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 March 31, 2014

or

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

For the transition period from ________ to _________

Commission File Number 001-35032

 

PARK STERLING CORPORATION

(Exact name of registrant as specified in its charter)

North Carolina	27-4107242
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

1043 E. Morehead Street, Suite 201
Charlotte, North Carolina	28204
(Address of principal executive offices)	(Zip Code)

(704) 716-2134

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐  Accelerated Filer ☒  Non-accelerated filer ☐   Smaller reporting company ☐

(Do not check if a smaller reporting company)

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

As of May 6, 2014, the registrant had outstanding 44,662,635 shares of common stock, $1.00 par value per share. 

PARK STERLING CORPORATION

Table of Contents

 

			Page No.
Part I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets March 31, 2014 and December 31, 2013	2
		Condensed Consolidated Statements of Income Three Months Ended March 31, 2014 and 2013	3
		Condensed Consolidated Statements of Comprehensive Income (Loss) Three Months Ended March 31, 2014 and 2013	4
		Condensed Consolidated Statements of Changes in Shareholders’ Equity Three Months Ended March 31, 2014 and 2013	5
		Condensed Consolidated Statements of Cash Flows Three Months Ended March 31, 2014 and 2013	6
		Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition andResults of Operations		48
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		69
Item 4.	Controls and Procedures		69
Part II.	Other Information
Item 1.	Legal Proceedings		69
Item 1A.	Risk Factors		69
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		70
Item 3.	Defaults Upon Senior Securities		70
Item 4.	Mine Safety Disclosures		70
Item 5.	Other Information		70
Item 6.	Exhibits		71

PARK STERLING CORPORATION

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Dollars in thousands)

	March 31, 2014			December 31, 2013*
ASSETS
Cash and due from banks	$	14,226		$	13,087
Interest-earning balances at banks		90,620			41,680
Federal funds sold		-			300
Investment securities available-for-sale, at fair value		340,215			349,491
Investment securities held-to-maturity (fair value of $51,191 and $51,334, respectively)		51,303			51,972
Nonmarketable equity securities		5,242			5,905
Loans held for sale		2,063			2,430
Loans:
Non-covered		1,237,653			1,224,674
Covered		65,173			71,134
Less allowance for loan losses		(9,076	)		(8,831	)
Net loans		1,293,750			1,286,977
Premises and equipment, net		55,893			55,923
Bank-owned life insurance		47,840			47,832
Deferred tax asset		34,183			36,318
Other real estate owned - noncovered		8,874			9,404
Other real estate owned - covered		6,652			5,088
Goodwill		26,420			26,420
FDIC indemnification asset		9,209			10,025
Core deposit intangible		8,372			8,629
Accrued interest receivable		3,972			4,222
Other assets		6,410			5,087
Total assets	$	2,005,244		$	1,960,790
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing	$	265,929		$	255,861
Interest-bearing		1,371,532			1,344,024
Total deposits		1,637,461			1,599,885
Short-term borrowings		2,287			996
FHLB advances		55,000			55,000
Subordinated debt		22,171			22,052
Accrued interest payable		389			412
Accrued expenses and other liabilities		21,970			20,362
Total liabilities		1,739,278			1,698,707
Shareholders' equity:
Common stock, $1.00 par value 200,000,000 shares authorized; 44,726,416 and 44,730,669 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively		44,726			44,731
Additional paid-in capital		222,412			222,559
Accumulated earnings (deficit)		2,254			(405	)
Accumulated other comprehensive income (loss)		(3,426	)		(4,802	)
Total shareholders' equity		265,966			262,083
Total liabilities and shareholders' equity	$	2,005,244		$	1,960,790

* Derived from audited financial statements.

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

2

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended March 31,
	2014			2013
Interest income
Loans, including fees	$	16,926		$	18,140
Federal funds sold		-			17
Taxable investment securities		1,971			866
Tax-exempt investment securities		222			190
Nonmarketable equity securities		66			48
Interest on deposits at banks		21			62
Total interest income		19,206			19,323
Interest expense
Money market, NOW and savings deposits		547			407
Time deposits		831			608
Short-term borrowings		-			6
FHLB advances		127			137
Subordinated debt		426			429
Total interest expense		1,931			1,587
Net interest income		17,275			17,736
Provision for loan losses		(17	)		309
Net interest income after provision for loan losses		17,292			17,427
Noninterest income
Service charges on deposit accounts		633			764
Income from fiduciary activities		678			598
Commissions and fees from investment brokerage		97			110
Gain on sale of securities available for sale		276			-
ATM and card income		548			488
Mortgage banking income		244			968
Income from bank-owned life insurance		1,120			381
Amortization of indemnification asset		(253	)		35
Other noninterest income		143			114
Total noninterest income		3,486			3,458
Noninterest expense
Salaries and employee benefits		9,228			8,778
Occupancy and equipment		2,005			1,908
Advertising and promotion		233			220
Legal and professional fees		661			893
Deposit charges and FDIC insurance		240			487
Data processing and outside service fees		1,346			1,653
Communication fees		436			432
Core deposit intangible amortization		257			257
Net cost (earnings) of operation of other real estate owned		53			(428	)
Loan and collection expense		288			326
Postage and supplies		175			329
Other tax expense		69			176
Other noninterest expense		752			890
Total noninterest expense		15,743			15,921
Income before income taxes		5,035			4,964
Income tax expense		1,480			1,724
Net income		3,555			3,240
Preferred dividends		-			51
Net income to common shareholders	$	3,555		$	3,189
Basic earnings per common share	$	0.08		$	0.07
Diluted earnings per common share	$	0.08		$	0.07
Dividends per common share	$	0.02		n/a
Weighted-average common shares outstanding
Basic		43,937,034			44,010,890
Diluted		44,264,178			44,069,053

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

3

PARK STERLING CORPORATION

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

(Dollars in thousands)

	Three Months Ended March 31,
	2014			2013
Net income	$	3,555		$	3,240
Unrealized holding gains (losses) on available-for-sale securities		3,354			(818	)
Income tax effect		(1,228	)		386
Reclassification of gains recognized in net income, reported as a gain on sale of securities available for sale on the condensed consolidated statement of income		(276	)		-
Income tax effect		104			-
		1,954			(432	)
Unrealized holding gain (loss) on swaps		(922	)		-
Income tax effect		344			-
		(578	)		-
Total other comprehensive income (loss)		1,376			(432	)
					.
Total comprehensive income	$	4,931		$	2,808

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

4

PARK STERLING CORPORATION

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

Three Months Ended March 31, 2014 and 2013

(Dollars in thousands)

	Preferred Stock				Common Stock						Additional Paid-In			Accumulated Earnings			Accumulated Other Comprehensive			Total Shareholders'
	Shares		Amount		Shares			Amount			Capital			(Deficit)			Income (Loss)			Equity
Balance at December 31, 2012		20,500,000	$	20,500		44,575,853		$	44,576		$	220,996		$	(13,568	)	$	3,198		$	275,702
Issuance of restricted stock grants		-		-		72,000			72			(72	)		-			-			-
Exercise of stock options		-		-		312			-			1			-			-			1
Share-based compensation expense		-		-		-			-			525			-			-			525
Dividends on preferred stock		-		-		-			-			-			(51	)		-			(51	)
Net income		-		-		-			-			-			3,240			-			3,240
Other comprehensive income (loss)		-		-		-			-			-			-			(432	)		(432	)
Balance at March 31, 2013		20,500,000	$	20,500		44,648,165		$	44,648		$	221,450		$	(10,379	)	$	2,766		$	278,985
Balance at December 31, 2013		-	$	-		44,730,669		$	44,731		$	222,559		$	(405	)	$	(4,802	)	$	262,083
Issuance of restricted stock grants		-		-		50,000			50			(50	)		-			-			-
Exercise of stock options		-		-		15,539			15			43			-			-			58
Share-based compensation expense		-		-		-			-			246			-			-			246
Common stock repurchased		-		-		(69,792	)		(70	)		(386	)		-			-			(456	)
Dividends on common stock		-		-		-			-			-			(896	)		-			(896	)
Net income		-		-		-			-			-			3,555			-			3,555
Other comprehensive income (loss)		-		-		-			-			-			-			1,376			1,376
Balance at March 31, 2014		-	$	-		44,726,416		$	44,726		$	222,412		$	2,254		$	(3,426	)	$	265,966

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

5

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	Three Months Ended March 31,
	2014			2013
Cash flows from operating activities
Net income	$	3,555		$	3,240
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Accretion on acquired loans		(2,239	)		(1,852	)
Net amortization (accretion) on investments		476			(412	)
Other depreciation and amortization		2,033			1,736
Provision for loan losses		(17	)		309
Share-based compensation expense		246			525
Deferred income taxes		1,355			2,172
Amortization (accretion) of FDIC indemnification asset		253			(35	)
Net gains on sales of investment securities available-for-sale		(276	)		-
Net gains on sales of loans held for sale		(62	)		(612	)
Net (gains) losses on sales of fixed assets		1			(16	)
Net gains on sales of other real estate owned		(127	)		(591	)
Writedowns on other real estate owned		146			228
Proceeds from life insurance death benefit		651			-
Income from bank-owned life insurance		(1,120	)		(381	)
Proceeds from loans held for sale		8,323			30,638
Disbursements for loans held for sale		(7,894	)		(27,538	)
Change in assets and liabilities:
Decrease (increase) in FDIC indemnification asset		(69	)		(23	)
Decrease in accrued interest receivable		250			115
(Increase) decrease in other assets		(1,407	)		1,154
Decrease in accrued interest payable		(23	)		(41	)
Increase (decrease) in accrued expenses and other liabilities		1,243			(507	)
Net cash provided by operating activities		5,298			8,109
Cash flows from investing activities
Net (increase) decrease in loans		(8,873	)		24,740
Purchases of premises and equipment		(909	)		(1,125	)
Proceeds from sales of premises and equipment		62			50
Purchases of investment securities available-for-sale		-			(66,681	)
Proceeds from sales of investment securities available-for-sale		2,396			-
Proceeds from maturities, calls and paydowns of investment securities available-for-sale		9,765			12,773
Proceeds from maturities, calls and paydowns of investment securities held-to-maturity		662			-
FDIC (reimbursement) payment of recoverable covered asset losses		632			3,415
Proceeds from sale of other real estate owned		2,494			7,342
Net redemptions of nonmarketable equity securities		663			1,509
Net cash provided (used) by investing activities		6,892			(17,977	)
Cash flows from financing activities
Net increase (decrease) in deposits		37,592			(37,183	)
Advances (repayments) of long-term borrowings		-			(15,000	)
Increase (decrease) in short-term borrowings		1,291			225
Exercise of stock options		58			-
Repurchase of common stock		(456	)		-
Dividends on common stock		(896	)		-
Dividends on preferred stock		-			(51	)
Net cash provided (used) by financing activities		37,589			(52,009	)
Net increase (decrease) in cash and cash equivalents		49,779			(61,877	)
Cash and cash equivalents, beginning		55,067			184,142
Cash and cash equivalents, ending	$	104,846		$	122,265
Supplemental disclosures of cash flow information:
Cash paid for interest	$	1,954		$	1,628
Cash paid for income taxes		129			-
Supplemental disclosure of noncash investing and financing activities:
Change in unrealized gain on available-for-sale securities, net of tax	$	1,954		$	(432	)
Change in unrealized gain on cash flow hedge, net of tax		(578	)		-
Loans transferred to other real estate owned		3,547			3,157

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

6

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 1 – Basis of Presentation

Park Sterling Corporation (the “Company”) was formed on October 6, 2010 to serve as the holding company for Park Sterling Bank (the “Bank”) and is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). At March 31, 2014 and December 31, 2013, the Company’s primary operations and business were that of owning the Bank.

The accompanying unaudited condensed consolidated financial statements and notes have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with GAAP. Because the accompanying unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP, they should be read in conjunction with the Company’s audited consolidated financial statements and accompanying footnotes (the “2013 Audited Financial Statements”) included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”) on March 6, 2014 (the “2013 Form 10-K”).

In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all normal, recurring adjustments necessary to present fairly the financial position of the Company as of March 31, 2014 and December 31, 2013, and the results of its operations and cash flows for the three months ended March 31, 2014 and 2013. Operating results for the three-month period ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year or for other interim periods.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are susceptible to significant change in the near term are the valuation of purchased credit-impaired (“PCI”) loans, the valuation of the allowance for loan losses, the determination of the need for a deferred tax asset valuation allowance and the fair value of financial instruments and other accounts.

Tabular information, other than share and per share data, is presented in thousands of dollars. Certain amounts reported in prior periods have been reclassified to conform to the current period presentation.

Note 2 - Recent Accounting Pronouncements

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

7

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 3– Business Combinations and Goodwill

Business Combinations

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

Provident Community Bancshares, Inc.

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

The Provident Community acquisition is being accounted for under the acquisition method of accounting with the Company treated as the acquirer. The assets and liabilities of Provident Community will be recorded by the Company at their respective fair values as of May 1, 2014 and the excess of the merger consideration over the fair value of Provident Community’s net assets will be allocated to goodwill. The calculations to determine fair values were incomplete at the time of filing of this Quarterly Report on Form 10-Q.

8

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 4 – Investment Securities

The amortized cost, unrealized gains and losses, and estimated fair value of securities available-for-sale at March 31, 2014 and December 31, 2013 are as follows:

Amortized Cost and Fair Value of Investment Portfolio

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
March 31, 2014
Securities available-for-sale:
U.S. Government agencies	$	512	$	41	$	-		$	553
Municipal securities		12,116		669		-			12,785
Residential agency pass-through securities		86,278		1,086		(304	)		87,060
Residential collateralized mortgage obligations		102,940		292		(1,700	)		101,532
Commercial mortgage-backed securities		66,052		-		(3,688	)		62,364
Asset-backed securities		72,204		-		(2,082	)		70,122
Corporate and other securities		3,961		-		(9	)		3,952
Equity securities		1,250		597		-			1,847
Total securities available-for-sale	$	345,313	$	2,685	$	(7,783	)	$	340,215
Securities held-to-maturity:
Residential agency pass-through securities	$	40,498	$	70	$	-		$	40,568
Residential collateralized mortgage obligations		4,910		-		(14	)		4,896
Asset-backed securities		5,895		-		(168	)		5,727
Total securities held-to-maturity	$	51,303	$	70	$	(182	)	$	51,191
December 31, 2013
Securities available-for-sale:
U.S. Government agencies	$	513	$	45	$	-		$	558
Municipal securities		15,826		680		-			16,506
Residential agency pass-through securities		90,043		741		(536	)		90,248
Residential collateralized mortgage obligations		105,667		51		(2,369	)		103,349
Commercial mortgage-backed securities		66,396		-		(4,994	)		61,402
Asset-backed securities		73,369		1		(2,293	)		71,077
Corporate and other securities		4,461		-		(16	)		4,445
Equity securities		1,393		513		-			1,906
Total securities available-for-sale	$	357,668	$	2,031	$	(10,208	)	$	349,491
Securities held-to-maturity:
Residential agency pass-through securities	$	41,125	$	-	$	(392	)	$	40,733
Residential collateralized mortgage obligations		4,982		-		(74	)		4,908
Asset-backed securities		5,865		-		(172	)		5,693
Total securities held-to-maturity	$	51,972	$	-	$	(638	)	$	51,334

At March 31, 2014 and December 31, 2013, investment securities with a fair market value of $123.9 million and $99.5 million, respectively, were pledged to secure public and trust deposits, to secure interest rate swaps, and for other purposes as required and permitted by law.

At March 31, 2014 and December 31, 2013, commercial MBS include $56.5 million and $55.7 million, respectively, of delegated underwriting and servicing (“DUS”) bonds collateralized by multi-family properties and backed by an agency of the U.S. government, and $5.9 million and $5.7 million, respectively, of private-label securities collateralized by commercial properties.

9

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

At both March 31, 2014 and December 31, 2013, asset-backed securities include a $5.7 million security which is approximately 42% collateralized by the Federal family education loan program and approximately 58% collateralized by private student loan program.

The amortized cost and fair value of investment securities available-for-sale and held-to-maturity at March 31, 2014 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All of the Company’s residential agency pass-through securities and residential collateralized mortgage obligations are backed by an agency of the United States government. None of our residential agency pass-through securities or residential collateralized mortgage obligations are private-label securities.

Maturities of Investment Portfolio

	March 31, 2014
	Amortized Cost		Fair Value
Securities available-for-sale:
U.S. Government agencies
Due after one year through five years	$	512	$	553
Municipal securities
Due under one year		150		151
Due after ten years		11,966		12,634
Residential agency pass-through securities
Due after five years through ten years		19,744		19,870
Due after ten years		66,534		67,190
Residential collateralized mortgage obligations
Due after ten years		102,940		101,532
Commercial mortgage-backed obligations
Due after five years through ten years		66,052		62,364
Asset-backed securities
Due after five years through ten years		3,860		3,786
Due after ten years		68,344		66,336
Corporate and other securities
Due after five years through ten years		3,961		3,952
Equity securities
Due after ten years		1,250		1,847
Total securities available-for-sale	$	345,313	$	340,215
Securities held-to-maturity:
Residential agency pass-through securities
Due after ten years	$	40,498	$	40,568
Residential collateralized mortgage obligations
Due after ten years		4,910		4,896
Asset-backed securities
Due after ten years		5,895		5,727
Total securities held-to-maturity	$	51,303	$	51,191

Securities available-for-sale of $2.4 million were sold in the three months ended March 31, 2014 resulting in a gross gain of $0.3 million. There were no sales of securities during the three months ended March 31, 2013.

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 March 31, 2014 and December 31, 2013. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, and it is more likely than not that the Company will not have to sell the investments before recovery of their amortized cost basis, none of the securities are deemed to be other than temporarily impaired. At March 31, 2014, seven securities have been in a continuous loss position for twelve months or more. At December 31, 2013, five securities had been in a continuous loss position for twelve months or more.

10

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The “Volcker Rule” under the Dodd-Frank Act generally prohibits banks and their affiliates from engaging in proprietary trading and investing in and sponsoring a covered fund (such as a hedge fund and or private equity fund). At March 31, 2014 and December 31, 2013, the Company held four investments in senior tranches of collateralized loan obligations ("CLOs") with a fair value of $23.5 million and $23.4 million, respectively, which are included in asset-backed securities, which could be impacted by the Volcker Rule. The collateral eligibility language in one of the securities, with a fair value of $5.0 million, was amended during the fourth quarter of 2013 to comply with the new bank investment criteria under the Volcker Rule. The Company’s investments in the remaining securities, which had a net unrealized loss of $294,000 at March 31, 2014 and $274,000 at December 31, 2013, are currently prohibited under the Volcker Rule. The Company is awaiting intended document amendment strategies, if any, from the managers on these securities before determining any disposition plans for those investments. Under current Federal regulations, banks have until July 21, 2017 to conform their CLO interests to avoid the trading restrictions under the Volcker Rule. Unless the documentation is amended to avoid inclusion within the rule’s prohibitions, the Company would have to recognize other-than-temporary-impairment with respect to these securities in conformity with GAAP rules. The Company held no other security types potentially affected by the Volcker Rule at either March 31, 2014 or December 31, 2013.

11

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Investment Portfolio Gross Unrealized Losses and Fair Value

	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
March 31, 2014
Securities available-for-sale:
Residential agency pass-through securities	$	21,620	$	(304	)	$	-	$	-		$	21,620	$	(304	)
Residential collateralized mortgage obligations		59,692		(1,140	)		17,924		(560	)		77,616		(1,700	)
Commercial mortgage-backed securities		38,441		(1,990	)		23,923		(1,698	)		62,364		(3,688	)
Asset-backed securities		60,280		(2,002	)		9,842		(80	)		70,122		(2,082	)
Corporate and other securities		3,952		(9	)		-		-			3,952		(9	)
Total temporarily impaired available-for-sale securities	$	183,985	$	(5,445	)	$	51,689	$	(2,338	)	$	235,674	$	(7,783	)
Securities held-to-maturity:
Residential collateralized mortgage obligations	$	4,896	$	(14	)	$	-	$	-		$	4,896	$	(14	)
Asset-backed securities		5,727		(168	)		-		-			5,727		(168	)
Total temporarily impaired held-to-maturity securities	$	10,623	$	(182	)	$	-	$	-		$	10,623	$	(182	)
December 31, 2013
Securities available-for-sale:
Residential agency pass-through securities	$	32,674	$	(536	)	$	-	$	-		$	32,674	$	(536	)
Residential collateralized mortgage obligations		55,856		(1,687	)		18,167		(682	)		74,023		(2,369	)
Commercial mortgage-backed securities		42,391		(3,247	)		19,011		(1,747	)		61,402		(4,994	)
Asset-backed securities		56,106		(2,236	)		4,986		(57	)		61,092		(2,293	)
Corporate and other securities		3,945		(16	)		-		-			3,945		(16	)
Total temporarily impaired available-for-sale securities	$	190,972	$	(7,722	)	$	42,164	$	(2,486	)	$	233,136	$	(10,208	)
Securities held-to-maturity:
Residential agency pass-through securities	$	40,733	$	(392	)	$	-	$	-		$	40,733	$	(392	)
Residential collateralized mortgage obligations		4,908		(74	)		-		-			4,908		(74	)
Asset-backed securities		5,693		(172	)		-		-			5,693		(172	)
Total temporarily impaired held-to-maturity securities	$	51,334	$	(638	)	$	-	$	-		$	51,334	$	(638	)

The Company has nonmarketable equity securities consisting of investments in several financial institutions and the investments in CSBC Statutory Trust I and Community Capital Corporation Statutory Trust I. These investments totaled $5.2 million at March 31, 2014 and $5.9 million December 31, 2013. Included in these amounts at March 31, 2014 and December 31, 2013 was $4.2 million and $4.9 million, respectively, of Federal Home Loan Bank (“FHLB”) stock. All nonmarketable equity securities were evaluated for impairment as of March 31, 2014 and December 31, 2013. The following factors have been considered in determining the carrying amount of FHLB stock: (1) management’s current belief that the Company has sufficient liquidity to meet all operational needs in the foreseeable future and would not need to dispose of the stock below recorded amounts, (2) management’s belief that the FHLB has the ability to absorb economic losses given the expectation that the FHLB has a high degree of government support and (3) redemptions and purchases of the stock are at the discretion of the FHLB. At March 31, 2014 and December 31, 2013, the Company estimated that the fair values of nonmarketable equity securities equaled or exceeded the cost of each of these investments, and, therefore, the investments were not impaired.

12

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:

	March 31, 2014						December 31, 2013
	PCI loans		All other loans		Total		PCI loans		All other loans		Total
Commercial:
Commercial and industrial	$	5,160	$	119,858	$	125,018	$	5,737	$	116,663	$	122,400
Commercial real estate (CRE) - owner-occupied		31,959		233,169		265,128		35,760		231,821		267,581
CRE - investor income producing		52,045		357,853		409,898		56,996		325,191		382,187
AC&D - 1-4 family construction		-		19,267		19,267		-		19,959		19,959
AC&D - lots, land & development		20,292		40,185		60,477		22,699		42,890		65,589
AC&D - CRE		118		42,341		42,459		121		56,638		56,759
Other commercial		648		3,926		4,574		137		3,712		3,849
Total commercial loans		110,222		816,599		926,821		121,450		796,874		918,324
Consumer:
Residential mortgage		30,444		141,934		172,378		32,826		140,550		173,376
Home equity lines of credit (HELOC)		1,375		141,748		143,123		1,402		142,352		143,754
Residential construction		6,366		33,432		39,798		6,920		33,901		40,821
Other loans to individuals		1,096		18,569		19,665		1,189		17,606		18,795
Total consumer loans		39,281		335,683		374,964		42,337		334,409		376,746
Total loans		149,503		1,152,282		1,301,785		163,787		1,131,283		1,295,070
Deferred costs		-		1,041		1,041		-		738		738
Total loans, net of deferred costs	$	149,503	$	1,153,323	$	1,302,826	$	163,787	$	1,132,021	$	1,295,808

Included in the March 31, 2014 and December 31, 2013 loan totals are $65.2 million and $71.1 million, respectively, of covered loans pursuant to FDIC loss share agreements. Of these amounts, at March 31, 2014, approximately $62.2 million is included in PCI loans and $3.0 million is included in all other loans. At December 31, 2013, $68.0 million is included in PCI loans and $3.2 million is included in all other loans.

At both March 31, 2014 and December 31, 2013, the Company had sold participations in loans aggregating $3.2 million and $3.3 million, respectively, to other financial institutions on a nonrecourse basis. 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 does not service residential mortgage loans for the benefit of others.

Loans sold with limited recourse are 1-4 family residential mortgages originated by the Company and sold to various other financial institutions. Various recourse agreements exist, ranging from thirty days to twelve months. The Company’s exposure to credit loss in the event of nonperformance by the other party to the loan is represented by the contractual notional amount of the loan. Since none of the loans has ever been returned to the Company, the amount of total loans sold with limited recourse does not necessarily represent future cash requirements. The Company uses the same credit policies in making loans held for sale as it does  for on-balance sheet instruments. Total loans sold with limited recourse in the three months ended March 31, 2014 were $8.3 million. Total loans sold with limited recourse in the three months ended March 31, 2013 were $30.6 million.

13

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

At March 31, 2014, the carrying value of loans pledged as collateral to the FHLB on borrowings and to the Federal Reserve totaled $466.1 million. At December 31, 2013, the carrying value of loans pledged as collateral to the FHLB and the Federal Reserve totaled $472.4 million.

Concentrations of Credit - Loans are primarily made within the Company’s operating footprint of North Carolina, South Carolina, Virginia and Georgia. Real estate loans can be affected by the condition of the local real estate market. Commercial and industrial loans can be affected by the local economic conditions. The commercial loan portfolio has concentrations in business loans secured by real estate and real estate development loans. Primary concentrations in the consumer loan portfolio include home equity lines of credit and residential mortgages. At March 31, 2014 and December 31, 2013, the Company had no loans outstanding with foreign entities.

14

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 months ended March 31, 2014.

	Commercial and industrial			CRE - owner-occupied		CRE - investor income producing			AC&D		AC&D - 1-4 family construction			AC&D - lots, land & development			AC&D - CRE			Other commercial		Residential mortgage			HELOC			Residential construction			Other loans to individuals			Total
For the three months ended March 31, 2014
Allowance for Loan Losses:
Balance, beginning of period	$	1,491		$	399	$	1,797		$	-	$	839		$	1,751		$	299		$	25	$	358		$	1,050		$	390		$	72		$	8,471
Provision for loan losses		(87	)		30		(50	)		-		(85	)		(979	)		(77	)		1		216			413			(12	)		14			(616	)
Charge-offs		-			-		(273	)		-		-			(4	)		-			-		(11	)		(66	)		(7	)		(10	)		(371	)
Recoveries		143			2		76			-		-			812			-			-		10			11			11			4			1,069
Net charge-offs		143			2		(197	)		-		-			808			-			-		(1	)		(55	)		4			(6	)		698
Balance, end of period	$	1,547		$	431	$	1,550			-	$	754		$	1,580		$	222		$	26	$	573		$	1,408		$	382		$	80		$	8,553
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-		$	-	$	360		$	-	$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	360
PCI Impairment charge-offs		-			-		(5	)		-		-			-			-			-		-			(144	)		-			-			(149	)
PCI impairment recoveries		-			-		-			-		-			-			-			-		-			-			-			-			-
Net PCI impairment charge-offs		-			-		(5	)		-		-			-			-			-		-			(144	)		-			-			(149	)
PCI provision for loan losses		-			-		163			-		-			-			-			-		-			145			1			3			312
Benefit attributable to FDIC loss share agreements		-			-		287			-		-			-			-			-		-			-			-			-			287
Total provision for loan losses charged to operations		-			-		450			-		-			-			-			-		-			145			1			3			599
Provision for loan losses recorded through FDIC loss share receivable		-			-		(287	)		-											-		-			-			-			-			(287	)
Balance, end of period	$	-		$	-	$	518		$	-	$	-		$	-		$	-		$	-	$	-		$	1		$	1		$	3		$	523
Total Allowance for Loan Losses	$	1,547		$	431	$	2,068		$	-	$	754		$	1,580		$	222		$	26	$	573		$	1,409		$	383		$	83		$	9,076

15

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			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 March 31, 2013
Allowance for Loan Losses:
Balance, beginning of period	$	849		$	496		$	1,102		$	4,157		$	-	$	-	$	-	$	8		$	454		$	1,463		$	1,046		$	49		$	9,624
Provision for loan losses		795			(219	)		255			(238	)		-		-		-		(9	)		(122	)		35			(649	)		25			(127	)
Charge-offs		(13	)		-			(253	)		-			-		-		-		-			(2	)		(82	)		-			(16	)		(366	)
Recoveries		45			45			131			299			-		-		-		7			19			24			53			8			631
Net charge-offs		32			45			(122	)		299			-		-		-		7			17			(58	)		53			(8	)		265
Balance, end of period	$	1,676		$	322		$	1,235		$	4,218		$	-	$	-	$	-	$	6		$	349		$	1,440		$	450		$	66		$	9,762
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	225		$	-		$	-		$	542		$	-	$	-	$	-	$	-		$	200		$	-		$	-		$	-		$	967
PCI provision for loan losses		(225	)		-			16			(143	)		-		-		-		386			118			3			245			36			436
PCI impairment charge-off		-			-			(16	)		(14	)		-		-		-		(386	)		-			-			-			-			(416	)
Balance, end of period	$	-		$	-		$	-		$	385		$	-	$	-	$	-	$	-		$	318		$	3		$	245		$	36		$	987
Total Allowance for Loan Losses	$	1,676		$	322		$	1,235		$	4,603		$	-	$	-	$	-	$	6		$	667		$	1,443		$	695		$	102		$	10,749

16

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 March 31, 2014 and December 31, 2013.

	Commercial and industrial		CRE - owner-occupied		CRE - investor income producing		AC&D		AC&D - 1-4 family construction		AC&D - lots, land & development		AC&D - CRE		Other commercial		Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total
At March 31, 2014
Allowance for Loan Losses:
Individually evaluated for impairment	$	24	$	24	$	12	$	-	$	16	$	8	$	-	$	19	$	208	$	397	$	5	$	-	$	713
Collectively evaluated for impairment		1,523		407		1,538		-		738		1,572		222		7		365		1,011		377		80		7,840
		1,547		431		1,550		-		754		1,580		222		26		573		1,408		382		80		8,553
Purchased credit-impaired		-		-		518		-		-		-		-		-		-		1		1		3		523
Total	$	1,547	$	431	$	2,068	$	-	$	754	$	1,580	$	222	$	26	$	573	$	1,409	$	383	$	83	$	9,076
Recorded Investment in Loans:
Individually evaluated for impairment	$	815	$	3,028	$	1,019	$	-	$	95	$	1,157	$	-	$	261	$	4,262	$	3,011	$	51	$	56	$	13,755
Collectively evaluated for impairment		119,043		230,141		356,834		-		19,172		39,028		42,341		3,665		137,672		138,737		33,381		18,513		1,138,527
		119,858		233,169		357,853		-		19,267		40,185		42,341		3,926		141,934		141,748		33,432		18,569		1,152,282
Purchased credit-impaired		5,160		31,959		52,045		-		-		20,292		118		648		30,444		1,375		6,366		1,096		149,503
Total	$	125,018	$	265,128	$	409,898	$	-	$	19,267	$	60,477	$	42,459	$	4,574	$	172,378	$	143,123	$	39,798	$	19,665	$	1,301,785
At December 31, 2013
Allowance for Loan Losses:
Individually evaluated for impairment	$	14	$	14	$	527	$	-	$	-	$	-	$	-	$	18	$	167	$	137	$	7	$	-	$	884
Collectively evaluated for impairment		1,477		385		1,270		-		839		1,751		299		7		191		913		383		72		7,587
		1,491		399		1,797		-		839		1,751		299		25		358		1,050		390		72		8,471
Purchased credit-impaired		-		-		360		-		-		-		-		-		-		-		-		-		360
Total	$	1,491	$	399	$	2,157	$	-	$	839	$	1,751	$	299	$	25	$	358	$	1,050	$	390	$	72	$	8,831
Recorded Investment in Loans:
Individually evaluated for impairment	$	265	$	1,902	$	3,216	$	-	$	-	$	1,888	$	-	$	262	$	4,513	$	3,014	$	66	$	60	$	15,186
Collectively evaluated for impairment		116,398		229,919		321,975		-		19,959		41,002		56,638		3,450		136,037		139,338		33,835		17,546		1,116,097
		116,663		231,821		325,191		-		19,959		42,890		56,638		3,712		140,550		142,352		33,901		17,606		1,131,283
Purchased credit-impaired		5,737		35,760		56,996		-		-		22,699		121		137		32,826		1,402		6,920		1,189		163,787
Total	$	122,400	$	267,581	$	382,187	$	-	$	19,959	$	65,589	$	56,759	$	3,849	$	173,376	$	143,754	$	40,821	$	18,795	$	1,295,070

17

PARK STERLING CORPORATION\

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

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

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

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

The historical loss experience of the Company is collected quarterly by evaluating internal loss data. The estimated historical loss rates are grouped by loan product type. The Company utilizes average historical losses to represent management’s estimate of losses inherent in a particular portfolio. The historical look back period is estimated by loan type, and the Company applies the appropriate historical loss period which best reflects the inherent loss in the applicable portfolio considering prevailing market conditions. A minimum reserve is utilized when the Company has insufficient internal loss history or when internal loss history falls below the minimum reserve percentage. Minimums are determined by analyzing Federal Reserve Bank charge-off data for all insured federal- and state-chartered commercial banks.

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

18

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

	March 31,		December 31,
	2014		2013
Look back periods (in calendar quarters)
Commercial:
Commercial and industrial		15		15
CRE - owner-occupied	Minimum		Minimum
CRE - investor income producing		15		15
AC&D - 1-4 family construction		15		15
AC&D - lots, land, & development		15		15
AC&D - CRE	Minimum		Minimum
Other commercial	Minimum		Minimum
Residential mortgage		15		12
HELOC		15		12
Residential construction		13		12
Other loans to individuals	Minimum		Minimum

The changes in the look back periods noted above were made to provide a better estimate of the loss inherent in the portfolio for each loan category and to reflect the availability of loss history. The Company also performs a quantitative calculation on the acquired purchased performing loan portfolio. There is no allowance for loan losses established at the acquisition date for purchased performing loans. The historical loss experience discussed above is applied to the acquired purchased performing loan portfolio and the result is compared to the remaining fair value mark on this portfolio. A provision for loan losses is recorded for any further deterioration in these loans subsequent to the acquisition. At March 31, 2014 and December 31, 2013, this analysis did not indicate a need for a provision for loan losses for the acquired purchased performing portfolio. The remaining mark on the acquired purchased performing loan portfolio was $4.1 million and $4.5 million at March 31, 2014 and December 31, 2013, respectively.

3)         Qualitative Reserve Component. Qualitative reserves represent an estimate of the amount for which it is probable that environmental or other relevant factors will cause the aforementioned loss contingency estimate to differ from the Company’s historical loss experience or other assumptions. The Company focuses directly on five specific environmental factors. These five factors include portfolio trends, portfolio concentrations, economic and market conditions, changes in lending practices and other factors. Management believes these refinements simplify application of the qualitative component of the allowance methodology. 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 five environmental factors for inclusion in the allowance methodology are as follows:

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

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

19

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

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

v. Other factors, which is intended to capture environmental factors not specifically identified above.

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

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

This analysis resulted in net impairment for the three months ended March 31, 2014 of $312 thousand. The net impairment of $360 thousand as of December 31, 2013, which impacted a pool comprised of CRE-investor income producing loans was reversed during 2014 as estimated cash flows in those impacted pools improved or projected losses were fully recognized. During the three months ended March 31, 2014, new impairment of $672 thousand was recorded; approximately $523 thousand of this impairment is attributable to covered loans under the FDIC loss share agreements. These covered loan impairments were a function of an increase in expected losses and as a result, the FDIC indemnification asset was increased. See Note 6 – FDIC Loss Share Agreements for further discussion. A full breakdown of the net impairment or recovery is detailed in the allowance by segment table above for the three months ended March 31, 2014 and 2013.

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

20

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

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 portfolio segment 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.

21

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

	As of March 31, 2014
	Commercial and industrial		CRE - owner-occupied		CRE - investor income producing		AC&D - 1-4 family construction		AC&D - lots, land & development		AC&D - CRE		Other commercial		Total Commercial
Pass	$	122,427	$	256,902	$	403,839	$	19,172	$	56,390	$	42,459	$	4,313	$	905,502
Special mention		1,419		6,115		3,954		-		1,949		-		149		13,586
Classified		1,172		2,111		2,105		95		2,138		-		112		7,733
Total	$	125,018	$	265,128	$	409,898	$	19,267	$	60,477	$	42,459	$	4,574	$	926,821

	Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total Consumer
Pass	$	168,513	$	136,558	$	38,875	$	19,203	$	363,149
Special mention		2,053		3,327		708		458		6,546
Classified		1,812		3,238		215		4		5,269
Total	$	172,378	$	143,123	$	39,798	$	19,665	$	374,964
Total Loans									$	1,301,785

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

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

22

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

	30-59 Days Past Due		60-89 Days Past Due		Past Due 90 Days or More		PCI Loans		Current		Total Loans
As of March 31, 2014
Commercial:
Commercial and industrial	$	65	$	138	$	118	$	5,160	$	119,537	$	125,018
CRE - owner-occupied		-		38		176		31,959		232,955		265,128
CRE - investor income producing		19		12		977		52,045		356,845		409,898
AC&D - 1-4 family construction		-		-		-		-		19,267		19,267
AC&D - lots, land & development		-		-		48		20,292		40,137		60,477
AC&D - CRE		-		-		-		118		42,341		42,459
Other commercial		-		-		112		648		3,814		4,574
Total commercial loans		84		188		1,431		110,222		814,896		926,821
Consumer:
Residential mortgage		31		-		3		30,444		141,900		172,378
HELOC		268		76		1,148		1,375		140,256		143,123
Residential construction		-		454		94		6,366		32,884		39,798
Other loans to individuals		10		40		19		1,096		18,500		19,665
Total consumer loans		309		570		1,264		39,281		333,540		374,964
Total loans	$	393	$	758	$	2,695	$	149,503	$	1,148,436	$	1,301,785
As of December 31, 2013
Commercial:
Commercial and industrial	$	96	$	52	$	149	$	5,737	$	116,366	$	122,400
CRE - owner-occupied		418		-		209		35,760		231,194		267,581
CRE - investor income producing		655		-		3,161		56,996		321,375		382,187
AC&D - 1-4 family construction		-		-		-		-		19,959		19,959
AC&D - lots, land & development		48		-		292		22,699		42,550		65,589
AC&D - CRE		-		-		-		121		56,638		56,759
Other commercial		-		112		-		137		3,600		3,849
Total commercial loans		1,217		164		3,811		121,450		791,682		918,324
Consumer:
Residential mortgage		-		32		1,340		32,826		139,178		173,376
HELOC		248		160		698		1,402		141,246		143,754
Residential construction		25		-		66		6,920		33,810		40,821
Other loans to individuals		14		11		-		1,189		17,581		18,795
Total consumer loans		287		203		2,104		42,337		331,815		376,746
Total loans	$	1,504	$	367	$	5,915	$	163,787	$	1,123,497	$	1,295,070

23

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Impaired Loans - Allclasses of loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect allamounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impaired loans may include all classesofnonaccrual loans and loans modified in a troubled debt restructuring (“TDR”). If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the presentvalue of estimated future cash flows using the rate implicit in the original loan agreement or at the fair value of collateral if repayment is expected solely from the collateral.

Additionally, a portion of the Company’s qualitative factors accounts for potential impairment on loans generally less than $150 thousand. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

The Company’s quarterly cash flow analyses of PCI loan pools indicated net impairment of $312 thousand during the quarter ended March 31, 2014. The net impairment of $360 thousand as of December 31, 2013, which impacted a single covered pool comprised of CRE-investor income producing loans, was reversed during 2014. The impairment of $672 thousand recognized during the first quarter of 2014 was in a single consumer real estate loan pool. During the first quarter of 2013, the Company’s quarterly cash flow analysis indicated that two of the Company’s PCI loan pools, both real estate pools, had net impairment of $436 thousand. These amounts are not included in the tables below.

24

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 March 31, 2014 and December 31, 2013:

	March 31, 2014						December 31, 2013
			Unpaid		Related				Unpaid		Related
	Recorded		Principal		Allowance For		Recorded		Principal		Allowance For
	Investment		Balance		Loan Losses		Investment		Balance		Loan Losses
Impaired Loans with No Related Allowance Recorded:
Commercial:
Commercial and industrial	$	668	$	958	$	-	$	183	$	473	$	-
CRE - owner-occupied		2,881		3,008		-		1,815		1,955		-
CRE - investor income producing		950		1,710		-		30		47		-
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		1,109		2,752				1,888		4,475
AC&D - CRE		-		-				-		-
Other commercial		149		165		-		150		167		-
Total commercial loans		5,757		8,593		-		4,066		7,117		-
Consumer:
Residential mortgage		2,700		3,775		-		3,080		3,926		-
HELOC		1,352		1,841		-		2,478		2,855		-
Residential construction		18		39		-		26		39		-
Other loans to individuals		55		55		-		58		62		-
Total consumer loans		4,125		5,710		-		5,642		6,882		-
Total impaired loans with no related allowance recorded	$	9,882	$	14,303	$	-	$	9,708	$	13,999	$	-
Impaired Loans with an Allowance Recorded:
Commercial:
Commercial and industrial	$	147	$	156	$	24	$	82	$	90	$	14
CRE - owner-occupied		147		151		24		87		88		14
CRE - investor income producing		69		75		12		3,186		3,673		527
AC&D - 1-4 family construction		95		94		16		-		-		-
AC&D - lots, land & development		48		49		8		-		-		-
AC&D - CRE		-		-		-		-		-		-
Other commercial		112		112		19		112		112		18
Total commercial loans		618		637		103		3,467		3,963		573
Consumer:
Residential mortgage		1,562		1,613		208		1,433		1,485		167
HELOC		1,659		1,713		397		536		587		137
Residential construction		33		36		5		40		42		7
Other loans to individuals		1		8		-		2		4		-
Total consumer loans		3,255		3,370		610		2,011		2,118		311
Total impaired loans with an allowance recorded	$	3,873	$	4,007	$	713	$	5,478	$	6,081	$	884
Total Impaired Loans:
Commercial:
Commercial and industrial	$	815	$	1,114	$	24	$	265	$	563	$	14
CRE - owner-occupied		3,028		3,159		24		1,902		2,043		14
CRE - investor income producing		1,019		1,785		12		3,216		3,720		527
AC&D - 1-4 family construction		95		94		16		-		-		-
AC&D - lots, land & development		1,157		2,801		8		1,888		4,475		-
AC&D - CRE		-		-		-		-		-		-
Other commercial		261		277		19		262		279		18
Total commercial loans		6,375		9,230		103		7,533		11,080		573
Consumer:
Residential mortgage		4,262		5,388		208		4,513		5,411		167
HELOC		3,011		3,554		397		3,014		3,442		137
Residential construction		51		75		5		66		81		7
Other loans to individuals		56		63		-		60		66		-
Total consumer loans		7,380		9,080		610		7,653		9,000		311
Total impaired loans	$	13,755	$	18,310	$	713	$	15,186	$	20,080	$	884

25

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The average recorded investment and interest income recognized on impaired loans, by class, for the three months ended March 31, 2014 and March 31, 2013 are shown in the table below.

	Three Months Ended March 31,
	2014				2013
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
Impaired Loans with No Related Allowance Recorded:
Commercial:
Commercial and industrial	$	334	$	8	$	536	$	-
CRE - owner-occupied		2,217		31		1,361		4
CRE - investor income producing		322		10		2,673		-
AC&D		-		-		6,726		18
AC&D - 1-4 family construction		-		-		-		-
AC&D - lots, land & development		2,229		44		-		-
AC&D - CRE		-		-		-		-
Other commercial		154		4		131		-
Total commercial loans		5,256		97		11,427		22
Consumer:
Residential mortgage		2,778		15		1,341		18
Home equity lines of credit		1,499		6		1,034		-
Residential construction		9		-		78		-
Other loans to individuals		61		1		59		1
Total consumer loans		4,347		22		2,512		19
Total impaired loans with no related allowance recorded	$	9,603	$	119	$	13,939	$	41
Impaired Loans with an Allowance Recorded:
Commercial:
Commercial and industrial	$	470	$	-	$	436	$	-
CRE - owner-occupied		77		2		12		-
CRE - investor income producing		2,843		-		1,411		36
AC&D		-		-		609		-
AC&D - 1-4 family construction		19		2		-		-
AC&D - lots, land & development		60				-		-
AC&D - CRE		-				-		-
Other commercial		45		-		-		-
Total commercial loans		3,514		4		2,468		36
Consumer:
Residential mortgage		1,352		9		1,134		9
Home equity lines of credit		1,151		2		431		-
Residential construction		30		-		-		-
Other loans to individuals		2		-		-		-
Total consumer loans		2,535		11		1,565		9
Total impaired loans with an allowance recorded	$	6,049	$	15	$	4,033	$	45
Total Impaired Loans:
Commercial:
Commercial and industrial	$	804	$	8	$	972	$	-
CRE - owner-occupied		2,294		33		1,373		4
CRE - investor income producing		3,165		10		4,084		36
AC&D		-		-		7,335		18
AC&D - 1-4 family construction		19		2		-		-
AC&D - lots, land & development		2,289		44		-		-
AC&D - CRE		-		-		-		-
Other commercial		199		4		131		-
Total commercial loans		8,770		101		13,895		58
Consumer:
Residential mortgage		4,130		24		2,475		27
Home equity lines of credit		2,650		8		1,465		-
Residential construction		39		-		78		-
Other loans to individuals		63		1		59		1
Total consumer loans		6,882		33		4,077		28
Total impaired loans	$	15,652	$	134	$	17,972	$	86

26

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

During the three months ended March 31, 2014 and 2013, the Company recognized $134 thousand and $86 thousand, respectively, of interest income with respect to impaired loans, specifically accruing TDRs, within the period the loans were impaired.

Nonaccrual and Past Due Loans - It is the general policy of the Company to place a loan on nonaccrual status when there is probable loss or when there is reasonable doubt that all principal will be collected, or when it is over 90 days past due. At March 31, 2014, there was $493 thousand in loans past due 90 days or more and accruing interest. At December 31, 2013, there was $17 thousand in loans past due 90 days or more and accruing interest. These loans were considered fully collectible at March 31, 2014 and December 31, 2013. The recorded investment in nonaccrual loans at March 31, 2014 and December 31, 2013 follows:

	March 31,		December 31,
	2014		2013
Commercial:
Commercial and industrial	$	250	$	200
CRE - owner-occupied		176		209
CRE - investor income producing		528		3,192
AC&D - 1-4 family construction		-		-
AC&D - lots, land & development		48		292
AC&D - CRE		-		-
Other commercial		112		112
Total commercial loans		1,114		4,005
Consumer:
Residential mortgage		1,645		2,007
HELOC		2,281		2,348
Residential construction		51		66
Other loans to individuals		1		2
Total consumer loans		3,978		4,423
Total nonaccrual loans	$	5,092	$	8,428

Purchased Credit-Impaired Loans – PCI loans had an unpaid principal balance of $180.1 million and $197.0 million and a carrying value of $149.5 million and $163.8 million at March 31, 2014 and December 31, 2013, respectively. PCI loans represented 7.5% and 8.4% of total assets at March 31, 2014 and December 31, 2013, respectively. Determining the fair value of the PCI loans at the time of acquisition required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called the accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and is called the nonaccretable difference. In accordance with GAAP, there was no carryover of previously established allowance for loan losses from acquired companies.

27

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 three months ended March 31, 2014 and 2013 follows:

	Three Months Ended March 31,
	2014			2013
Accretable yield, beginning of period	$	39,249		$	42,734
Interest income		(3,692	)		(3,575	)
Reclassification of nonaccretable difference due to improvement in expected cash flows		4,504			4,693
Other changes, net		1,023			1,716
Accretable yield, end of period	$	41,084		$	45,568

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

The Company had allocated $333 thousand and $565 thousand, respectively, of specific reserves to customers whose loan terms have been modified in a TDR as of March 31, 2014 and December 31, 2013. As of March 31, 2014, the Company had 11 TDR loans totaling $5.0 million, of which $1.8 million are nonaccrual loans. As of December 31, 2013, the Company had 11 TDR loans totaling $8.2 million, of which $4.4 million are nonaccrual loans.

For the three months ended March 31, 2014 and 2013, the following tables represent a breakdown of the types of concessions made by loan class.

	Three months ended March 31, 2014
	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Below market interest rate
Other Commercial		1	$	165	$	165
HELOC		2		1,549		1,549
Total		3	$	1,714	$	1,714

	Three months ended March 31, 2013
	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Below market interest rate
CRE-investor income producing		1	$	3,610	$	3,610
Residential mortgage		1		43		43
Total		2	$	3,653	$	3,653

28

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 that were modified as TDRs within the 12 months ended March 31, 2014 or 2013 and for which there was a payment default during the three months ended March 31, 2014 or 2013.

The Company does not deem a TDR to be successful until it has been re-established as an accruing loan. The following table presents the successes and failures of the types of modifications indicated within the 12 months ended March 31, 2014 and 2013:

	Twelve Months Ended March 31, 2014
	Paid in full				Paying as restructured				Foreclosure/Default
	Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment
Below market interest rate		-	$	-		3	$	2,037		-	$	-
Extended payment terms		-		-		8		2,954		-	$	-
Total		-	$	-		11	$	4,991		-	$	-

	Twelve Months Ended March 31, 2013
	Paid in full				Paying as restructured				Foreclosure/Default
	Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment
Below market interest rate		-	$	-		2	$	3,653		-	$	-
Total		-	$	-		2	$	3,653		-	$	-

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

	Three Months Ended March 31,
	2014			2013
Beginning balance	$	17,247		$	4,184
Disbursements		62			40
Repayments		(2,408	)		(1,565	)
Ending balance	$	14,901		$	2,659

At March 31, 2014 and December 31, 2013, the Company had pre-approved but unused lines of credit totaling $2.7 million and $3.0 million, respectively, to related parties.

29

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 6 – FDIC Loss Share Agreements

In connection with the Citizens South Banking Corporation (“Citizens South”) acquisition, the Bank assumed two purchase and assumption agreements with the Federal Deposit Insurance Corporation (“FDIC”) that cover approximately $65.2 million and $71.1 million of covered loans as of March 31, 2014 and December 31, 2013, respectively, and $6.7 million and $5.1 million of covered other real estate owned (“OREO”) as of March 31, 2014 and December 31, 2013, respectively. Citizens South acquired these assets in prior transactions with the FDIC.

Within the first purchase and assumption agreement are two loss share agreements that originated in March 2010, related to Citizen South’s acquisition of Bank of Hiawassee, a Georgia state-chartered bank headquartered in Hiawassee, Georgia. Under these loss share agreements, the FDIC will cover 80% of net loan losses up to $102 million and 95% of net loan losses that exceed $102 million. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans, five years for losses on all other loans and eight years for recoveries on all other loans. At March 31, 2014 and December 31, 2013, the Bank recorded an estimated receivable from the FDIC in the amount of $6.5 million and $6.6 million, respectively, related to these loss share agreements.

Within the second purchase and assumption agreement are two loss share agreements that originated in April 2011, related to Citizens South’s acquisition of New Horizons Bank, a Georgia state-chartered bank headquartered in East Ellijay, Georgia. The first loss share agreement covers certain residential loans and OREO for a period of ten years. The other loss share agreement covers all remaining covered assets for a period of five years. Pursuant to the terms of these loss share agreements, the FDIC is obligated to reimburse the Bank for 80% of all eligible losses, which begins with the first dollar of loss occurred, and certain collection and disposition expenses with respect to covered assets. The Bank has a corresponding obligation to reimburse the FDIC for 80% of eligible recoveries with respect to covered assets for a period of ten years for residential properties and eight years for all other covered assets. At March 31, 2014 and December 31, 2013, the Bank recorded an estimated receivable from the FDIC in the amount of $2.7 million and $3.4 million, respectively, related to these loss share agreements.

The following table provides changes in the estimated receivable from the FDIC for the three months ended March 31, 2014 and 2013:

	March 31,
	2014			2013
Balance, beginning of period	$	10,025		$	18,697
Decrease in expected losses on loans		(287	)		-
Additional losses to OREO		93			201
Reimbursable expenses (income)		263			(178	)
(Amortization) accretion discounts and premiums, net		(253	)		35
Reimbursements from the FDIC		(632	)		(3,415	)
Balance, end of period	$	9,209		$	15,340

The estimated receivable from the FDIC is measured separately from the related covered assets and is recorded at carrying value. At March 31, 2014 and December 31, 2013, the projected cash flows related to the FDIC receivable for losses on covered loans and assets were approximately $8.1 million and $11.5 million, respectively.

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 March 31, 2014 and December 31, 2013, the true-up amount was estimated to be approximately $5.2 million and $5.0 million, respectively, at the end of the loss share agreements. These amounts are recorded in other liabilities on the balance sheet. The actual payment will be determined at the end of the term of the loss sharing agreements and is based on the negative bid, expected losses, intrinsic loss estimate, and assets covered under the loss share agreements.

30

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 $15.5 million and $14.5 million in OREO at March 31, 2014 and December 31, 2013, respectively. The portion of OREO covered under the loss share agreements with the FDIC at March 31, 2014 and December 31, 2013 totaled $6.7 million and $5.1 million, respectively.   

Transactions in OREO for the three months ended March 31, 2014 and 2013 are summarized below:

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

	March 31,		December 31,
	2014		2013
Non-covered OREO:
CRE - owner-occupied	$	524	$	591
CRE - investor income producing		2,436		2,933
AC&D - 1-4 family construction		2,707		2,811
AC&D - lots, land, & development		1,373		1,448
Other commercial		257		195
Residential mortgage		864		704
HELOC		115		124
Residential construction		598		598
OREO covered by FDIC loss share agreements		6,652		5,088
	$	15,526	$	14,492

31

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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 March 31, 2014 and December 31, 2013, the Company had a net DTA in the amount of approximately $34.2 million and $36.3 million, respectively. The decline is a function of first quarter 2014 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 that as of March 31, 2014 and December 31, 2013 that it is more likely than not that it will be able to fully realize the existing DTA and therefore considered it appropriate not to establish a DTA valuation allowance at either March 31, 2014 or December 31, 2013.

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. Potential shares that may be issued by the Company 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 reduced by the number of shares assumed to be repurchased from the issuance proceeds, using the average market price for the period of the Company's stock. Weighted-average shares for the basic and diluted EPS calculations have been reduced by the average number of unvested restricted shares.

Weighted-Average Shares for Earnings Per Share Calculation

	Three Months Ended March 31
	2014		2013
Weighted-average number of common shares outstanding excluding unvested restricted shares		43,937,034		44,010,890
Effect of dilutive stock options and unvested restricted shares		327,144		58,163
Weighted-average number of common shares and dilutive potential common shares outstanding		44,264,178		44,069,053

There were 1,933,224 outstanding options and 718,257 outstanding unvested restricted shares that were anti-dilutive for the three months ended March 31, 2014. There were 249,001 dilutive stock options and 78,142 dilutive unvested restricted shares outstanding for the three months ended March 31, 2014.

32

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

There were 3,085,827 outstanding options and 693,650 outstanding unvested restricted shares that anti-dilutive for the three-months ended March 31, 2013. There were 33,553 dilutive stock options and 24,610 dilutive unvested restricted shares outstanding for the three months ended March 31, 2013.

At March 31, 2014, 554,400 of the outstanding restricted shares had performance conditions, which will vest one-third each when the Company’s share price achieves, for 30 consecutive trading days, $8.125, $9.10 and $10.40, respectively.    

Note 10 – Preferred Stock

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

Note 11 - Commitments and Contingencies

In the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit, which are not reflected in the accompanying unaudited condensed consolidated financial statements. At March 31, 2014, we had $328.6 million of pre-approved but unused lines of credit, $4.4 million of standby letters of credit and $3.4 million of commercial letters of credit. At December 31, 2013, we had $279.5 million of pre-approved but unused lines of credit, $3.6 million of standby letters of credit and $1.9 million of commercial letters of credit. In management’s opinion, these commitments represent no more than normal lending risk to us and will be funded from normal sources of liquidity.

Note 12 - Derivative Financial Instruments and Hedging Activities

The following table presents information on the Company's swaps at March 31, 2014:

Individual Swap Information

									Floating
Original		Current							Rate
Notional		Notional		Termination	Fixed			Floating	Payer			Hedge	Type of
Amount		Amount		Date	Rate			Rate	Spread			Treatment	Hedge
$	2,555	$	2,384	10/10/15		5.50	%	USD-LIBOR-BBA		2.88	%	Yes	Fair Value
	3,595		3,184	04/27/17		5.25	%	USD-LIBOR-BBA		2.73	%	Yes	Fair Value
	3,269		3,269	04/01/19		4.45	%	USD-LIBOR-BBA		2.90	%	Yes	Fair Value
	12,500		12,500	12/31/18		1.688	%	USD-Federal Funds-H15		0.25	%	Yes	Cash Flow
	12,500		12,500	12/31/20		2.341	%	USD-Federal Funds-H15		0.25	%	Yes	Cash Flow
	25,000		25,000	12/31/20		3.104	%	USD-Federal Funds-H15		0.25	%	Yes	Cash Flow
	20,000		20,000	10/21/21		3.439	%	USD-LIBOR-BBA		0.00	%	Yes	Cash Flow
	2,600		2,600	03/15/21		4.34	%	USD-LIBOR-BBA		2.15	%	No	N/A
	489		489	03/15/21		4.64	%	USD-LIBOR-BBA		2.15	%	No	N/A
$	82,508	$	81,926

At March 31, 2014, the Company had three loan swaps accounted for as fair value hedges in accordance with ASC 815, Derivatives and Hedging. The aggregate original notional amount of these loan swaps was $9.4 million. These derivative instruments are used to protect the Company from interest rate risk caused by changes in the London Interbank Offered Rate (“LIBOR”) curve in relation to certain designated fixed rate loans. The derivative instruments are used to convert these fixed rate loans to an effective floating rate. If the LIBOR rate is below the stated fixed rate of the loan for a given period, the Company will owe the floating rate payer the notional amount times the difference between LIBOR and the stated fixed rate. If LIBOR is above the stated rate for any given period during the term of the contract, the Company will receive payments based on the notional amount times the difference between LIBOR and the stated fixed rate. These derivative instruments are carried at a fair market value of $(244) thousand and $(258) thousand at March 31, 2014 and December 31, 2013, respectively, and are included in other liabilities. The loans being hedged are also recorded at fair value. These fair value hedges had no indications of ineffectiveness for any of the periods presented. The Company recorded interest expense on these loan swaps of $35 thousand and $67 thousand in the three months ended March 31, 2014 and 2013, respectively.

33

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The Company 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 $(83) thousand and $298 thousand at March 31, 2014 and December 31, 2013, respectively, and is included in other liabilities at March 31, 2014 and other assets at December 31, 2013.

The Company entered into three interest rate swap agreements during December 2013 with an aggregate notional amount of $50.0 million. These derivative instruments are used to protect the Company from future interest rate risk related to a seven-year commitment of floating rate broker-dealer sweep accounts through a brokered deposit program. These derivative instruments are a combination of a $12.5 million forward starting, five-year interest rate swap; a $12.5 million forward starting, seven-year interest rate swap; and a $25.0 million two-year forward starting swap. Effective dates for these derivative instruments are January 2, 2014, January 2, 2014 and January 4, 2016, respectively. These instruments carry a fixed rate of 1.688% with monthly payments commencing February 3, 2014, a fixed rate of 2.341% with monthly payments commencing February 3, 2014, and a fixed rate of 3.104% with monthly payments commencing February 1, 2016, respectively. These derivative instruments are accounted for as cash flow hedges with effective changes in fair market value recorded in other comprehensive income net of tax. These derivative instruments are carried at a fair market value of $(295) thousand and $247 thousand at March 31, 2014 and December 31, 2013, respectively, and are included in other liabilities at March 31, 2014 and other assets at December 31, 2013.

To meet the needs of the Company's customers, the Company has entered into certain swap agreements to convert variable rate loans receivable into fixed rates for the customer's cash flow management needs. To offset this interest rate risk, the Company has entered into substantially identical agreements with a third party to swap these fixed rate agreements into variable rates. The interest rate swaps are used to provide fixed rate financing while managing interest rate risk and were not designated as hedges. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR, with payments being calculated on the notional amount. The interest rate swaps are settled monthly and mature on March 15, 2021. The interest rate swaps had a notional amount of $3.1 million at March 31, 2014, representing the amount of fixed-rate receivables outstanding and liabilities outstanding, and are included in other assets and other liabilities at their fair values of $216 thousand. All changes in fair value are recorded as other income within non-interest income. Fair values for interest rate swap agreements are based upon the amounts required to settle the contracts. At March 31, 2014, there was no impact to earnings as the changes in the fair value of both the fixed and variable legs of the swaps completely offset each other.

34

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 13 – Accumulated Other Comprehensive Income

Accumulated other comprehensive income included the following as of March 31, 2014 and December 31, 2013:

	March 31, 2014								December 31, 2013
	Accumulated other comprehensive income (loss)			Deferred tax expense (benefit)		Accumulated other comprehensive income (loss), net of tax			Accumulated other comprehensive income			Deferred tax expense (benefit)			Accumulated other comprehensive income, net of tax
Unrealized gains (losses) on investment securities available for sale	$	(5,098	)	$	1,907	$	(3,191	)	$	(8,177	)	$	3,032		$	(5,145	)
Unrealized gains (losses) on cash flow hedge		(378	)		143		(235	)		545			(202	)		343
Total	$	(5,476	)	$	2,050	$	(3,426	)	$	(7,632	)	$	2,830		$	(4,802	)

35

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The following table highlights changes in accumulated other comprehensive income by component for the three months ended March 31, 2014 and 2013:

March 31, 2014	Gains (losses) on cash flow hedges (1)			Unrealized gains and losses on available-for-sale securities (1)			Total
Beginning balance	$	343		$	(5,145	)	$	(4,802	)
Other comprehensive income (loss) before reclassifications		(578	)		2,126			1,548
Amounts reclassified from accumulated other comprehensive income (loss)		-			(172	)		(172	)
Net current period other comprehensive income (loss)		(578	)		1,954			1,376
Ending balance	$	(235	)	$	(3,191	)	$	(3,426	)

(1) All amounts are net of tax.

March 31, 2013	Unrealized gains on available-for-sale securities (1)
Beginning balance	$	3,198
Other comprehensive income (loss) before reclassifications		(432	)
Amounts reclassified from accumulated other comprehensive income (loss)		-
Net current period other comprehensive income (loss)		(432	)
Ending balance	$	2,766

(1) All amounts are net of tax.

March 31, 2014
Details about accumulated other comprehensive income (loss)	Amount reclassified from accumulated other comprehensive income (loss)			Affected line item in the statement where net income is presented
Unrealized gains on available for sale securities	$	(276	)	Gain on sale of securities available-for-sale
		104		Income taxes
	$	(172	)	Net income

March 31, 2013
Details about accumulated other comprehensive income (loss)	Amount reclassified from accumulated other comprehensive income (loss)		Affected line item in the statement where net income is presented
Unrealized gains on available for sale securities	$	-	Gain on sale of securities available-for-sale
		-	Income taxes
	$	-	Net income

36

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 14 - Fair Value Measurements

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

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

Investment Securities Available-for-sale and Investment Securities Held-to-Maturity - Fair value for investment securities is based on the quoted market price if such information is available. If a quoted market price is not available, fair values are based on quoted market prices of comparable instruments.

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

Loans Held for Sale - For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics.

Loans, net of allowance - The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Further adjustments are made to reflect current market conditions. There is no discount for liquidity included in the expected cash flow assumptions.

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

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

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

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

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

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

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

37

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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.

38

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 March 31, 2014 and December 31, 2013 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)
March 31, 2014:
Financial assets:
Cash and cash equivalents	$	104,846	$	104,846	$	104,846	$	-	$	-
Investment securities available-for-sale		340,215		340,215		1,847		338,368		-
Investment securities held-to-maturity		51,303		51,191		-		51,191
Nonmarketable equity securities		5,242		5,242		-		5,242		-
Loans held for sale		2,063		2,063		-		2,063		-
Loans, net of allowance		1,293,750		1,272,513		-		9,081		1,263,432
FDIC indemnification asset		9,209		9,209		-		-		9,209
Accrued interest receivable		3,972		3,972		-		3,972		-
Financial liabilities:
Deposits with no stated maturity		1,101,098		1,101,098		-		1,101,098		-
Deposits with stated maturities		536,363		536,740		-		536,740		-
Swap fair value hedge		244		244		-		244		-
Interest rate swaps		593		593		-		593		-
Borrowings		79,458		79,314		-		79,314		-
Accrued interest payable		389		389		-		389		-
December 31, 2013:
Financial assets:
Cash and cash equivalents	$	55,067	$	55,067	$	55,067	$	-	$	-
Investment securities available-for-sale		349,491		349,491		1,906		347,585		-
Investment securities held-to-maturity		51,972		51,334		-		51,334		-
Nonmarketable equity securities		5,905		5,905		-		5,905		-
Loans held for sale		2,430		2,430		-		2,430		-
Loans, net of allowance		1,286,977		1,267,349		-		5,884		1,261,465
FDIC indemnification asset		10,025		10,025		-		-		10,025
Interest rate swaps		545		545		-		545		-
Accrued interest receivable		4,222		4,222		-		4,222		-
Financial liabilities:
Deposits with no stated maturity		1,055,457		1,055,457		-		1,055,457		-
Deposits with stated maturities		544,428		545,111		-		545,111		-
Swap fair value hedge		258		258		-		258		-
Borrowings		78,048		77,899		-		77,899		-
Accrued interest payable		412		412		-		412		-

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 mortgage-backed securities (“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.

39

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Derivative Instruments - Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company uses a third party to measure the fair value on a recurring basis. The Company classifies derivative instruments held or issued for risk management purposes as Level 2. As of March 31, 2014 and December 31, 2013, the Company’s derivative instruments consist of interest rate swaps and swap fair value hedges.

Loans - Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures it for the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, discounted cash flows or a pooled probability of default and loss given default calculation. Those impaired loans not requiring a specific allowance represent loans for which the fair value exceeds the recorded investments in such loans. Impaired loans where a specific allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The Company records such impaired loans as nonrecurring Level 3.

At March 31, 2014 and December 31, 2013, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. The Company records the five loans involved in fair value hedges at fair market value on a recurring basis. The Company does not record other loans at fair value on a recurring basis.

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

Other real estate owned - OREO is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value less costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is measured due to further deterioration in the value of the OREO since initial recognition, the Company records the foreclosed asset as nonrecurring Level 3.

40

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 March 31, 2014 and December 31, 2013 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
March 31, 2014
U.S. Government agencies	$	-	$	553		$	-	$	553
Municipal securities		-		12,785			-		12,785
Residential agency pass-through securities		-		87,060			-		87,060
Residential collateralized mortgage obligations		-		101,532			-		101,532
Commercial mortgage-backed obligations		-		62,364			-		62,364
Asset-backed securities		-		70,122			-		70,122
Corporate and other securities		-		3,952			-		3,952
All other equity securities		1,847		-			-		1,847
Interest rate swaps		-		(593	)		-		(593	)
Fair value loans		-		9,081			-		9,081
Swap fair value hedge		-		(244	)		-		(244	)
December 31, 2013
U.S. Government agencies	$	-	$	558		$	-	$	558
Municipal securities		-		16,506			-		16,506
Residential agency pass-through securities		-		90,248			-		90,248
Residential collateralized mortgage obligations		-		103,349			-		103,349
Commercial mortgage-backed obligations		-		61,402			-		61,402
Asset-backed securities		-		71,077			-		71,077
Corporate and other securities		-		4,445			-		4,445
All other equity securities		1,906		-			-		1,906
Interest rate swaps		-		545			-		545
Fair value loans		-		5,884			-		5,884
Swap fair value hedge		-		(258	)		-		(258	)

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

At December 31, 2013, the Company transferred its corporate debt security investment from Level 3 to Level 2. In December 2013, the Company received notice that this corporate debt security would be satisfied at its book value in January 2014. The full book value of this security was received on January 31, 2014. At March 31, 2014, the Company had no Level 3 assets measured at fair value on a recurring basis.

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.

41

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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 March 31, 2014 and December 31, 2013:

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
March 31, 2014
OREO	$	-	$	-	$	3,519	$	3,519
Impaired loans:
Commercial and industrial		-		-		55		55
CRE - owner-occupied		-		-		57		57
CRE - investor income producing		-		-		33		33
AC&D - 1-4 family construction		-		-		80		80
AC&D - lots, land & development		-		-		40		40
Residential mortgage		-		-		167		167
HELOC		-		-		1,020		1,020
December 31, 2013
OREO	$	-	$	-	$	9,085	$	9,085
Impaired loans:
Commercial and industrial		-		-		69		69
CRE - owner-occupied		-		-		73		73
CRE - investor income producing		-		-		2,659		2,659
Other commercial		-		-		93		93
Residential mortgage		-		-		510		510
HELOC		-		-		184		184
Residential construction		-		-		34		34
Other loans to individuals		-		-		1		1

42

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 March 31, 2014.

	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs		Weighted Average Discount
OREO	$	3,519	Appraisals	Discount to reflect current market conditions		0% - 55%		24.21	%
Impaired loans		34	Discounted cash flows	Percent of total contractual cash flows not expected to be collected		0% - 50%		9.77	%
		460	Probability of default model	Discount to reflect probability and loss given default		0% - 100%		12.11	%
		958	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability		0% - 60%		18.58	%
	$	4,971

In accordance with accounting for foreclosed property, the carrying value of OREO is periodically reviewed and written down to fair value and any loss is included in earnings. During the three months ended March 31, 2014, OREO with a carrying value of $0.9 million was written down by $0.1 million to $0.8 million. During the three months ended March 31, 2013, OREO with a carrying value of $4.1 million was written down by $0.2 million to $3.9 million.

There were no transfers between valuation levels for any accounts for the three months ended March 31, 2014 and 2013. If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period that the accounts are valued.

43

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 15 – Shareholders’ Equity

Share-Based Plans

The Company maintains share-based plans for directors and employees. During 2010, the Board of Directors of the Bank adopted and shareholders approved the Park Sterling Bank 2010 Stock Option Plan for Directors and the Park Sterling Bank 2010 Employee Stock Option Plan (the “2010 Plans”), which provided for an aggregate of 1,859,550 shares of Common Stock reserved for the granting of options. The 2010 Plans were substantially similar to the 2006 option plans for directors and employees, which provided for an aggregate of 990,000 of shares of Common Stock reserved for options. Upon effectiveness of the holding company reorganization, the Company assumed all outstanding options under the 2010 Plans and the 2006 plans, and the Company’s Common Stock was substituted as the stock issuable upon the exercise of options under these plans. As a result, there will be no further awards under the 2010 Plans.

Also during 2010, the Board of Directors of the Company adopted and shareholders approved the Park Sterling Corporation 2010 Long-Term Incentive Plan for directors and employees ( the “LTIP”), which was effective upon the holding company reorganization and replaced the 2010 Plans. The LTIP provides for an aggregate of 1,016,400 of shares of Common Stock reserved for issuance to employees and directors in connection with stock options, restricted stock awards, and other stock-based awards. At March 31, 2014, there were options to purchase 1,996,779 shares of Common Stock outstanding and 27,493 shares remaining available for future grants under the LTIP.

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

44

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Under the 2008 Citizens South Plan, the Company may grant future non-qualified stock options and stock appreciation rights (“SARs”) to eligible employees and directors of, or service providers to, the Company or the Bank who were not employees or directors of or service providers to the Company or the Bank at the effective time of the merger. Stock options and SARS are evidenced by an award agreement that specifies, as applicable, the number of shares, date of grant, exercise price, vesting period and expiration date, and other information. Awards under the 2008 Citizens South Plan have an exercise price at least equal to the fair market value of the Common Stock on the grant date, cannot be exercised more than 10 years after the grant date and generally expire or are forfeited upon termination of employment prior to the end of the award term, except in limited circumstances such as death, disability, retirement or change in control. No awards may be granted under the 2008 Citizens South Plan after May 2018. At March 31, 2014, there were options to purchase 171,761 shares of Common Stock outstanding and 101,353 shares remaining available for future grants under the 2008 Citizens South Plan.

The 2003 Citizens South Plan and the 1999 Citizens South Plan are no longer active plans and no future awards can be granted thereunder. At March 31, 2014, there were options to purchase 12,431 shares of Common Stock outstanding under the 2003 Citizens South Plan, and there were options to purchase 1,254 shares of Common Stock outstanding under the 1999 Citizens South Plan.

The exercise price of each option under these plans is not less than the market price of the Company’s Common Stock on the date of the grant. The exercise price of all options outstanding at March 31, 2014 under these plans ranges from $3.04 to $15.45 and the average exercise price was $7.34. The Company funds the option shares from authorized but unissued shares. The Company does not typically purchase shares to fulfill the obligations of the stock benefit plans. Options granted become exercisable in accordance with the plans’ vesting schedules, which are generally three years. All unexercised options expire ten years after the date of the grant.

As contemplated during the Public Offering, in 2011 the Company awarded certain stock price performance-based restricted shares to officers and directors following the holding company reorganization. During 2013, 13,860 stock price performance-based restricted shares were forfeited, and there were 554,400 stock price performance-based restricted shares outstanding at March 31, 2014. These 554,400 shares vest one-third each when the Company’s stock price per share reaches the following performance thresholds for 30 consecutive trading days: (i) 125% of offer price ($8.13); (ii) 140% of offer price ($9.10); and (iii) 160% of offer price ($10.40). These anti-dilutive restricted shares are issued (and thereby have voting rights), but are not included in earnings per share calculations until they vest (and thereby have economic rights).

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

	Outstanding Options									Nonvested Restricted Shares
	Number Outstanding			Weighted Average Exercise Price		Weighted Average Contractual Term (Years)		Intrinsic Value		Number Outstanding			Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
At December 31, 2013		2,225,551		$	7.35		5.65	$	-		770,399		$	4.35	$	5,123,156
Options Granted		12,500			6.73		-		-		-			-		-
Restricted Shares Granted		-			-		-		-		50,000			7.02		332,500
Options Exercised		(15,539	)		3.76		-		-		-			-		-
Restricted Shares Vested		-			-		-		-		(24,000	)		5.60		159,603
Expired and forfeited		(40,287	)		9.46		-		-		-			-		-
At March 31, 2014		2,182,225		$	7.34		5.47	$	631,404		796,399		$	4.48	$	5,296,053
Exercisable at March 31, 2014		2,147,725		$	7.37		5.42

45

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The average fair value per share of options granted in the first quarter of 2014 was $2.96. Assumptions used for grants were as follows. There were no stock options granted during the three-month period ended March 31, 2013.

Assumptions in Estimating Option Values

Weighted-average volatility	38.80	%
Expected dividend yield	1.19	%
Risk-free interest rate	2.19	%
Expected life (years)	7

At March 31, 2014, unrecognized compensation cost related to nonvested stock options of $53 thousand is expected to be recognized over a weighted-average period of 0.96 years. Total compensation expense for stock options was $18 thousand and $323 thousand for the three months ended March 31, 2014 and 2013, respectively.

At March 31, 2014, unrecognized compensation cost related to nonvested restricted shares of $1.4 million is expected to be recognized over a weighted-average period of 0.98 years. Total compensation expense for restricted shares was $228 thousand and $202 thousand for the three months ended March 31, 2014 and 2013, respectively.

Note 16 – Subsequent Event

Dividend Declaration

On April 23, 2014, the Company announced that its Board of Directors has declared a quarterly dividend of $0.02 per common share, payable on May 20, 2014 to all common shareholders of record as of the close of business on May 6, 2014.

Redemption of MasterCard Class B Shares

On April 17, 2014, the Company received $936 thousand in proceeds from the sale of its holdings of Class B common stock of Mastercard Inc.  These shares had no book value and were not recorded on the Company’s balance sheet. The proceeds will be recorded as other income.  On January 1, 2014, Mastercard effected a 10-for-1 stock split of its Class B Shares, and subsequently the Company provided notice of and instructions for the conversion of the Mastercard Class B Shares then held by it into Class A Shares and the subsequent sale of such Class A Shares on the Company’s behalf, all pursuant to procedures established by Mastercard for the holders of its Class B Shares. The value of the shares was unknown until receipt of the proceeds.

46

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 merger with Provident Community BancShares, Inc. (“Provident Community”), the general business strategy of engaging in bank mergers, organic growth, branch openings and closings, expansion in new markets, expansion or addition of product capabilities, expected footprint of the banking franchise and anticipated asset size; anticipated loan growth; changes in loan mix and deposit mix; capital and liquidity levels; net interest income; provision expense; noninterest income and noninterest expenses; realization of deferred tax asset; credit trends and conditions, including loan losses, allowance for loan loss, charge-offs, delinquency trends and nonperforming asset levels; the amount, timing and prices of share repurchases; the payment of common stock dividends; and other similar matters. These forward-looking statements are not guarantees of future results or performance and by their nature involve certain risks and uncertainties that are based on management’s beliefs and assumptions and on the information available to management at the time that these disclosures were prepared. Actual outcomes and results may differ materially from those expressed in, or implied by, any of these forward-looking statements.

You should not place undue reliance on any forward-looking statement and should consider all of the following uncertainties and risks, as well as those more fully discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”) on March 6, 2014 (the “2013 Form 10-K”) and in any of the Company’s subsequent filings with the SEC: failure to realize synergies and other financial benefits from the Provident Community merger within the expected time frames; increases in expected costs or decreases in expected savings or difficulties related to integration of the merger; inability to identify and successfully negotiate and complete additional combinations with potential merger partners or to successfully integrate such businesses into the Company, including the Company’s ability to 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 effectively redeploy resources from the custody business to the core asset management business; failure to generate an adequate return on investment related to the Richmond loan production office or other hiring initiatives; inability to generate future organic growth in loan balances or retail banking or wealth management results through the hiring of new personnel, development of new products or otherwise; the effects of negative or soft economic conditions, including stress in the commercial real estate markets or delay or failure of recovery in the residential real estate markets; changes in consumer and investor confidence and the related impact on financial markets and institutions; changes in interest rates; failure of assumptions underlying the establishment of 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 additional government shutdown and further debt ceiling impasses, including the risk of a United States credit rating downgrade or default, or continued global economic instability, which would 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.

47

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

The purpose of this discussion and analysis is to focus on significant changes in our financial condition as of and results of operations during the three-month period ended March 31, 2014. This discussion and analysis highlights and supplements information contained elsewhere in this Quarterly Report on Form 10-Q, particularly the preceding unaudited condensed consolidated financial statements and accompanying notes (the “Unaudited Financial Statements”).

Executive Overview

The Company reported net income available to common shareholders of $3.6 million, or $0.08 per share, for the three months ended March 31, 2014 compared to $3.2 million, or $0.07 per share, for the three months ended March 31, 2013. The increase in net income available to common shareholders from the first quarter of 2013 resulted from the combination of lower noninterest expense levels and a modest $17 thousand net release in provision for loan losses in the first quarter of 2014.

The Company reported adjusted net income available to common shareholders, which excludes merger-related expenses and gain or loss on sale of securities, of $3.4 million, or $0.08 per share, for the three months ended March 31, 2014 compared to $3.8 million, or $0.09 per share, for the three months ended March 31, 2013. The first quarter for 2014 reflects a lower adjustment for merger-related expenses and a higher adjustment for gain on sale of securities, compared to the first quarter of 2013.

Net interest margin was 3.97% at March 31, 2014, representing an 18 basis point decrease from 4.15% at March 31, 2013. The reduction in net interest margin from March 31, 2013 resulted primarily from a 20 basis point decrease in yield on loans, due primarily to lower interest rates on new loans, and a 10 basis point increase in the cost of interest-bearing liabilities, driven primarily by the expiration of accounting-related fair market value adjustments on acquired deposits in the fourth quarter of 2013.

Total assets increased $44.5 million, or 2%, to $2.00 billion at March 31, 2014, compared to total assets of $1.96 billion at December 31, 2013. Cash and equivalents increased $49.8 million, or 90%, to $104.8 million, due both to lower securities balances and to growth in total deposits. Total securities, including non-marketable securities, decreased $10.6 million, or 3%, to $396.8 million, due in part to the sale of $2.1 million in municipal bonds at the parent level to generate cash to support the merger with Provident Community, which closed on May 1, 2014. Cash merger consideration totaled $6.5 million, including $1.4 million paid to Provident Community’s common stockholders and $5.1 million paid to the United States Department of the Treasury ("Treasury") for all of Provident Community’s outstanding Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the "Series A Preferred Stock") (representing a 45%, or $4.2 million, discount from its face value).

Asset quality continued to improve in the first quarter and remains a point of strength for the Company. Nonperforming loans decreased $3.2 million, or 26%, to $9.1 million at March 31, 2014, or 0.70% of total loans, compared to $12.3 million at December 31, 2013, or 0.95% of total loans. Nonperforming assets decreased $2.1 million, or 8%, to $24.7 million at March 31, 2014, or 1.23% of total assets, compared to $26.8 million at December 31, 2013, or 1.37% of total assets. Nonperforming assets at March 31, 2014 include $6.7 million of covered other real estate owned (“OREO”) representing 27% of total nonperforming assets at March 31, 2014, compared to $5.1 million of covered OREO representing 19% of total nonperforming assets at December 31, 2013. The Company currently expects 80% of losses and associated expenses on covered OREO to be reimbursed under its FDIC loss share agreements.

Total deposits increased $37.6 million, or 2.3%, to $1.64 billion at March 31, 2014, compared to $1.60 billion at December 31, 2013, reflecting strong results in both retail and commercial banking as the Company has continued to emphasize growing transaction account relationships. Total shareholders’ equity increased $3.9 million, or 1%, to $266.0 million at March 31, 2014 compared to $262.1 million at December 31, 2013, driven by retained earnings and lower unrealized losses in the marketable securities portfolio. The Company’s ratio of tangible common equity to tangible assets decreased to 11.73% at March 31, 2014 from 11.79% at December 31, 2013. The Company’s Tier 1 leverage ratio increased to 11.73% in March 31, 2014 from 11.63% at December 31, 2013.

48

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

Business Overview

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

Consistent with our growth strategy, in January 2014, the Bank opened a loan production office in Richmond, Virginia.  In addition, on May 1, 2014, the Company completed its acquisition of Provident Community pursuant to the Agreement and Plan of Merger dated as of March 4, 2014 (the “Agreement”), under which Provident Community, a bank holding company headquartered in Rock Hill, South Carolina, was merged with and into the Company with the Company as the surviving entity. Pursuant to the Agreement, each share of Provident Community common stock was cancelled and converted into the right to receive a cash payment from the Company equal to $0.78 per share, or approximately $1.4 million in the aggregate. In addition, immediately prior to completion of the merger, the Company purchased from the Treasury the issued and outstanding shares of Series A Preferred Stock and all of the related warrants to purchase shares of Provident Community’s common stock, for an aggregate purchase price of approximately $5.1 million (representing a 45% discount from face value). Thereafter, pursuant to the Agreement, the Series A Preferred Stock and related warrants were cancelled in connection with the completion of the merger. Simultaneously with the completion of the merger, Provident Community Bank, N.A. merged into the Bank. The information in this Form 10-Q, including the information under this Item 2, is as of March 31, 2014 and does not reflect any changes in the business operations or financial condition of the Company after that date.

The Company provides a full array of retail and commercial banking services, including wealth management, through its offices located in North Carolina, South Carolina, Virginia and Georgia. Our objective since inception has been to provide the strength and product diversity of a larger bank and the service and relationship attention that characterizes a community bank.

Non-GAAP Financial Measures

In addition to traditional measures, management uses tangible assets, tangible common equity, tangible book value, adjusted allowance for loan losses, adjusted net income (loss), and adjusted noninterest expenses, and related ratios and per-share measures, each of which is a non-GAAP financial measure. Management uses (i) tangible assets, tangible common equity and tangible book value (which exclude goodwill and other intangibles from equity and assets) and related ratios to evaluate the adequacy of shareholders' equity and to facilitate comparisons with peers; (ii) adjusted allowance for loan losses (which includes net fair market value adjustments related to acquired loans) to evaluate both its asset quality and asset quality trends, and to facilitate comparisons with peers; and (iii) adjusted net income (loss) 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.

49

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

	March 31,			December 31,
	2014			2013
	(Unaudited)			(Unaudited)
	(dollars in thousands, except per share amounts)
Tangible common equity to tangible assets
Total assets	$	2,005,244		$	1,960,790
Less: intangible assets		(34,792	)		(35,049	)
Tangible assets	$	1,970,452		$	1,925,741
Total common equity	$	265,966		$	262,083
Less: intangible assets		(34,792	)		(35,049	)
Tangible common equity	$	231,174		$	227,034
Tangible common equity		231,174			227,034
Divided by: tangible assets		1,970,452			1,925,741
Tangible common equity to tangible assets		11.73	%		11.79	%
Common equity to assets		13.26	%		13.37	%
Adjusted allowance for loan losses (1)
Allowance for loan losses	$	9,076		$	8,831
Plus: acquisition accounting net FMV adjustments to acquired loans		34,663			37,783
Adjusted allowance for loan losses	$	43,739		$	46,614
Divided by: total loans (excluding LHFS)		1,302,826			1,295,808
Adjusted allowance for loan losses to total loans		3.36	%		3.60	%
Allowance for loan losses to total loans		0.70	%		0.68	%

	Three months ended
	March 31,			March 31,
	2014			2013
	(Unaudited)			(Unaudited)
Adjusted net income
Pretax income (as reported)	$	5,035		$	4,964
Plus: merger-related expenses		81			836
(gain) loss on sale of securities		(276	)		-
Adjusted pretax income		4,840			5,800
Tax expense		1,414			1,995
Adjusted net income	$	3,426		$	3,805
Preferred dividends		-			51
Adjusted net income available to common shareholders	$	3,426		$	3,754
Divided by: weighted average diluted shares		44,264,178			44,069,053
Adjusted net income available to common shareholders per share	$	0.08		$	0.09
Estimated tax rate		29.21	%		34.40	%
Adjusted noninterest expense
Noninterest expense	$	15,743		$	15,921
Less: merger-related expenses		(81	)		(836	)
Adjusted noninterest expense excluding merger-related expenses	$	15,662		$	15,085

(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.

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Recent Accounting Pronouncements

See Note 2 to the Unaudited Financial Statements for a description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

Critical Accounting Policies and Estimates

In the preparation of our financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States (“GAAP”) and in accordance with general practices within the banking industry. Our significant accounting policies are described in Note 2 – Summary of Significant Accounting Policies to the Company’s audited consolidated financial statements and accompanying notes (the “2013 Audited Financial Statements”) included in the 2013 Form 10-K. While all of these policies are important to understanding the Unaudited Financial Statements, certain accounting policies described below involve significant judgment and assumptions by management that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and assumptions that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

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

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

In addition, subsequent to acquisition, we periodically evaluate our estimate of cash flows expected to be collected. These evaluations, performed quarterly, require the continued usage of key assumptions and estimates, similar to the initial estimate of fair value. In the current economic environment, estimates of cash flows for PCI loans require significant judgment given the impact of home price and property value changes, changing loss severities, prepayment speeds and other relevant factors. Decreases in the expected cash flows will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan losses. Significant increases in the expected cash flows will generally result in an increase in interest income over the remaining life of the loan, or pool of loans. Disposals of loans, which may include sales of loans to third parties, receipt of payments in full or part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.

At March 31, 2014, PCI loans represent loans acquired from Community Capital and Citizens South that were deemed credit impaired. PCI loans that were classified as nonperforming loans by Community Capital or Citizens South 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.

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

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

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

FDIC Indemnification Asset. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, the FDIC indemnification asset was initially recorded at its fair value, and is measured separately from the related covered assets because the 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 non-interest income. Impairment of the underlying covered assets will increase the cash flows of the FDIC indemnification asset and result in a credit to the provision for loan losses for acquired loans. Impairment and, when applicable, its subsequent reversal are included in the provision for loan losses in the condensed consolidated statements of income.

52

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

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

As of March 31, 2014 and December 31, 2013, we had a net DTA in the amount of approximately $34.2 million and $37.4 million, respectively. 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 March 31, 2014 or December 31, 2013.

Additional information regarding our income taxes is presented in Note 8 —Income Taxes to the 2013 Audited Financial Statements.

53

Financial Condition at March 31, 2014 and December 31, 2013

Total assets increased $44.5 million to $2.00 billion at March 31, 2014 compared to total assets of $1.96 billion at December 31, 2013. During the three months, cash and interest-earning balances increased $50.1 million, or 91%. Total loans increased $6.8 million, or 0.5%, to $1.29 billion at March 31, 2014. Investment securities, which include available-for-sale and held-to-maturity securities, decreased $9.9 million, or 2.5%, to $391.5 million at March 31, 2014 from $401.4 million at December 31, 2013.

Total liabilities of $1.74 billion at March 31, 2014 increased $40.6 million, or 2.4%, compared to total liabilities of $1.70 billion at December 31, 2013. Total deposits increased $37.6 million, or 2.3%, to $1.64 billion at March 31, 2014. Total short-term borrowings increased $1.3 million, or 129.6%, to $2.3 million at March 31, 2014 from $1.0 million at December 31, 2013.

Total shareholders’ equity increased $3.9 million, or 1.5%, during the first three months to $266.0 million at March 31, 2014. This increase resulted from net income for the three months ended March 31, 2014 of $3.6 million and a $1.4 million increase in accumulated other comprehensive income offset by $246 thousand of share-based compensation expense and $896 thousand of dividends on common stock. There were 15,539 stock options exercised during the first three months of 2014, with total proceeds of $58 thousand, and the Company repurchased 69,792 shares of common stock, at an average cost of $6.50 per share, for a total of $456 thousand.

The following table presents selected ratios for the Company for the three months ended March 31, 2014 and 2013 and for the year ended December 31, 2013:

Selected Ratios

	Three months ended March 31, (annualized)						Twelve months ended December 31,
	2014			2013			2013*
Return on Average Assets		0.73	%		0.65	%		0.76	%
Return on Average Equity		5.43	%		4.64	%		5.42	%
Period End Equity to Total Assets		13.26	%		14.06	%		13.37	%

* Derived from audited financial statements.

Investments and Other Interest-earning Assets

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

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 March 31, 2014, investment securities totaled $391.5 million compared to $401.4 million at December 31, 2013. The decrease in investment securities in the first quarter of 2014 is due to the maturity or call of approximately $10.4 million in securities and the sale of approximately $2.4 million of available-for-sale securities. The securities sold generated a gain of $276 thousand.

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At March 31, 2014, our available-for-sale investment portfolio had a net unrealized loss of $5.1 million compared to an $8.2 million net unrealized loss at December 31, 2013. The improvement in the unrealized loss is a result of a decrease in market interest rates at period end. There were no securities with an unrealized loss deemed to be other than temporary at March 31, 2014 or December 31, 2013. 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). Included in our investment securities portfolio are four investments in senior tranches of collateralized loan obligations (“CLOs”) totaling $23.5 million at March 31, 2014 and $23.4 million at December 31, 2013, which could be impacted by the Volcker Rule. The collateral eligibility language in one of the securities, totaling $5.0 million, was amended during the fourth quarter of 2013 to comply with the applicable investment criteria under the Volcker Rule. Our investments in the remaining three CLOs, which had a net unrealized loss of $294,000 and $274,000 at March 31, 2014 and December 31, 2013, respectively, currently would be prohibited under the Volcker Rule. We are awaiting intended document amendment strategies, if any, from the managers on these securities before determining any disposition plans for those investments. Under current Federal regulations, banks have until July 21, 2017 to conform their CLO interests to avoid the trading restrictions under the Volcker Rule. Unless the documentation is amended to avoid inclusion within the rule’s prohibitions, we would have to recognize other-than-temporary-impairment with respect to these securities in conformity with GAAP rules. We held no other security types potentially affected by the Volcker Rule at either March 31, 2014 or December 31, 2013.

At March 31, 2014, we had $90.6 million in interest-bearing deposits at correspondent banks, of which $90.2 million was on deposit with the Federal Reserve Bank, compared to $41.7 million in interest-bearing deposits at correspondent banks at December 31, 2013. Our balances have increased due to strong deposit growth.

Loans

We consider asset quality to be of primary importance, and employ seasoned credit professionals and documented processes to ensure effective oversight of credit approvals and asset quality monitoring. Our internal loan policy is reviewed by our board of directors’ Loan and Risk Committee on an annual basis and our underwriting guidelines are reviewed and updated on a periodic basis. A formal loan review process is maintained both to ensure adherence to lending policies and to ensure accurate loan grading and is reviewed by our board of directors at least annually. Since inception, we have promoted the separation of loan underwriting from the loan production staff through our credit department. Currently, credit administration analysts are responsible for underwriting and assigning proper risk grades for all loans with an individual, or relationship, exposure in excess of $500 thousand. Underwriting is completed on standardized forms including a loan approval form and separate credit memorandum. The credit memorandum includes a summary of the loan's structure and a detailed analysis of loan purpose, borrower strength (including individual and global cash flow worksheets), repayment sources and, when applicable, collateral positions and guarantor strength. The credit memorandum further identifies exceptions to policy and/or regulatory limits, total exposure, internal risk grades and other relevant credit information. Loans are approved or denied by varying levels of signature authority based on total customer relationship exposure, with a minimum requirement of at least two authorized signatures. A management-level loan committee is responsible for approving all credits in excess of the chief credit officer’s lending authority, which was increased in March 2013 from $1 million to $3 million.

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

All acquisition, construction and development (“AC&D”) loans, whether related to commercial or consumer borrowers, are subject to policies, guidelines and procedures specifically designed to properly identify, monitor and mitigate the risk associated with these loans. Loan officers receive and review a cost budget from the borrower at the time an AC&D loan is originated. Loan draws are monitored against the budgeted line items during the development period in order to identify potential cost overruns. Individual draw requests are verified through review of supporting invoices as well as site inspections performed by an external inspector. Additional periodic site inspections are performed by loan officers at times that do not coincide with draw requests in order to keep abreast of ongoing project conditions. Our exposure to AC&D loans has declined significantly since inception of the Bank and current loan origination is focused on 1 – 4 family residential construction for retail customers and 1-4 family residential home construction to selected well-qualified builders, as well as owner-occupied commercial and pre-leased commercial build-to-suit properties. Concentrations as a percent of capital are reported to the board of directors on a quarterly basis. Market conditions for AC&D loans continued to improve in 2013 due to increasing new home sales in our primary markets. As of March 31, 2014, approximately 3% of our AC&D loan portfolio, commercial and consumer, falls under the watch list.

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Our second mortgage exposure is primarily attributable to our home equity lines of credit (“HELOC”) portfolio, which totaled approximately $143 million as of March 31, 2014, of which approximately 63% is secured by second mortgages and approximately 37% is secured by first mortgages.

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 March 31, 2014, total loans, net of deferred fees, increased $7.0 million compared to December 31, 2013. The composition of the portfolio remained unchanged from December 31, 2013 with commercial loans representing 71% of the total loan portfolio and consumer loans representing 29% of the total loan portfolio at March 31, 2014. Residential mortgages and home equity lines of credit represented 13% and 11% of total loans, respectively. The combination of commercial and industrial and CRE-owner-occupied loans also held at 30% of total loans. CRE-investor income producing loans increased to 31% from 29% of total loans. AC&D loans decreased to 9% from 11% 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.

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The following table presents a breakdown of our allowance for loan losses, by component and by loan product type, as of March 31, 2014 and December 31, 2013. Details of the five 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

	March 31, 2014
	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	$	24		0.26	%	$	1,337		14.73	%	$	186		2.05	%	$	-		0.00	%
CRE - owner-occupied		24		0.26	%		335		3.69	%		71		0.78	%		-		0.00	%
CRE - investor income producing		12		0.13	%		1,347		14.84	%		192		2.12	%		518		5.71	%
AC&D - 1-4 family construction		16		0.18	%		661		7.28	%		78		0.86	%		-		0.00	%
AC&D - lots, land & development		8		0.09	%		1,336		14.72	%		236		2.60	%		-		0.00	%
AC&D - CRE		-		0.00	%		196		2.16	%		25		0.28	%		-		0.00	%
Other commercial		19		0.21	%		7		0.08	%		1		0.01	%		-		0.00	%
Consumer:
Residential mortgage		208		2.29	%		153		1.69	%		212		2.34	%		-		0.00	%
Home equity lines of credit		397		4.37	%		769		8.47	%		242		2.67	%		1		0.01	%
Residential construction		5		0.06	%		328		3.61	%		48		0.53	%		1		0.01	%
Other loans to individuals		-		0.00	%		71		0.78	%		9		0.10	%		3		0.03	%
	$	713		7.86	%	$	6,540		72.06	%	$	1,300		14.32	%	$	523		5.76	%

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

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The allowance for loan losses was $9.1 million, or 0.70% of total loans, at March 31, 2014 compared to $8.8 million, or 0.68% of total loans, at December 31, 2013. 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 (i) an increase of $49 thousand in the quantitative component of the allowance due to changes in look back periods and rates which better reflect the inherent loss in the portfolio, (ii) an increase of $204 thousand in the qualitative component of the allowance primarily due to a $150 thousand qualitative adjustment to the residential mortgage portfolio to better reflect inherent losses not captured by the historical losses and higher non-acquired loan balances resulting from acquired purchased performing loans fully amortizing their mark and moving out of the acquired pool, (iii) an increase of $163 thousand in the reserve on PCI loans driven by the reversal of $360 thousand of previously recognized impairments offset by current period net impairment of impairments of $672 thousand and current period charge-offs of $149 thousand on previously impaired PCI loans that transferred to OREO and (iv) a decrease of $171 thousand in specific reserves which change periodically as loans move through or out of the impairment process.

In accordance with GAAP, loans acquired from both Community Capital and Citizens South were adjusted to reflect estimated fair market value at acquisition and the associated allowance for loan losses was eliminated. At March 31, 2014, acquired loans comprised 40% of our total loans, compared to 44% at December 31, 2013. The ratio of the allowance for loan losses to total loans was 0.70% at March 31, 2014 and 0.68% at December 31, 2013. The ratio of the adjusted allowance for loan losses to total loans, which includes the remaining acquisition accounting fair market value adjustments for acquired loans, was 3.36% at March 31, 2014 and 3.60% at December 31, 2013. Adjusted allowance for loan losses to loans is a non-GAAP financial measure which is provided as supplemental information for comparing the combined allowance and fair market value adjustments to the combined acquired and non-acquired loan portfolios. Fair market value adjustments are available only for losses on acquired loans. For a reconciliation to the most comparable GAAP measure, see “Non-GAAP Financial Measures” above.

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

We evaluate and estimate off-balance sheet credit exposure at the same time we estimate credit losses for loans by a similar process, including an estimate of commitment usage levels. These estimated credit losses are not recorded as part of the allowance for loan losses, but are recorded to a separate liability account by a charge to income, if material. Loan commitments, unused lines of credit and standby letters of credit make up the off-balance sheet items reviewed for potential credit losses. At both March 31, 2014 and December 31, 2013, $125 thousand was recorded as an other liability for off-balance sheet credit exposure.

Nonperforming Assets

Nonperforming assets, which consist of nonaccrual loans, accruing troubled debt restructurings (“TDRs”), accruing loans for which payments are 90 days or more past due, and OREO, totaled $24.7 million at March 31, 2014 compared to $26.8 million at December 31, 2013. Nonperforming loans, which consist of nonaccrual loans, accruing TDRs and accruing loans for which payments are 90 days or more past due, decreased $3.2 million, or 26%, to $9.1 million, or 0.70% of total loans and OREO at March 31, 2014, compared to $12.3 million, or 0.95% of total loans and OREO at December 31, 2013.

It is our general policy to place a loan on nonaccrual status when it is over 90 days past due and there is reasonable doubt that all principal and interest will be collected. Nonaccrual loans decreased $3.3 million, or 40%, in the first quarter of 2014 from $8.5 million at December 31, 2013. Nonaccrual TDRs are included in the nonaccrual loan amounts noted. At March 31, 2014, nonaccrual TDR loans were $191 thousand and had no recorded allowance. At December 31, 2013, nonaccrual TDR loans were $4.4 million and had no recorded allowance. Accruing TDRs totaled $3.6 million at March 31, 2014 and $3.9 million at December 31, 2013.

We grade loans with an internal risk grade scale of 10 through 90, with grades 10 through 50 representing “pass” loans, grade 60 representing “special mention” and grades 70 and higher representing “classified” credit grades, respectively. Loans are reviewed on a regular basis internally, and at least annually by an external loan review group, to ensure loans are graded appropriately. Credits are reviewed for past due trends, declining cash flows, significant decline in collateral value, weakened guarantor financial strength, management concerns, market conditions and other factors that could jeopardize the repayment performance of the loan. Documentation deficiencies including collateral perfection and outdated or inadequate financial information are also considered in grading loans.

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All loans graded 60 or worse are included on our list of “watch loans,” which represent potential problem loans, and are updated and reported to both management and the Loan and Risk Committee of the board of directors quarterly. Additionally, the watch list committee may review other loans with more favorable ratings if there are concerns that the loan may become a problem. Impairment analyses are performed on all loans graded “substandard” (risk grade of 70 or worse) and generally greater than $150 thousand as well as selected other loans as deemed appropriate. At March 31, 2014, we maintained “watch loans” totaling $33.1 million compared to $35.2 million at December 31, 2013. Approximately $8 million and $7 million of the watch loans at March 31, 2014 and December 31, 2013, respectively, were acquired loans. The future level of watch loans cannot be predicted, but rather will be determined by several factors, including overall economic conditions in the markets served.

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

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

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

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

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

At March 31, 2014, OREO totaled $15.5 million, all of which is recorded at values based on our most recent appraisals. Included in that total is $6.6 million of OREO covered under the FDIC loss share agreements. At December 31, 2013, OREO totaled $14.5 million, all of which was recorded at values based on the most recent appraisals then available. Included in that total is $5.6 million of OREO covered under the 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.

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Total deposits at March 31, 2014 were $1.6 billion, an increase of $37.6 million, or 2.3%, from December 31, 2013. Noninterest bearing demand deposits increased $10.1 million, or 3.9%, and represented 16% of total deposits at March 31, 2014. Money market, NOW and savings deposits increased $36.5 million, or 5%. Increases in these deposit types were the result of strong retail sales efforts. Non-brokered time deposits decreased $5.9 million, or 1.3%. The managed decrease in time deposits reflects management’s continued emphasis on growing transaction account relationships. Finally, brokered deposits decreased $3.1 million, or 1.9%. Brokered deposits remain attractive given their relatively lower interest costs and flexible term structures, and will continue to be selectively utilized in our normal funding and interest rate risk management practices. Brokered deposits consist of brokered interest-bearing deposits, brokered money market accounts, and brokered certificates of deposits. Brokered money market and interest-bearing deposits are the result of the brokered money market deposit program initiated in December 2013 in connection with our $50 million investment strategy. The following is a summary of deposits at March 31, 2014 and December 31, 2013:

	March 31,		December 31,
	2014		2013
	(dollars in thousands)
Noninterest bearing demand deposits	$	265,929	$	255,861
Interest-bearing demand deposits		295,857		296,995
Money market deposits		425,181		390,059
Savings		51,230		48,701
Brokered deposits		163,190		166,280
Certificates of deposit and other time deposits		436,074		441,989
Total deposits	$	1,637,461	$	1,599,885

Total borrowings increased $1.4 million, or 1.8%, to $79.5 million at March 31, 2014 compared to $78.0 million at December 31, 2013. Borrowings at March 31, 2014 include $15.3 million (after acquisition accounting fair market value adjustments) of Tier 1-eligible subordinated debt and $6.9 million of Tier 2-eligible subordinated debt. Our Tier-2-eligible subordinated debt, which consists of the Bank’s 11% Subordinated Notes due June 30, 2019, is subject to redemption at the option of the Bank beginning June 30, 2014, at a redemption price of 100% of the principal amount plus accrued but unpaid interest, subject to any applicable regulatory approvals.

Results of Operations

The following table summarizes components of net income and the changes in those components for the three months ended March 31, 2014 and 2013:

	Three Months Ended March 31,
	2014			2013		Change
	(Unaudited)					$			%
	(Dollars in thousands)
Gross interest income	$	19,206		$	19,323	$	(117	)		-0.6	%
Gross interest expense		1,931			1,587		344			21.7	%
Net interest income		17,275			17,736		(461	)		-2.6	%
Provision for loan losses		(17	)		309		(326	)		-105.5	%
Noninterest income		3,486			3,458		28			0.8	%
Noninterest expense		15,743			15,921		(178	)		-1.1	%
Net income before taxes		5,035			4,964		71			1.4	%
Income tax expense		1,480			1,724		(244	)		-14.2	%
Net income		3,555			3,240		315			9.7	%
Preferred dividends		-			51		(51	)		100.0	%
Net income to common shareholders	$	3,555		$	3,189	$	366			11.5	%

Net Income. Net income for the three months ended March 31, 2014 was $3.6 million compared to $3.2 million for the three months ended March 31, 2013. The increase in net income was the result of a net release in provision for loan losses compared to provision expense of $309 thousand for the three months ended March 31, 2013. Annualized return on average assets improved during the three-month period ended March 31, 2014 to 0.73% from 0.65% for the same period in 2013. Annualized return on average equity also improved to 5.43% during the three-month period ended March 31, 2014 from 4.64% for the three-month period ended March 31, 2013.

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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 decreased to $17.3 million for the three-month period ended March 31, 2014 from $17.7 million for the three months ended March 31, 2013. The decrease is primarily due to a decrease in the yield on loans and the increase in the rate paid on interest bearing deposits. The yield earned on average loans decreased 20 basis points to 5.26% for the first quarter of 2014, compared to 5.46% for the first quarter of 2013. The rate paid on interest bearing deposits increased 11 basis points to 0.41% for the first quarter of 2014, compared to 0.30% for the first quarter of 2013.

Total average interest-earning assets remained flat at $2.0 billion for the three months ended March 31, 2014 compared to the same period in the previous year. Average balances of total interest-bearing liabilities remained flat at $1.4 billion in the three-month period ended March 31, 2014, compared to the same period in 2013. Our net interest margin decreased from 4.15% in the three-month period ended March 31, 2013 to 3.97% in the corresponding period in 2014. This decrease in net interest margin reflects the lower interest rates on new loans, the expiration of accounting-related fair market value adjustments on acquired deposits in the third quarter of 2013, as well as the increase in cost of interest bearing liabilities.

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

Average Balance Sheets and Net Interest Analysis

	For the Three Months Ended March 31,
	2014								2013
	Average Balance			Income/ Expense		Yield/ Rate			Average Balance			Income/ Expense		Yield/ Rate
	(dollars in thousands)
Assets
Interest-earning assets:
Loans, including fees (1)(2)	$	1,305,157		$	16,926		5.26	%	$	1,346,603		$	18,140		5.46	%
Federal funds sold		447			-		0.00	%		46,081			17		0.15	%
Taxable investment securities		383,613			1,971		2.06	%		244,899			866		1.41	%
Tax-exempt investment securities		15,595			222		5.69	%		17,896			190		4.25	%
Nonmarketable equity securities		5,796			66		4.62	%		6,642			48		2.93	%
Other interest-earning assets		53,559			21		0.16	%		70,062			62		0.36	%
Total interest-earning assets		1,764,167			19,206		4.42	%		1,732,183			19,323		4.52	%
Allowance for loan losses		(9,365	)							(11,716	)
Cash and due from banks		14,379								30,117
Premises and equipment		55,935								57,388
Other assets		151,525								170,081
Total assets	$	1,976,641							$	1,978,053
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand	$	292,373		$	63		0.09	%	$	304,179		$	91		0.12	%
Savings and money market		462,457			434		0.38	%		435,943			317		0.29	%
Time deposits - core		436,385			684		0.64	%		506,504			344		0.28	%
Brokered deposits		166,391			197		0.48	%		107,381			263		0.99	%
Total interest-bearing deposits		1,357,606			1,378		0.41	%		1,354,007			1,015		0.30	%
Federal Home Loan Bank advances		55,533			127		0.93	%		55,167			137		1.01	%
Other borrowings		23,038			426		7.50	%		30,774			435		5.73	%
Total borrowed funds		78,571			553		2.85	%		85,941			572		2.70	%
Total interest-bearing liabilities		1,436,177			1,931		0.55	%		1,439,948			1,587		0.45	%
Net interest rate spread					17,275		3.87	%					17,736		4.08	%
Noninterest-bearing demand deposits		252,865								240,263
Other liabilities		22,068								19,108
Shareholders' equity		265,531								278,734
Total liabilities and shareholders' equity	$	1,976,641							$	1,978,053
Net interest margin							3.97	%							4.15	%

(1)  Average loan balances include nonaccrual loans.

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

Provision for Loan Losses. Our provision for loan losses decreased $0.3 million, or 106%, to a modest release of $17 thousand during the three months ended March 31, 2014, from a $0.3 million charge during the corresponding period in 2013. Included in the loan loss provision for the first quarter of 2014 was (i) a net impairment charge of $312 thousand associated with PCI pools, (ii) a $287 thousand charge attributable to FDIC loss share agreements caused by a decrease in expected loss in those acquired loans and (iii) a net $616 thousand release of allowance as we move through the economic cycle and historical losses better reflect the inherent loss in our portfolio and improvements or disposition of impaired loans.

We had $0.7 million in net recoveries, excluding charge-offs on PCI loans, during the three months ended March 31, 2014 compared to net charge-offs of $34 thousand during the corresponding period in 2013. The net recoveries in the first quarter of 2014 reflected the favorable resolution of problem assets from the legacy Park Sterling portfolio, including both disposition of a single troubled debt restructuring that was designated a nonaccrual loan in the fourth quarter of 2013 as well as recoveries from a large residential development nonaccrual loan. Charge-offs on PCI loans were $149 thousand for loans which transferred to OREO during the three months ended March 31, 2014. There were $402 thousand in charge-offs on PCI loans for the same period in 2013.

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Noninterest Income. The following table presents components of noninterest income for the three months ended March 31, 2014 and 2013:

	Three months ended March 31,
	2014			2013		Change
	(Unaudited)					$			%
	(dollars in thousands)
Service charges on deposit accounts	$	633		$	764	$	(131	)		-17.1	%
Income from fiduciary activities		678			598		80			13.4	%
Commissions and fees from investment brokerage		97			110		(13	)		-11.8	%
Gain on sale of securities available for sale		276			-		276			100.0	%
ATM and card income		548			488		60			12.3	%
Mortgage banking income		244			968		(724	)		-74.8	%
Income from bank-owned life insurance		1,120			381		739			194.0	%
Amortization (accretion) of indemnification asset		(253	)		35		(288	)		-822.9	%
Other noninterest income		143			114		29			25.4	%
Total noninterest income	$	3,486		$	3,458	$	28			0.8	%

Noninterest income remained flat for the three months ended March 31, 2014 when compared to the three months ended March 31, 2013. Noteworthy changes among categories include (i) a $131 thousand decrease in service charges on deposit accounts; (ii) a $276 thousand gain on sale of securities available-for-sale; (iii) a $724 thousand decrease in mortgage banking income due to lower activity in loan closings and the period end pipeline,; (iv) $739 thousand increase in income from bank-owned life insurance due primarily to death benefit proceeds of $651 thousand received in the first quarter; and (v) a $288 thousand increase in amortization of the indemnification asset related to the loss share agreements with the FDIC.

Noninterest Expense. The following table presents components of noninterest expense for the three months ended March 31, 2014 and 2013:

	Three months ended March 31,
	2014		2013			Change
	(Unaudited)					$			%
	(dollars in thousands)
Salaries and employee benefits	$	9,228	$	8,778		$	450			5.1	%
Occupancy and equipment		2,005		1,908			97			5.1	%
Advertising and promotion		233		220			13			5.9	%
Legal and professional fees		661		893			(232	)		-26.0	%
Deposit charges and FDIC insurance		240		487			(247	)		-50.7	%
Data processing and outside service fees		1,346		1,653			(307	)		-18.6	%
Communication fees		436		432			4			0.9	%
Core deposit intangible amortization		257		257			-			0.0	%
Net cost (earnings) of operation of OREO		53		(428	)		481			-112.4	%
Loan and collection expense		288		326			(38	)		-11.7	%
Postage and supplies		175		329			(154	)		-46.8	%
Other tax expense		69		176			(107	)		-60.8	%
Other noninterest expense		752		890			(138	)		-15.5	%
Total noninterest expense	$	15,743	$	15,921		$	(178	)		-1.1	%

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Total noninterest expense declined slightly to $15.7 million for the three months ended March 31, 2014, a decrease of 1.1% from $15.9 million for the corresponding period in 2013. Excluding merger-related expenses of $81 thousand and $836 thousand for the three-month periods ended March 31, 2014 and 2013, respectively, noninterest expense increased $0.5 million for the three months ended March 31, 2014, compared to the corresponding period in the prior year. Adjusted noninterest expenses, which exclude merger-related expenses, are a non-GAAP financial measure. For a reconciliation to the most comparable GAAP measure, see “Non-GAAP Financial Measures” above.

Salaries and employee benefits expenses increased $0.4 million, or 5.1%, to $9.2 million in the first quarter of 2014, compared to $8.8 million in the comparable period of 2013, primarily due to hiring initiatives designed to drive future organic growth opportunities. Total full-time equivalents increased to 470 at March 31, 2014 from 450 at March 31, 2013. Compensation expense for share-based compensation plans was $246 thousand in the first quarter of 2014 compared to $525 thousand in the comparable period of 2013.

Other notable variances during the first quarter of 2014 include (i) a decrease in legal and professional fees of $0.2 million, or 26.0%, to $0.7 million in the first quarter of 2014 related to merger expenses in the first quarter of 2013 from the Citizens South acquisition; (ii) a decrease in FDIC insurance of $0.2 million, or 50.7%, to $0.2 million resulting from a true-up of the estimated assessment and (iii) a decrease in data processing of $0.3 million, or 18.6%, to $1.3 million related to merger costs from the Citizens South acquisition.

Additionally, we realized a net loss on operation of other real estate during the first quarter of 2014 of $53 thousand. This represents an increase of $481 thousand, or 112.4%, when compared to the earnings from operation of OREO of $0.4 million during the comparable period of 2013. We sold 34 properties in the first quarter of 2014 at a net gain of approximately $127 thousand compared to 80 properties in the first quarter of 2013 at a net gain of approximately $729 thousand.

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 March 31, 2014, we recognized income tax expense of $1.5 million compared to income tax expense of $1.7 million for the same period in 2013. The effective tax rate for the three months ended March 31, 2014 is 29.39% compared to 34.73% for the same period in 2013. The change in the effective tax rate was due to the amount of tax-exempt income on municipal securities and the death benefits received on bank-owned life insurance relative to the size of pre-tax income.                

Liquidity and Capital Resources

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

Our internal liquidity ratio (total liquid assets, or cash and cash equivalents, divided by deposits and short-term liabilities) at March 31, 2014 was 22.11% compared to 20.92% at December 31, 2013. Both ratios exceeded our minimum internal target of 10%. In addition, at March 31, 2014, we had $254.2 million of credit available from the FHLB, $156.9 million of credit available from the Federal Reserve Discount Window, and available lines totaling $70.0 million from correspondent banks.

At March 31, 2014, we had $328.6 million of pre-approved but unused lines of credit, $4.4 million of standby letters of credit and $3.4 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.

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Our capital position is reflected in our shareholders’ equity, subject to certain adjustments for regulatory purposes. Shareholders’ equity, or capital, is a measure of our net worth, soundness and viability. We continue to remain in a well-capitalized position. Shareholders’ equity on March 31, 2014 was $266.0 million compared to $262.1 million at December 31, 2013. The $4.0 million increase was the result of net income of $3.6 million during the first three months of 2014, $1.4 million increase in accumulated other comprehensive income from unrealized securities losses, $246 thousand of net share based compensation expense, and $58 thousand in proceeds from the exercise of stock options. The increases were offset by $896 thousand in dividends on common stock, and the repurchase of 69,792 shares of common stock at a total cost of $456 thousand during the first three months of 2014, as part of our previously announced stock repurchase program.

Risk-based capital regulations adopted by the Federal Reserve Board and the FDIC require bank holding companies and banks to achieve and maintain specified ratios of capital to risk-weighted assets. The risk-based capital rules currently in effect are designed to measure “Tier 1” capital (consisting generally of common shareholders’ equity, a limited amount of qualifying perpetual preferred stock and trust preferred securities, and minority interests in consolidated subsidiaries, net of goodwill and other intangible assets, deferred tax assets in excess of certain thresholds and certain other items) and total capital (consisting of Tier 1 capital and Tier 2 capital, which generally includes certain preferred stock, mandatorily convertible debt securities and term subordinated debt) in relation to the credit risk of both on- and off-balance sheet items. Under the guidelines, one of four risk weights is applied to the different on-balance sheet items. Off-balance sheet items, such as loan commitments, are also subject to risk weighting after conversion to balance sheet equivalent amounts. Under current regulations, all banks must maintain a minimum total capital to total risk weighted assets ratio of 8.00%, at least half of which must be in the form of core, or Tier 1, capital. These guidelines also specify that banks that are experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels. At March 31, 2014, the Company and the Bank both satisfied their minimum regulatory capital requirements and each was “well capitalized” within the meaning of federal regulatory requirements.

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

							Regulatory Minimums
							For Capital Adequacy Purposes			To Be Well Capitalized Under Prompt Corrective Actions Provisions
	March 31, 2014			December 31, 2013			Ratio			Ratio
	(dollars in thousands)
Park Sterling Corporation
Tier 1 capital	$	225,702		$	218,552
Tier 2 capital		16,223			15,956
Total capital	$	241,925		$	234,508
Risk-weighted assets	$	1,413,311		$	1,424,574
Average assets for Tier 1	$	1,923,622		$	1,879,283
Risk-based capital ratios
Tier 1 capital		15.97	%		15.34	%		4.00	%		6.00	%
Total capital		17.12	%		16.46	%		8.00	%		10.00	%
Tier 1 leverage ratio		11.73	%		11.63	%		4.00	%		5.00	%
Park Sterling Bank
Tier 1 capital	$	201,389		$	193,830
Tier 2 capital		16,223			15,956
Total capital	$	217,612		$	209,786
Risk-weighted assets	$	1,414,550		$	1,420,331
Average assets for Tier 1	$	1,907,664		$	1,861,925
Risk-based capital ratios
Tier 1 capital		14.24	%		13.65	%		4.00	%		6.00	%
Total capital		15.38	%		14.77	%		8.00	%		10.00	%
Tier 1 leverage ratio		10.56	%		10.41	%		4.00	%		5.00	%

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

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

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

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

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

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

Management is currently assessing the impact of the Final Rules to its regulatory capital ratios but does not expect these changes to result in a material difference.

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

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

Information about our off-balance sheet risk exposure is presented in Note 16 - Off-Balance Sheet Risk of the 2013 Audited Financial Statements. As part of ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities (“SPE”s), which generally are established for facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of March 31, 2014, we were not involved in any unconsolidated SPE transactions.

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Impact of Inflation and Changing Prices

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

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

There have been no material changes in our quantitative and qualitative disclosures about market risk as of March 31, 2014 from those disclosed or incorporated in Part II, Item 7A. “Quantitative and Qualitative Disclosures about Market Risk.” presented our 2013 Form 10-K.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Control Over Financial Reporting

There was no change in the Company’s internal control over financial reporting that occurred during the first fiscal quarter of 2014 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A Risk Factors

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

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

The following table provides information regarding the Company’s purchases of common stock during the three months ended March 31, 2014:

Period	(a) Total Number of Shares Purchased (1)		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (2)
Repurchases from January 1, 2014 through January 31, 2014		-	$	-		-		2,140,733
Repurchases from February 1, 2014 through February 28, 2014		56,409		6.49		56,409		2,084,324
Repurchases from March 1, 2014 through March 31, 2014		13,383		6.54		9,200		2,075,124
Total		69,792	$	6.50		65,609		2,075,124

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

(2) On November 2, 2012, we announced a program which expires on December 31, 2014 to repurchase up to 2,200,000 of our common shares from time to time, depending on market conditions and other factors.

During the three months ended March 31, 2014, the Company did not have any unregistered sales of equity securities.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

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Item 6. Exhibits

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

Exhibit Number	Description of Exhibits
3.1	Articles of Incorporation of the Company, as amended
3.2	Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013; (ii) Condensed Consolidated Statements of Income for the three months ended March 31, 2014 and 2013; (iii) Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2014 and 2013; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2014 and 2013; (v) Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013; and (vi) Notes to Condensed Consolidated Financial Statements*

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

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SIGNATURES

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

		PARK STERLING CORPORATION
Date: May 9, 2014	By:	/s/ James C. Cherry
		James C. Cherry
		Chief Executive Officer (authorized officer)
Date: May 9, 2014	By:	/s/ David L. Gaines
		David L. Gaines
		Chief Financial Officer

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Exhibit Index

Exhibit Number	Description of Exhibits
3.1	Articles of Incorporation of the Company, as amended
3.2	Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013; (ii) Condensed Consolidated Statements of Income for the three months ended March 31, 2014 and 2013; (iii) Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2014 and 2013; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2014 and 2013; (v) Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013; and (vi) Notes to Condensed Consolidated Financial Statements*

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