	70,000	$	-	$	3,788


Fair value hedges:
Interest rate contracts:
Pay fixed rate swaps with counterparty	Other liabilities		23,088		-		807		23,118		-		344

Not designated as hedges:
Customer-related interest rate contracts:
Matched interest rate swaps with borrower	Other assets		148,332		8,083		-		97,571		3,174		-
Matched interest rate swaps with counterparty	Other liabilities		148,332		-		8,600		97,571		-		3,174
Matched foreign exchange contract with borrower	Other assets		272		8		-		662		19		-
Matched foreign exchange contract with counterparty	Other liabilities		272		-		8		662		-		19
			297,208		8,091		8,608		196,466		3,193		3,193

Total derivatives		$	365,296	$	8,091	$	13,012	$	289,584	$	3,193	$	7,325

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 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 $(871) thousand and $(1.4) million at June 30, 2016 and December 31, 2015, respectively, and is included in other liabilities.

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. In January 2016, the $25.0 million two-year forward starting swap was terminated, resulting in a $1.9 million breakage fee. This breakage fee will be amortized into interest expense over the remaining life of the underlying instruments of approximately 60 months. The remaining derivative instruments are carried at a fair market value of $(2.7) million and $(2.4) million at June 30, 2016 and December 31, 2015, respectively, and are included in other liabilities.

At both June 30, 2016 and December 31, 2015, the Company had loan swaps, with an aggregate notional amount of $23.1 million, accounted for as fair value hedges in accordance with ASC 815,Derivatives and Hedging. These derivative instruments are used to protect the Company from interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. The derivative instruments are used to convert these fixed rate loans to an effective floating rate. If the variable 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 the variable rate and the stated fixed rate. If the variable rate 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 the variable rate and the stated fixed rate..

To meet the needs of the Company’s customers, at June 30, 2016 the Company had interest rate swap agreements in place to convert certain fixed-rate receivables to floating rates. 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 the customer 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 plus credit spread, 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 $148.3 million at June 30, 2016 and are included in other assets and other liabilities at their fair values of $8.1 million and $8.6 million, respectively. 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 December 31, 2015, the interest rate swaps had a notional amount of $97.6 millionrepresenting the amount of fixed-rate receivables outstanding and liabilities outstanding, and are included in other assets and other liabilities at their fair values of $2.9 million.

In 2015, the Company began entering into foreign exchange contracts to convert Euros to U.S. Dollars on behalf of the Company’s customers. To offset this foreign exchange risk, the Company has entered into substantially identical agreements with a third party to hedge these foreign exchange contracts. The contracts are used to offset exposure to foreign currency risk associated with non-U.S. dollar transactions. The foreign exchange contracts had a notional amount of $272 thousand at June 30, 2016 representing the amount of contracts outstanding in U.S. dollars, and are included in other assets and other liabilities at their fair value of $8 thousand. All changes in fair value are recorded as other noninterest income and other noninterest expense. The notional amount of foreign exchange contracts at December 31, 2015 were $662 thousand, and were included in other assets and other liabilities at their fair value of $19 thousand.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The following table details the location and amounts recognized in the Condensed Consolidated Statements of Income and Condensed Consolidated Statements of Comprehensive Income:

	Effective Portion
	Pre-tax gain (loss) recognized in OCI												Pre-tax gain (loss) reclassified from AOCI into income
	For the three months ended					For the six months ended						Location of amounts	For the three months ended				For the six months ended
	June 30,					June 30,						reclassifiedfrom	June 30,				June 30,
	2016			2015		2016			2015			AOCI into Income	2016		2015		2016		2015

Cash flow hedges:
Interest rate contracts	$	(475	)	$	646	$	(1,700	)	$	(610	)	Total interest expense	$	88	$	103	$	177	$	206

		Pre-tax gain (loss) recognized in income
		For the three months ended						For the six months ended
	Location of amounts	June 30,						June 30,
	recognized in income	2016			2015			2016			2015
Fair value hedges:
Interest rate contracts
Pay fixed rate swaps with counterparty	Total interest income	$	(80	)	$	(96	)	$	(153	)	$	(200	)

Not designated as hedges:
Client-related interest rate contracts	Other income		(143	)		43			(288	)	$	(33	)
		$	(223	)	$	(53	)	$	(441	)	$	(233	)

Because of the unfavorable position of outstanding swap instruments at June 30, 2016 and December 31, 2015, the Company posted collateral of approximately $15.8 million and $10.5 million in securities, respectively, with the related counterparties.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 12 – Accumulated Other Comprehensive Income

The before and after tax amounts allocated to each component of other comprehensive income are presented in the following table. Reclassification adjustments related to securities available for sale are included in gain on sale of securities available-for-sale in the accompanying Condensed Consolidated Statements of Income. Amortization of net unrealized losses on securities transferred to held-to-maturity is included in interest income on taxable investment securities in the accompanying Condensed Consolidated Statements of Income.

	For the Three Months Ended June 30, 2016									For the Three Months Ended June 30, 2015
	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	$	2,118		$	838		$	1,280		$	(3,150	)	$	(1,175	)	$	(1,975	)
Change in net unrealized gain (loss) on securities transferred to held to maturity		26			37			(11	)		73			28			45
Reclassification adjustment for net gains recognized in net income		87			(33	)		120			-			-			-
Total securities available for sale and transferred securities		2,231			842			1,389			(3,077	)		(1,147	)		(1,930	)

Derivatives:
Change in the accumulated loss on effective cash flow hedge derivatives		(475	)		(114	)		(361	)		646			322			324
Change in the accumulated loss on terminated cash flow hedge derivatives		93			33			60			-			-			-
Reclassification adjustment for interest payments		88			(32	)		121			103			(39	)		142
Total derivatives		(294	)		(113	)		(181	)		749			283			466

Total other comprehensive income (loss)	$	1,937		$	729		$	1,208		$	(2,328	)	$	(864	)	$	(1,464	)

	For the Six Months Ended June 30, 2016									For the Six Months Ended June 30, 2015
	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	$	6,809		$	2,504		$	4,305		$	(165	)	$	(69	)	$	(96	)
Change in net unrealized gain (loss) on securities transferred to held to maturity		52			64			(12	)		209			86			123
Reclassification adjustment for net gains recognized in net income		93			33			60			-			-			-
Total securities available for sale and transferred securities		6,954			2,601			4,353			44			17			27

Derivatives:
Change in the accumulated loss on effective cash flow hedge derivatives		(1,700	)		46			(1,746	)		(610	)		(230	)		(380	)
Change in the accumulated loss on terminated cash flow hedge derivatives		186			(611	)		797			-			-			-
Reclassification adjustment for interest payments		177			65			112			206			78			128
Total derivatives		(1,337	)		(500	)		(837	)		(404	)		(152	)		(252	)

Total other comprehensive income (loss)	$	5,617		$	2,101		$	3,516		$	(360	)	$	(135	)	$	(225	)

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

	Securities Available for Sale			Securities Transferred from Available for Sale to Held to Maturity			Derivatives			Accumulated Other Comprehensive Income (Loss)
Balance, January 1, 2016	$	564		$	(1,065	)	$	(2,362	)	$	(2,863	)
Other comprehensive income (loss) before reclassifications		4,293			-			(1,746	)		2,547
Amounts reclassified from accumulated other comprehensive loss		60			-			112			173
Transfer of securities from available for sale to held to maturity		12			(12	)		-			-
Terminated cash flow hedge derivatives		-			-			797			797
Net other comprehensive income (loss) during the period		4,365			(12	)		(837	)		3,516
Balance, June 30, 2016	$	4,929		$	(1,077	)	$	(3,199	)	$	653

Balance, January 1, 2015	$	1,313		$	(1,282	)	$	(1,506	)	$	(1,475	)
Other comprehensive income (loss) before reclassifications		27			-			(380	)		(353	)
Amounts reclassified from accumulated other comprehensive loss		-			-			128			128
Transfer of securities from available for sale to held to maturity		(123	)		123			-			-
Net other comprehensive income (loss) during the period		(96	)		123			(252	)		(225	)
Balance, June 30, 2015	$	1,217		$	(1,159	)	$	(1,758	)	$	(1,700	)

Note 13 - 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.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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 currently offered for debt with the same or similar remaining maturities and collateral requirements.

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

Derivative Instruments – The fair value of derivative instruments, including interest rate swaps and swap fair value hedges, 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.

Level 1

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

Level 2

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

Level 3

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

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 June 30, 2016 and December 31, 2015 are as follows:

Financial Instruments Carrying Amounts and Estimated Fair Values

					Fair Value Measurements
	Carrying Amount		Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2016
Financial assets:
Cash and cash equivalents	$	69,873	$	69,873	$	69,873	$	-	$	-
Investment securities available-for-sale		393,131		393,131		1,341		390,430		1,360
Investment securities held-to-maturity		102,125		106,762		-		106,762
Nonmarketable equity securities		14,420		14,420		-		14,420		-
Loans held for sale		11,967		11,967		-		11,967		-
Loans, net of allowance		2,316,024		2,289,239		-		148,332		2,140,907
FDIC indemnification asset		1,165		1,370		-		-		1,370
Accrued interest receivable		6,842		6,842		-		6,842		-
Derivative instruments		8,091		8,091		-		8,091		-

Financial liabilities:
Deposits with no stated maturity		1,725,235		1,725,235		-		1,725,235		-
Deposits with stated maturities		748,188		749,850		-		749,850		-
Borrowings		297,890		297,832		-		297,832		-
Accrued interest payable		568		568		-		568		-
Derivative instruments		13,012		13,012		-		13,012		-

December 31, 2015
Financial assets:
Cash and cash equivalents	$	70,526	$	70,526	$	70,526	$	-	$	-
Investment securities available-for-sale		384,934		384,934		-		383,434		1,500
Investment securities held-to-maturity		106,458		107,629		-		107,629		-
Nonmarketable equity securities		11,366		11,366		-		11,366		-
Loans held for sale		4,943		4,943		-		4,943		-
Loans, net of allowance		1,732,751		1,674,081		-		32,117		1,641,964
FDIC indemnification asset		943		925		-		-		925
Accrued interest receivable		5,082		5,082		-		5,082		-
Derivative instruments		3,193		3,193		-		3,193		-

Financial liabilities:
Deposits with no stated maturity		1,412,882		1,412,882		-		1,412,882		-
Deposits with stated maturities		539,780		541,823		-		541,823		-
Borrowings		239,258		239,159		-		239,159		-
Accrued interest payable		515		515		-		515		-
Derivative instruments		7,325		7,325		-		7,325		-

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. Securities classified as Level 3 include a corporate debt security in a less liquid market whose value is determined by reference to the going rate of a similar debt security if it were to enter the market at period end. The derived market value requires significant management judgment and is further substantiated by discounted cash flow methodologies.

Derivative Instruments-Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company uses a third party to measure the fair value on a recurring basis. The Company classifies derivative instruments held or issued for risk management purposes as Level 2. 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 June 30, 2016 and December 31, 2015, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. The Company records 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.

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 June 30, 2016 and December 31, 2015 measured at fair value on a recurring basis:

Fair Value on a Recurring Basis

Description	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Assets/Liabilities at Fair Value
June 30, 2016
U.S. Government agencies	$	-	$	504		$	-	$	504
Municipal securities		-		14,218			-		14,218
Residential agency pass-through securities		-		182,345			-		182,345
Residential collateralized mortgage obligations		-		106,866			-		106,866
Asset-backed securities		-		86,497			-		86,497
Corporate and other securities		-		-			1,360		1,360
All other equity securities		1,341		-			-		1,341
Fair value loans		-		148,332			-		148,332
Derivative instruments		-		(4,921	)		-		(4,921	)

December 31, 2015
U.S. Government agencies	$	-	$	514		$	-	$	514
Municipal securities		-		14,796			-		14,796
Residential agency pass-through securities		-		131,460			-		131,460
Residential collateralized mortgage obligations		-		151,631			-		151,631
Commercial mortgage-backed obligations		-		4,756			-		4,756
Asset-backed securities		-		79,120			-		79,120
Corporate and other securities		-		-			1,500		1,500
All other equity securities		1,157		-			-		1,157
Fair value loans		-		32,117			-		32,117
Derivative instruments		-		(4,132	)		-		(4,132	)

Securities measured on a Level 3 recurring basis at June 30, 2016 and December 31, 2015 include a corporate debt security whose value is determined by the going rate of a similar debt security if it were to enter the market at period end with additional liquidity discounts applied due to a smaller available market. There were no transfers between valuation levels for any accounts for the three and six months ended June 30, 2016 and 2015. If different valuation techniques were deemed necessary, we would consider those transfers to occur at the end of the period that the accounts are valued.

The following is a reconciliation of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2016 and 2015.

	Securities Available for Sale (in thousands)
	Three Months Ended June 30,					Six Months Ended June 30,
	2016		2015			2016			2015

Fair value, beginning of the period	$	1,360	$	1,568		$	1,500		$	1,570
Change in unrealized gain recognized in other comprehensive income		-		(6	)		(140	)		(8	)
Fair value, end of the period	$	1,360	$	1,562		$	1,360		$	1,562

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.

The following table sets forth by level, within the fair value hierarchy, the Company’s assets at fair value on a nonrecurring basis at June 30, 2016 and December 31, 2015:

Fair Value on a Nonrecurring Basis

Description	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Assets/ (Liabilities) at Fair Value
June 30, 2016
OREO	$	-	$	-	$	1,947	$	1,947
Impaired loans:
Residential construction		-		-		266		266

December 31, 2015
OREO	$	-	$	-	$	5,451	$	5,451
Impaired loans:
CRE - investor income producing		-		-		365		365
Residential mortgage		-		-		725		725
Residential construction		-		-		251		251

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 June 30, 2016, OREO with a carrying value of $0.6 million was written down by $0.1 million to $0.5 million. During the six months ended June 30, 2016, OREO with a carrying value of $3.6 million was written down by $0.3 million to $3.3 million. During the three months ended June 30, 2015, OREO with a carrying value of $2.5 million was written down by $375 thousand to $2.2 million. During the six months ended June 30, 2015, OREO with a carrying value of $3.3 million was written down by $485 thousand to $2.8 million.

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 the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a nonrecurring basis at June 30, 2016.

	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs				Weighted Average Discount

OREO	$	1,947	Appraisals	Discount to reflect currentmarket conditions		0%	-	30%		17.94	%

Impaired loans		266	Collateral basedmeasurements	Discount to reflect currentmarket conditions and ultimate collectability		0%	-	60%		23.88	%

	$	2,213

Note 14 – Shareholders’ Equity

The Company maintains share-based plans for directors and employees to attract, retain and provide incentives for key employees in the form of incentive and non-qualified stock options and restricted stock. As a result of the First Capital merger, the Company assumed the First Capital Bancorp, Inc. 2010 Stock Incentive Plan (renamed the Park Sterling Corporation 2010 Stock Incentive Plan) which at the effective date of the merger had 184,789 shares available for future awards to be issued under the plan. The total number of shares available for issuance under all outstanding share-based plans is 612,035 as of June 30, 2016.

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

	Outstanding Options									Nonvested 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, 2015		2,094,493		$	7.43		3.73	$	1,518,937		959,309		$	5.02	$	6,966,295
Restricted shares granted		-			-		-		-		236,534			7.34		-
Options exercised		(274,890	)		-		-		-		-			-		-
Restricted shares vested		-			-		-		-		(188,895	)		6.43		-
Expired and forfeited		(2,500	)		-		-		-		(38,783	)		6.82		-

At June 30, 2016		1,817,103		$	7.57		3.09	$	1,000,653		968,165		$	5.23	$	6,819,858

Exercisable at June 30, 2016		1,812,936

At June 30, 2016, unrecognized compensation cost related to nonvested stock options of $9 thousand is expected to be recognized over a weighted-average period of 0.73 years. There was no net compensation expense for stock options for the three months ended June 30, 2016 due to a forfeiture that offset the expense. Total compensation expense for stock options was $5 thousand for the three months ended June 30, 2015. Total compensation expense for stock options was $13 thousand and $16 thousand for the six months ended June 30, 2016 and 2015, respectively.

At June 30, 2016, unrecognized compensation cost related to nonvested restricted shares of $2.5 million is expected to be recognized over a weighted-average period of 1.46 years. Total compensation expense for restricted shares was $387 thousand and $284 thousand for the three months ended June 30, 2016 and 2015, respectively. Total compensation expense for restricted shares was $670 thousand and $574 thousand for the six months ended June 30, 2016 and 2015, respectively.

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 15 – Subsequent Event

Dividend Declaration

On July 27, 2016, the Company announced that its Board of Directors declared a quarterly dividend of $0.04 per common share, payable on August 23, 2016 to all common shareholders of record as of the close of business on August 9, 2016.

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 Company’s merger with First Capital Bancorp, Inc. (“First Capital”), 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 any 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, 2015 filed with the Securities and Exchange Commission (“SEC”) on March 4, 2016 (the “2015 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 First Capital merger within 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 new branches or other hiring initiatives; inability to generate future organic growth in loan balances, retail banking, wealth management, mortgage banking or capital markets results through the hiring of new personnel, development of new products, including new online and mobile banking platforms for treasury services, opening ofde novo branches, or otherwise; inability to capitalize on identified revenue enhancements or expense management opportunities; inability to generate future ATM and card income from marketing expenses; 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 noninterest expense levels; 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 impasse, 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.

Item 2. Management’s Discussion and Analysis ofFinancial 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 six-month period ended June 30, 2016. 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 of $8.3 million, or $0.16 per share, for the six months ended June 30, 2016 compared to $8.1 million, or $0.18 per share, for the six months ended June 30, 2015. Changes in net income from the first six months of 2015 include a 25.7% increase in net interest income and a 14.9% increase in noninterest income, which were partially offset by a 28.7% increase in all noninterest expense levels driven by the acquisition of First Capital Bancorp, Inc. (“First Capital”) on January 1, 2016, and a $1.3 million increase in provision for loan losses driven by an increase in qualitative factors following the added market volatility and heightened uncertainty which emerged at the end of the second quarter.

The Company reported adjusted net income, which excludes merger-related expenses and gain or loss on sale of securities, of $12.6 million, or $0.24 per share, for the six months ended June 30, 2016, compared to $8.2 million, or $0.19 per share, for the six months ended June 30, 2015. The increase in adjusted net income resulted from higher net interest and noninterest income, partially offset by the increase in noninterest expenses, again driven primarily by the acquisition of First Capital and the increase in provision for loan losses.

Net interest margin was 3.73% for the six months ended June 30, 2016, representing an 8 basis point decrease from 3.81% for the six months ended June 30, 2015. This decrease in net interest margin reflects primarily the lower interest rates on new loans and core net interest margin compression, partially offset by the additional accretion of fair value marks on purchased performing loans acquired from First Capital.

Total assets increased $659.8 million, or 26.2%, to $3.2 billion at June 30, 2016, compared to total assets of $2.5 billion at December 31, 2015. Cash and equivalents decreased 0.9% and total investment securities increased 1.8%. Total loans, excluding loans held for sale, increased 33.6%, to $2.3 billion due primarily to the acquisition of First Capital, as well as continued success in origination efforts.

Asset quality remains a point of strength for the Company with nonperforming loans to total loans of 0.33% and nonperforming assets to total assets of 0.35% at June 30, 2016. Nonperforming loans decreased 6%, to $7.8 million, at June 30, 2016, compared to $8.3 million, or 0.47% of total loans, at December 31, 2015. Nonperforming assets decreased to $11.0 million, at June 30, 2016, compared to $13.7 million, or 0.54% of total assets, at December 31, 2015.

Total deposits increased 26.7%, to $2.5 billion at June 30, 2016, compared to $2.0 billion at December 31, 2015, due to the acquisition of First Capital and growth in both retail and commercial banking as the Company has continued to emphasize growing transaction account relationships. Total shareholders’ equity increased 24.5%, to $354.5 million at June 30, 2016 compared to $284.7 million at December 31, 2015, driven by the issuance of shares in connection with the acquisition of First Capital, retained earnings and an increase in unrealized gains in the marketable securities portfolio and cash flow hedges. The Company’s ratio of total common equity to total assets decreased to 11.17% at June 30, 2016 from 11.32% at December 31, 2015. The Company’s ratio of tangible common equity to tangible assets decreased to 9.00% at June 30, 2016 from 9.93% at December 31, 2015. The Company’s Tier 1 leverage ratio decreased to 10.06% at June 30, 2016 from 11.00% at December 31, 2015, primarily due to higher intangible assets as a result of the First Capital acquisition.

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.

On January 1, 2016, the Company completed its acquisition of First Capital pursuant to the Agreement and Plan of Merger, dated as of September 30, 2015 (the “Agreement”), under which First Capital, a bank holding company headquartered in Richmond, Virginia, was merged with and into the Company with the Company as the surviving entity. Pursuant to the Agreement, upon completion of the merger, First Capital common shareholders received either $5.54 in cash or 0.7748 Park Sterling shares for each First Capital share they held, subject to the limitation that the total consideration for shareholders consisted of 30.0% in cash and 70.0% in Park Sterling shares; First Capital warrant holders received either $1.77 in cash or 0.24755 Park Sterling shares for each First Capital warrant they held, subject to the limitation that the total consideration for warrant holders consisted of 30.0% in cash and 70.0% in Park Sterling shares; and each outstanding option to purchase shares of First Capital common stock was converted into the right to receive cash equal to the product of (a) $5.54 minus the per share exercise price of such option, and (b) the number of shares of First Capital common stock subject to the option. Simultaneously with completion of the merger, First Capital Bank merged into the Bank. The merger helps us achieve our strategic goal of building out our Richmond presence by significantly enhancing our local branch network and adding talented bankers and leadership to our local team while increasing our operating scale to drive efficiencies and position the Company for accelerated revenue growth opportunities to further strengthen financial returns to shareholders.

The Company serves professionals, individuals, and small and mid-sized businesses by offering a full array of financial services, including deposit, mortgage banking, cash management, consumer and business finance, capital markets and wealth management services with a commitment to “Answers You Can Bank On^SM.” The Company prides itself on being large enough to help customers achieve their financial aspirations, yet small enough to care that they do. Our focus is on building a banking franchise that is noted for sound risk management, strong community focus and exceptional customer service.

Non-GAAP Financial Measures

In addition to traditional measures, management uses tangible assets, tangible common equity, adjusted allowance for loan losses, adjusted net income, and adjusted noninterest expenses, and related ratios and per-share measures, including adjusted return on average assets and adjusted return on average equity, each of which is a non-GAAP financial measure. Management uses (i) tangible assets and tangible common equity (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) to evaluate both its asset quality and asset quality trends, and to facilitate comparisons with peers; and (iii) adjusted net income and adjusted noninterest expense (which exclude merger-related expenses and gain or loss on sale of securities, as applicable) to evaluate its core earnings and to facilitate comparisons with peers.

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

	June 30, 2016 (Unaudited)			December 31, 2015 (Unaudited)
	(dollars in thousands, except per share amounts)
Tangible common equity to tangible assets
Total assets	$	3,174,075		$	2,514,260
Less: intangible assets		(75,551	)		(38,768	)
Tangible assets	$	3,098,524		$	2,475,492

Total common equity	$	354,450		$	284,704
Less: intangible assets		(75,551	)		(38,768	)
Tangible common equity	$	278,899		$	245,936

Tangible common equity		278,899			245,936
Divided by: tangible assets		3,098,524			2,475,492
Tangible common equity to tangible assets		9.00	%		9.93	%
Common equity to assets		11.17	%		11.32	%

Adjusted allowance for loan losses (1)
Allowance for loan losses	$	10,873		$	9,064
Plus: acquisition accounting net FMV adjustments to acquired loans		31,277			28,173
Adjusted allowance for loan losses	$	42,150		$	37,237
Divided by: total loans (excluding LHFS before FMV adjustments)		2,358,174			1,769,988
Adjusted allowance for loan losses to total loans		1.79	%		2.10	%
Allowance for loan losses to total loans		0.47	%		0.51	%

	Three months ended						Six months ended
	June 30, 2016 (Unaudited)			June 30, 2015 (Unaudited)			June 30, 2016 (Unaudited)			June 30, 2015 (Unaudited)
Adjusted net income
Pretax income (as reported)	$	8,597		$	6,542		$	13,211		$	12,150
Plus: merger-related expenses		1,268			167			6,461			289
(gain) loss on sale of securities		87			-			93			-
Adjusted pretax income		9,952			6,709			19,765			12,439
Tax expense		3,509			2,331			7,155			4,196
Adjusted net income	$	6,443		$	4,378		$	12,610		$	8,243

Divided by: weighted average diluted shares		52,704,537			44,301,895			52,650,886			44,287,424
Adjusted net income per share	$	0.12		$	0.10		$	0.24		$	0.19
Estimated tax rate		34.26	%		34.75	%		36.20	%		33.73	%

Adjusted noninterest expense
Noninterest expense	$	21,946		$	18,232		$	48,099		$	37,371
Less: merger-related expenses		(1,268	)		(167	)		(6,461	)		(289	)
Adjusted noninterest expense	$	20,678		$	18,065		$	41,638		$	37,082

Adjusted return on average assets
Adjusted net income	$	6,443		$	4,378		$	12,610		$	8,243
Divided by: average assets		3,135,031			2,406,671			3,133,828			2,395,150
Multiplied by: annualization factor		4.02			4.01			2.01			2.02
Adjusted return on average assets		0.83	%		0.73	%		0.81	%		0.69	%
Return on average assets		0.71	%		0.71	%		0.53	%		0.68	%

Adjusted return on average equity
Adjusted net income	$	6,443		$	4,378		$	12,610		$	8,243
Divided by: average common equity		352,505			280,676			350,531			279,436
Multiplied by: annualization factor		4.02			4.01			2.01			2.02
Adjusted return on average equity		7.35	%		6.26	%		7.23	%		5.95	%
Return on average equity		6.33	%		6.10	%		4.76	%		5.81	%

(1)

Provided merely as supplemental information for comparing the combined allowance and fair market value adjustments to the combined acquired and non-acquired loan portfolios; fair market adjustments are available only for losses on acquired loans.

Recent Accounting Pronouncements

See Note 2 — Recent Accounting Pronouncements, 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 “2015 Audited Financial Statements”) included in the 2015 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 the present value 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.

At June 30, 2016, PCI loans represent loans acquired in connection with the acquisitions of Community Capital Corporation (“Community Capital”), Citizens South Banking Corporation (“Citizens South”), Provident Community Bancshares, Inc. (“Provident Community”) and First Capital, that were deemed credit impaired at the time of acquisition. PCI loans that had been classified as nonperforming loans by these 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 2015 Audited Financial Statements, and Note 5 – Loans and Allowance for Loan Losses to the Unaudited Financial Statements included in this Form 10-Q.

OREO.Other real estate owned (“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 OREO, 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 OREO 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 OREO, 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 them 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 noninterest 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.

The purchase and assumption agreements between the Bank and the FDIC, as discussed in Note 6 – FDIC Loss Share Agreements to the 2015 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.

Our loss share agreement related to New Horizon’s non-single family assets expired on June 30, 2016. On July 1, 2016, the remaining balances associated with the New Horizon non-single family loans and foreclosed properties were transferred from the covered portfolio to the non-covered portfolio. Therefore, after June 30, 2016, we will bear all future losses on that portfolio of loans and foreclosed properties. Our loss share agreement related to Bank of Hiawassee’s non-single family assets expired on March 31, 2015. On April 1, 2015, the remaining balances associated with the Bank of Hiawassee non-single family loans and foreclosed properties were transferred from the covered portfolio to the non-covered portfolio. Therefore, after March 31, 2015, we will bear all future losses on that portfolio of loans and foreclosed properties.

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 both June 30, 2016 and December 31, 2015, we had a net DTA in the amount of approximately $29.0 million. The unchanged balance reflects the increase in deferred tax assets related to the merger with First Capital in the first quarter, which was offset by 2016 earnings. We evaluate the carrying amount of our DTA quarterly 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 the Company generating a sufficient level of taxable income in future periods, which can be difficult to predict. If our forecast of taxable income within the carry forward periods available under applicable law is not sufficient to cover the amount of net deferred assets, such assets may be impaired. Based on the weight of available evidence, we have determined that it is more likely than not that we will be able to fully realize the existing DTA. Accordingly, we considered it appropriate not to establish a DTA valuation allowance at either June 30, 2016 or December 31, 2015.

Additional information regarding our income taxes is presented in Note 12 —Income Taxes to the 2015 Audited Financial Statements and Note 8 — Income Taxes to the Unaudited Financial Statements included in this Form 10-Q.

Financial Condition at June 30, 2016 and December 31, 2015

Total assets increased $659.8 million to $3.2 billion at June 30, 2016 compared to total assets of $2.5 billion at December 31, 2015. During the six months, cash and equivalents decreased $0.7 million, or 0.9%, to $69.9 million at June 30, 2016 from $70.5 million at December 31, 2015; total loans, excluding loans held for sale, increased $585.1million, or 33.6%, to $2.3 billion at June 30, 2016 from $1.7 billion at December 31, 2015; and investment securities, which include available-for-sale and held-to-maturity securities, increased slightly to $495.3 million at June 30, 2016 from $491.4 million at December 31, 2015. These changes were driven by the acquisition of First Capital and organic growth during the period.

Total liabilities of $2.8 billion at June 30, 2016 increased $590.1 million, or 26.5%, compared to total liabilities of $2.2 billion at December 31, 2015. Total deposits increased $520.8 million, or 26.7%, to $2.5 billion at June 30, 2016 reflecting both the acquisition of First Capital as well as growth in commercial and retail banking. Total borrowings increased $58.6 million, or 24.5%, to $297.9 million at June 30, 2016 from $239.3 million at December 31, 2015, including an increase of $8.6 million in trust preferred subordinated debt, net of acquisition accounting fair market value adjustments, assumed in the First Capital acquisition and the incurrence of an additional $50 million of FHLB borrowings.

Total shareholders’ equity increased $69.7 million, or 26.2%, during the first half of the year to $354.5 million at June 30, 2016. The $69.7 million increase was due to $61.3 million related to the 8,376,094 shares issued in connection with the acquisition of First Capital, $8.3 million of net income for the six months ended June 30, 2016, a $3.5 million improvement in accumulated other comprehensive income resulting from unrealized securities gains and $683 thousand of net share-based compensation. Additionally, there were 274,890 stock options exercised during the first six months of 2016, resulting in total proceeds of $1.8 million. These increases were partially offset by the repurchase of 248,349 shares of Common Stock in open market transactions pursuant to our previously announced share repurchase program, the acquisition of 123,826 shares in connection with satisfaction of tax withholding obligations on vested restricted stock and payment of $3.2 million of dividends on common stock.

The following table presents selected ratios for the Company for the three and six months ended June 30, 2016 and 2015 and for the year ended December 31, 2015:

Selected Ratios

	Three months ended June 30, (annualized)						Six months ended June 30, (annualized)						Twelve months ended December 31,
	2016			2015			2016			2015			2015
Return on Average Assets		0.71	%		0.71	%		0.53	%		0.68	%		0.68	%

Return on Average Equity		6.33	%		6.10	%		4.76	%		5.81	%		5.90	%

Period End Equity to Total Assets		11.17	%		11.32	%		11.17	%		11.32	%		11.32	%

Investment Securities and Other 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.

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 June 30, 2016, investment securities totaled $495.3 million compared to $491.4 million at December 31, 2015. Securities available-for-sale of $24.3 million were sold in the three months ended June 30, 2016 resulting in gross losses of $87 thousand. Securities available-for-sale of $124.4 million were sold in the six months ended June 30, 2016 resulting in gross gains of $94 thousand and gross losses of $187 thousand. There were no sales of securities during the three or six months ended June 30, 2015. The significant amount of sales of securities during the first quarter of 2016 is due to the sale of securities held by First Capital immediately following the acquisition.

At June 30, 2016, our available-for-sale investment portfolio had a net unrealized gain of $7.9 million compared to a $903 thousand net unrealized gain at December 31, 2015. The improvement in the unrealized gain is a result of an improvement in market rates at period end. There were no securities with an unrealized loss deemed to be other than temporary at June 30, 2016 or December 31, 2015.

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 and or private equity fund). At June 30, 2016 and December 31, 2015, the Company held a collateralized loan obligation (“CLO”) with a fair value of $5.0 million, which was included in asset-backed securities, that currently would be prohibited under the Volcker Rule unless the collateral eligibility language in the CLO is amended to comply with the new bank investment criteria under the Volcker Rule. The net unrealized loss of the prohibited CLO was $68,250 and $57,300 at June 30, 2016 and December 31, 2015, respectively. The Company will determine any disposition plans for this security as the documentation is, or is not, amended. Unless the documentation is amended to avoid inclusion within the rule’s prohibitions, the Company would have to recognize other-than-temporary-impairment with respect to this security in conformity with GAAP rules and dispose of the security by July 21, 2017. The Company held no other security types potentially affected by the Volcker Rule at June 30, 2016.

At June 30, 2016, we had $35.0 million in interest-bearing deposits at correspondent banks, all of which was on deposit with the Federal Reserve Bank, compared to $16.5 million in interest-bearing deposits at correspondent banks at December 31, 2015. This increase reflects the deposit of cash that was maintained on hand at December 31, 2015 in anticipation of the First Capital merger, which ultimately was funded with proceeds from a senior unsecured term loan.

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. Since inception, we have promoted the separation of loan underwriting from the loan production staff through our credit department. Currently, credit administration analysts or portfolio managers are responsible for underwriting and assigning proper risk grades for all commercial loans with exposure in excess of $500 thousand. Underwriting is completed on standardized forms including a loan approval form and supporting documents which outline 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. A management-level loan committee reviews all loans greater than $3 million and is responsible for approving all credits in excess of the chief credit officer and senior credit officers’ lending authority, which was $5 million at June 30, 2016.

Our loan underwriting policy contains 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 usually 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 current AC&D 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 over the past three years due to increasing new home sales in our primary markets. As of June 30, 2016, approximately 1% of our AC&D loan portfolio, commercial and consumer, falls under the watch list.

Our second mortgage exposure is primarily attributable to our home equity lines of credit (“HELOC”) portfolio, which totaled approximately $181.0 million as of June 30, 2016. 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 June 30, 2016, total loans, net of deferred fees and excluding loans held for sale, increased $585.1 million compared to December 31, 2015 due to the acquisition of First Capital and organic loan growth. The acquisition of First Capital led to shifts in the allocation of the loan portfolio from December 31, 2015 to June 30, 2016. The combination of commercial and industrial and owner-occupied real estate loans decreased to 31% of total loans at June 30, 2016 from 32% of total loans at December 31, 2015. Investor income producing commercial real estate increased to 33% from 29% of total loans and AC&D loans increased to 14% of total loans as compared to 10% of total loans at December 31, 2015. Total consumer loans decreased to 22% from 28% of total loans, with residential mortgages decreasing to 10%, home equity lines of credit decreasing to 8% and residential construction decreasing to 3%, of total loans.

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 June 30, 2016 and December 31, 2015. 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

	June 30, 2016
	Specific Reserve					Quantitative Reserve					Qualitative Reserve					PCI Reserve
	$		% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance
	(dollars in thousands)
Commercial:
Commercial and industrial	$	-		0.00	%	$	479		4.41	%	$	1,649		15.17	%	$	-		0.00	%
CRE - owner-occupied		-		0.00	%		143		1.32	%		1,088		10.01	%		-		0.00	%
CRE - investor income producing		-		0.00	%		202		1.86	%		2,370		21.80	%		-		0.00	%
AC&D - 1-4 family construction		-		0.00	%		-		0.00	%		485		4.46	%		-		0.00	%
AC&D - lots, land & development		-		0.00	%		1		0.01	%		448		4.12	%		-		0.00	%
AC&D - CRE		-		0.00	%		44		0.40	%		792		7.28	%		-		0.00	%
Other commercial		-		0.00	%		-		0.00	%		70		0.64	%		-		0.00	%
Consumer:
Residential mortgage		-		0.00	%		200		1.84	%		621		5.71	%		-		0.00	%
Home equity lines of credit		194		1.78	%		394		3.62	%		945		8.69	%		-		0.00	%
Residential construction		20		0.18	%		99		0.91	%		320		2.94	%		-		0.00	%
Other loans to individuals		-		0.00	%		10		0.09	%		299		2.75	%		-		0.00	%
Total	$	214		1.97	%	$	1,572		14.46	%	$	9,087		83.57	%	$	-		0.00	%

	December 31, 2015
	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	$	-		0.00	%	$	745		8.22	%	$	1,076		11.87	%	$	-		0.00	%
CRE - owner-occupied		-		0.00	%		116		1.28	%		1,019		11.24	%		-		0.00	%
CRE - investor income producing		-		0.00	%		726		8.01	%		1,373		15.15	%		-		0.00	%
AC&D - 1-4 family construction		-		0.00	%		-		0.00	%		247		2.73	%		-		0.00	%
AC&D - lots, land, & development		-		0.00	%		-		0.00	%		278		3.07	%		-		0.00	%
AC&D - CRE		-		0.00	%		37		0.41	%		642		7.08	%		-		0.00	%
Other commercial		-		0.00	%		-		0.00	%		69		0.76	%		-		0.00	%
Consumer:														0	%
Residential mortgage		-		0.00	%		169		1.86	%		503		5.55	%		-		0.00	%
HELOC		192		2.12	%		286		3.16	%		859		9.48	%		-		0.00	%
Residential construction		-		0.00	%		253		2.79	%		208		2.29	%		-		0.00	%
Other loans to individuals		-		0.00	%		-		0.00	%		266		2.93	%		-		0.00	%

Total	$	192		2.12	%	$	2,332		25.73	%	$	6,540		72.15	%	$	-		0.00	%

The allowance for loan losses was $10.9 million, or 0.47% of total loans, at June 30, 2016 compared to $9.1 million, or 0.52% of total loans, at December 31, 2015. 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 was a function of an increase of $2.8 million in the qualitative component of the allowance primarily due to due to an increase in the economic and market trends factor in light of market volatility and heightened uncertainty which emerged at the end of the quarter, organic loan growth and additional provision recorded for the purchased performing loans. This increase was partially offset by a decrease of $1.0 million in the quantitative component of the allowance due to a decrease in historical loss rates applied to the portfolio as older periods with higher rates of net charge-offs are replaced with more recent periods with higher rates of net recoveries. There was also an increase of $22 thousand in specific reserves for the six months ended June 30, 2016 on a single residential construction loan relationship.

In accordance with GAAP, loans acquired from Community Capital, Citizens South, Provident Community and First Capital were adjusted to reflect estimated fair market value at acquisition and the associated allowance for loan losses was eliminated. At June 30, 2016, acquired loans comprised 33% of our total loans, compared to 22% at December 31, 2015. The ratio of the allowance for loan losses to total loans was 0.47% at June 30, 2016 and 0.52% at December 31, 2015. 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 1.79% at June 30, 2016 and 2.10% at December 31, 2015. 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 the Company’s 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 June 30, 2016 and December 31, 2015, $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 $11.0 million, or 0.35% of total assets at June 30, 2016 compared to $13.7 million, or 0.54%, of total assets at December 31, 2015. Nonperforming loans, which consist of nonaccrual loans, accruing TDRs and accruing loans for which payments are 90 days or more past due, decreased $0.5 million, or 6%, to $7.8 million, or 0.33% of total loans at June 30, 2016, compared to $8.3 million, or 0.47% of total loans at December 31, 2015. Nonperforming loans continue to remain at low levels and, when presented, are resolved as expeditiously as possible by management. Nonperforming assets at June 30, 2016 include $0.4 million of covered OREO representing 3% of total nonperforming assets at June 30, 2016, compared to $1.2 million of covered OREO representing 9% of total nonperforming assets at December 31, 2015.

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 increased $0.9 million, or 20%, in the first half of 2016 from $4.3 million at December 31, 2015 to $5.2 million at June 30, 2016. Nonaccrual TDRs are included in the nonaccrual loan amounts noted. At June 30, 2016, nonaccrual TDR loans were $560 thousand and had no related allowance recorded. At December 31, 2015, nonaccrual TDR loans were $466 thousand and had no related allowances recorded. Accruing TDRs totaled $2.6 million at June 30, 2016 and $2.8 million at December 31, 2015 and had related allowances of $194 thousand recorded at both June 30, 2016 and December 31, 2015.

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 periodically and reported to both management and the Loan and Risk Committee of the board of directors quarterly. Impairment analyses are performed on all classified loans (risk grade of 70 or worse) generally greater than $150 thousand as well as selected other loans as deemed appropriate. At June 30, 2016, we maintained “watch loans” totaling $29.8 million compared to $31.2 million at December 31, 2015. Approximately $24.5 million and $26.8 million of the watch loans at June 30, 2016 and December 31, 2015, 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 June 30, 2016, OREO totaled $3.2 million, all of which is recorded at values based on our most recent appraisals. Included in that total is $0.4 million of OREO covered under the FDIC loss share agreements. At December 31, 2015, OREO totaled $5.5 million, all of which was recorded at values based on the most recent appraisals then available. Included in that total was $1.2 million of OREO covered under the FDIC loss share agreements. The Company currently expects 80% of losses and associated expenses on covered OREO to be reimbursed under its FDIC loss share agreements.

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 June 30, 2016 were $2.5 billion, an increase of $520.8 million, or 26.7%, from December 31, 2015. Noninterest bearing demand deposits increased $145.4 million, or 41.4% at June 30, 2016. Non-brokered money market, NOW and savings deposits increased $172.3 million, or 17.3%. Non-brokered time deposits increased $179.3 million, or 37.6%, and brokered deposits, which consist of brokered interest-bearing deposits, brokered money market accounts, and brokered certificates of deposits, increased $23.8 million, or 18.5%. Increases were primarily due to the acquisition of First Capital and retail sales efforts. The following is a summary of deposits at June 30, 2016 and December 31, 2015:

	June 30, 2016		December 31, 2015
	(dollars in thousands)
Noninterest bearing demand deposits	$	496,195	$	350,836
Interest-bearing demand deposits		429,145		407,204
Money market deposits		644,992		500,569
Savings		95,174		89,271
Brokered deposits		152,202		128,390
Certificates of deposit and other time deposits		655,715		476,392
Total deposits	$	2,473,423	$	1,952,662

Total borrowings increased $58.6 million to $297.9 million at June 30, 2016 compared to $239.3 million at December 31, 2015. Borrowings at June 30, 2016 include $33.2 million (after acquisition accounting fair market value adjustments) of Tier 1-eligible subordinated debt related to trust preferred securities, of which $8.6 million was assumed in connection with the acquisition of First Capital, a $29.7 million senior unsecured term loan and $235.0 million of FHLB borrowings.

The following table details short and long-term borrowings at June 30, 2016 and December 31, 2015:

					June 30, 2016					December 31, 2015
							Weighted					Weighted
		Interest					Average					Average
	Maturity	Rate			Balance		Interest Rate			Balance		Interest Rate
Short-term borrowings:
FHLB Daily Rate Credit	1/6/2016		0.4900	%		-				$	10,000
FHLB Fixed Rate Credit	1/7/2016		0.3532	%		-					10,000
FHLB Fixed Rate Credit	1/7/2016		0.3532	%		-					10,000
FHLB Adjustable Rate Credit	1/11/2016		0.3900	%		-					80,000
FHLB Adjustable Rate Credit	1/21/2016		0.3800	%		-					40,000
FHLB Adjustable Rate Credit	1/21/2016		0.3567	%		-					15,000
FHLB Fixed Rate Credit	7/5/2016		0.4300	%		60,000					-
FHLB Fixed Rate Credit	7/7/2016		0.3800	%		20,000					-
FHLB Fixed Rate Credit	7/18/2016		0.4000	%		80,000
FHLB Fixed Rate Credit	7/20/2016		0.4000	%		20,000
FHLB Fixed Rate Hybrid	9/26/2016		1.9050	%		5,000					5,000
FHLB Fixed Rate Hybrid	9/26/2016		2.0675	%		5,000					5,000
FHLB Fixed Rate Hybrid	9/26/2016		2.2588	%		5,000					5,000
FHLB Fixed Rate Hybrid	9/26/2016		2.0250	%		5,000					5,000
Total short-term borrowings						200,000		0.37	%		185,000		0.57	%

Long-term borrowings:
FHLB Adjustable Rate Credit	7/7/2017		0.6566	%		20,000					-
FHLB Adjustable Rate Credit	7/21/2017		0.6649	%		15,000					-
Total Federal Home Loan Bank						35,000		0.66	%		-		0.00	%
Junior subordinated debt	12/15/35		2.2039	%		9,885					9,743
Junior subordinated debt	01/10/24		4.8012	%		4,760					-
Junior subordinated debt	03/01/37		2.3751	%		5,490					5,424
Junior subordinated debt	10/01/36		2.3522	%		2,758					2,724
Junior subordinated debt	09/21/36		2.3339	%		3,816					-
Junior subordinated debt	06/15/36		2.1839	%		6,467					6,371
Senior unsecured term loan	12/18/22		4.7500	%		29,714					30,000
Total long-term borrowings						62,890		3.63	%		54,262		3.56	%
	Total borrowings				$	297,890				$	239,262

Results of Operations

The following table summarizes components of net income and the changes in those components for the three and six months ended June 30, 2016 and 2015:

Condensed Consolidated Statements of Income

	Three Months Ended June 30,									Six Months Ended June 30,
	2016		2015		Change					2016		2015		Change
	(Unaudited)					$	%			(Unaudited)					$	%
	(Dollars in thousands)									(Dollars in thousands)
Gross interest income	$	29,698	$	22,458	$	7,240		32.2	%	$	59,860	$	44,643	$	15,217		34.1	%
Gross interest expense		3,648		1,842		1,806		98.0	%		7,214		3,601		3,613		100.3	%
Net interest income		26,050		20,616		5,434		26.4	%		52,646		41,042		11,604		28.3	%

Provision for loan losses		882		134		748		558.2	%		1,438		314		1,124		358.0	%

Noninterest income		5,375		4,292		1,083		25.2	%		10,102		8,793		1,309		14.9	%
Noninterest expense		21,946		18,232		3,714		20.4	%		48,099		37,371		10,728		28.7	%
Net income before taxes		8,597		6,542		2,055		31.4	%		13,211		12,150		1,061		8.7	%

Income tax expense		3,045		2,273		772		34.0	%		4,919		4,098		821		20.0	%

Net income	$	5,552	$	4,269	$	1,283		30.1	%	$	8,292	$	8,052	$	240		3.0	%

Net Income. Net income for the three months ended June 30, 2016 was $5.6 million, compared to $4.3 million for the three months ended June 30, 2015. Changes in net income from the second quarter of 2015 include a 26.4% increase in net interest income and a 25.2% increase in noninterest income, which were partially offset by a 20.4% increase in noninterest expense levels and a $748 thousand increase in provision for loan losses. Annualized return on average assets remained flat during the three-month period ended June 30, 2016 at 0.71% compared to the same period in 2015. Adjusted annualized return on average assets improved to 0.83% during the three-month period ended June 30, 2016 compared to 0.73% for the same period in 2015. Annualized return on average equity increased to 6.33% for the three-month period ended June 30, 2016 from 6.10% for the three-month period ended June 30, 2015. Adjusted annualized return on average equity improved to 7.35% during the three-month period ended June 30, 2016 compared to 6.26% for the same period in 2015.

Net income for the six months ended June 30, 2016, was $8.3 million compared to $8.1 million for the same period in 2015. This increase in net income is due to increases in net interest income and noninterest income, offset by an increase in noninterest expenses and provision for loan losses. Annualized return on average assets for the six-month periods ended June 30, 2016 and 2015 was 0.53% and 0.68%, respectively. Adjusted annualized return on average assets for the six-month periods ended June 30, 2016 and 2015 was 0.81% and 0.69%, respectively. Annualized return on average equity decreased to 4.76% for the six-month period ended June 30, 2016 from 5.81% for the six-month period ended June 30, 2015. Adjusted annualized return on average equity increased to 7.23% for the six-month period ended June 30, 2016 from 5.95% for the six-month period ended June 30, 2015.

Changes in the return on average assets for the three and six months ended June 30, 2016 were a function of the slower rate of increase on net income compared to the rate of increase on average assets due to merger related expenses. Changes in the return on average equity for the three and six months ended June 30, 2016 were a function of the rate of increase on net income compared to the rate of increase on average equity due to merger related share issuances. Increases in adjusted return on average assets and adjusted return on average equity for the three and six months ended June 30, 2016 were due to improved earnings. Adjusted return on average assets and adjusted return on average equity are non-GAAP financial measures. For a reconciliation to the most comparable GAAP measure, see “Non-GAAP Financial Measures” above. For a reconciliation to the most comparable GAAP measure, see “Non-GAAP Financial Measures” above.

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 $26.1 million for the three-month period ended June 30, 2016 from $20.6 million for the three months ended June 30, 2015. The increase is primarily due to an increase in average interest earning assets, which represented both the acquisition of First Capital and organic loan growth, as well as additional interest income driven by the recognition of $0.7 million of the purchased performing fair value mark related to the acquisition of First Capital loans into income during the period. Net interest income increased to $52.6 million for the six-month period ended June 30, 2016 from $41.0 million for the six months ended June 30, 2015. The increase is again due to an increase in average interest earning assets, which represented organic loan growth as well as the acquisition of First Capital, and the recognition of $1.8 million of the purchased performing fair value mark from that acquisition during the first six months of 2016.

Total average interest-earning assets increased to $2.8 billion in the three and six months ended June 30, 2016 compared to $2.2 billion in the three and six months ended June 30, 2015. Average balances of total interest-bearing liabilities increased to $2.3 billion in the three and six-month periods ended June 30, 2016, compared to $1.8 billion in the same periods in 2015. The increases in average balances are the result of the First Capital merger and organic growth. Our net interest margin decreased from 3.78% in the three-month period ended June 30, 2015 to 3.69% in the corresponding period in 2016. This decrease in net interest margin reflects primarily the lower interest rates on new loans and core net interest margin compression, partially offset by the additional accretion of fair value marks on purchased performing loans acquired from First Capital. Our net interest margin decreased from 3.81% in the six-month period ended June 30, 2015 to 3.73% in the corresponding period in 2016 for reasons consistent with the three-month period decline noted above.

The following table summarizes 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 June 30,
	2016								2015
	Average Balance			Income/ Expense		Yield/ Rate (3)			Average Balance			Income/ Expense		Yield/ Rate (3)
	(dollars in thousands)
Assets
Interest-earning assets:
Loans, including fees (1)(2)	$	2,298,569		$	26,729		4.68	%	$	1,643,844		$	19,667		4.80	%
Federal funds sold		3,848			5		0.52	%		730			-		0.00	%
Taxable investment securities		484,057			2,640		2.18	%		474,807			2,508		2.11	%
Tax-exempt investment securities		14,131			137		3.88	%		13,960			143		4.10	%
Nonmarketable equity securities		12,832			153		4.80	%		12,177			122		4.02	%
Other interest-earning assets		29,727			34		0.46	%		39,921			18		0.18	%
Total interest-earning assets		2,843,164			29,698		4.20	%		2,185,439			22,458		4.12	%
Allowance for loan losses		(9,961	)							(8,895	)
Cash and due from banks		35,011								16,356
Premises and equipment		66,029								58,912
Other assets		200,788								154,859
Total assets	$	3,135,031							$	2,406,671

Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand	$	426,427		$	81		0.08	%	$	411,806		$	71		0.07	%
Savings and money market		744,945			840		0.45	%		525,359			405		0.31	%
Time deposits - core		686,003			1,272		0.75	%		458,139			632		0.55	%
Brokered deposits		139,164			270		0.78	%		133,981			176		0.53	%
Total interest-bearing deposits		1,996,539			2,463		0.50	%		1,529,285			1,284		0.34	%
Short-term borrowings		163,132			251		0.62	%		148,901			76		0.20	%
Long-term FHLB borrowings		64,808			440		2.73	%		55,000			131		0.96	%
Subordinated debt		33,102			494		6.00	%		23,833			351		5.91	%
Total borrowed funds		261,042			1,185		1.83	%		227,734			558		0.98	%
Total interest-bearing liabilities		2,257,581			3,648		0.65	%		1,757,019			1,842		0.42	%
Net interest rate spread					26,050		3.55	%					20,616		3.70	%
Noninterest-bearing demand deposits		483,465								338,092
Other liabilities		41,480								30,884
Shareholders' equity		352,505								280,676
Total liabilities and shareholders' equity	$	3,135,031							$	2,406,671
Net interest margin							3.69	%							3.78	%

(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.

Average Balance Sheets and Net Interest Analysis

	For the Six Months Ended June 30,
	2016								2015
	Average Balance			Income/ Expense		Yield/ Rate (3)			Average Balance			Income/ Expense		Yield/ Rate (3)
	(dollars in thousands)
Assets
Interest-earning assets:
Loans, including fees (1)(2)	$	2,286,696		$	53,853		4.74	%	$	1,623,279		$	38,778		4.82	%
Federal funds sold		5,372			13		0.49	%		596			-		0.00	%
Taxable investment securities		485,605			5,327		2.19	%		477,255			5,299		2.22	%
Tax-exempt investment securities		15,089			284		3.76	%		13,409			281		4.19	%
Nonmarketable equity securities		13,340			307		4.63	%		12,371			249		4.06	%
Other interest-earning assets		32,326			76		0.47	%		43,887			36		0.17	%
Total interest-earning assets		2,838,428			59,860		4.24	%		2,170,797			44,643		4.15	%

Allowance for loan losses		(9,912	)							(8,633	)
Cash and due from banks		35,885								16,646
Premises and equipment		66,271								59,133
Other assets		203,156								157,207
Total assets	$	3,133,828							$	2,395,150

Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand	$	426,610		$	168		0.08	%	$	409,863		$	139		0.07	%
Savings and money market		739,124			1,671		0.45	%		521,374			800		0.31	%
Time deposits - core		698,146			2,492		0.72	%		459,713			1,220		0.54	%
Brokered deposits		132,994			548		0.83	%		137,254			352		0.52	%
Total interest-bearing deposits		1,996,874			4,879		0.49	%		1,528,204			2,511		0.33	%
Short-term borrowings		177,417			545		0.62	%		150,055			152		0.20	%
Long-term FHLB borrowings		65,316			850		2.62	%		53,950			259		0.00	%
Subordinated debt		33,015			940		5.73	%		23,749			679		5.77	%
Total borrowed funds		275,748			2,335		1.70	%		227,754			1,090		0.97	%
Total interest-bearing liabilities		2,272,622			7,214		0.64	%		1,755,958			3,601		0.41	%
Net interest rate spread					52,646		3.60	%					41,042		3.73	%
Noninterest-bearing demand deposits		469,961								328,805
Other liabilities		40,714								30,951
Shareholders' equity		350,531								279,436
Total liabilities and shareholders' equity	$	3,133,828							$	2,395,150
Net interest margin							3.73	%							3.81	%

(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 for Loan Losses. Our provision for loan losses increased $748 thousand to $882 thousand during the three months ended June 30, 2016, compared to $134 thousand during the corresponding period in 2015. Our provision for loan losses increased $1.1 million, or 358%, to a provision of $1.4 million during the six months ended June 30, 2016, from a $0.3 million provision during the corresponding period in 2015. Included in the loan loss provision for both periods of 2016 was an increase in allowance for loan losses of $2.8 million to the qualitative component of the allowance primarily due to an increase in the economic and market trends factor in light of market volatility and heightened uncertainty which emerged at the end of the second quarter, organic loan growth and additional provision recorded for the purchased performing loans.

We had $159 thousand in net recoveries during the three months ended June 30, 2016 compared to net charge-offs of $327 thousand during the corresponding period in 2015. We had $371 thousand in net recoveries during the six months ended June 30, 2016 compared to net charge-offs of $179 thousand during the corresponding period in 2015. The net recoveries in the first half of 2016 reflected the continued resolution of problem assets from the legacy Park Sterling portfolio. There were no charge-offs in excess of fair market value adjustments on PCI loans during the three- or six-months ended June 30, 2016.

Noninterest Income. The following table presents components of noninterest income for the three and six months ended June 30, 2016 and 2015:

Noninterest Income

	Three months ended June 30,												Six months ended June 30,
	2016			2015			Change						2016			2015			Change
	(Unaudited)							$		%			(Unaudited)							$		%
	(dollars in thousands)
Service charges on deposit accounts	$	1,528		$	1,107		$	421			38.0	%	$	3,017		$	2,126		$	891			41.9	%
Income from fiduciary activities		580			774			(194	)		-25.1	%		1,244			1,506			(262	)		-17.4	%
Commissions and fees from investment brokerage		283			132			151			114.4	%		422			262			160			61.1	%
Income from capital markets		767			394			373			94.7	%		835			792			43			5.4	%
Gain (loss) on sale of securities available for sale		(87	)		-			(87	)		100.0	%		(93	)		-			(93	)		100.0	%
ATM and card income		776			629			147			23.4	%		1,349			1,323			26			2.0	%
Mortgage banking income		873			956			(83	)		-8.7	%		1,648			1,907			(259	)		-13.6	%
Income from bank-owned life insurance		526			553			(27	)		-4.9	%		1,514			1,321			193			14.6	%
Amortization of indemnification asset and true-up liability expense		(25	)		(165	)		140			-84.8	%		(172	)		(559	)		387			-69.2	%
Other noninterest income		154			(88	)		242			-275.0	%		338			115			223			193.9	%

Total noninterest income	$	5,375		$	4,292		$	1,083			25.2	%	$	10,102		$	8,793		$	1,309			14.9	%

Noninterest income increased $1.1 million, or 25.2%, for the three months ended June 30, 2016 when compared to the three months ended June 30, 2015. Noteworthy changes among categories include (i) a $421 thousand increase in service charges on deposit accounts due to an increase in deposits from First Capital; (ii) a $194 thousand decrease in income from fiduciary activities due to declines in assets under management; (iii) a $151 thousand increase in commissions and fees from investment brokerage due to higher second quarter volumes; (iv) a $373 increase in income from capital markets due to strong business volumes originated in the second quarter; (v) a $147 thousand increase in ATM and card income due to steady volume and a year-to-date adjustment for chip card conversion costs; and (vi) a $242 thousand increase in other noninterest income as the three months ended June 30, 2015 included a $196 thousand reduction of capital on certain limited partnership investments based on final 2014 partnership documentation received. Also included in the second quarter of 2016 were losses on sale of securities of $87 thousand. There were no gains or losses on the sale of securities during the second quarter of 2015.

Noninterest income increased $1.3 million, or 14.9%, for the six months ended June 30, 2016 compared to the six months ended June 30, 2015. Noteworthy changes among categories include (i) an $891 thousand increase in service charges on deposit accounts, as a direct contribution of the First Capital merger; (ii) a $262 thousand decrease in income from fiduciary activities due to declines in assets under management; (iii) a $160 thousand increase in commissions and fees from investment brokerage due to higher volumes; (iv) a $259 thousand decrease in mortgage banking income due to decreased activity in loan closings and the period end pipeline; (vi) a $193 thousand increase in income from bank-owned life insurance due primarily to death benefits received in the first quarter of 2016; and (vii) a $223 thousand increase in other noninterest income primarily as a result of a $196 thousand reduction of capital on certain limited partnership investments based on final 2014 partnership documentation received, which was included during the 2015 period. Also included in the first six months of 2016 were losses on sale of securities of $93 thousand. There were no gains or losses on the sale of securities during the first six months of 2015.

Noninterest Expense. The following table presents components of noninterest expense for the three and six months ended June 30, 2016 and 2015:

Noninterest Expense

	Three months ended June 30,										Six months ended June 30,
	2016		2015		Change						2016		2015		Change
	(Unaudited)				$			%			(Unaudited)				$			%
	(dollars in thousands)
Salaries and employee benefits	$	11,774	$	10,021	$	1,753			17.5	%	$	24,792	$	20,452	$	4,340			21.2	%
Occupancy and equipment		3,041		2,491		550			22.1	%		6,166		5,046		1,120			22.2	%
Advertising and promotion		367		304		63			20.7	%		788		678		110			16.2	%
Legal and professional fees		950		660		290			43.9	%		1,675		1,458		217			14.9	%
Deposit charges and FDIC insurance		478		433		45			10.4	%		910		825		85			10.3	%
Data processing and outside service fees		2,224		1,640		584			35.6	%		7,747		3,288		4,459			135.6	%
Communication fees		505		541		(36	)		-6.7	%		988		1,119		(131	)		-11.7	%
Core deposit intangible amortization		458		347		111			32.0	%		916		695		221			31.8	%
Net cost of operation of other real estate owned		70		232		(162	)		-69.8	%		336		267		69			25.8	%
Loan and collection expense		273		242		31			12.8	%		310		396		(86	)		-21.7	%
Postage and supplies		191		116		75			64.7	%		364		265		99			37.4	%
Other noninterest expense		1,615		1,205		410			34.0	%		3,107		2,882		225			7.8	%

Total noninterest expense	$	21,946	$	18,232	$	3,714			20.4	%	$	48,099	$	37,371	$	10,728			28.7	%

Total noninterest expense increased to $21.9 million for the three months ended June 30, 2016, an increase of $3.7 million, or 20.4%, from $18.2 million for the corresponding period in 2015. Excluding merger-related expenses of $1.3 million and $167 thousand for the three-month periods ended June 30, 2016 and 2015, respectively, adjusted noninterest expense increased $2.6 million for the three months ended June 30, 2016, compared to the corresponding period in the prior year. Merger expenses for the three months ended June 30, 2016 included $263 thousand of salary and employee benefit expenses, $249 thousand of data processing charges related to the termination of First Capital’s core processing contract, $313 thousand of professional fees, $80 thousand of advertising expense and $361 thousand of other expenses. Merger expenses for the three months ended June 30, 2015 included $60 thousand of professional fees and $106 thousand of other expenses related to previous mergers. Total noninterest expense increased to $48.1 million for the six months ended June 30, 2016, an increase of $10.7 million, or 28.7%, from $37.4 million for the corresponding period in 2015. Excluding merger-related expenses of $6.5 million and $289 thousand for the six-month periods ended June 30, 2016 and 2015, respectively, adjusted noninterest expense increased $4.6 million, or 12.3%, for the six months ended June 30, 2016, compared to the corresponding period in the prior year. Adjusted noninterest 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 expenses increased $1.8 million, or 17.5%, to $11.8 million in the second quarter of 2016, compared to $10.0 million in the comparable period of 2015, primarily as a result of increased headcount associated with the acquisition of First Capital and organic growth and merger and non-merger related compensation expense of $416 thousand. Total full-time equivalents increased to 529 at June 30, 2016 from 503 at June 30, 2015. Compensation expense for share-based compensation plans was $389 thousand in the second quarter of 2016 compared to $290 thousand in the comparable period of 2015.

Other notable variances during the second quarter of 2016 include (i) an increase in occupancy and equipment expense of $550 thousand, or 22.1%; (ii) a $290 thousand increase in legal and professional fees; (iii) an increase in data processing fees of $584 thousand, or 35.6% due to the expenses associated with the First Capital core system conversion; (iv) an $111 thousand increase in core deposit intangible amortization; and (v) an increase of $410 thousand, or 34.0% in other noninterest expense as the second quarter of 2016 included $320 thousand in other merger-related expenses. The majority of these increases were related to the acquisition of First Capital, as well as organic growth. Offsetting these increases was a $162 thousand decrease in net cost of operation of other real estate owned, as management continues to sell OREO properties and thus reduce costs.

Six-month comparison and analysis

Salaries and employee benefits expenses increased $4.3 million, or 21.2%, to $24.8 million in the six months ended June 30, 2016 compared to $20.5 million in the comparable period of 2015. These increases are primarily due to merger-related compensation expenses of $1.4 million, non-merger related severance expense of $334 thousand, an increase in incentive based compensation of $816 thousand and increased headcount.

Other notable changes between categories during the six months ended June 30, 2016 when compared to the six months ended June 30, 2015 include (i) an increase in occupancy and equipment expense of $1.1 million, or 22.2%, to $6.2 million primarily due to the addition of the First Capital branches as well as improvements to our Wilmington and Charleston locations; (ii) an increase in data processing fees of $4.5 million, or 135.6%; (iii) an increase in core deposit intangible amortization of $221 thousand, or 31.8%; and (vii) a $225 thousand, or 7.8%, increase in other noninterest expense. These increases were primarily related to the acquisition of First Capital.

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 June 30, 2016, we recognized income tax expense of $3.0 million compared to income tax expense of $2.2 million for the same period in 2015. The effective tax rate for the three months ended June 30, 2016 is 35.42% compared to 34.74% for the same period in 2015. The change in the effective tax rate was due in part to certain non-deductible merger-related expenses.

For the six months ended June 30, 2016, we recognized income tax expense of $4.9 million compared to income tax expense of $4.1 million for the same period in 2015. The effective tax rate for the six months ended June 30, 2016 is 37.23% compared to 33.73% for the same period in 2015. The change in the effective tax rate was due in part to certain non-deductible merger-related expenses as well as adjustments made to deferred tax assets for the true-up in tax rates and a re-measurement due to the First Capital acquisition.

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 and is charged with monitoring our asset / liability mix, interest rate sensitivity and liquidity risk management.

Our ongoing philosophy is to remain in a liquid position as reflected by such indicators as the composition of our earning assets, typically including some level of federal funds sold, balances at the Federal Reserve Bank, and/or other short-term investments; asset quality; well-capitalized position; and profitable operating results. Cyclical and other economic trends and conditions can disrupt our desired liquidity position at any time. We expect that these conditions would generally be of a short-term nature. At June 30, 2016, we had $344.3 million of credit available from the FHLB, $301.4 million of credit available from the Federal Reserve Discount Window, and available lines totaling $70.0 million from correspondent banks. We believe that our liquidity position continues to be very adequate and readily available. At December 31, 2015, we had total Federal funds credit lines of $371.0 million with no outstanding advances. If additional liquidity were needed, we would turn to short-term borrowings as an alternative immediate funding source and would consider other appropriate actions such as promotions to increase core deposits or the sale of a portion of our investment portfolio. At June 30, 2016, we had $754.3 million of pre-approved but unused lines of credit, $10.0 million of standby letters of credit and $12.2 million 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 contingency funding plan describes several potential stages based on stressed liquidity levels. Our board of directors reviews liquidity benchmarks quarterly. Also, we review on at least an annual basis our liquidity position and our contingency funding plans with our principal banking regulators. We maintain various wholesale sources of funding. If our deposit retention efforts were to be unsuccessful, the bank would utilize these alternative sources of funding. Under such circumstances, depending on the external source of funds, our interest cost would vary based on the range of interest rates charged to us. This could increase our cost of funds, impacting net interest margins and net interest spreads.

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 at June 30, 2016 was $354.5 million, compared to $284.7 million at December 31, 2015. The $69.7 million increase was due to $61.3 million related to the 8,376,094 shares issued in connection with the acquisition of First Capital, $8.3 million of net income for the six months ended June 30, 2016, a $3.5 million improvement in accumulated other comprehensive income from unrealized securities gains and cash flow hedges and $683 thousand of net share-based compensation. Additionally, there were 274,890 stock options exercised during the first six months of 2016, resulting in total proceeds of $1.8 million. These increases were partially offset by the repurchase of 248,349 shares of Common Stock in open market transactions pursuant to our previously announced share repurchase program, the acquisition of 123,826 shares in connection with satisfaction of tax withholding obligations on vested restricted stock and the payment of $3.2 million of dividends on common stock.

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 are designed to measure different components of capital in relation to the credit risk of both on- and off-balance sheet items. Under the guidelines, one of four risk weights is applied to the various 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. 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.

Effective January 2, 2015, the Company and Bank are now subject to the new regulatory risk-based capital rules adopted by the federal banking agencies implementing Basel III. Under the new capital guidelines, applicable regulatory capital components consist of (1) common equity Tier 1 capital (common stock, including related surplus, and retained earnings, plus limited amounts of minority interest in the form of common stock, net of goodwill and other intangibles (other than mortgage servicing assets), deferred tax assets arising from net operating loss and tax credit carry forwards above certain levels, mortgage servicing rights above certain levels, gain on sale of securitization exposures and certain investments in the capital of unconsolidated financial institutions, and adjusted by unrealized gains or losses on cash flow hedges and accumulated other comprehensive income items (subject to the ability of a non-advanced approaches institution to make a one-time irrevocable election to exclude from regulatory capital most components of AOCI)), (2) additional Tier 1 capital (qualifying non-cumulative perpetual preferred stock, including related surplus, plus qualifying Tier 1 minority interest and, in the case of holding companies with less than $15 billion in consolidated assets at December 31, 2009, certain grandfathered trust preferred securities and cumulative perpetual preferred stock in limited amounts, net of mortgage servicing rights, deferred tax assets related to temporary timing differences, and certain investments in financial institutions) and (3) Tier 2 capital (the allowance for loan and lease losses in an amount not exceeding 1.25% of standardized risk-weighted assets, plus qualifying preferred stock, qualifying subordinated debt and qualifying total capital minority interest, net of Tier 2 investments in financial institutions). Total Tier 1 capital, plus Tier 2 capital, constitutes total risk-based capital. The required minimum ratios are as follows:

●

common equity Tier 1 capital ratio (common equity Tier 1 capital to standardized total risk-weighted assets) of 4.5%;

●

Tier 1 capital ratio (Tier 1 capital to standardized total risk-weighted assets) of 6%;

●

total capital ratio (total capital to standardized total risk-weighted assets) of 8%; and

●

leverage ratio (Tier 1 capital to average total consolidated assets) of 4%.

The new capital guidelines 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. The phase-in of the capital conservation buffer requirement began on January 1, 2016.

The final regulatory capital rules also incorporate these changes in regulatory capital into the prompt corrective action framework, under which the thresholds for “adequately capitalized” banking organizations are equal to the new minimum capital requirements. Under this framework, in order to be considered “well capitalized”, insured depository institutions are 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%.

At June 30, 2016 and December 31, 2015, both the Company and the Bank were “well capitalized”. Actual and required capital levels at June 30, 2016 and December 31, 2015 are presented below:

	Capital Ratios at June 30, 2016
	Actual					Minimum Basel III Phase In Requirement					Minimum Basel III Fully Phased In Requirements					Well Capitalized Requirement
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
The Bank
Total capital (to risk-weighted assets)	$	340,424		13.42	%	$	202,940		8.00	%	$	266,359		10.50	%	$	253,675		10.00	%
Tier 1 capital (to risk-weighted assets)		329,510		12.99	%		152,205		6.00	%		215,624		8.50	%		202,940		8.00	%
Common equity Tier 1 capital (to risk-weighted assets)		329,510		12.99	%		114,154		4.50	%		177,572		7.00	%		164,889		6.50	%
Tier 1 capital (to average assets)		329,510		10.81	%		121,949		4.00	%		121,949		4.00	%		152,436		5.00	%
Risk Weighted Assets		2,536,749
Average Assets for Tier 1		3,048,719

The Company
Total capital (to risk-weighted assets)	$	318,650		12.55	%	$	203,077		8.00	%	$	266,538		10.50	%		N/A		N/A
Tier 1 capital (to risk-weighted assets)		307,736		12.12	%		152,308		6.00	%		215,769		8.50	%		N/A		N/A
Common equity Tier 1 capital (to risk-weighted assets)		282,721		11.14	%		114,231		4.50	%		177,692		7.00	%		N/A		N/A
Tier 1 capital (to average assets)		307,736		10.06	%		122,350		4.00	%		122,350		4.00	%		N/A		N/A
Risk Weighted Assets		2,538,461
Average Assets for Tier 1		3,058,742

	Capital Ratios at December 31, 2015
	Actual					Minimum Basel III Phase In Requirement					Minimum Basel III Fully Phased In Requirements					Well Capitalized Requirement
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
The Bank
Total capital (to risk-weighted assets)	$	268,354		13.86	%	$	154,840		8.00	%	$	203,228		10.50	%	$	193,550		10.00	%
Tier 1 capital (to risk-weighted assets)		259,290		13.40	%		116,130		6.00	%		164,518		8.50	%		154,840		8.00	%
Common equity Tier 1 capital (to risk-weighted assets)		259,290		13.40	%		87,098		4.50	%		135,485		7.00	%		125,808		6.50	%
Tier 1 capital (to average assets)		259,290		10.66	%		97,255		4.00	%		97,255		4.00	%		121,568		5.00	%
Risk Weighted Assets		1,935,503
Average Assets for Tier 1		2,431,369

The Company
Total capital (to risk-weighted assets)	$	277,669		14.30	%	$	155,334		8.00	%	$	203,877		10.50	%		N/A		N/A
Tier 1 capital (to risk-weighted assets)		268,605		13.83	%		116,501		6.00	%		165,043		8.50	%		N/A		N/A
Common equity Tier 1 capital (to risk-weighted assets)		251,807		12.97	%		87,376		4.50	%		135,918		7.00	%		N/A		N/A
Tier 1 capital (to average assets)		268,605		11.00	%		97,672		4.00	%		97,672		4.00	%		N/A		N/A
Risk Weighted Assets		1,941,681
Average Assets for Tier 1		2,441,811

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

In the ordinary course of operations, we may 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 15 - Off-Balance Sheet Risk of the 2015 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 June 30, 2016, we were not involved in any unconsolidated SPE transactions.

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.

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 June 30, 2016 from those disclosed or incorporated in Part II, Item 7A. “Quantitative and Qualitative Disclosures about Market Risk.” presented our 2015 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 ControlOver Financial Reporting

There was no change in the Company’s internal control over financial reporting that occurred during the second fiscal quarter of 2016 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 2015 Form 10-K.

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 June 30, 2016:

Period	(a) Total Number of Shares Purchased (1)		(b) Average Price Paid per Share (1)		(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 April 1, 2016through April 30, 2016		6,506	$	6.89		-		1,900,000

Repurchases from May 1, 2016through May 31, 2016		24,009		7.35		5,000		1,895,000

Repurchases from June 1, 2016through June 30, 2016		150,692		7.41		145,000		1,750,000

Total		181,207		7.38		150,000		1,750,000

(1)

Included in the total number of shares purchased are 6,506, 19,009, and 5,692 shares of the Company’s Common Stock acquired by the Company in connection with satisfaction of tax withholding obligations on vested restricted stock in April, May and June, respectively.

(2)

On October 29, 2014, the board of directors approved a new share repurchase 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. The new share repurchase program replaced the prior share repurchase program which expired on November 1, 2014.

During the three months ended June 30, 2016,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.

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

3.2	Bylaws of the Company, as amended, incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q (File No. 001-35032) filed May 6, 2016

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 June 30, 2016 and December 31, 2015; (ii) Condensed Consolidated Statements of Income for the three and six months ended June 30, 2016 and 2015; (iii) Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and 2015; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2016 and 2015; (v) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015; and (vi) Notes to Condensed Consolidated Financial Statements

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: August 9, 2016	By:	/s/ James C. Cherry
		James C. Cherry
		Chief Executive Officer (authorized officer)

Date: August 9, 2016	By:	/s/ Donald K. Truslow
		Donald K. Truslow
		Chief Financial Officer

Exhibit Index

Exhibit Number	Description of Exhibits

3.1	Articles of Incorporation of the Company, as amended

3.2	Bylaws of the Company, as amended, incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q (File No. 001-35032) filed May 6, 2016

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 June 30, 2016 and December 31, 2015; (ii) Condensed Consolidated Statements of Income for the three and six months ended June 30, 2016 and 2015; (iii) Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and 2015; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2016 and 2015; (v) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015; and (vi) Notes to Condensed Consolidated Financial Statements

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Park Sterling (PSTB) Inactive 10-Q2016 Q2 Quarterly report

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