UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2015

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 incorporation or organization)	(I.R.S. Employer Identification No.)
1043 E. Morehead Street, Suite 201
Charlotte, North Carolina	28204
(Address of principal executive offices)	(Zip Code)

(704) 716-2134

(Registrant’s telephone number, including area code)

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

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

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

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

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

As of August 6, 2015, the registrant had outstanding 44,917,218 shares of common stock, $1.00 par value per share.

PARK STERLING CORPORATION

Table of Contents

		Page No.
Part I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets June 30, 2015 and December 31, 2014	1
	Condensed Consolidated Statements of Income Three and Six Months Ended June 30, 2015 and 2014	2
	Condensed Consolidated Statements of Comprehensive Income Three and Six Months Ended June 30, 2015 and 2014	3
	Condensed Consolidated Statements of Changes in Shareholders’ Equity Six Months Ended June 30, 2015 and 2014	4
	Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2015 and 2014	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	46
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	65
Item 4.	Controls and Procedures	65
Part II.	OTHER INFORMATION
Item 1.	Legal Proceedings	65
Item 1A.	Risk Factors	65
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	66
Item 3.	Defaults Upon Senior Securities	66
Item 4.	Mine Safety Disclosures	66
Item 5.	Other Information	66
Item 6.	Exhibits	67

 i

PARK STERLING CORPORATION

Part I. Financial Information

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Dollars in thousands)

	June 30,			December 31,
	2015				2014*
ASSETS
Cash and due from banks	$	17,042		$	16,549
Interest-earning balances at banks		26,940			34,356
Federal funds sold		360			485
Investment securities available-for-sale, at fair value		402,489			375,683
Investment securities held-to-maturity (fair value of $113,182 and $117,627 at June 30, 2015 and December 31, 2014, respectively)		111,633			115,741
Nonmarketable equity securities		13,500			11,532
Loans held for sale		10,701			11,602
Loans:
Non-covered		1,637,115			1,538,354
Covered		20,348			42,339
Less allowance for loan losses		(8,468	)		(8,262	)
Net loans		1,648,995			1,572,431
Premises and equipment, net		58,979			59,247
Bank-owned life insurance		57,823			57,712
Deferred tax asset		32,137			35,696
Other real estate owned - noncovered		8,904			8,979
Other real estate owned - covered		884			3,011
Goodwill		29,197			29,197
FDIC indemnification asset		1,209			3,964
Core deposit intangible		10,265			10,960
Accrued interest receivable		4,852			4,467
Other assets		7,970			7,618
Total assets	$	2,443,880		$	2,359,230
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing	$	347,162		$	321,019
Interest-bearing		1,527,779			1,530,335
Total deposits		1,874,941			1,851,354
Short-term borrowings		180,000			125,000
Long-term borrowings		55,000			55,000
Subordinated debt		23,922			23,583
Accrued interest payable		375			398
Accrued expenses and other liabilities		29,899			28,790
Total liabilities		2,164,137			2,084,125
Shareholders' equity:
Common stock, $1.00 par value 200,000,000 shares authorized; 44,910,686 and 44,859,798 shares issued and outstanding at June 30, 2015 and December 31, 2014, respectively		44,911			44,860
Additional paid-in capital		222,271			222,819
Retained earnings		14,261			8,901
Accumulated other comprehensive loss		(1,700	)		(1,475	)
Total shareholders' equity		279,743			275,105
Total liabilities and shareholders' equity	$	2,443,880		$	2,359,230

* Derived from audited financial statements.

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

1

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2015			2014			2015			2014
Interest income
Loans, including fees	$	19,667		$	18,734		$	38,778		$	35,660
Taxable investment securities		2,508			2,152			5,299			4,123
Tax-exempt investment securities		143			133			281			355
Nonmarketable equity securities		122			85			249			151
Interest on deposits at banks		18			53			36			74
Total interest income		22,458			21,157			44,643			40,363
Interest expense
Money market, NOW and savings deposits		532			615			1,052			1,162
Time deposits		752			828			1,459			1,659
Short-term borrowings		76			1			152			1
Long-term borrowings		131			128			259			255
Subordinated debt		351			506			679			932
Total interest expense		1,842			2,078			3,601			4,009
Net interest income		20,616			19,079			41,042			36,354
Provision for loan losses		134			(365	)		314			(382	)
Net interest income after provision for loan losses		20,482			19,444			40,728			36,736
Noninterest income
Service charges on deposit accounts		1,107			1,001			2,126			1,634
Income from fiduciary activities		774			642			1,506			1,320
Commissions and fees from investment brokerage		132			131			262			228
Income from capital markets		394			35			792			35
Gain (loss) on sale of securities available for sale		-			(33	)		-			243
ATM and card income		629			726			1,323			1,274
Mortgage banking income		956			653			1,907			897
Income from bank-owned life insurance		553			525			1,321			1,645
Amortization of indemnification asset		(209	)		(606	)		(514	)		(859	)
Loss share true-up liability expense		44			(132	)		(45	)		(362	)
Other noninterest income (expense)		(88	)		1,036			115			1,409
Total noninterest income		4,292			3,978			8,793			7,464
Noninterest expense
Salaries and employee benefits		10,021			9,684			20,452			18,912
Occupancy and equipment		2,491			2,249			5,046			4,254
Advertising and promotion		304			223			678			456
Legal and professional fees		660			1,122			1,458			1,783
Deposit charges and FDIC insurance		433			368			825			608
Data processing and outside service fees		1,640			1,544			3,288			2,890
Communication fees		541			538			1,119			974
Core deposit intangible amortization		347			317			695			574
Net cost of operation of other real estate owned		232			206			267			259
Loan and collection expense		242			304			396			592
Postage and supplies		116			170			265			345
Other noninterest expense		1,205			1,511			2,882			2,332
Total noninterest expense		18,232			18,236			37,371			33,979
Income before income taxes		6,542			5,186			12,150			10,221
Income tax expense		2,273			1,760			4,098			3,240
Net income	$	4,269		$	3,426		$	8,052		$	6,981
Basic earnings per common share	$	0.10		$	0.08		$	0.18		$	0.16
Diluted earnings per common share	$	0.10		$	0.08		$	0.18		$	0.16
Dividends per common share	$	0.03			0.02		$	0.06		$	0.04
Weighted-average common shares outstanding
Basic		43,971,007			43,947,134			43,944,638			43,942,112
Diluted		44,301,895			44,213,802			44,287,424			44,240,105

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

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PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(Dollars in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
Net income	$	4,269		$	3,426		$	8,052		$	6,981
Securities available for sale and transferred securities:
Change in net unrealized gains (losses) during the period		(3,150	)		5,667			(165	)		9,022
Change in net unrealized gain (loss) on securities transferred to held to maturity		73			(2,209	)		209			(2,209	)
Reclassification adjustment for net (gains) losses recognized in net income		-			33			-			(243	)
Total securities available for sale and transferred securities		(3,077	)		3,491			44			6,570
Derivatives:
Change in the accumulated gain (loss) on effective cash flow hedge derivatives		646			(1,071	)		(610	)		(2,096	)
Reclassification adjustment for interest payments		103			106			206			209
Total derivatives		749			(965	)		(404	)		(1,887	)
Other comprehensive income (loss), before tax		(2,328	)		2,526			(360	)		4,683
Deferred tax expense (benefit) related to other comprehensive income (loss)		(864	)		941			(135	)		1,722
Other comprehensive income (loss), net of tax		(1,464	)		1,585			(225	)		2,961
Total comprehensive income	$	2,805		$	5,011		$	7,827		$	9,942

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

3

PARK STERLING CORPORATION

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

(Dollars in thousands)

	Six Months Ended June 30, 2015 and 2014
													Accumulated
							Additional			Retained			Other			Total
	Common Stock						Paid-In			Earnings			Comprehensive			Shareholders'
	Shares			Amount			Capital			(Deficit)			Loss			Equity
Balance at December 31, 2013		44,730,669		$	44,731		$	222,559		$	(405	)	$	(4,802	)	$	262,083
Shares issued		252			-			-			-			-			-
Issuance of restricted stock grants		220,650			221			(221	)		-			-			-
Forfeitures of restricted stock grants		(3,333	)		(4	)		4			-			-			-
Exercise of stock options		39,451			39			138			-			-			177
Share-based compensation expense		-			-			531			-			-			531
Common stock repurchased or reacquired		(154,173	)		(154	)		(853	)		-			-			(1,007	)
Dividends on common stock		-			-			-			(1,789	)		-			(1,789	)
Net income		-			-			-			6,981			-			6,981
Other comprehensive income		-			-			-			-			2,961			2,961
Balance at June 30, 2014		44,833,516		$	44,833		$	222,158		$	4,787		$	(1,841	)	$	269,937
Balance at December 31, 2014		44,859,798		$	44,860		$	222,819		$	8,901		$	(1,475	)	$	275,105
Shares issued		1,182			1			(1	)		-			-			-
Issuance of restricted stock grants		212,300			212			(212	)		-			-			-
Forfeitures of restricted stock grants		(8,917	)		(9	)		9			-			-			-
Exercise of stock options		28,963			29			112			-			-			141
Share-based compensation expense		-			-			590			-			-			590
Common stock repurchased or reacquired		(182,640	)		(182	)		(1,046	)		-			-			(1,228	)
Dividends on common stock		-			-			-			(2,692	)		-			(2,692	)
Net income		-			-			-			8,052			-			8,052
Other comprehensive loss		-			-			-			-			(225	)		(225	)
Balance at June 30, 2015		44,910,686		$	44,911		$	222,271		$	14,261		$	(1,700	)	$	279,743

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

4

PARK STERLING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	Six Months Ended
	June 30,
	2015			2014
Cash flows from operating activities
Net income	$	8,052		$	6,981
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion on acquired loans		(3,720	)		(4,865	)
Net amortization on investments		1,209			160
Other depreciation and amortization		5,433			4,719
Provision (release) for loan losses		314			(382	)
Share-based compensation expense		590			531
Deferred income taxes		3,695			3,478
Amortization of FDIC indemnification asset		514			859
Net gains on sales of investment securities available-for-sale		-			(243	)
Net gains on sales of loans held for sale		(830	)		(355	)
Net losses on sales of fixed assets		349			82
Net gains on sales of other real estate owned		(307	)		(202	)
Writedowns on other real estate owned		485			182
Income from bank-owned life insurance		(1,321	)		(1,645	)
Proceeds from loans held for sale		54,326			23,692
Disbursements for loans held for sale		(52,595	)		(26,905	)
Change in assets and liabilities:
(Increase) decrease in FDIC indemnification asset		90			(23	)
(Increase) decrease in accrued interest receivable		(385	)		460
Increase in other assets		(352	)		(1,650	)
Decrease in accrued interest payable		(23	)		(1,582	)
Increase in accrued expenses and other liabilities		746			2,882
Net cash provided by operating activities		16,270			6,174
Cash flows from investing activities
Net increase in loans		(79,027	)		(75,222	)
Purchases of premises and equipment		(2,401	)		(2,276	)
Proceeds from sales of premises and equipment		169			79
Purchases of investment securities available-for-sale		(56,061	)		(72,345	)
Purchases of investment securities held-to-maturity		(4,958	)		(10,017	)
Proceeds from sales of investment securities available-for-sale		-			126,314
Proceeds from maturities, calls and paydowns of investment securities available-for-sale		28,115			17,721
Proceeds from maturities, calls and paydowns of investment securities held-to-maturity		9,040			1,643
Proceeds from life insurance death benefit		1,054			651
FDIC payment of recoverable covered asset losses		2,151			2,196
Proceeds from sale of other real estate owned		5,701			6,749
Net (purchases) redemptions of nonmarketable equity securities		(1,968	)		2,947
Acquisitions, net of cash acquired		-			59,045
Net cash provided (used) by investing activities		(98,185	)		57,485
Cash flows from financing activities
Net increase (decrease) in deposits		23,646			(1,596	)
Net repayments of long-term borrowings		-			(48,310	)
Net advances in short-term borrowings		55,000			2,819
Exercise of stock options		141			177
Repurchase of common stock		(1,228	)		(1,007	)
Dividends on common stock		(2,692	)		(1,789	)
Net cash provided (used) by financing activities		74,867			(49,706	)
Net increase (decrease) in cash and cash equivalents		(7,048	)		13,953
Cash and cash equivalents, beginning		51,390			55,067
Cash and cash equivalents, ending	$	44,342		$	69,020
Supplemental disclosures of cash flow information:
Cash paid for interest	$	3,624		$	4,030
Cash paid for income taxes		338			160
Supplemental disclosure of noncash investing and financing activities:
Change in unrealized gain on available-for-sale securities, net of tax	$	27		$	6,570
Change in unrealized loss on cash flow hedge, net of tax		(252	)		(1,887	)
Securities available-for-sale transferred to held-to-maturity		-			58,972
Loans transferred to other real estate owned		3,677			5,280

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

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PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 1 – Basis of Presentation

Park Sterling Corporation (the “Company”) was formed on October 6, 2010 to serve as the holding company for Park Sterling Bank (the “Bank”) and is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). At June 30, 2015 and December 31, 2014, 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 “2014 Audited Financial Statements”) included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed with the Securities and Exchange Commission (“SEC”) on March 6, 2015 (the “2014 Form 10-K”).

In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which consist of normal, recurring adjustments, necessary to present fairly the financial position of the Company as of June 30, 2015 and December 31, 2014, the results of its operations for the three and six months ended June 30, 2015 and 2014, and cash flows for the six months ended June 30, 2015 and 2014. Operating results for the three- and six-month periods ended June 30, 2015 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 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2015-01, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items” (“ASU 2015-01”). ASU 2015-01 eliminated from U.S. GAAP the concept of an extraordinary item, which is an event or transaction that is both unusual in nature and infrequently occurring. The guidance will be effective for the Company for interim and annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company does not expect this guidance to have a material effect on its financial statements.

In February 2015, the FASB issued Accounting Standards Update No. 2015-02, “Amendments to the Consolidation Analysis” (“ASU 2015-02”). ASU 2015-02 amended the consolidation requirements in Accounting Standards Codification (“ASC”) 810 Consolidation. The amendments change the consolidation analysis required under U.S. GAAP, and modify how variable interests held by a reporting entity’s related parties affect its consolidation conclusions. The amendments will be effective for the Company for interim and annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

During the first quarter of 2015, the Company adopted Accounting Standards Update 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)” (“ASU 2014-04”). ASU 2014-04 amended the Receivables—Troubled Debt Restructurings by Creditors subtopic of the ASC to address the reclassification of consumer mortgage loans collateralized by residential real estate upon foreclosure. The amendments clarify the criteria for concluding that an in-substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. The amendments also outline interim and annual disclosure requirements. The amendments are effective for the Company for interim and annual reporting periods beginning after December 15, 2014. Additional disclosures have been included in the Notes to Condensed Consolidated Financial Statements as a result of adoption.

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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, Provident Community Bancshares, Inc. (“Provident Community”) was merged with and into the Company, with the Company as the surviving entity, pursuant to the Agreement and Plan of Merger, dated as of March 4, 2014 (the “Agreement and Plan of Merger”). Under the terms of the Agreement and Plan of Merger, 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 U.S. Department of the Treasury (“Treasury”) the issued and outstanding shares of Provident Community’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Provident Community Series A Preferred Stock”) and all of the related warrants to purchase shares of Provident Community’s common stock, for an aggregate purchase price of approximately $5.1 million (representing a 45% discount from face value). Thereafter, pursuant to the Agreement and Plan of Merger, the Provident Community Series A Preferred Stock and related warrants were cancelled in connection with the completion of the merger. Simultaneously with completion of the merger, Provident Community Bank, N.A. was merged into the Bank.

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PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The assets acquired and liabilities assumed from Provident Community were recorded at their fair value as of the closing date of the merger. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available. Goodwill of $3.4 million was initially recorded at the time of the acquisition. As a result of refinements to the fair value mark on loans, other real estate owned (“OREO”), other assets and other liabilities, goodwill as indicated below is $2.7 million. The following table summarizes the consideration paid by the Company in the merger with Provident Community and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date:

	As Recorded by Provident Community		Fair Value and Other Merger Related Adjustments			As Recorded by the Company
Consideration Paid
Cash						$	1,397
Fair value of non-controlling interest							5,096
Fair Value of Total Consideration Transferred						$	6,493
Recognized amounts of identifiable assets acquired and liabilities assumed:
Cash and cash equivalents	$	65,538	$	-		$	65,538
Securities		124,035		-			124,035
Nonmarketable equity securities		2,948		-			2,948
Loans held for sale		390		-			390
Loans, net of allowance		112,412		(6,797	)		105,615
Premises and equipment		3,150		32			3,182
Core deposit intangibles		-		3,600			3,600
Interest receivable		748		(3	)		745
Other real estate owned		3,666		(702	)		2,964
Bank owned life insurance		8,536		-			8,536
Deferred tax asset		1,628		4,901			6,529
Other assets		1,438		(248	)		1,190
Total assets acquired	$	324,489	$	783		$	325,272
Deposits	$	264,281	$	177		$	264,458
Federal Home Loan Bank advances		37,500		3,915			41,415
Junior Subordinated Debt		12,372		(4,558	)		7,814
Short term borrowings		4,760		-			4,760
Other liabilities		2,087		985			3,072
Total liabilities assumed	$	321,000	$	519		$	321,519
Total identifiable assets	$	3,489	$	264		$	3,753
Goodwill resulting from acquisition						$	2,740

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 June 30, 2015 and December 31, 2014 are as follows:

Amortized Cost and Fair Value of Investment Portfolio
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
June 30, 2015
Securities available-for-sale:
U.S. Government agencies	$	506	$	21	$	-		$	527
Municipal securities		14,554		684		(21	)		15,217
Residential agency pass-through securities		145,553		1,831		(140	)		147,244
Residential collateralized mortgage obligations		166,458		883		(911	)		166,430
Commercial mortgage-backed securities		4,915		-		(73	)		4,842
Asset-backed securities		65,857		89		(773	)		65,173
Corporate and other securities		1,454		108		-			1,562
Equity securities		1,250		244					1,494
Total securities available-for-sale	$	400,547	$	3,860	$	(1,918	)	$	402,489
Securities held-to-maturity:
Residential agency pass-through securities	$	44,722	$	843	$	(76	)	$	45,489
Residential collateralized mortgage obligations		8,103		131		-			8,234
Commercial mortgage-backed obligations		54,631		5		(1,124	)		53,512
Asset-backed securities		6,023		-		(76	)		5,947
Total securities held-to-maturity	$	113,479	$	979	$	(1,276	)	$	113,182
December 31, 2014
Securities available-for-sale:
U.S. Government agencies	$	508	$	29	$	-		$	537
Municipal securities		11,955		896		-			12,851
Residential agency pass-through securities		144,955		2,156		(96	)		147,015
Residential collateralized mortgage obligations		144,773		625		(1,318	)		144,080
Commercial mortgage-backed securities		4,974		-		(106	)		4,868
Asset-backed securities		61,833		-		(783	)		61,050
Corporate and other securities		3,328		242		-			3,570
Equity securities		1,250		462		-			1,712
Total securities available-for-sale	$	373,576	$	4,410	$	(2,303	)	$	375,683
Securities held-to-maturity:
Residential agency pass-through securities	$	43,331	$	1,123	$	-		$	44,454
Residential collateralized mortgage obligations		8,440		124		-			8,564
Commercial mortgage-backed obligations		60,783		-		(2,041	)		58,742
Asset-backed securities		5,978		-		(111	)		5,867
Total securities held-to-maturity	$	118,532	$	1,247	$	(2,152	)	$	117,627

In the second quarter of 2014, commercial mortgage-backed securities (“MBS”) with a fair market value of $58.5 million were transferred from available-for-sale to held-to-maturity. These securities had an aggregate unrealized loss of $2.2 million ($1.5 million, net of tax) on the date of transfer. The net unamortized, unrealized loss on the transferred securities included in accumulated other comprehensive income in the accompanying balance sheet as of June 30, 2015 and December 31, 2014 totaled $1.8 million and $2.1 million, respectively. This amount will be amortized out of accumulated other comprehensive income over the remaining life of the underlying securities as an adjustment of the yield on those securities. As a result, the amortized cost of these investments of $54.6 million is higher than the $52.8 million carrying value of the securities as of June 30, 2015. There were no transfers of securities from available-for-sale to held-to-maturity during the three and six months ended June 30, 2015.

9

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

At June 30, 2015 and December 31, 2014, investment securities with a fair market value of $179.9 million and $162.8 million, respectively, were pledged to secure public and trust deposits, to secure interest rate swaps, and for other purposes as required and permitted by law.  

At June 30, 2015 and December 31, 2014, commercial MBS include $51.6 million and $56.8 million, respectively, of delegated underwriting and servicing (“DUS”) bonds collateralized by multi-family properties and backed by an agency of the U.S. government, and $6.0 million of private-label securities collateralized by commercial properties.

At June 30, 2015 and December 31, 2014, asset-backed securities include a $6.0 million security that is approximately 45% collateralized by the Federal family education loan program and 55% collateralized by a private student loan program. 

The amortized cost and fair value of investment securities available-for-sale and held-to-maturity at June 30, 2015 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 U.S. government. None of our residential agency pass-through securities or residential collateralized mortgage obligations are private-label securities.

10

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Maturities of Investment Portfolio
	June 30, 2015
	Amortized		Fair
	Cost		Value
Securities available-for-sale:
U.S. Government agencies
Due after one year through five years	$	506	$	527
Municipal securities
Due after five years through ten years		3,603		3,607
Due after ten years		10,951		11,610
Residential agency pass-through securities
Due after five years through ten years		12,144		12,383
Due after ten years		133,409		134,861
Residential collateralized mortgage obligations
Due after five years through ten years		7,799		7,749
Due after ten years		158,659		158,681
Commercial mortgage-backed obligations
Due after one year through five years		4,915		4,842
Asset-backed securities
Due after five years through ten years		10,000		9,856
Due after ten years		55,857		55,317
Corporate and other securities
Due after ten years		1,454		1,562
Equity securities
No maturity		1,250		1,494
Total securities available-for-sale	$	400,547	$	402,489
Securities held-to-maturity:
Residential agency pass-through securities
Due after ten years	$	44,722	$	45,489
Residential collateralized mortgage obligations
Due after ten years		8,103		8,234
Commercial mortgage-backed obligations
Due after five years through ten years		54,631		53,512
Asset-backed securities
Due after ten years		6,023		5,947
Total securities held-to-maturity	$	113,479	$	113,182

Securities available-for-sale of $123.9 million and $126.3 million were sold in the three and six months ended June 30, 2014, respectively, resulting in a gross loss of $33,000 and a gross gain of $243,000, respectively. There were no sales of securities in the three and six months ended June 30, 2015. Sales of securities during the second quarter of 2014 were securities acquired in the acquisition of Provident Community and sold immediately following the merger.

Management evaluates its investments quarterly for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. The following table shows gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position for securities with unrealized losses at June 30, 2015 and December 31, 2014. None of the securities are deemed to be other-than-temporarily impaired since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, as all but one of the bonds are issued by U.S. government agencies with the remaining bond being partially guaranteed by a government agency, and it is more likely than not that the Company will not have to sell the investments before recovery of their amortized cost basis. At June 30, 2015, there were 20 securities in a loss position for twelve months or more. At December 31, 2014, there were 23 securities in a loss position for twelve months or more.

11

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) amended the Bank Holding Company Act (the “BHC Act”) to require the federal banking regulatory agencies to adopt rules that prohibit 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), commonly referred to as the “Volcker Rule.” In December 2013, the federal banking regulatory agencies adopted a final rule construing the Volcker Rule, effective April 1, 2014. Banking entities have until July 21, 2016 (expected to be extended to July 21, 2017) to conform their activities to the requirements of the rule. At December 31, 2014, the Company held two investments in senior tranches of collateralized loan obligations (“CLOs”) with a fair value of $14.8 million, which are included in asset-backed securities and could be impacted by the Volcker Rule. The collateral eligibility language in one of the securities, with a fair value of $9.8 million, was amended during the first quarter of 2015 to comply with the new bank investment criteria under the Volcker Rule. The Company’s investment in the remaining CLO, which had a net unrealized loss of $33,000 at June 30, 2015, currently would be prohibited under the Volcker Rule. The Company will determine any disposition plans for this security as the documentation is, or is not, amended. Unless the documentation is amended to avoid inclusion within the rule’s prohibitions prior to the expected July 2017 deadline, the Company would have to recognize other-than-temporary-impairment with respect to this security in conformity with GAAP rules. The Company held no other security types potentially affected by the Volcker Rule at June 30, 2015.

Investment Portfolio Gross Unrealized Losses and Fair Value
	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
June 30, 2015
Securities available-for-sale:
Municipal securities	$	3,284	$	(21	)	$	-	$	-		$	3,284	$	(21	)
Residential agency pass-through securities		20,637		(92	)		3,658		(48	)		24,295		(140	)
Residential collateralized mortgage obligations		42,326		(257	)		30,345		(654	)		72,671		(911	)
Commercial mortgage-backed securities		-		-			4,842		(73	)		4,842		(73	)
Asset-backed securities		7,965		(34	)		41,284		(739	)		49,249		(773	)
Total temporarily impaired available-for-sale securities	$	74,212	$	(404	)	$	80,129	$	(1,514	)	$	154,341	$	(1,918	)
Securities held-to-maturity:
Residential agency pass-through securities	$	4,881	$	(76	)	$	-	$	-		$	4,881	$	(76	)
Commercial mortgage-backed securities		6,110		(71	)		45,560		(1,053	)		51,670		(1,124	)
Asset-backed securities		-		-			5,947		(76	)		5,947		(76	)
Total temporarily impaired held-to-maturity securities	$	10,991	$	(147	)	$	51,507	$	(1,129	)	$	62,498	$	(1,276	)
December 31, 2014
Securities available-for-sale:
Residential agency pass-through securities	$	-	$	-		$	3,857	$	(96	)	$	3,857	$	(96	)
Residential collateralized mortgage obligations		29,122		(142	)		48,824		(1,176	)		77,946		(1,318	)
Commercial mortgage-backed securities		-		-			4,868		(106	)		4,868		(106	)
Asset-backed securities		38,528		(296	)		22,522		(487	)		61,050		(783	)
Total temporarily impaired available-for-sale securities	$	67,650	$	(438	)	$	80,071	$	(1,865	)	$	147,721	$	(2,303	)
Securities held-to-maturity:
Commercial mortgage-backed securities	$	-	$	-		$	58,743	$	(2,041	)	$	58,743	$	(2,041	)
Asset-backed securities		-		-			5,867		(111	)		5,867		(111	)
Total temporarily impaired held-to-maturity securities	$	-	$	-		$	64,610	$	(2,152	)	$	64,610	$	(2,152	)

The Company has nonmarketable equity securities consisting of investments in several unaffiliated financial institutions, as well as investments in four statutory trusts related to trust preferred securities issued by predecessor companies. These investments totaled $13.5 million at June 30, 2015 and $11.5 million December 31, 2014. Included in these amounts at June 30, 2015 and December 31, 2014 was $12.1 million and $10.1 million, respectively, of Federal Home Loan Bank (“FHLB”) stock. All nonmarketable equity securities were evaluated for impairment as of June 30, 2015 and December 31, 2014. At June 30, 2015 and December 31, 2014, 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:

	June 30, 2015						December 31, 2014
	PCI loans		All other loans		Total		PCI loans		All other loans		Total
Commercial:
Commercial and industrial	$	6,223	$	183,132	$	189,355	$	5,552	$	168,234	$	173,786
Commercial real estate (CRE) - owner-occupied		24,946		305,907		330,853		30,554		303,228		333,782
CRE - investor income producing		38,732		459,458		498,190		43,866		426,781		470,647
AC&D - 1-4 family construction		457		31,043		31,500		514		28,887		29,401
AC&D - lots, land & development		7,549		41,131		48,680		13,660		41,783		55,443
AC&D - CRE		-		86,570		86,570		112		71,478		71,590
Other commercial		2,068		5,144		7,212		1,187		3,858		5,045
Total commercial loans		79,975		1,112,385		1,192,360		95,445		1,044,249		1,139,694
Consumer:
Residential mortgage		25,772		189,079		214,851		28,730		176,420		205,150
Home equity lines of credit (HELOC)		1,677		155,283		156,960		1,734		153,563		155,297
Residential construction		4,805		58,168		62,973		6,574		49,308		55,882
Other loans to individuals		590		27,106		27,696		758		21,828		22,586
Total consumer loans		32,844		429,636		462,480		37,796		401,119		438,915
Total loans		112,819		1,542,021		1,654,840		133,241		1,445,368		1,578,609
Deferred costs		-		2,623		2,623		-		2,084		2,084
Total loans, net of deferred costs	$	112,819	$	1,544,644	$	1,657,463	$	133,241	$	1,447,452	$	1,580,693

Included in the June 30, 2015 and December 31, 2014 loan totals are $20.3 million and $42.3 million, respectively, of covered loans pursuant to Federal Deposit Insurance Corporation (“FDIC”) loss share agreements. Of these amounts, at June 30, 2015, approximately $18.2 million is included in PCI loans and $2.2 million is included in all other loans. Our loss share agreement related to Bank of Hiawassee’s non-single family assets expired on March 31, 2015, and on April 1, 2015, the remaining balance of $19.6 million associated with the Bank of Hiawassee non-single family loans was transferred from the covered portfolio to the non-covered portfolio. At December 31, 2014, $39.8 million is included in PCI loans and $2.5 million is included in all other loans.

At June 30, 2015 and December 31, 2014, the Company had sold participations in loans aggregating $18.9 million and $6.5 million, respectively, to other financial institutions on a nonrecourse basis. During the six months ended June 30, 2015, a participation was sold on one large relationship for $11.4 million. 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. As a result of the Provident Community merger, the Company serviced $3.1 million and $3.7 million of residential mortgage loans for the benefit of others as of June 30, 2015 and December 31, 2014, respectively.

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. Total loans sold with limited recourse in the three and six months ended June 30, 2015 were $27.9 million and $53.5 million, respectively. Total loans sold with limited recourse in the three and six months ended June 30, 2014 were $13.1 million and $21.4 million, respectively.

13

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

At June 30, 2015, the carrying value of loans pledged as collateral to the FHLB on borrowings and to the Federal Reserve totaled $679.4 million. At December 31, 2014, the carrying value of loans pledged as collateral to the FHLB and the Federal Reserve totaled $560.4 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 June 30, 2015 and December 31, 2014, 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 and six months ended June 30, 2015 and 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		Residential mortgage			HELOC			Residential construction			Other loans to individuals			Total
For the three months ended June 30, 2015
Allowance for Loan Losses:
Balance, beginning of period	$	2,045		$	781		$	1,988		$	141		$	179		$	475	$	38	$	531		$	1,843		$	458		$	111		$	8,590
Provision for loan losses		(597	)		519			42			99			(31	)		195		22		145			(478	)		(77	)		161			-
Charge-offs		(67	)		(220	)		-			-			-			-		-		(46	)		(67	)		(3	)		(15	)		(418	)
Recoveries		13			-			7			-			119			-		-		22			62			3			21			247
Net (charge-offs) recoveries		(54	)		(220	)		7			-			119			-		-		(24	)		(5	)		-			6			(171	)
Balance, end of period	$	1,394		$	1,080		$	2,037		$	240		$	267		$	670	$	60	$	652		$	1,360		$	381		$	278		$	8,419
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-		$	-		$	-		$	-		$	-		$	-	$	-	$	-		$	-		$	-		$	-		$	-
PCI Impairment charge-offs		(51	)		-			(39	)		-			-			-		-		(66	)		-			-			-			(156	)
PCI impairment recoveries		-			-			-			-			-			-		-		-			-			-			-			-
Net PCI impairment charge-offs		(51	)		-			(39	)		-			-			-		-		(66	)		-			-			-			(156	)
PCI provision for loan losses		51			-			88			-			-			-		-		66			-			-			-			205
Benefit attributable to FDIC loss share agreements		-			-			(71	)		-			-			-		-		-			-			-			-			(71	)
Total provision for loan losses charged to operations		51			-			17			-			-			-		-		66			-			-			-			134
Provision for loan losses recorded through FDIC loss share receivable		-			-			71											-		-			-			-			-			71
Balance, end of period	$	-		$	-		$	49		$	-		$	-		$	-	$	-	$	-		$	-		$	-		$	-		$	49
Total Allowance for Loan Losses	$	1,394		$	1,080		$	2,086		$	240		$	267		$	670	$	60	$	652		$	1,360		$	381		$	278		$	8,468
For the six months ended June 30, 2015
Allowance for Loan Losses:
Balance, beginning of period	$	1,563		$	721		$	1,751		$	458		$	591		$	395	$	32	$	443		$	1,651		$	542		$	115		$	8,262
Provision for loan losses		(78	)		578			80			(218	)		(567	)		275		28		296			(285	)		(87	)		158			180
Charge-offs		(154	)		(220	)		-			-			-			-		-		(117	)		(80	)		(78	)		(34	)		(683	)
Recoveries		63			1			206			-			243			-		-		30			74			4			39			660
Net (charge-offs) recoveries		(91	)		(219	)		206			-			243			-		-		(87	)		(6	)		(74	)		5			(23	)
Balance, end of period	$	1,394		$	1,080		$	2,037		$	240		$	267		$	670	$	60	$	652		$	1,360		$	381		$	278		$	8,419
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-		$	-		$	-		$	-		$	-		$	-	$	-	$	-		$	-		$	-		$	-		$	-
PCI Impairment charge-offs		(51	)		-			(39	)		-			-			-		-		(66	)		-			-			-			(156	)
PCI impairment recoveries		-			-			-			-			-			-		-		-			-			-			-			-
Net PCI impairment charge-offs		(51	)		-			(39	)		-			-			-		-		(66	)		-			-			-			(156	)
PCI provision for loan losses		51			-			88			-			-			-		-		66			-			-			-			205
Benefit attributable to FDIC loss share agreements		-			-			(71	)		-			-			-		-		-			-			-			-			(71	)
Total provision for loan losses charged to operations		51			-			17			-			-			-		-		66			-			-			-			134
Provision for loan losses recorded through FDIC loss share receivable		-			-			71											-		-			-			-			-			71
Balance, end of period	$	-		$	-		$	49		$	-		$	-		$	-	$	-	$	-		$	-		$	-		$	-		$	49
Total Allowance for Loan Losses	$	1,394		$	1,080		$	2,086		$	240		$	267		$	670	$	60	$	652		$	1,360		$	381		$	278		$	8,468

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 - 1-4 family construction			AC&D - lots, land & development			AC&D - CRE			Other commercial		Residential mortgage			HELOC			Residential construction			Other loans to individuals			Total
For the three months ended June 30, 2014
Allowance for Loan Losses:
Balance, beginning of period	$	1,547	$	431		$	1,550		$	754		$	1,580		$	222		$	26	$	573		$	1,408		$	382		$	80		$	8,553
Provision for loan losses		162		(209	)		(137	)		412			(493	)		1			25		(212	)		356			238			22			165
Charge-offs		-		-			-			(15	)		-			-			-		(52	)		(332	)		-			(12	)		(411	)
Recoveries		64		251			12			64			359			-			-		63			20			31			7			871
Net (charge-offs) recoveries		64		251			12			49			359			-			-		11			(312	)		31			(5	)		460
Balance, end of period	$	1,773	$	473		$	1,425		$	1,215		$	1,446		$	223		$	51	$	372		$	1,452		$	651		$	97		$	9,178
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-	$	-		$	518		$	-		$	-		$	-		$	-	$	-		$	1		$	1		$	3		$	523
PCI Impairment charge-offs		-		-			-			-			-			-			-		-			(1	)		-			-			(1	)
PCI impairment recoveries		-		-			-			-			-			-			-		-			-			-			-			-
Net PCI impairment charge-offs		-		-			-			-			-			-			-		-			(1	)		-			-			(1	)
PCI provision for loan losses		-		-			(517	)		-			-			-			-		-			-			(1	)		(3	)		(521	)
Benefit attributable to FDIC loss share agreements		-		-			(9	)		-			-			-			-		-			-			-			-			(9	)
Total provision for loan losses charged to operations		-		-			(526	)		-			-			-			-		-			-			(1	)		(3	)		(530	)
Provision for loan losses recorded through FDIC loss share receivable		-		-			8												-		-			-			-			-			8
Balance, end of period	$	-	$	-		$	-		$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	-
Total Allowance for Loan Losses	$	1,773	$	473		$	1,425		$	1,215		$	1,446		$	223		$	51	$	372		$	1,452		$	651		$	97		$	9,178
For the six months ended June 30, 2014
Allowance for Loan Losses:
Balance, beginning of period	$	1,491	$	399		$	1,797		$	839		$	1,751		$	299		$	25	$	358		$	1,050		$	390		$	72		$	8,471
Provision for loan losses		76		(179	)		(186	)		327			(1,472	)		(76	)		25		4			769			225			36			(451	)
Charge-offs		-		-			(273	)		(15	)		(4	)		-			-		(63	)		(398	)		(7	)		(22	)		(782	)
Recoveries		206		253			87			64			1,171			-			1		73			31			43			11			1,940
Net (charge-offs) recoveries		206		253			(186	)		49			1,167			-			1		10			(367	)		36			(11	)		1,158
Balance, end of period	$	1,773	$	473		$	1,425		$	1,215		$	1,446		$	223		$	51	$	372		$	1,452		$	651		$	97		$	9,178
PCI Impairment Allowance for Loan Losses:
Balance, beginning of period	$	-	$	-		$	360		$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	360
PCI Impairment charge-offs		-		-			(5	)		-			-			-			-		(1	)		(144	)		-			-			(150	)
PCI impairment recoveries		-		-			-			-			-			-			-		-			-			-			-			-
Net PCI impairment charge-offs		-		-			(5	)		-			-			-			-		(1	)		(144	)		-			-			(150	)
PCI provision for loan losses		-		-			(354	)		-			-			-			-		1			144			-			-			(209	)
Benefit attributable to FDIC loss share agreements		-		-			278			-			-			-			-		-			-			-			-			278
Total provision for loan losses charged to operations		-		-			(76	)		-			-			-			-		1			144			-			-			69
Provision for loan losses recorded through FDIC loss share receivable		-		-			(279	)											-		-			-			-			-			(279	)
Balance, end of period	$	-	$	-		$	-		$	-		$	-		$	-		$	-	$	1		$	-		$	-		$	-		$	-
Total Allowance for Loan Losses	$	1,773	$	473		$	1,425		$	1,215		$	1,446		$	223		$	51	$	373		$	1,452		$	651		$	97		$	9,178

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 June 30, 2015 and December 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		Residential mortgage		HELOC		Residential construction		Other loans to individuals		Total
At June 30, 2015
Allowance for Loan Losses:
Individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	45	$	282	$	-	$	-	$	327
Collectively evaluated for impairment		1,394		1,080		2,037		240		267		670		60		607		1,078		381		278		8,092
		1,394		1,080		2,037		240		267		670		60		652		1,360		381		278		8,419
Purchased credit-impaired		-		-		49		-		-		-		-		-		-		-		-		49
Total	$	1,394	$	1,080	$	2,086	$	240	$	267	$	670	$	60	$	652	$	1,360	$	381	$	278	$	8,468
Recorded Investment in Loans:
Individually evaluated for impairment	$	-	$	2,116	$	452	$	-	$	1,019	$	-	$	-	$	1,288	$	1,574	$	247	$	-	$	6,696
Collectively evaluated for impairment		183,132		303,791		459,006		31,043		40,112		86,570		5,144		187,791		153,709		57,921		27,106		1,535,325
		183,132		305,907		459,458		31,043		41,131		86,570		5,144		189,079		155,283		58,168		27,106		1,542,021
Purchased credit-impaired		6,223		24,946		38,732		457		7,549		-		2,068		25,772		1,677		4,805		590		112,819
Total	$	189,355	$	330,853	$	498,190	$	31,500	$	48,680	$	86,570	$	7,212	$	214,851	$	156,960	$	62,973	$	27,696	$	1,654,840
At December 31, 2014
Allowance for Loan Losses:
Individually evaluated for impairment	$	44	$	18	$	57	$	-	$	11	$	-	$	19	$	138	$	382	$	4	$	12	$	685
Collectively evaluated for impairment		1,519		703		1,694		458		580		395		13		305		1,269		538		103		7,577
		1,563		721		1,751		458		591		395		32		443		1,651		542		115		8,262
Purchased credit-impaired		-		-		-		-		-		-		-		-		-		-		-		-
Total	$	1,563	$	721	$	1,751	$	458	$	591	$	395	$	32	$	443	$	1,651	$	542	$	115	$	8,262
Recorded Investment in Loans:
Individually evaluated for impairment	$	376	$	2,889	$	1,271	$	-	$	1,073	$	-	$	143	$	2,525	$	2,481	$	369	$	90	$	11,217
Collectively evaluated for impairment		167,858		300,339		425,510		28,887		40,710		71,478		3,715		173,895		151,082		48,939		21,738		1,434,151
		168,234		303,228		426,781		28,887		41,783		71,478		3,858		176,420		153,563		49,308		21,828		1,445,368
Purchased credit-impaired		5,552		30,554		43,866		514		13,660		112		1,187		28,730		1,734		6,574		758		133,241
Total	$	173,786	$	333,782	$	470,647	$	29,401	$	55,443	$	71,590	$	5,045	$	205,150	$	155,297	$	55,882	$	22,586	$	1,578,609

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 loans greater than $150,000, for which it is probable that the Company will be unable to collect all amounts due according to contractual terms based on current information and events. Impairment measurement reflects only a deterioration of credit quality and not changes in market rates that may cause a change in the fair value of the impaired loan. The amount of impairment may be measured in one of three ways, including (i) calculating the present value of expected future cash flows, discounted at the loan’s interest rate implicit in the original document and deducting estimated selling costs, if any; (ii) observing quoted market prices for identical or similar instruments traded in active markets, or employing model-based valuation techniques for which all significant assumptions are observable in the market; and (iii) determining the fair value of collateral, which is utilized for both collateral dependent loans and for loans when foreclosure is probable.

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

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. The look back periods utilized by management in determining the quantitative reserve component was 15 periods for all loan product types at both June 30, 2015 and December 31, 2014.

The Company also performs a quantitative calculation on the purchased performing loan portfolio. There is no allowance for loan losses established at the acquisition date for purchased performing loans. The historical loss experience discussed above is applied to the purchased performing loan portfolio and the result is compared to the remaining fair value mark on this portfolio. A provision for loan losses is recorded for any further deterioration in these loans subsequent to the acquisition. At June 30, 2015 and December 31, 2014, this analysis indicated a need for $232 thousand and $117 thousand of reserves for the purchased performing portfolio, respectively. The remaining mark on the purchased performing loan portfolio was $2.5 million and $3.0 million at June 30, 2015 and December 31, 2014, 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. These factors include portfolio trends, portfolio concentrations, economic and market conditions, changes in lending practices, changes in loan review systems, geographic considerations and other factors. Each of the factors, except other factors, can range from 0.00% (not applicable) to 0.15% (very high). Other factors are reviewed on a situational basis and are adjusted in five basis point increments, up or down, with a maximum of 1.00%. Details of the seven environmental factors for inclusion in the allowance methodology are as follows:

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

18

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

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

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

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

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

vii. Other factors, which is intended to capture the incremental adjustment, by loan type, to internally calculated minimum reserves (as discussed below), environmental factors not specifically identified above and additional risk considerations for impaired loans less than or equal to $150 thousand that are not specifically reviewed.

The Company reviews and applies minimum reserves as part of the qualitative component when deemed necessary through the use of Other Factors. Additional other factors for minimum reserve levels are typically utilized when historical loss data materially understates historic loss rates due to a rapidly declining economic environment, significant recovery periods or insufficient historic loss data. Minimums loss levels are determined by analyzing Federal Reserve Bank charge-off data for all insured federal- and state-chartered commercial banks.

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 of $156 thousand for the three and six months ended June 30, 2015. Additionally, in the three and six month periods ended June 30, 2015, approximately $71 thousand is attributable to covered loans under 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. During the three and six months ended June 30, 2014 this analysis resulted in net (recovery) impairment of ($521) thousand and ($209) thousand, respectively. Additionally, in the three and six month periods ended June 30, 2014, approximately $9 thousand and $(278) thousand, respectively, are attributable to covered loans under FDIC loss share agreements. In the three month period ended June 30, 2014, these covered loan impairments were a function of an increase in expected losses and as a result, the FDIC indemnification asset was increased. In the six month period ended June 30, 2014, these covered impairments were a function of a decrease in expected losses. See Note 6 – FDIC Loss Share Agreements for further discussion. A full breakdown of the net impairment or recovery is detailed in the allowance by segment table above for the three and six months ended June 30, 2015 and 2014.

19

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The allowance for loan losses is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. The increase in the allowance for loan losses from December 31, 2014 to June 30, 2015 was a function of the following:

(1) A decrease of $701 thousand in the quantitative component of the allowance due to a decrease in historical loss rates applied to the portfolio as significant charge-offs from 2011 are replaced with lower net charge-off periods in 2015. This decrease in historical loss rates applied was partially offset by an increase in quantitative reserves for impaired loans less than or equal to $150 thousand that are now collectively reviewed.

(2) An increase of $1.2 million in the qualitative component of the allowance primarily due to new application of additional other factors for impaired loans less than or equal to $150 thousand to capture additional risk characteristics of those pools. In addition, as historical loss rates continue to decline, Other Factors (which capture minimum losses) are now applied to all loan pools. Finally, an additional provision of $232 thousand was recorded for the purchased performing pools.

(3) A decrease of $358 thousand in specific reserves as impaired loans less than or equal to $150 thousand are no longer specifically reviewed.

(4) A $49 thousand increase in reserves on PCI pools which reflect a $156 thousand impairment in several pools as discussed above.

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 June 30, 2015 and December 31, 2014, $125 thousand was recorded as an other liability for off-balance sheet credit exposure.

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

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

Pass:	Loans in classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. PCI loans that were recorded at estimated fair value on the acquisition date are generally assigned a “pass” loan grade because their net financial statement value is based on the present value of expected cash flows. Management believes there is a low likelihood of loss related to those loans that are considered pass.
Special Mention:	Loans in classes that comprise the commercial and consumer portfolio segments that have potential weaknesses that deserve management's close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan. Management believes there is a moderate likelihood of some loss related to those loans that are considered special mention.
Classified:	Loans in the classes that comprise the commercial and consumer portfolio segments that are inadequately protected by the sound worth and paying capacity of the borrower or of the collateral pledged, if any. Management believes that there is a distinct possibility that the Company will sustain some loss if the deficiencies related to classified loans are not corrected in a timely manner.

20

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The Company's credit quality indicators are periodically updated on a case-by-case basis. The following tables present the recorded investment in the Company's loans as of June 30, 2015 and December 31, 2014, by loan class and by credit quality indicator.

	As of June 30, 2015
	Commercial and industrial		CRE - owner-occupied		CRE - investor income producing		AC&D - 1-4 family construction		AC&D - lots, land & development		AC&D - CRE		Other commercial		Total Commercial
Pass	$	189,058	$	323,933	$	491,224	$	31,500	$	45,974	$	86,570	$	7,074	$	1,175,333
Special mention		101		3,513		5,369		-		1,221		-		-		10,204
Classified		196		3,407		1,597		-		1,485		-		138		6,823
Total	$	189,355	$	330,853	$	498,190	$	31,500	$	48,680	$	86,570	$	7,212	$	1,192,360
	Residential mortgage		HELOC		Residential construction		Other loans to individuals								Total Consumer
Pass	$	208,469	$	150,622	$	62,225	$	27,637							$	448,953
Special mention		4,666		4,786		282		22								9,756
Classified		1,716		1,552		466		37								3,771
Total	$	214,851	$	156,960	$	62,973	$	27,696							$	462,480
Total Loans															$	1,654,840

	As of December 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	$	172,638	$	328,712	$	461,955	$	29,401	$	52,568	$	71,590	$	4,902	$	1,121,766
Special mention		493		1,925		6,934		-		1,335		-		-		10,687
Classified		655		3,145		1,758		-		1,540		-		143		7,241
Total	$	173,786	$	333,782	$	470,647	$	29,401	$	55,443	$	71,590	$	5,045	$	1,139,694
	Residential mortgage		HELOC		Residential construction		Other loans to individuals								Total Consumer
Pass	$	202,214	$	147,893	$	55,290	$	22,445							$	427,842
Special mention		1,802		6,122		227		99								8,250
Classified		1,134		1,282		365		42								2,823
Total	$	205,150	$	155,297	$	55,882	$	22,586							$	438,915
Total Loans															$	1,578,609

21

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 June 30, 2015 and December 31, 2014.

		30-59		60-89	Past Due
	Days		Days		90 Days		PCI
	Past Due		Past Due		or More		Loans		Current		Total Loans
As of June 30, 2015
Commercial:
Commercial and industrial	$	1,337	$	131	$	2	$	6,223	$	181,662	$	189,355
CRE - owner-occupied		937		-		176		24,946		304,794		330,853
CRE - investor income producing		-		-		250		38,732		459,208		498,190
AC&D - 1-4 family construction		-		-		-		457		31,043		31,500
AC&D - lots, land & development		-		23		-		7,549		41,108		48,680
AC&D - CRE		-		-		-		-		86,570		86,570
Other commercial		-		-		-		2,068		5,144		7,212
Total commercial loans		2,274		154		428		79,975		1,109,529		1,192,360
Consumer:
Residential mortgage		190		414		561		25,772		187,914		214,851
HELOC		349		140		298		1,677		154,496		156,960
Residential construction		100		-		265		4,805		57,803		62,973
Other loans to individuals		267		53		2		590		26,784		27,696
Total consumer loans		906		607		1,126		32,844		426,997		462,480
Total loans	$	3,180	$	761	$	1,554	$	112,819	$	1,536,526	$	1,654,840
As of December 31, 2014
Commercial:
Commercial and industrial	$	123	$	18	$	73	$	5,552	$	168,020	$	173,786
CRE - owner-occupied		-		-		1,616		30,554		301,612		333,782
CRE - investor income producing		-		-		571		43,866		426,210		470,647
AC&D - 1-4 family construction		-		-		-		514		28,887		29,401
AC&D - lots, land & development		-		-		-		13,660		41,783		55,443
AC&D - CRE		-		-		-		112		71,478		71,590
Other commercial		40		143		-		1,187		3,675		5,045
Total commercial loans		163		161		2,260		95,445		1,041,665		1,139,694
Consumer:
Residential mortgage		57		68		1,058		28,730		175,237		205,150
HELOC		343		60		228		1,734		152,932		155,297
Residential construction		157		-		341		6,574		48,810		55,882
Other loans to individuals		29		1		41		758		21,757		22,586
Total consumer loans		586		129		1,668		37,796		398,736		438,915
Total loans	$	749	$	290	$	3,928	$	133,241	$	1,440,401	$	1,578,609

22

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Impaired Loans - All classes of loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impaired loans may include all classes of nonaccrual loans and loans modified in a troubled debt restructuring (“TDR”). A specific valuation allowance is allocated, if necessary on impaired loans greater than $150 thousand, so that the loan is reported net, at the present value of estimated future cash flows using the rate implicit in the original loan agreement or at the fair value of collateral if repayment is expected solely from the collateral. Additionally, a portion of the Company’s qualitative factors accounts for potential impairment on loans generally less than $150 thousand. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

The Company’s quarterly cash flow analyses of PCI loan pools indicated a net impairment of $156 thousand during the three and six months ended June 30, 2015. The Company’s quarterly cash flow analyses of PCI loan pools indicated a net release of previous impairment of $521 thousand for the three months ended June 30, 2014 and $209 thousand for the six months ended June 30, 2014 as the pools impacted showed improved expected cash flows. These amounts are not included in the tables below.

23

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 specifically reviewed for impairment, by class, and the corresponding allowance for loan losses at June 30, 2015 and December 31, 2014. The table below also presents the recorded investment, unpaid principal balance and related allowance for impaired loans less than $150,000 not specifically reviewed at June 30, 2015 and December 31, 2014:

	June 30, 2015						December 31, 2014
			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	$	-	$	-	$	-	$	47	$	126	$	-
CRE - owner-occupied		2,116		2,267		-		2,753		2,841		-
CRE - investor income producing		452		452		-		844		915		-
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		1,019		1,137				881		970		-
AC&D - CRE		-		-				-		-		-
Other commercial		-		-		-		-		-		-
Total commercial loans		3,587		3,856		-		4,525		4,852		-
Consumer:
Residential mortgage		652		672		-		1,135		1,222		-
HELOC		349		604		-		756		1,256		-
Residential construction		247		376		-		341		415		-
Other loans to individuals		-		-		-		-		-		-
Total consumer loans		1,248		1,652		-		2,232		2,893		-
Total impaired loans with no related allowance recorded	$	4,835	$	5,508	$	-	$	6,757	$	7,745	$	-
Impaired Loans with an Allowance Recorded:
Commercial:
Commercial and industrial	$	-	$	-	$	-	$	329	$	348	$	44
CRE - owner-occupied		-		-		-		136		141		18
CRE - investor income producing				-		-		427		442		57
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		-		-		-		192		217		11
AC&D - CRE		-		-		-		-		-		-
Other commercial		-		-		-		143		159		19
Total commercial loans		-		-		-		1,227		1,307		149
Consumer:
Residential mortgage		636		658		45		1,390		1,439		138
HELOC		1,225		1,248		282		1,725		1,777		382
Residential construction		-		-		-		28		33		4
Other loans to individuals		-		-		-		90		90		12
Total consumer loans		1,861		1,906		327		3,233		3,339		536
Total impaired loans with an allowance recorded	$	1,861	$	1,906	$	327	$	4,460	$	4,646	$	685
Total Impaired Loans:
Commercial:
Commercial and industrial	$	-	$	-	$	-	$	376	$	474	$	44
CRE - owner-occupied		2,116		2,267		-		2,889		2,982		18
CRE - investor income producing		452		452		-		1,271		1,357		57
AC&D - 1-4 family construction		-		-		-		-		-		-
AC&D - lots, land & development		1,019		1,137		-		1,073		1,187		11
AC&D - CRE		-		-		-		-		-		-
Other commercial		-		-		-		143		159		19
Total commercial loans		3,587		3,856		-		5,752		6,159		149
Consumer:
Residential mortgage		1,288		1,330		45		2,525		2,661		138
HELOC		1,574		1,852		282		2,481		3,033		382
Residential construction		247		376		-		369		448		4
Other loans to individuals		-		-		-		90		90		12
Total consumer loans		3,109		3,558		327		5,465		6,232		536
Total Impaired Loans Individually Reviewed for Impairment	$	6,696	$	7,414	$	327	$	11,217	$	12,391	$	685
Other Impaired Loans	$	2,853	$	3,323	$	288	$	-	$	-	$	-

24

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

During the three and six months ended June 30, 2015, the Company recognized $47 thousand and $103 thousand, respectively, of interest income with respect to impaired loans, specifically accruing TDRs, within the period the loans were impaired. During the three and six months ended June 30, 2014, the Company recognized $107 thousand and $241 thousand, respectively, in interest income with respect to impaired loans. The average recorded investment and interest income recognized on individually reviewed impaired loans, by class, for the three and six months ended June 30, 2015 and 2014 are shown in the table below.

	Three Months Ended June 30,								Six Months Ended June 30,
	2015				2014				2015				2014
	Average		Interest		Average		Interest		Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized		Investment		Recognized
Impaired Loans with No Related Allowance Recorded:
Commercial:
Commercial and industrial	$	-	$	-	$	667	$	6	$	-	$	-	$	391	$	14
CRE - owner-occupied		2,163		-		2,881		15		2,360		-		2,328		46
CRE - investor income producing		599		5		945		7		650		13		456		17
AC&D - 1-4 family construction		-		-		-		-		-		-		-		-
AC&D - lots, land & development		940		14		1,102		34		920		26		1,738		78
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		-		-		74		-		-		-		122		4
Total commercial loans		3,702		19		5,669		62		3,930		39		5,035		159
Consumer:
Residential mortgage		850		-		2,353		16		922		-		2,707		31
Home equity lines of credit		434		-		1,382		7		468		2		1,504		13
Residential construction		247		-		18		-		272		-		12		-
Other loans to individuals		-		-		27		-		-		-		47		1
Total consumer loans		1,531		-		3,780		23		1,662		2		4,270		45
Total impaired loans with no related allowance recorded	$	5,233	$	19	$	9,449	$	85	$	5,592	$	41	$	9,305	$	204
Impaired Loans with an Allowance Recorded:
Commercial:
Commercial and industrial	$	-	$	-	$	135	$	-	$	-	$	-	$	246	$	-
CRE - owner-occupied		-		-		165		1		-		-		113		3
CRE - investor income producing		-		-		242		3		-		-		2,204		3
AC&D - 1-4 family construction		-		-		48		-		-		-		19		2
AC&D - lots, land & development		91		-		48		-		122		3		69		-
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		-		-		184		5		-		-		96		5
Total commercial loans		91		-		822		9		122		3		2,747		13
Consumer:
Residential mortgage		677		8		1,454		9		691		14		1,381		18
Home equity lines of credit		1,226		10		1,704		2		1,226		21		1,361		4
Residential construction		-		-		321		-		-		-		152		-
Other loans to individuals		-		-		33		2		-		-		15		2
Total consumer loans		1,903		18		3,512		13		1,917		35		2,909		24
Total impaired loans with an allowance recorded	$	1,994	$	18	$	4,334	$	22	$	2,039	$	38	$	5,656	$	37
Total Impaired Loans Individually Reviewed for Impairment
Commercial:
Commercial and industrial	$	-	$	-	$	802	$	6	$	-	$	-	$	637	$	14
CRE - owner-occupied		2,163		-		3,046		16		2,360		-		2,441		49
CRE - investor income producing		599		5		1,187		10		650		13		2,660		20
AC&D - 1-4 family construction		-		-		48		-		-		-		19		2
AC&D - lots, land & development		1,031		14		1,150		34		1,042		29		1,807		78
AC&D - CRE		-		-		-		-		-		-		-		-
Other commercial		-		-		258		5		-		-		218		9
Total commercial loans		3,793		19		6,491		71		4,052		42		7,782		172
Consumer:
Residential mortgage		1,527		8		3,807		25		1,613		14		4,088		49
Home equity lines of credit		1,660		10		3,086		9		1,694		23		2,865		17
Residential construction		247		-		339		-		272		-		164		-
Other loans to individuals		-		-		60		2		-		-		62		3
Total consumer loans		3,434		18		7,292		36		3,579		37		7,179		69
Total Impaired Loans Individually Reviewed for Impairment	$	7,227	$	37	$	13,783	$	107	$	7,631	$	79	$	14,961	$	241
Other Impaired Loans	$	2,953	$	10	$	-	$	-	$	2,894	$	24	$	-	$	-

25

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Nonaccrual and Past Due Loans - It is the general policy of the Company to place a loan on nonaccrual status when there is probable loss or when there is reasonable doubt that all principal will be collected, or when it is over 90 days past due. At June 30, 2015, there were no loans past due 90 days or more and accruing interest. At December 31, 2014, there was $30 thousand in loans past due 90 days or more and accruing interest. These loans were considered fully collectible at December 31, 2014. The recorded investment in nonaccrual loans at June 30, 2015 and December 31, 2014 was as follows:

	June 30,		December 31,
	2015		2014
Commercial:
Commercial and industrial	$	163	$	329
CRE - owner-occupied		2,116		1,616
CRE - investor income producing		380		680
AC&D - lots, land & development		6		7
Total commercial loans		2,665		2,632
Consumer:
Residential mortgage		1,257		1,549
HELOC		1,094		1,022
Residential construction		443		341
Other loans to individuals		86		41
Total consumer loans		2,880		2,953
Total nonaccrual loans	$	5,545	$	5,585

Purchased Credit-Impaired Loans – PCI loans had an unpaid principal balance of $141.5 million and $165.7 million and a carrying value of $112.8 million and $133.2 million at June 30, 2015 and December 31, 2014, respectively. PCI loans represented 4.6% and 5.6% of total assets at June 30, 2015 and December 31, 2014, respectively. Determining the fair value of the PCI loans at the time of acquisition requires 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 is no carryover of previously established allowance for loan losses from acquired companies.

A summary of changes in the accretable yield for PCI loans for the six months ended June 30, 2015 and 2014 follows:

Accretable yield table
	Six Months Ended June 30,
	2015			2014
Accretable yield, beginning of period	$	40,540		$	39,249
Addition from the Provident Community acquisition		-			5,589
Interest income		(6,651	)		(7,960	)
Reclassification of nonaccretable difference due to improvement in expected cash flows		2,808			6,334
Other changes, net		76			857
Accretable yield, end of period	$	36,773		$	44,069

26

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

As of June 30, 2015, the Company had 14 TDR loans totaling $3.6 million, of which $482 thousand are nonaccrual loans. As of December 31, 2014, the Company had 18 TDR loans totaling $4.1 million, of which $841 thousand are nonaccrual loans. The Company had allocated $45 thousand and $373 thousand, respectively, of specific reserves to customers whose loan terms have been modified in a TDR as of June 30, 2015 and December 31, 2014.

The following tables represent a breakdown of the types of concessions made by loan class for the three and six months ended June 30, 2015 and 2014.

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

	Three months ended June 30, 2014						Six months ended June 30, 2014
	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Extended payment terms
Commercial and industrial		1	$	14	$	14		1	$	14	$	14
CRE - investor income producing		1		94		94		1		94		94
Other commercial		-		-		-		1		165		165
HELOC		-		-		-		1		299		299
Residential construction		1		173		173		1		173		173
Total		3	$	281	$	281		5	$	745	$	745

Commercial TDRs - Commercial TDRs (including commercial and industrial, commercial real estate, AC&D and other commercial loans) often result from a workout where an existing commercial loan is restructured and a concession is given. These workouts may involve lengthening the amortization period of the amortized principal beyond market terms, or reducing the interest rate below market terms for the original remaining life of the loan. In the case of extended amortization, this concession reduces the minimum monthly payment and increases the balloon payment at the end of the term of the loan. Other concessions can potentially involve forgiveness of principal, collateral concessions, or reduction of accrued interest. The impact of the TDR on the allowance for loan losses is based on the changes in borrower payment performance rather than just the TDR classification. All TDRs are designated as impaired loans. TDRs, like other impaired loans, are measured based on discounted cash flows, comparing the modified loan to pre-modified terms or, if the loan is deemed to be collateral dependent, collateral value less anticipated selling costs. TDRs having a book balance of less than $150,000, along with other impaired loans of similar size, are measured in a pooled approach. TDRs may remain in accruing status if the borrower remains less than 90 days past due per the restructured loan terms and no loss is expected. A borrower may be considered for removal from TDR status if it is no longer experiencing financial difficulties and can qualify for new loan terms which do not represent a concession, subject to the normal underwriting standards and processes for similar extensions of credit. As of June 30, 2015, the Company has outstanding one commercial TDR with a reduced interest rate and seven commercial TDRs where an extension of maturity was granted. As of June 30, 2015, one of the commercial TDRs is not paying in accordance with the terms of the modification.

27

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Consumer TDRs - Consumer TDRs (including residential mortgage, HELOC, residential construction and other consumer loans) often result from a workout where an existing loan is modified and a concession is given. These workouts typically lengthen the amortization period of the amortized principal beyond market terms or reduce the interest rate below market terms. The impact of the TDR on the allowance for loan losses is based on the changes in borrower payment performance rather than the TDR classification. TDRs like other impaired loans are measured based on discounted cash flows or collateral value, less anticipated selling costs, of the modified loan using pre-modified interest rates. As of June 30, 2015, the Company has outstanding two consumer TDRs with a reduced interest rate and four consumer TDRs where an extension of maturity was granted. All consumer TDRs are paying according to the terms of the modification as of June 30, 2015.

The following tables present loans that were modified as TDRs during the previous twelve months and for which there was a payment default during the six months ended June 30, 2015. There were no loans modified as TDRs during the previous twelve months for which there was a payment default during the six months ended June 30, 2014. There were no loans modified as TDRs during the previous twelve months for which there was a payment default during the three months ended June 30, 2014 or 2015.

	Six months ended June 30, 2015				Six months ended June 30, 2014
	Number of loans		Recorded Investment		Number of loans		Recorded Investment
Extended payment terms
CRE - investor income producing		1	$	84		-	$	-
Total		1	$	84		-	$	-

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 June 30, 2015 and 2014:

	Twelve Months Ended June 30, 2015
	Paid in full				Paying as restructured				Foreclosure/Default
	Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment
Below market interest rate		-	$	-		1	$	180		-	$	-
Extended payment terms		1		636		3		236		1		84
Total		1	$	636		4	$	416		1	$	84

	Twelve Months Ended June 30, 2014
	Paid in full				Paying as restructured				Foreclosure/Default
	Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment
Below market interest rate		-	$	-		3	$	1,954		-	$	-
Extended payment terms		-		-		11		3,195		-		-
Total		-	$	-		14	$	5,149		-	$	-

28

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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:

	Six Months Ended
	June 30,
	2015			2014
Beginning balance	$	14,040		$	17,247
Disbursements		1,486			209
Repayments		(1,107	)		(3,827	)
Ending balance	$	14,419		$	13,629

At June 30, 2015 and December 31, 2014, the Company had pre-approved but unused lines of credit totaling $2.2 million and $3.2 million, respectively, to related parties.

Note 6 – FDIC Loss Share Agreements

In connection with the acquisition of Citizens South Banking Corporation (“Citizens South”) in 2012, the Bank assumed two purchase and assumption agreements with the FDIC that cover approximately $20.3 million and $42.3 million of covered loans as of June 30, 2015 and December 31, 2014, respectively, and $884 thousand and $3.0 million of covered OREO as of June 30, 2015 and December 31, 2014, respectively. Citizens South acquired these assets in prior transactions with the FDIC.

Within the first purchase and assumption agreement are two loss share agreements that originated in March 2010, related to Citizen South’s acquisition of Bank of Hiawassee, a Georgia state-chartered bank headquartered in Hiawassee, Georgia. Under these loss-share agreements, the FDIC will cover 80% of net loan losses up to $102 million and 95% of net loan losses that exceed $102 million. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans, and five years for losses and eight years for recoveries on all other loans. The agreement related to Bank of Hiawassee’s non-single family assets expired on March 31, 2015. On April 1, 2015, the remaining balance of $19.6 million associated with the Bank of Hiawassee non-single family loans and $812,000 associated with non-single family foreclosed assets were transferred from the covered portfolio to the non-covered portfolio. Therefore, after March 31, 2015, the Company will bear all future losses on that portfolio of loans and foreclosed properties. At June 30, 2015 and December 31, 2014, the Bank recorded an estimated receivable from the FDIC in the amount of $666 thousand and $3.0 million, respectively, related to the remaining single-family loss share agreement.

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 June 30, 2015 and December 31, 2014, the Bank recorded an estimated receivable from the FDIC in the amount of $543 thousand and $1.0 million, respectively, related to these loss share agreements.

29

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The following table provides changes in the estimated receivable from the FDIC for the six months ended June 30, 2015 and 2014:

FDIC Loss Share Receivable
	For the six months ended
	June 30,
	2015			2014
Balance, beginning of period	$	3,964		$	10,025
Increase (decrease) in expected losses on loans		71			(278	)
Additional losses to OREO		(6	)		(228	)
Reimbursable expenses (income)		(155	)		529
Amortization discounts and premiums, net		(514	)		(859	)
Reimbursements from the FDIC		(2,151	)		(2,196	)
Balance, end of period	$	1,209		$	6,993

The estimated receivable from the FDIC is measured separately from the related covered assets and is recorded at carrying value. At June 30, 2015 and December 31, 2014, the projected cash flows related to the FDIC receivable for losses on covered loans and assets were approximately $1.2 million and $3.8 million, respectively. Included in the estimated receivable above is a component of amortization which will be recognized over the life of the respective agreement, with increases or decreases based on estimated performance of the underlying loans.

In relation to the FDIC indemnification asset is an expected “true-up” with the FDIC related to the loss share agreements described above. The loss share agreements between the Bank and the FDIC with respect to New Horizons Bank and Bank of Hiawassee each contain a provision that obligates the Company to make a true-up payment to the FDIC if the realized losses of each of these acquired banks are less than expected. An estimate of this amount is determined each reporting period. At June 30, 2015 and December 31, 2014, the “true-up” amount was estimated to be approximately $5.6 million and $5.4 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, including any recovery period, 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 $9.8 million and $12.0 million in OREO at June 30, 2015 and December 31, 2014, respectively. The portion of OREO covered under the loss share agreements with the FDIC at June 30, 2015 and December 31, 2014 totaled $884 thousand and $3.0 million, respectively. The Company’s loss share agreement related to Bank of Hiawassee’s non-single family assets expired on March 31, 2015, and on April 1, 2015, the remaining balance of $812,000 associated with the Bank of Hiawassee non-single family foreclosed assets were transferred from the covered portfolio to the non-covered portfolio. Therefore, after March 31, 2015, the Company will bear all future losses on that portfolio of foreclosed properties.

Transactions in OREO for the three and six months ended June 30, 2015 and 2014 are summarized below:

	Three months ended						Six months ended
	June 30,						June 30,
Non-Covered OREO	2015			2014			2015			2014
Beginning balance	$	8,570		$	8,874		$	8,979		$	9,404
Additions		1,413			301			3,001			1,511
Transfers from covered to non-covered		812			-			812			-
Acquired through merger		-			3,128			-			3,128
Sales		(1,510	)		(1,249	)		(3,404	)		(2,968	)
Writedowns		(381	)		(117	)		(484	)		(138	)
Ending balance	$	8,904		$	10,937		$	8,904		$	10,937
Covered OREO	2015			2014			2015			2014
Beginning balance	$	1,713		$	6,652		$	3,011		$	5,088
Additions		197			1,432			676			3,769
Transfers from covered to non-covered		(812	)		-			(812	)		-
Sales		(214	)		(2,831	)		(1,990	)		(3,579	)
Writedowns		-			(19	)		(1	)		(44	)
Ending balance	$	884		$	5,234		$	884		$	5,234

As of June 30, 2015, the Company has $1.3 million of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process.

Note 8 – Income Taxes

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

As of June 30, 2015 and December 31, 2014, the Company had a net DTA in the amount of approximately $32.1 million and $35.6 million, respectively. The decline is a function of 2015 earnings and changes in the fair value of available-for-sale securities. The Company evaluates the carrying amount of the DTA on a quarterly basis in accordance with the guidance provided in FASB ASC Topic 740, in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e., a likelihood of more than 50%) that some portion, or all, of the DTA will not be realized within its life cycle, based on the weight of available evidence. In most cases, the realization of the DTA is dependent upon generating a sufficient level of taxable income in future periods, which can be difficult to predict. In addition to projected earnings, the Company also considers projected asset quality, liquidity, its strong capital position, which could be leveraged to increase earning assets and generate taxable income, its growth plans and other relevant factors. Based on the weight of available evidence, the Company determined as of June 30, 2015 and December 31, 2014 that it is more likely than not that it will be able to fully realize the existing DTA and therefore considered it appropriate not to establish a DTA valuation allowance at either June 30, 2015 or December 31, 2014.

31

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 9 - Per Share Results

Basic earnings per share represent income available to common shareholders divided by the weighted-average number of shares outstanding during the relevant period. Diluted earnings per share reflect additional shares that would have been outstanding if dilutive potential shares had been issued. 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 and vesting of restricted shares reduced by the number of shares assumed to be repurchased from the issuance proceeds, using the average market price for the period of the Company's stock. Weighted-average shares for the basic and diluted EPS calculations have been reduced by the average number of unvested restricted shares.

For the three months ended June 30, 2015, the Company issued 205,800 restricted stock awards, issued 3,885 shares pursuant to the exercise of stock options, repurchased 145,809 shares in open market transactions and acquired 23,366 shares in connection with satisfaction of tax withholding obligations on vested restricted stock. For the three months ended June 30, 2014, the Company issued 170,650 restricted stock awards, issued 23,912 shares pursuant to the exercise of stock options, repurchased 71,134 shares of Common Stock in open market transactions and acquired 13,247 shares in connection with satisfaction of tax withholding obligations on vested restricted stock.

For the six months ended June 30, 2015, the Company issued 212,300 restricted stock awards, issued 28,963 shares pursuant to the exercise of stock options, issued 1,182 shares of common stock to employees under the 2014 Long-term Incentive Plan, repurchased 149,609 shares in open market transactions and acquired 33,031 shares in connection with satisfaction of tax withholding obligations on vested restricted stock. For the six months ended June 30, 2014, the Company issued 220,650 restricted stock awards, issued 39,451 shares pursuant to the exercise of stock options, repurchased 140,926 shares of Common Stock in open market transactions and acquired 13,247 shares in connection with satisfaction of tax withholding obligations on vested restricted stock.

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

Weighted-Average Shares for Earnings Per Share Calculation
	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2015		2014		2015		2014
Weighted-average number of common shares outstanding excluding unvested restricted shares		43,971,007		43,947,134		43,944,638		43,942,112
Effect of dilutive stock options and unvested restricted shares		330,888		266,668		342,786		297,993
Weighted-average number of common shares and dilutive potential common shares outstanding		44,301,895		44,213,802		44,287,424		44,240,105

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

32

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

There were 1,970,670 outstanding options and 872,793 outstanding unvested restricted shares that were anti-dilutive for the three months ended June 30, 2014. There were 220,245 dilutive stock options and 46,423 dilutive unvested restricted shares outstanding for the three months ended June 30, 2014.

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

There were 1,956,625 outstanding options and 855,514 outstanding unvested restricted shares that were anti-dilutive for the six months ended June 30, 2014. There were 234,291 dilutive stock options and 63,702 dilutive unvested restricted shares outstanding for the six months ended June 30, 2014.

At June 30, 2015, 554,400 of the outstanding unvested restricted shares had performance conditions, which will vest one-third each when the Company’s share price achieves, for 30 consecutive trading days, $8.125, $9.10 and $10.40, respectively. These anti-dilutive restricted shares are issued (and thereby have voting rights), but are not included in basic earnings per share calculations until they vest (and thereby have economic rights).

Note 10 - Commitments and Contingencies

In the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit, which are not reflected in the accompanying unaudited condensed consolidated financial statements. At June 30, 2015, we had $372.2 million of pre-approved but unused lines of credit, $7.8 million of standby letters of credit and $617 thousand of commercial letters of credit. At December 31, 2014, we had $328.3 million of pre-approved but unused lines of credit, $5.4 million of standby letters of credit and $717 thousand of commercial letters of credit. In management’s opinion, these commitments represent no more than normal lending risk to us and will be funded from normal sources of liquidity.

Note 11 - Derivative Financial Instruments and Hedging Activities

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

		June 30, 2015						December 31, 2014
				Estimated Fair Value						Estimated Fair Value
		Notional						Notional
	Balance Sheet Location	Amount		Gain		Loss		Amount		Gain		Loss
Cash flow hedges:
Interest rate contracts:
Pay fixed swaps with counterparty	Other assets and other liabilities	$	70,000	$	-	$	2,818	$	70,000	$	-	$	2,414
Fair value hedges:
Interest rate contracts:
Pay fixed rate swaps with counterparty	Other liablities		26,761		-		468		24,792		-		440
Not designated as hedges:
Customer-related interest rate contracts:
Matched interest rate swaps with borrower	Other assets		69,700		1,534		-		35,289		1,154		-
Matched interest rate swaps with counterparty	Other liabilities		69,700		-		1,534		35,289		-		1,154
Matched foreign exchange contract with borrower	Other assets		905		11		-		-		-		-
Matched foreign exchange contract with counterparty	Other liabilities		905		-		11		-		-		-
			141,210		1,545		1,545		70,578		1,154		1,154
Total derivatives		$	237,971	$	1,545	$	4,831	$	165,370	$	1,154	$	4,008

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 $(1.0) million and $(939) thousand at June 30, 2015 and December 31, 2014, respectively, and is included in other liabilities. As a result of the unfavorable position of the instrument at June 30, 2015 and December 31, 2014, the Company posted collateral of approximately $1.0 million and $939 thousand, respectively, with the counterparty.

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 $(1.8) million and $(1.5) million at June 30, 2015 and December 31, 2014, respectively, and are included in other liabilities. As a result of the unfavorable position of the instruments at June 30, 2015 and December 31, 2014, the Company posted collateral of approximately $1.8 million and $1.5 million, respectively, with the counterparty.

At June 30, 2015, the Company had seven loan swaps, with an aggregate notional amount of $26.8 million, accounted for as fair value hedges in accordance with ASC 815, Derivatives and Hedging. These derivative instruments are used to protect the Company from interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. The derivative instruments are used to convert these fixed rate loans to an effective floating rate. If the 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. At December 31, 2014, the Company had seven loan swaps, with an aggregate notional amount of $26.1 million, accounted for as fair value hedges.

To meet the needs of the Company’s customers, at June 30, 2015 the Company had seventeen interest rate swap agreements in place to convert certain fixed-rate receivables to floating rates and certain fixed-rate obligations to floating rates. To offset this interest rate risk, the Company has entered into substantially identical agreements with a third party to swap these fixed rate agreements into variable rates. The interest rate swaps are used to provide the customer fixed rate financing while managing interest rate risk and were not designated as hedges. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR, with payments being calculated on the notional amount. The interest rate swaps are settled monthly, with varying maturities. The interest rate swaps had a notional amount of $69.7 million at June 30, 2015 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 $1.5 million. 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.

There were seven interest rate swap agreements to cover certain fixed-rate receivables to floating rates and certain fixed-rate obligations to floating rates at December 31, 2014. The interest rate swaps had a notional amount of $35.3 million at December 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 $1.2 million. All changes in fair value are recorded as other income within non-interest income.

For the three and six months ended June 30, 2015, the $43 thousand and $(33) thousand impact to earnings, respectively, reflects customer credit valuation adjustments occurring during the period, 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)

In the second quarter of 2015, the Company entered into six foreign exchange contracts to convert Euros to U.S. Dollars on behalf of the Company’s customers. To offset this foreign exchange risk, the Company has entered into substantially identical agreements with a third party to swap these foreign exchange contracts. The contracts are used to hedge exposure to foreign currency risk associated with non-U.S. dollar transactions. The foreign exchange contracts had a notional amount of $904 thousand at June 30, 2015 representing the amount of contracts outstanding in U.S. dollars, and are included in other assets and other liabilities at their fair value of $11 thousand. All changes in fair value are recorded as other noninterest income and other noninterest expense.

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

	Effective Portion
	Pre-tax gain (loss) recognized in OCI												Pre-tax gain (loss) reclassified from AOCI into income						Pre-tax gain (loss) reclassified from AOCI into income
	For the three months ended June 30,					For the six months ended June 30,						Location of amounts reclassified	For the three months ended June 30,						For the six months ended June 30,
	2015		2014			2015			2014			from AOCI into Income	2015			2014			2015			2014
Cash flow hedges:
Interest rate contracts	$	646	$	(1,071	)	$	(610	)	$	(2,096	)	Total interest expense	$	103		$	106		$	206		$	209
													Pre-tax gain (loss) recognized in income
												Location of amounts	For the three months ended June 30,						For the six months ended June 30,
												recognized in income	2015			2014			2015			2014
Fair value hedges:
Interest rate contracts
Pay fixed rate swaps with counterparty												Total interest income	$	(96	)	$	(45	)	$	(200	)	$	(80	)
Not designated as hedges:
Client-related interest rate contracts												Other income		43			-			(33	)	$	-
													$	(53	)	$	(45	)	$	(233	)	$	(80	)

35

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 12 – Accumulated Other Comprehensive Income (Loss)

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

	For the Three Months Ended									For the Three Months Ended
	June 30, 2015									June 30, 2014
	Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount			Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
Securities available for sale and transferred securities:
Change in net unrealized gains (losses) during the period	$	(3,150	)	$	(1,175	)	$	(1,975	)	$	5,667		$	2,095		$	3,572
Change in net unrealized gain (loss) on securities transferred to held to maturity		73			28			45			(2,209	)		(831	)		(1,378	)
Reclassification adjustment for net gains recognized in net income		-			-			-			33			40			(7	)
Total securities available for sale and transferred securities		(3,077	)		(1,147	)		(1,930	)		3,491			1,304			2,187
Derivatives:
Change in the accumulated loss on effective cash flow hedge derivatives		646			322			324			(1,071	)		(403	)		(668	)
Reclassification adjustment for interest payments		103			(39	)		142			106			40			66
Total derivatives		749			283			466			(965	)		(363	)		(602	)
Total other comprehensive income (loss)	$	(2,328	)	$	(864	)	$	(1,464	)	$	2,526		$	941		$	1,585

	For the Six Months Ended									For the Six Months Ended
	June 30, 2015									June 30, 2014
	Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount			Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
Securities available for sale and transferred securities:
Change in net unrealized gains (losses) during the period	$	(165	)	$	(69	)	$	(96	)	$	9,022		$	3,248		$	5,774
Change in net unrealized gain (loss) on securities transferred to held to maturity		209			86			123			(2,209	)		(831	)		(1,378	)
Reclassification adjustment for net gains recognized in net income		-			-			-			(243	)		12			(255	)
Total securities available for sale and transferred securities		44			17			27			6,570			2,429			4,141
Derivatives:
Change in the accumulated loss on effective cash flow hedge derivatives		(610	)		(230	)		(380	)		(2,096	)		(786	)		(1,310	)
Reclassification adjustment for interest payments		206			78			128			209			79			130
Total derivatives		(404	)		(152	)		(252	)		(1,887	)		(707	)		(1,180	)
Total other comprehensive income (loss)	$	(360	)	$	(135	)	$	(225	)	$	4,683		$	1,722		$	2,961

36

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

	Securities Available for Sale			Securities Transferred from Available for Sale to Held to Maturity			Derivatives			Accumulated Other Comprehensive Income (Loss)
Balance, January 1, 2015	$	1,313		$	(1,282	)	$	(1,506	)	$	(1,475	)
Other comprehensive income (loss) before reclassifications		(96	)		-			(380	)		(476	)
Amounts reclassified from accumulated other comprehensive loss		-			123			128			251
Net other comprehensive income (loss) during the period		(96	)		123			(252	)		(225	)
Balance, June 30, 2015	$	1,217		$	(1,159	)	$	(1,758	)	$	(1,700	)
Balance, January 1, 2014	$	(5,145	)	$	-		$	343		$	(4,802	)
Other comprehensive income (loss) before reclassifications		5,774			-			(1,180	)		4,594
Amounts reclassified from accumulated other comprehensive loss		(255	)		-			-			(255	)
Transfer of securities from available for sale to held to maturity		-			(1,378	)		-			(1,378	)
Net other comprehensive income (loss) during the period		5,519			(1,378	)		(1,180	)		2,961
Balance, June 30, 2014	$	374		$	(1,378	)	$	(837	)	$	(1,841	)

Note 13 - Fair Value Measurements

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

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

Investment Securities Available-for-sale and Investment Securities Held-to-Maturity - Fair value for investment securities is based on the quoted market price if such information is available. If 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.

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 based on 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.

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.

37

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

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

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

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

Junior Subordinated Debentures – Junior subordinated debentures are variable rate borrowings that reprice frequently therefore the carrying amounts are reasonable estimates of fair value.

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

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

Financial Instruments with Off-Balance Sheet Risk - With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments.

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

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

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 June 30, 2015 and December 31, 2014 are as follows:

  Financial Instruments Carrying Amounts and Estimated Fair Values

					Fair Value Measurements
	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets or Liabilities		Significant Other Observable Inputs		Significant Unobservable Inputs
	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2015
Financial assets:
Cash and cash equivalents	$	44,342	$	44,342	$	44,342	$	-	$	-
Investment securities available-for-sale		402,489		402,489		-		400,927		1,562
Investment securities held-to-maturity		111,633		113,182		-		113,182
Nonmarketable equity securities		13,500		13,500		-		13,500		-
Loans held for sale		10,701		10,701		-		10,701		-
Loans, net of allowance		1,648,995		1,587,181		-		69,700		1,517,481
FDIC indemnification asset		1,209		1,422		-		-		1,422
Accrued interest receivable		4,852		4,852		-		4,852		-
Derivative instruments		1,545		1,545		-		1,545		-
Financial liabilities:
Deposits with no stated maturity		1,336,009		1,336,009		-		1,336,009		-
Deposits with stated maturities		538,932		541,043		-		541,043		-
Borrowings		258,922		258,609		-		258,609		-
Accrued interest payable		375		375		-		375		-
Derivative instruments		4,831		4,831		-		4,831		-
December 31, 2014
Financial assets:
Cash and cash equivalents	$	51,390	$	51,390	$	51,390	$	-	$	-
Investment securities available-for-sale		375,683		375,683		1,712		372,401		1,570
Investment securities held-to-maturity		115,741		117,627		-		117,627		-
Nonmarketable equity securities		11,532		11,532		-		11,532		-
Loans held for sale		11,602		11,602		-		11,602		-
Loans, net of allowance		1,572,431		1,514,294		-		28,800		1,485,494
FDIC indemnification asset		3,964		3,802		-		-		3,802
Accrued interest receivable		4,467		4,467		-		4,467		-
Derivative instruments		1,154		1,154		-		1,154		-
Financial liabilities:
Deposits with no stated maturity		1,309,973		1,309,973		-		1,309,973		-
Deposits with stated maturities		541,381		543,728		-		543,728		-
Borrowings		203,583		203,207		-		203,207		-
Accrued interest payable		398		398		-		398		-
Derivative instruments		4,008		4,008		-		4,008		-

39

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

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

Investment Securities - Investment securities available-for-sale are recorded at fair value on a recurring basis. Investment securities held-to-maturity are valued at quoted market prices or dealer quotes similar to securities available-for-sale. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, United States Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include MBS issued by government-sponsored entities or private label entities, municipal bonds and corporate debt securities that are valued using quoted prices for similar instruments in active markets. The derived market value requires significant management judgment and is further substantiated by discounted cash flow methodologies.

Derivative Instruments - Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. 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. The Company classifies derivative instruments held or issued for risk management purposes as Level 2. The Company’s derivative instruments consist of interest rate swaps, swap fair value hedges, and foreign exchange contracts.

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. The fair value of impaired loans greater than $150,000 is estimated using one of several methods, including collateral value, discounted cash flows or observable market value method. 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. Impaired loans less than or equal to $150,000 are deemed immaterial for specific review.

At June 30, 2015 and December 31, 2014, substantially all of the individually reviewed impaired loans were evaluated based on the fair value of the collateral. The Company records the seven loans involved in fair value hedges at fair market value on a recurring basis at June 30, 2015. 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 June 30, 2015 and December 31, 2014 measured at fair value on a recurring basis:

Fair Value on a Recurring Basis 

Description	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Assets/Liabilities at Fair Value
June 30, 2015
U.S. Government agencies	$	-	$	527		$	-	$	527
Municipal securities		-		15,217			-		15,217
Residential agency pass-through securities		-		147,244			-		147,244
Residential collateralized mortgage obligations		-		166,430			-		166,430
Commercial mortgage-backed obligations		-		4,842			-		4,842
Asset-backed securities		-		65,173			-		65,173
Corporate and other securities		-		-			1,562		1,562
All other equity securities		1,494		-			-		1,494
Fair value loans		-		69,700			-		69,700
Derivative instruments		-		(3,286	)		-		(3,286	)
December 31, 2014
U.S. Government agencies	$	-	$	537		$	-	$	537
Municipal securities		-		12,851			-		12,851
Residential agency pass-through securities		-		147,015			-		147,015
Residential collateralized mortgage obligations		-		144,080			-		144,080
Commercial mortgage-backed obligations		-		4,868			-		4,868
Asset-backed securities		-		61,050			-		61,050
Corporate and other securities		-		2,000			1,570		3,570
All other equity securities		1,712		-			-		1,712
Fair value loans		-		28,800			-		28,800
Derivative instruments		-		(2,854	)		-		(2,854	)

Securities measured on a Level 3 recurring basis at June 30, 2015 and December 31, 2014 include a corporate debt security whose value is determined by the going rate of a similar debt security if it were to enter the market at period end with additional liquidity discounts applied due to a smaller available market.

The following is a reconciliation of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2015 and 2014.

	Securities Available for Sale
	(in thousands)
	Three Months Ended June 30,					Six Months Ended June 30,
	2015			2014		2015			2014
Fair value, beginning of the period	$	1,568		$	-	$	1,570		$	-
Security acquired from Provident Community		-			1,437		-			1,437
Change in unrealized gain recognized in other comprehensive income		(6	)		-		(8	)		-
Fair value, end of the period	$	1,562		$	1,437	$	1,562		$	1,437

41

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Assets Recorded at Fair Value on a Nonrecurring Basis

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

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

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

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

42

PARK STERLING CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

The following table sets forth by level, within the fair value hierarchy, the Company’s assets at fair value on a nonrecurring basis at June 30, 2015 and December 31, 2014:

  Fair Value on a Nonrecurring Basis

	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable		Assets/
	Assets		Inputs		Inputs		(Liabilities)
Description	(Level 1)		(Level 2)		(Level 3)		at Fair Value
June 30, 2015
OREO	$	-	$	-	$	6,513	$	6,513
Impaired loans:
CRE - investor income producing		-		-		375		375
Residential mortgage		-		-		21		21
HELOC		-		-		18		18
Residential construction		-		-		293		293
December 31, 2014
OREO	$	-	$	-	$	7,408	$	7,408
Impaired loans:
Commercial and industrial		-		-		208		208
CRE - owner-occupied		-		-		56		56
CRE - investor income producing		-		-		353		353
Other commercial		-		-		148		148
Residential mortgage		-		-		954		954
HELOC		-		-		570		570
Residential construction		-		-		357		357
Other loans to individuals		-		-		78		78

In accordance with accounting for foreclosed property, the carrying value of OREO is periodically reviewed and written down to fair value and any loss is included in earnings. During the three months ended June 30, 2015, OREO with a carrying value of $2.5 million was written down by $375 thousand to $2.2 million. During the six months ended June 30, 2015, OREO with a carrying value of $3.3 million was written down by $485 thousand to $2.8 million. During the three months ended June 30, 2014, OREO with a carrying value of $1.0 million was written down by $136 thousand to $0.9 million. During the six months ended June 30, 2014, OREO with a carrying value of $2.0 million was written down by $182 thousand to $1.8 million.

The table below presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a nonrecurring basis at June 30, 2015.

								Weighted
	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs			Average Discount
OREO	$	6,513	Appraisals	Discount to reflect current market conditions		0% - 30	%		1.21	%
Impaired loans		707	Collateral based measurements	Discount to reflect current market conditions		0% - 60	%		21.00	%
				and ultimate collectability
	$	7,220

There were no transfers between valuation levels for any accounts for the three or six months ended June 30, 2015 and 2014. 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 14 – Shareholders’ Equity

The Company maintains a share-based plan for directors and employees to attract, retain and provide incentives for directors and key employees in the form of incentive and non-qualified stock options, restricted stock and other equity-based awards. The total number of shares available for issuance under the outstanding share-based plan is 635,237 as of June 30, 2015.

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

	Outstanding Options									Nonvested Restricted Shares
				Weighted		Weighted							Weighted
				Average		Average							Average		Aggregate
	Number			Exercise		Contractual		Intrinsic		Number			Grant Date		Intrinsic
	Outstanding			Price		Term (Years)		Value		Outstanding			Fair Value		Value
At December 31, 2014		2,171,357		$	7.40		4.69	$	1,668,621		921,095		$	4.81	$	6,770,049
Restricted shares granted		-			-		-		-		212,300			6.71		-
Options exercised		(28,963	)		4.87		-		-		-			-		-
Restricted shares vested		-			-		-		-		(139,134	)		5.94		-
Expired and forfeited		(22,275	)		9.09		-		-		(8,917	)		6.49		-
At June 30, 2015		2,120,119		$	7.42		4.24	$	1,363,286		985,344		$	5.05	$	7,094,479
Exercisable at June 30, 2015		2,106,785

At June 30, 2015, unrecognized compensation cost related to nonvested stock options of $29 thousand is expected to be recognized over a weighted-average period of 1.10 years. Total compensation expense for stock options was $5 thousand and $8 thousand for the three months ended June 30, 2015 and 2014, respectively. Total compensation expense for stock options was $16 thousand and $26 thousand for the six months ended June 30, 2015 and 2014, respectively.

At June 30, 2015, unrecognized compensation cost related to nonvested restricted shares of $2.5 million is expected to be recognized over a weighted-average period of 1.46 years. Total compensation expense for restricted shares was $284 thousand and $277 thousand for the three months ended June 30, 2015 and 2014, respectively. Total compensation expense for restricted shares was $574 thousand and $505 thousand for the six months ended June 30, 2015 and 2014, respectively.

Note 15 – Subsequent Event

Dividend Declaration

On July 22, 2015, the Company announced that its Board of Directors declared a quarterly dividend of $0.03 per common share, payable on August 19, 2015 to all common shareholders of record as of the close of business on August 5, 2015.

44

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

You should not place undue reliance on any forward-looking statement and should consider all of the following uncertainties and risks, as well as those more fully discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed with the Securities and Exchange Commission (“SEC”) on March 6, 2015 (the “2014 Form 10-K”) and in any of the Company’s subsequent filings with the SEC: increases in expected costs or decreases in expected savings or difficulties related to merger integration matters; inability to identify and successfully negotiate and complete additional combinations with other potential merger partners or to successfully integrate such businesses into the Company, including the Company’s ability to adequately estimate or to realize the benefits and cost savings from and limit any unexpected liabilities acquired as a result of any such business combination; failure to generate an adequate return on investment related to new branches or other hiring initiatives; inability to generate future organic growth in loan balances, retail banking, wealth management, mortgage banking or capital markets results through the hiring of new personnel, development of new products, opening of de novo branches, or otherwise; inability to capitalize on identified revenue enhancements or expense management opportunities; variability in the performance of covered loans and associated loss-share related expenses; the effects of negative or soft economic conditions, including stress in the commercial real estate markets or failure of continued recovery in the residential real estate markets; changes in consumer and investor confidence and the related impact on financial markets and institutions; changes in interest rates; failure of assumptions underlying noninterest expense levels; failure of assumptions underlying the establishment of allowances for loan losses; deterioration in the credit quality of the loan portfolio or in the value of the collateral securing those loans; deterioration in the value of securities held in the investment securities portfolio; the possibility of recognizing other-than-temporary impairments on holdings of collateralized loan obligation securities as a result of the Volcker Rule; the impacts on the Company of a potential increasing rate environment; the potential impacts of any government shutdown or debt ceiling 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.

45

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

The purpose of this discussion and analysis is to focus on significant changes in our financial condition as of and results of operations during the three- and six-month periods ended June 30, 2015. This discussion and analysis highlights and supplements information contained elsewhere in this Quarterly Report on Form 10-Q, particularly the preceding unaudited condensed consolidated financial statements and accompanying notes (the “Unaudited Financial Statements”).

Executive Overview

The Company reported net income of $8.1 million, or $0.18 per share, for the six months ended June 30, 2015 compared to $7.0 million, or $0.16 per share, for the six months ended June 30, 2014. Changes in net income from the first six months of 2014 include a 13% increase in net interest income and a 17% increase in noninterest income, partially offset by a 10% increase in noninterest expense levels and a $696 thousand increase in provision for loan losses.

The Company reported adjusted net income, which excludes merger-related expenses and gain or loss on sale of securities, of $8.2 million, or $0.19 per share, for the six months ended June 30, 2015 compared to $7.3 million, or $0.16 per share, for the six months ended June 30, 2014. The increase in adjusted net income resulted from higher net interest and noninterest income, partially offset by the increase in provision for loan losses and noninterest expense, driven by organic growth and the acquisition of Provident Community.

Net interest margin was 3.81% for the six months ended June 30, 2015, representing a 15 basis point decrease from 3.96% for the six months ended June 30, 2014. This reduction resulted primarily from a 50 basis point decrease in yield on loans, due primarily to lower interest rates on new loans, offset by a 13 basis point decrease in the cost of interest-bearing liabilities, also due to lower interest rates.

Total assets increased $84.7 million, or 4%, to $2.44 billion at June 30, 2015, compared to total assets of $2.36 billion at December 31, 2014. Cash and equivalents decreased 14%, to fund organic loan growth, and total loans increased 5%, to $1.65 billion, due to continued success in origination efforts.

Asset quality remains a point of strength for the Company. Nonperforming loans decreased 3%, to $8.7 million at June 30, 2015, or 0.52% of total loans, compared to $8.9 million at December 31, 2014, or 0.56% of total loans. Nonperforming assets decreased to $18.4 million at June 30, 2015, or 0.75% of total assets, compared to $20.9 million at December 31, 2014, or 0.89% of total assets.

Total deposits increased 1.3%, to $1.87 billion at June 30, 2015, compared to $1.85 billion at December 31, 2014, reflecting strong results in both retail and commercial banking as the Company has continued to emphasize growing transaction account relationships. Total shareholders’ equity increased 1.7%, to $279.7 million at June 30, 2015 compared to $275.1 million at December 31, 2014, driven by retained earnings. The Company’s ratio of tangible common equity to tangible assets decreased to 9.99% at June 30, 2015 from 10.13% at December 31, 2014. The Company’s Tier 1 leverage ratio increased to 11.09% at June 30, 2015 from 10.17% at December 31, 2014, primarily due to beneficial changes under the BASEL III regulatory standard, which went into effect on January 1, 2015.

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 June 2015, the Bank opened a second de novo branch in the greater Richmond market for which regulatory approval had been received earlier in the year. On May 1, 2014, the Company completed its acquisition of Provident Community, with Provident Community, a bank holding company headquartered in Rock Hill, South Carolina, being merged into the Company and Provident Community Bank, N.A. being merged into the Bank. The information in this Form 10-Q, including the information under this Item 2, is as of June 30, 2015 and does not reflect any changes in the business operations or financial condition of the Company after that date.

46

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

Non-GAAP Financial Measures

In addition to traditional measures, management uses tangible assets, tangible common equity, adjusted allowance for loan losses, adjusted net income, and adjusted noninterest expenses, and related ratios and per-share measures, 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 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.

47

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

Reconciliation of Non-GAAP Financial Measures
	June 30,			December 31,
	2015			2014
	(dollars in thousands, except per share amounts)
Tangible common equity to tangible assets
Total assets	$	2,443,880		$	2,359,230
Less: intangible assets		(39,462	)		(40,157	)
Tangible assets	$	2,404,418		$	2,319,073
Total common equity	$	279,743		$	275,105
Less: intangible assets		(39,462	)		(40,157	)
Tangible common equity	$	240,281		$	234,948
Tangible common equity		240,281			234,948
Divided by: tangible assets		2,404,418			2,319,073
Tangible common equity to tangible assets		9.99	%		10.13	%
Common equity to assets		11.45	%		11.66	%
Adjusted allowance for loan losses (1)
Allowance for loan losses	$	8,468		$	8,262
Plus: acquisition accounting net FMV adjustments to acquired loans		31,159			35,419
Adjusted allowance for loan losses	$	39,627		$	43,681
Divided by: total loans (excluding LHFS)		1,657,463			1,580,693
Adjusted allowance for loan losses to total loans		2.39	%		2.76	%
Allowance for loan losses to total loans		0.51	%		0.52	%

	Three months ended						Six months ended
	June 30,			June 30,			June 30,			June 30,
	2015			2014			2015			2014
Adjusted net income
Pretax income (as reported)	$	6,542		$	5,186		$	12,150		$	10,221
Plus: merger-related expenses		167			594			289			675
(gain) loss on sale of securities		-			33			-			(243	)
Adjusted pretax income		6,709			5,813			12,439			10,653
Tax expense		2,331			1,972			4,196			3,386
Adjusted net income	$	4,378		$	3,841		$	8,243		$	7,267
Divided by: weighted average diluted shares		44,301,895			44,213,802			44,287,424			44,240,105
Adjusted net income per share	$	0.10		$	0.09		$	0.19		$	0.16
Estimated tax rate		34.75	%		33.93	%		33.73	%		31.78	%
Adjusted noninterest expense
Noninterest expense	$	18,232		$	18,236		$	37,371		$	33,979
Less: merger-related expenses		(167	)		(594	)		(289	)		(675	)
Adjusted noninterest expense	$	18,065		$	17,642		$	37,082		$	33,304

(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.

48

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 “2014 Audited Financial Statements”) included in the 2014 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 June 30, 2015, PCI loans represent loans acquired in connection with the acquisitions of Community Capital Corporation (“Community Capital”), Citizens South Banking Corporation (“Citizens South”) and Provident Community, that were deemed credit impaired. PCI loans that had been classified as nonperforming loans by these institutions are no longer classified as nonperforming so long as, at acquisition and quarterly re-estimation periods, we believe we will fully collect the new carrying value of these loans. It is important to note that judgment regarding the timing and amount of cash flows to be collected is required to classify PCI loans as performing, even if the loan is contractually past due.

Allowance for Loan Losses. The allowance for loan losses is based upon management's ongoing evaluation of the loan portfolio and reflects an amount considered by management to be its best estimate of known and inherent losses in the portfolio as of the balance sheet date. The determination of the allowance for loan losses involves a high degree of judgment and complexity. In making the evaluation of the adequacy of the allowance for loan losses, management considers current economic and market conditions, independent loan reviews performed periodically by third parties, portfolio trends and concentrations, delinquency information, management's internal review of the loan portfolio, internal historical loss rates and other relevant factors. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require us to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Although provisions have been established by loan segments based upon management's assessment of their differing inherent loss characteristics, the entire allowance for losses on loans, other than the portion related to PCI loans and specific reserves on impaired loans, is available to absorb further loan losses in any segment.Further information regarding our policies and methodology used to estimate the allowance for possible loan losses is presented in Note 5 – Loans and Allowance for Loan Losses to the 2014 Audited Financial Statements, and Note 5 – Loans and Allowance for Loan Losses to the Unaudited Financial Statements included in this Form 10-Q.

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

Subsequent declines in the fair value of OREO below the new cost basis are recorded through valuation adjustments. Significant judgments and complex estimates are required in estimating the fair value of 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 OREO, a component of non-interest expense.

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

The purchase and assumption agreements between the Bank and the FDIC, as discussed in Note 6 – FDIC Loss Share Agreements to the 2014 Audited Financial Statements, and Note 6 – FDIC Loss Share Agreements to the Unaudited Financial Statements included in this Form 10-Q, each contain a provision that obligates the Bank to make a true-up payment to the FDIC if the realized losses of each of the applicable acquired banks are less than expected. Any such true-up payment that is materially higher than current estimates could have a negative effect on our business, financial condition and results of operations. These amounts are recorded in other liabilities on the balance sheet. The actual payment will be determined at the end of the term of the loss sharing agreements and is based on the negative bid, expected losses, intrinsic loss estimate, and assets covered under the loss share agreements.

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

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

As of June 30, 2015 and December 31, 2014, we had a net DTA in the amount of approximately $32.1 million and $35.6 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 June 30, 2015 or December 31, 2014.

Additional information regarding our income taxes is presented in Note 12 —Income Taxes to the 2014 Audited Financial Statements.

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Financial Condition at June 30, 2015 and December 31, 2014

Total assets increased $84.7 million to $2.44 billion at June 30, 2015 compared to total assets of $2.36 billion at December 31, 2014. During the six months, cash and interest-earning balances decreased $7.0 million, or 13.7%. Total loans increased $76.8 million, or 4.9%, to $1.65 billion at June 30, 2015 from $1.57 billion. Investment securities, which include available-for-sale and held-to-maturity securities, increased $22.7 million to $514.1 million at June 30, 2015 from $491.4 million at December 31, 2014.

Total liabilities of $2.16 billion at June 30, 2015 increased $80.0 million, or 3.8%, compared to total liabilities of $2.08 billion at December 31, 2014. Total deposits increased $23.6 million, or 1.3%, to $1.87 billion at June 30, 2015. Total borrowings increased $55.3 million, or 27.2%, to $258.9 million at June 30, 2015 from $203.6 million at December 31, 2014.

Total shareholders’ equity increased $4.6 million, or 1.7%, during the first six months to $279.7 million at June 30, 2015. This increase resulted from net income for the six months ended June 30, 2015 of $8.1 million and $585 thousand of share-based compensation expense, partially offset by a $225 thousand increase in accumulated other comprehensive loss, and $2.7 million of dividends on common stock. There were 28,963 stock options exercised during the first six months of 2015, resulting in total proceeds of $141 thousand. The Company repurchased 149,609 shares of common stock in open market transactions, at an average cost of $6.66 per share, for a total of $996 thousand and acquired 33,031 shares in connection with satisfaction of tax withholding obligations on vested restricted stock.

The following table presents selected ratios for the Company for the three and six months ended June 30, 2015 and 2014 and for the year ended December 31, 2014:

Selected Ratios

	Three months ended						Six months ended						Twelve months
	June 30,						June 30,						ended
	(annualized)						(annualized)						December 31,
	2015			2014			2015			2014			2014
Return on Average Assets		0.71	%		0.63	%		0.68	%		0.68	%		0.59	%
Return on Average Equity		6.10	%		5.16	%		5.81	%		5.29	%		4.78	%
Period End Equity to Total Assets		11.45	%		12.02	%		11.45	%		12.02	%		11.66	%

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 June 30, 2015, investment securities totaled $514.1 million compared to $491.4 million at December 31, 2014. There were no sales of securities during the three or six months ended June 30, 2015.

At June 30, 2015, our available-for-sale investment portfolio had a net unrealized gain of $1.9 million compared to a $2.1 million net unrealized gain at December 31, 2014. The decrease in the unrealized gain is a result of fluctuations in market interest rates at period end. There were no securities with an unrealized loss deemed to be other-than-temporary at June 30, 2015 or December 31, 2014.

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 December 31, 2014, the Company held two investments in senior tranches of collateralized loan obligations (“CLOs”) with a fair value of $14.8 million, which were included in asset-backed securities and could be impacted by the Volcker Rule. The collateral eligibility language in one of the securities, with a fair value of $9.8 million, was amended during the first quarter of 2015 to comply with the new bank investment criteria under the Volcker Rule. The Company’s investment in the remaining CLO, which had a net unrealized loss of $33,000 at June 30, 2015, currently would be prohibited under the Volcker Rule. The Company will determine any disposition plans for this security as the documentation is, or is not, amended. Unless the documentation is amended to avoid inclusion within the rule’s prohibitions prior to the expected July 21, 2017 deadline, the Company would have to recognize other-than-temporary-impairment with respect to this security in conformity with GAAP rules. The Company held no other security types potentially affected by the Volcker Rule at June 30, 2015.

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At June 30, 2015, we had $26.9 million in interest-bearing deposits at correspondent banks, of which $26.8 million was on deposit with the Federal Reserve Bank, compared to $34.4 million in interest-bearing deposits at correspondent banks at December 31, 2014. Our balances have decreased due to funding strong loan 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. Since inception, we have promoted the separation of loan underwriting from the loan production staff through our credit department. Currently, credit administration analysts are responsible for underwriting and assigning proper risk grades for all loans with an individual, or relationship, exposure in excess of $500 thousand. Underwriting is completed on standardized forms including a loan approval form and separate credit memorandum. The credit memorandum includes a summary of the loan's structure and a detailed analysis of loan purpose, borrower strength (including individual and global cash flow worksheets), repayment sources and, when applicable, collateral positions and guarantor strength. The credit memorandum further identifies exceptions to policy and/or regulatory limits, total exposure, internal risk grades and other relevant credit information. Loans are approved or denied by varying levels of signature authority based on total customer relationship exposure, with a minimum requirement of at least two authorized signatures. A management-level loan committee is responsible for approving all credits in excess of the chief credit officer’s lending authority, which was increased in October 2014 from $3 million to $5 million.

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 2015 due to increasing new home sales in our primary markets. As of June 30, 2015, approximately 2% of our AC&D loan portfolio, commercial and consumer, falls under the watch list.

Our second mortgage exposure is primarily attributable to our home equity lines of credit (“HELOC”) portfolio, which totaled approximately $157.0 million as of June 30, 2015.

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

At June 30, 2015, total loans, net of deferred fees, increased $76.8 million compared to December 31, 2014. The Company’s metropolitan markets, which include Charlotte, Raleigh and Wilmington, North Carolina, Greenville and Charleston, South Carolina and Richmond, Virginia, reported a $78.6 million, or 19% annualized, increase in total loans from December 31, 2014 to $901.3 million at June 30, 2015, due to continued success in origination efforts. The community markets reported a $21.0 million, or 10% annualized, decrease in total loans from December 31, 2014 to $385.0 million at June 30, 2015, primarily due to more limited attractive lending opportunities. The Company’s central business units, which primarily include mortgage, builder finance, private banking and special assets, reported a $19.2 million, or 11% annualized, increase in total loans from December 31, 2014 to $371.2 million at June 30, 2015, as growth in mortgage, private banking and builder finance more than offset reductions in special asset loans, including covered loans. The composition of the portfolio shifted slightly from December 31, 2014. Total consumer loans increased slightly to 27.9% of total loans, with residential mortgages holding at 13.0%, home equity lines of credit decreasing to 9.5% from 9.8% of total, and other consumer loans increasing to 1.7% from 1.4% of total. The combination of commercial and industrial and owner-occupied real estate loans decreased to 31.4% from 32.1% of total loans, while investor owned commercial real estate increased slightly to 30.1%of total loans. AC&D loans increased to 10.1% of total loans from 9.9% of total loans.

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Asset Quality and Allowance for Loan Losses

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

The following table presents a breakdown of our allowance for loan losses, by component and by loan product type, as of June 30, 2015 and December 31, 2014. Details of the seven environmental factors for consideration in the qualitative component of the allowance methodology as well as additional information about the four components and our policies and methodology used to estimate the allowance for loan losses are presented in Note 5 – Loans and Allowance for Loan Losses to the Unaudited Financial Statements included in this Form 10-Q.

Allowance Allocation by Component

	June 30, 2015
	Specific Reserve					Quantitative Reserve					Qualitative Reserve					PCI Reserve
	$		% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance
	(dollars in thousands)
Commercial:
Commercial and industrial	$	-		0.00	%	$	682		8.05	%	$	712		8.41	%	$	-		0.00	%
CRE - owner-occupied		-		0.00	%		109		1.29	%		971		11.47	%		-		0.00	%
CRE - investor income producing		-		0.00	%		760		8.97	%		1,277		15.08	%		49		0.58	%
AC&D - 1-4 family construction		-		0.00	%		-		0.00	%		240		2.83	%		-		0.00	%
AC&D - lots, land & development		-		0.00	%		-		0.00	%		267		3.15	%		-		0.00	%
AC&D - CRE		-		0.00	%		37		0.44	%		633		7.48	%		-		0.00	%
Other commercial		-		0.00	%		6		0.07	%		54		0.64	%		-		0.00	%
Consumer:
Residential mortgage		45		0.53	%		143		1.69	%		464		5.48	%		-		0.00	%
Home equity lines of credit		282		3.33	%		451		5.33	%		627		7.40	%		-		0.00	%
Residential construction		-		0.00	%		195		2.30	%		186		2.20	%		-		0.00	%
Other loans to individuals		-		0.00	%		-		0.00	%		278		3.28	%		-		0.00	%
	$	327		3.86	%	$	2,383		28.14	%	$	5,709		67.42	%	$	49		0.58	%

	December 31, 2014
	Specific Reserve					Quantitative Reserve					Qualitative Reserve					Reserve on PCI Loans
	$		% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance			$		% of Total Allowance
	(dollars in thousands)
Commercial:
Commercial and industrial	$	44		0.53	%	$	737		8.92	%	$	764		9.25	%	$	-		0.00	%
CRE - owner-occupied		18		0.22	%		160		1.94	%		539		6.52	%		-		0.00	%
CRE - investor income producing		57		0.69	%		800		9.68	%		952		11.52	%		-		0.00	%
AC&D - 1-4 family construction		-		0.00	%		222		2.69	%		229		2.77	%		-		0.00	%
AC&D - lots, land, & development		11		0.13	%		281		3.40	%		292		3.53	%		-		0.00	%
AC&D - CRE		-		0.00	%		36		0.44	%		358		4.33	%		-		0.00	%
Other commercial		19		0.23	%		4		0.05	%		9		0.11	%		-		0.00	%
Consumer:
Residential mortgage		138		1.67	%		101		1.22	%		202		2.44	%		-		0.00	%
HELOC		382		4.62	%		472		5.71	%		785		9.50	%		-		0.00	%
Residential construction		4		0.05	%		261		3.16	%		270		3.27	%		-		0.00	%
Other loans to individuals		12		0.15	%		8		0.10	%		95		1.15	%		-		0.00	%
Total	$	685		8.29	%	$	3,082		37.30	%	$	4,495		54.41	%	$	-		0.00	%

The allowance for loan losses was $8.5 million, or 0.51% of total loans, at June 30, 2015 compared to $8.3 million, or 0.52% of total loans, at December 31, 2014. The allowance for loan losses is increased by provisions charged to operations and reduced by loans charged off, net of recoveries.

In the second quarter of 2015, management modified the methodology used for the determination of allowance for loan losses to collectively review impaired loans with a balance of less than or equal to $150 thousand. These loans are no longer individually reviewed for specific impairment but rather are reviewed on a pooled basis in a manner consistent with unimpaired loans with additional qualitative factors applied when necessary to reflect the additional risk characteristics of these loans. This change in methodology resulted in a decrease in specific reserves and an increase in quantitative and qualitative reserve components.

The increase in the allowance for loan losses was a function of an increase of $1.2 million in the qualitative component of the allowance primarily due to additional risk factors included for impaired loans less than or equal to $150 thousand now collectively reviewed for impairment as well as additional provision of $232 thousand recorded for the purchased performing pools. These increases were offset by a decrease of $701 thousand in the quantitative component of the allowance due primarily to a decrease in historical loss rates applied to the portfolio as significant charge-offs from 2011 are replaced with lower charge-off periods in 2015, partially offset by the increase in reserves for impaired loans less than or equal to $150 thousand now collectively reviewed and a decrease of $358 thousand in specific reserves as impaired loans less than or equal to $150 thousand are no longer specifically reviewed. Also included in the allowance for loan losses are $49 thousand in PCI reserves which reflect a $156 thousand impairment in several PCI pools during the quarter. There were no reserves related to PCI loans at December 31, 2014.

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In accordance with GAAP, loans acquired from Community Capital, Citizens South and Provident Community were adjusted to reflect estimated fair market value at acquisition and the associated allowance for loan losses was eliminated. At June 30, 2015, acquired loans comprised 26% of our total loans, compared to 32% at December 31, 2014. The ratio of the allowance for loan losses to total loans was 0.51% at June 30, 2015 and 0.52% at December 31, 2014. 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 2.39% at June 30, 2015 and 2.76% at December 31, 2014. 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 June 30, 2015 and December 31, 2014, $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 $18.4 million, or 0.75% of total assets at June 30, 2015 compared to $20.9 million or 0.89% of total assets at December 31, 2014. Nonperforming loans, which consist of nonaccrual loans, accruing TDRs and accruing loans for which payments are 90 days or more past due, decreased $244 thousand, or 3%, to $8.7 million, or 0.52% of total loans at June 30, 2015, compared to $8.9 million, or 0.56% of total loans at December 31, 2014. Nonperforming assets at June 30, 2015 include $884 thousand of covered OREO representing 5% of total nonperforming assets at June 30, 2015, compared to $3.0 million of covered OREO representing 14% of total nonperforming assets at December 31, 2014.

It is our general policy to place a loan on nonaccrual status when there is probable loss or when there is reasonable doubt that all principal and interest will be collected, or when it is over 90 days past due. Nonaccrual loans decreased $40 thousand, or 1%, in the first six months of 2014 from $5.6 million at December 31, 2014 to $5.5 million at June 30, 2015. Nonaccrual TDRs are included in the nonaccrual loan amounts noted. At June 30, 2015, nonaccrual TDR loans were $482 thousand and had no recorded allowance. At December 31, 2014, nonaccrual TDR loans were $841 thousand and had a recorded allowance of $1 thousand. Accruing TDRs totaled $3.1 million and $3.2 million, respectively, at June 30, 2015 and December 31, 2014.

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

All loans graded 60 or worse are included on our list of “watch loans,” which represent potential problem loans, and are updated and reported to both management and the Loan and Risk Committee of the board of directors quarterly. Additionally, the watch list committee may review other loans with more favorable ratings if there are concerns that the loan may become a problem. Impairment analyses are performed on all classified loans (risk grade of 70 or worse) and generally greater than $150 thousand as well as selected other loans as deemed appropriate. At June 30, 2015, we maintained “watch loans” totaling $30.6 million compared to $29.0 million at December 31, 2014. Approximately $10.9 million and $7.4 million of the watch loans at June 30, 2015 and December 31, 2014, 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.

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

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

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

At June 30, 2015, OREO totaled $9.8 million, all of which is recorded at values based on our most recent appraisals. Included in that total is $884 thousand of OREO covered under the FDIC loss share agreements. At December 31, 2014, OREO totaled $12.0 million, all of which was recorded at values based on the most recent appraisals then available. Included in that total was $3.0 million of OREO covered under the FDIC loss share agreements. The Company currently expects 80% of losses and associated expenses on covered OREO to be reimbursed under its FDIC loss share agreements. Our loss share agreement related to Bank of Hiawassee’s non-single family assets expired on March 31, 2015, and on April 1, 2015, the remaining balance of $812,000 associated with the Bank of Hiawassee non-single family foreclosed assets was transferred from the covered portfolio to the non-covered portfolio.

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 June 30, 2015 were $1.87 billion, an increase of $23.6 million, or 1.3%, from December 31, 2014. Noninterest bearing demand deposits increased $26.1 million, or 8.1%, and represented 19% of total deposits at June 30, 2015. Money market, NOW and savings deposits increased $1.7 million, or 0.2%. Increases in these deposit types were the result of strong retail sales efforts. Non-brokered time deposits increased $1.2 million, or 0.3%, and brokered deposits, which consist of brokered interest-bearing deposits, brokered money market accounts, and brokered certificates of deposits, decreased $5.4 million, or 4%. The following is a summary of deposits at June 30, 2015 and December 31, 2014:

	June 30,		December 31,
	2015		2014
	(dollars in thousands)
Noninterest bearing demand deposits	$	347,162	$	321,019
Interest-bearing demand deposits		407,496		405,012
Money market deposits		432,337		435,922
Savings		86,615		83,820
Brokered deposits		136,343		141,771
Certificates of deposit and other time deposits		464,988		463,810
Total deposits	$	1,874,941	$	1,851,354

Total borrowings increased $55.3 million to $258.9 million at June 30, 2015 compared to $203.6 million at December 31, 2014. The increase in borrowings in 2015 was due to an additional $55 million in short-term advances from the FHLB to help fund significant loan growth. Borrowings at June 30, 2015 also include $23.9 million (after acquisition accounting fair market value adjustments) of Tier 1-eligible subordinated debt related to trust preferred securities.

Results of Operations

The following table summarizes components of net income and the changes in those components for the three and six months ended June 30, 2015 and 2014:

Condensed Consolidated Statements of Income

	Three Months Ended											Six Months Ended
	June 30,											June 30,
	2015		2014			Change						2015		2014			Change
	(Unaudited)						$		%			(Unaudited)						$		%
	(Dollars in thousands)											(Dollars in thousands)
Gross interest income	$	22,458	$	21,157		$	1,301			6.1	%	$	44,643	$	40,363		$	4,280			10.6	%
Gross interest expense		1,842		2,078			(236	)		-11.4	%		3,601		4,009			(408	)		-10.2	%
Net interest income		20,616		19,079			1,537			8.1	%		41,042		36,354			4,688			12.9	%
Provision for loan losses		134		(365	)		499			-136.7	%		314		(382	)		696			-182.2	%
Noninterest income		4,292		3,978			314			7.9	%		8,793		7,464			1,329			17.8	%
Noninterest expense		18,232		18,236			(4	)		0.0	%		37,371		33,979			3,392			10.0	%
Net income before taxes		6,542		5,186			1,356			26.1	%		12,150		10,221			1,929			18.9	%
Income tax expense		2,273		1,760			513			29.1	%		4,098		3,240			858			26.5	%
Net income	$	4,269	$	3,426		$	843			24.6	%	$	8,052	$	6,981		$	1,071			15.3	%

Net Income. Net income for the three months ended June 30, 2015 was $4.3 million, compared to $3.4 million for the three months ended June 30, 2014. Changes in net income from the second quarter of 2014 include an 8% increase in net interest income, a 7% increase in noninterest income, and a slight decrease in noninterest expense levels. These increases were offset partially by a $499 thousand increase in provision for loan losses. Net income for the six months ended June 30, 2015, was $8.1 million compared to $7.0 million for the same period in 2014. This increase in net income is due to increases in net interest income and noninterest income, offset by an increase in noninterest expenses and provision for loan losses. Annualized return on average assets for the three-month periods ended June 30, 2015 and 2014 was 0.71% and 0.63%, respectively. Annualized return on average equity increased to 6.10% for the three-month period ended June 30, 2015 from 5.16% for the three-month period ended June 30, 2014. Annualized return on average assets for the six-month periods ended June 30, 2015 and 2014 was 0.68%. Annualized return on average equity increased to 5.81% for the six-month period ended June 30, 2015 from 5.29% for the six-month period ended June 30, 2014.

Net Interest Income. Our largest source of earnings is net interest income, which is the difference between interest income on interest-earning assets and interest expense paid on deposits and other interest-bearing liabilities. The primary factors that affect net interest income are changes in volume and yields of earning assets and interest-bearing liabilities, which are affected in part by management’s responses to changes in interest rates through asset/liability management. Net interest income increased to $20.6 million for the three-month period ended June 30, 2015 from $19.1 million for the three months ended June 30, 2014. The increase is primarily due to an increase in average interest earning assets, which represented organic growth. Net interest income increased to $41.0 million for the six-month period ended June 30, 2015 from $36.4 million for the six months ended June 30, 2014. The increase is again due to an increase in average interest earning assets, which represented organic growth as well as the acquisition of Provident Community.

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Total average interest-earning assets increased to $2.2 billion in the three months ended June 30, 2015 compared to $1.9 billion in the three months ended June 30, 2014. Average balances of total interest-bearing liabilities increased to $1.8 billion in the three-month period ended June 30, 2015, compared to $1.6 billion in the same period in 2014. Our net interest margin decreased from 3.95% in the three-month period ended June 30, 2014 to 3.78% in the corresponding period in 2015. This decrease in net interest margin reflects primarily the lower interest rates on new loans, partially offset by a decrease in cost of interest-bearing liabilities.

Total average interest-earning assets increased to $2.2 billion for the six months ended June 30, 2015, from $1.9 billion for the same period in the previous year. Average balances of total interest-bearing liabilities increased to $1.8 billion in the six-month period ended June 30, 2015, compared to $1.5 billion for the same period in 2014. The increases in average balances are the result of the Provident Community merger and organic growth for the six-month period. Our net interest margin decreased from 3.96% in the six-month period ended June 30, 2014 to 3.81% in the corresponding period in 2015. The decrease in net interest margin reflects the lower interest rates on new loans.

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The following table summarizes net interest income and average yields and rates paid for the periods indicated:

Average Balance Sheets and Net Interest Analysis

	For the Three Months Ended June 30,
	2015								2014
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate (3)			Balance			Expense		Rate (3)
	(dollars in thousands)
Assets
Interest-earning assets:
Loans, including fees (1)(2)	$	1,643,844		$	19,667		4.80	%	$	1,397,158		$	18,734		5.38	%
Federal funds sold		730			-		0.00	%		427			-		0.00	%
Taxable investment securities		474,807			2,508		2.11	%		416,187			2,152		2.07	%
Tax-exempt investment securities		13,960			143		4.10	%		12,809			133		4.15	%
Nonmarketable equity securities		12,177			122		4.02	%		5,697			85		5.98	%
Other interest-earning assets		39,921			18		0.18	%		106,181			53		0.20	%
Total interest-earning assets		2,185,439			22,458		4.12	%		1,938,459			21,157		4.38	%
Allowance for loan losses		(8,895	)							(9,588	)
Cash and due from banks		16,356								17,856
Premises and equipment		58,912								58,347
Other assets		154,859								163,840
Total assets	$	2,406,671							$	2,168,914
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand	$	411,806		$	71		0.07	%	$	333,130		$	87		0.10	%
Savings and money market		525,359			405		0.31	%		515,943			473		0.37	%
Time deposits - core		458,139			632		0.55	%		488,936			693		0.57	%
Brokered deposits		133,981			176		0.53	%		154,520			190		0.49	%
Total interest-bearing deposits		1,529,285			1,284		0.34	%		1,492,529			1,443		0.39	%
Short-term borrowings		148,901			76		0.20	%		5,462			1		0.07	%
Long-term FHLB borrowings		55,000			131		0.96	%		55,000			128		0.93	%
Subordinated debt		23,833			351		5.91	%		27,094			506		7.49	%
Total borrowed funds		227,734			558		0.98	%		87,556			635		2.91	%
Total interest-bearing liabilities		1,757,019			1,842		0.42	%		1,580,085			2,078		0.53	%
Net interest rate spread					20,616		3.70	%					19,079		3.85	%
Noninterest-bearing demand deposits		338,092								298,313
Other liabilities		30,884								24,212
Shareholders' equity		280,676								266,304
Total liabilities and shareholders' equity	$	2,406,671							$	2,168,914
Net interest margin							3.78	%							3.95	%

(1) Average loan balances include nonaccrual loans.

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

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

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Average Balance Sheets and Net Interest Analysis

	For the Six Months Ended June 30,
	2015								2014
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate (3)			Balance			Expense		Rate (3)
	(dollars in thousands)
Assets
Interest-earning assets:
Loans, including fees (1)(2)	$	1,623,279		$	38,778		4.82	%	$	1,351,412		$	35,660		5.32	%
Federal funds sold		596			-		0.00	%		437			-		0.00	%
Taxable investment securities		477,255			5,299		2.22	%		399,990			4,123		2.06	%
Tax-exempt investment securities		13,409			281		4.19	%		14,194			355		5.00	%
Nonmarketable equity securities		12,371			249		4.06	%		5,746			151		5.30	%
Other interest-earning assets		43,887			36		0.17	%		80,015			74		0.19	%
Total interest-earning assets		2,170,797			44,643		4.15	%		1,851,794			40,363		4.40	%
Allowance for loan losses		(8,633	)							(9,477	)
Cash and due from banks		16,646								16,127
Premises and equipment		59,133								57,147
Other assets		157,207								157,718
Total assets	$	2,395,150							$	2,073,309
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand	$	409,863		$	139		0.07	%	$	312,865		$	150		0.10	%
Savings and money market		521,374			800		0.31	%		489,349			941		0.39	%
Time deposits - core		459,713			1,220		0.54	%		462,806			1,377		0.60	%
Brokered deposits		137,254			352		0.52	%		160,421			354		0.44	%
Total interest-bearing deposits		1,528,204			2,511		0.33	%		1,425,441			2,822		0.40	%
Short-term borrowings		53,950			152		0.57	%		55,265			255		0.93	%
Long-term FHLB borrowings		150,055			259		0.35	%		-			-		0.00	%
Subordinated debt		23,749			679		5.77	%		27,823			932		6.76	%
Total borrowed funds		227,754			1,090		0.97	%		83,088			1,187		2.88	%
Total interest-bearing liabilities		1,755,958			3,601		0.41	%		1,508,529			4,009		0.54	%
Net interest rate spread					41,042		3.73	%					36,354		3.86	%
Noninterest-bearing demand deposits		328,805								275,715
Other liabilities		30,951								23,145
Shareholders' equity		279,436								265,920
Total liabilities and shareholders' equity	$	2,395,150							$	2,073,309
Net interest margin							3.81	%							3.96	%

(1) Average loan balances include nonaccrual loans.

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

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

Provision for Loan Losses. Our provision for loan losses increased $499 thousand to a provision of $134 thousand during the three months ended June 30, 2015, compared to a $365 thousand release during the corresponding period in 2014. Included in the loan loss provision for the first quarter of 2015 was a $156 thousand impairment associated with PCI pools.

Our provision for loan losses increased $696 thousand, or 182%, to a provision of $314 thousand during the six months ended June 30, 2015, from a $382 thousand release during the corresponding period in 2014. Included in the loan loss provision for the first six months of 2015 was a net impairment of $156 thousand associated with PCI pools and a net $180 thousand provision on our originated portfolio due to organic loan growth.

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We had $327 thousand in net charge-offs during the three months ended June 30, 2015 compared to net recoveries of $460 thousand during the corresponding period in 2014. We had $179 thousand in net charge-offs during the six months ended June 30, 2015 compared to net recoveries of $1.2 million during the corresponding period in 2014. There were $156 thousand in charge-offs in excess of fair market value adjustments on PCI loans during the three and six months ended June 30, 2015, compared to no charge-offs on PCI loans for the same period in 2014.

Noninterest Income. The following table presents components of noninterest income for the three and six months ended June 30, 2015 and 2014:

Noninterest Income

	Three months ended												Six months ended
	June 30,												June 30,
	2015			2014			Change						2015			2014			Change
	(Unaudited)							$		%			(Unaudited)							$		%
	(dollars in thousands)
Service charges on deposit accounts	$	1,107		$	1,001		$	106			10.6	%	$	2,126		$	1,634		$	492			30.1	%
Income from fiduciary activities		774			642			132			20.6	%		1,506			1,320			186			14.1	%
Commissions and fees from investment brokerage		132			131			1			0.8	%		262			228			34			14.9	%
Income from capital markets		394			35			359			1025.7	%		792			35			757			2162.9	%
Gain (loss) on sale of securities available for sale		-			(33	)		33			-100.0	%		-			243			(243	)		-100.0	%
ATM and card income		629			726			(97	)		-13.4	%		1,323			1,274			49			3.8	%
Mortgage banking income		956			653			303			46.4	%		1,907			897			1,010			112.6	%
Income from bank-owned life insurance		553			525			28			5.3	%		1,321			1,645			(324	)		-19.7	%
Amortization of indemnification asset		(209	)		(606	)		397			-65.5	%		(514	)		(859	)		345			-40.2	%
Loss share true-up liability expense		44			(132	)		176			-133.3	%		(45	)		(362	)		317			-87.6	%
Other noninterest income (expense)		(88	)		1,036			(1,124	)		-108.5	%		115			1,409			(1,294	)		-91.8	%
Total noninterest income	$	4,292		$	3,978		$	314			7.9	%	$	8,793		$	7,464		$	1,329			17.8	%

Noninterest income increased $314 thousand, or 8%, for the three months ended June 30, 2015 when compared to the three months ended June 30, 2014. Noteworthy changes among categories include (i) a $106 thousand increase in service charges on deposit accounts; (ii) a $132 thousand increase in income from fiduciary activities; (iii) $359 thousand increase in capital markets income primarily due to customer-related interest rate hedging activity; (iv) a $303 thousand increase in mortgage banking income due to higher activity in loan closings and the period end pipeline; and (v) a $574 thousand decrease in amortization of the indemnification asset and true-up liability expense related to the loss share agreements with the FDIC. Income from ATM and card activity decreased $97 thousand and other noninterest income decreased $1.1 million. Other noninterest income for the three months ended June 30, 2015 included a $196 thousand reduction of capital on certain limited partnership investments based on final 2014 partnership documentation received while the second quarter of 2014 included a $936 thousand gain from the sale ofMasterCard Class A shares.

Noninterest income increased $1.3 million for the six months ended June 30, 2015 compared to the six months ended June 30, 2014. Noteworthy changes among categories include (i) a $492 thousand increase in service charges on deposit accounts, as a direct contribution of the Provident Community merger; (ii) a $186 thousand increase in income from fiduciary activities; (iii) a $757 thousand increase in capital markets income primarily due to customer-related interest rate hedging activity; (iv) a $1.0 million increase in mortgage banking income due to increased activity in loan closings and the period end pipeline; (v) a $662 thousand decrease in amortization of indemnification assets and true-up liability expense related to the loss share agreements with the FDIC; (vi) a $324 thousand decrease in income from bank-owned life insurance due primarily to decreased death benefits received in 2015 as compared to 2014; and (vii) a $1.2 million decrease in other noninterest income primarily as a result of the sale of MasterCard shares for $936 thousand in the first quarter of 2014 and a $196 thousand reduction of capital on certain limited partnership investments based on final 2014 partnership documentation received in the second quarter of 2015.

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Noninterest Expense. The following table presents components of noninterest expense for the three and six months ended June 30, 2015 and 2014:

Noninterest Expense

	Three months ended										Six months ended
	June 30,										June 30,
	2015		2014		Change						2015		2014		Change
	(Unaudited)					$		%			(Unaudited)					$		%
	(dollars in thousands)
Salaries and employee benefits	$	10,021	$	9,684	$	337			3.5	%	$	20,452	$	18,912	$	1,540			8.1	%
Occupancy and equipment		2,491		2,249		242			10.8	%		5,046		4,254		792			18.6	%
Advertising and promotion		304		223		81			36.3	%		678		456		222			48.7	%
Legal and professional fees		660		1,122		(462	)		-41.2	%		1,458		1,783		(325	)		-18.2	%
Deposit charges and FDIC insurance		433		368		65			17.7	%		825		608		217			35.7	%
Data processing and outside service fees		1,640		1,544		96			6.2	%		3,288		2,890		398			13.8	%
Communication fees		541		538		3			0.6	%		1,119		974		145			14.9	%
Core deposit intangible amortization		347		317		30			9.5	%		695		574		121			21.1	%
Net cost of operation of other real estate owned		232		206		26			12.6	%		267		259		8			3.1	%
Loan and collection expense		242		304		(62	)		-20.4	%		396		592		(196	)		-33.1	%
Postage and supplies		116		170		(54	)		-31.8	%		265		345		(80	)		-23.2	%
Other noninterest expense		1,205		1,511		(306	)		-20.3	%		2,882		2,332		550			23.6	%
Total noninterest expense	$	18,232	$	18,236	$	(4	)		0.0	%	$	37,371	$	33,979	$	3,392			10.0	%

Total noninterest expense remained flat at $18.2 million for the three months ended June 30, 2015, compared to the corresponding period in 2014. Excluding merger-related expenses of $167 thousand and $594 thousand for the three-month periods ended June 30, 2015 and 2014, respectively, noninterest expense increased $423 thousand for the three months ended June 30, 2015, compared to the corresponding period in the prior year. Total noninterest expense increased to $37.4 million for the six months ended June 30, 2015, an increase of 10% from $34.0 million for the corresponding period in 2014. Excluding merger-related expenses of $289 thousand and $675 thousand for the six-month periods ended June 30, 2015 and 2014, respectively, noninterest expense increased $3.8 million, or 11%, for the six months ended June 30, 2015, compared to the corresponding period in the prior year.Adjusted noninterest expense, which excludes merger-related expenses, is a non-GAAP financial measure. For a reconciliation to the most comparable GAAP measure, see “Non-GAAP Financial Measures” above.

Three-month comparison and analysis

Salaries and employee benefits expenses increased $337 thousand, or 3.5%, to $10.0 million for the three months ended June 30, 2015, compared to $9.7 million in the comparable period of 2014, primarily due to a full quarter of expense from Provident Community, as well as $116,000 of severance expense recorded in the second quarter of 2015 related to staff reductions across various business units. Total full-time equivalents decreased to 503 at June 30, 2015 from 541 at June 30, 2014. Compensation expense for share-based compensation plans was $290 thousand in the second quarter of 2015 compared to $285 thousand in the comparable period of 2014.

Other notable variances during the three months ended June 30, 2015 when compared to the three months ended June 30, 2014 include (i) an increase in occupancy and equipment expense of $242 thousand or 10.8%; (ii) a decrease in legal and professional fees of $462 thousand, or 41.2%, to $660 thousand in the first quarter of 2015 as the prior year included fees related to the Provident Community acquisition; and (iii) an increase in data processing fees of $96 thousand, or 6.2%. These increases were related to the acquisition of Provident Community, as well as organic growth. Other noninterest expense decreased $306 thousand, or 20.3%, due to a $129 thousand recovery related to bank card charge-offs recorded in the first quarter of 2015.

Six-month comparison and analysis

Salaries and employee benefits expenses increased $1.5 million, or 8.1%, to $20.5 million in the six months ended June 30, 2015 compared to $18.9 million in the comparable period of 2014. These increases are primarily due to hiring initiatives designed to drive future organic growth opportunities and severance expense recorded in 2015.

Other notable changes between categories during the six months ended June 30, 2015 when compared to the six months ended June 30, 2014 include (i) an increase in occupancy and equipment expense of $792 thousand, or 18.6%, to $5.0 million primarily due to the addition of the new Richmond branch and the acquisition of Provident Community; (ii) an increase in advertising and promotion expense of $222 thousand, or 48.7%; (iii) a decrease in legal and professional fees of $325 thousand, or 18.2%, as the prior year included fees related to the Provident Community acquisition; (iv) an increase in FDIC insurance of $217 thousand, or 35.7%, to $825 thousand; (v) an increase in data processing fees of $398 thousand, or 13.8%; (vi) an increase in communications fees of $107 thousand, or 10.6%, (vii) an increase in core deposit intangible amortization of $121 thousand, or 21.1%; (vii) a decrease in loan and collection expense of $196 thousand, or 33.1%; and (viii) a $550 thousand, or 23.6%, increase in other noninterest expense. These increases were primarily related to the acquisition of Provident Community, as well as organic growth.

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Income Taxes. We generate non-taxable income from tax-exempt investment securities and loans as well as from bank-owned life insurance. Accordingly, the level of such income in relation to income before taxes affects our effective tax rate. For the three months ended June 30, 2015, we recognized income tax expense of $2.2 million compared to income tax expense of $1.8 million for the same period in 2014. The effective tax rate for the three months ended June 30, 2015 is 34.74% compared to 33.94% for the same period in 2014. The change in the effective tax rate was due to the true-up of a tax credit recorded for the first six months of 2015.

For the six months ended June 30, 2015, we recognized income tax expense of $4.1 million compared to income tax expense of $3.2 million for the same period in 2014. The effective tax rate for the six months ended June 30, 2015 is 33.73% compared to 31.70% for the same period in 2014. The change in the effective tax rate for the six-month periods was due to the amount of death benefits received on bank-owned life insurance relative to the size of pre-tax income in 2014.

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 June 30, 2015 was 18.89% compared to 19.55% at December 31, 2014. Both ratios exceeded our minimum internal target of 10%. In addition, at June 30, 2015, we had $209.4 million of credit available from the FHLB, $234.9 million of credit available from the Federal Reserve Discount Window, and available lines totaling $70.0 million from correspondent banks.

At June 30, 2015, we had $372.2 million of pre-approved but unused lines of credit, $7.8 million of standby letters of credit and $617 thousand of commercial letters of credit. In management's opinion, these commitments represent no more than normal lending risk to us and will be funded from normal sources of liquidity.

Our capital position is reflected in our shareholders’ equity, subject to certain adjustments for regulatory purposes. Shareholders’ equity, or capital, is a measure of our net worth, soundness and viability. We continue to remain in a well-capitalized position. Shareholders’ equity at June 30, 2015 was $279.7 million, compared to $275.1 million at December 31, 2014. The $4.6 million increase was the result of net income of $8.1 million for the six months ended June 30, 2015, $585 thousand of net share-based compensation and $141 thousand in proceeds from the exercise of stock options. These increases were partially offset by a $225 thousand decline in accumulated other comprehensive income (loss) from unrealized securities gains, the repurchase of 149,609 shares of Common Stock in open market transactions pursuant to our previously announced share repurchase program and the acquisition of 33,031 shares in connection with satisfaction of tax withholding obligations on vested restricted stock.

Risk-based capital regulations adopted by the Federal Reserve Board and the FDIC require bank holding companies and banks to achieve and maintain specified ratios of capital to risk-weighted assets. The risk-based capital rules are designed to measure different components of capital in relation to the credit risk of both on- and off-balance sheet items. Under the guidelines, one of four risk weights is applied to the various on-balance sheet items. Off-balance sheet items, such as loan commitments, are also subject to risk weighting after conversion to balance sheet equivalent amounts. These guidelines also specify that banks that are experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels.

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

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

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

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

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

The new capital guidelines also provide that all covered banking organizations must maintain a new capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The capital conservation buffer requirement will be phased in beginning in January 1, 2016 at the 0.625% level and will be increased by that same amount on each subsequent January 1 until it reaches 2.5% on January 1, 2019. When fully phased in, the capital conservation buffer effectively will result in a required minimum common equity Tier 1 capital ratio of at least 7.0%, Tier 1 capital ratio of at least 8.5% and total capital ratio of at least 10.5%. The capital guidelines also provide for a “countercyclical capital buffer” that is applicable only to certain covered institutions and does not have any current applicability to the Company and the Bank. Failure to satisfy the capital buffer requirements will 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 regulatory capital rules also incorporate these changes in regulatory capital into the prompt corrective action framework, under which the thresholds for “adequately capitalized” banking organizations are equal to the new minimum capital requirements. Under this framework, in order to be considered “well capitalized”, insured depository institutions are required to maintain a Tier 1 leverage ratio of 5%, a common equity Tier 1 risk-based capital measure of 6.5%, a Tier 1 risked-based capital ratio of 8% and a total risk-based capital ratio of 10%. 

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At June 30, 2015, under the new regulations in effect on January 1, 2015, both the Company and the Bank were “well capitalized”. During the six months ended June 30, 2015, the Company’s and Bank’s regulatory capital ratios were positively impacted by phase-in provisions related to certain intangibles, deferred tax assets and deferred tax liabilities.At December 31, 2014, the Company and the Bank were “well capitalized” under the standards in effect at that time.Actual and required capital levels at June 30, 2015 and December 31, 2014 are presented below:

	Capital Ratios at June 30, 2015
	Actual					Minimum Basel III Phase In Requirement					Minimum Basel III Fully Phased In Requirements					Well Capitalized Requirement
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
The Bank
Total capital (to risk-weighted assets)	$	258,254		13.95	%	$	148,109		8.00	%	$	194,393		10.50	%	$	185,137		10.00	%
Tier 1 capital (to risk-weighted assets)		249,677		13.49	%		111,1082		6.00	%		157,366		8.50	%		148,109		8.00	%
Common equity Tier 1 capital (to risk-weighted assets)		249,677		13.49	%		83,311		4.50	%		129,596		7.00	%		120,339		6.50	%
Tier 1 capital (to average assets)		249,677		10.60	%		94,195		4.00	%		94,195		4.00	%		117,743		5.00	%
Risk Weighted Assets		1,851,365
Average Assets for Tier 1		2,354,869
The Company
Total capital (to risk-weighted assets)	$	270,173		14.58	%	$	148,246		8.00	%	$	194,573		10.50	%	N/A		N/A
Tier 1 capital (to risk-weighted assets)		261,596		14.12	%		111,188		6.00	%		157,511		8.50	%	N/A		N/A
Common equity Tier 1 capital (to risk-weighted assets)		245,328		13.24	%		83,388		4.50	%		129,715		7.00	%	N/A		N/A
Tier 1 capital (to average assets)		261,596		11.09	%		94,376		4.00	%		94,376		4.00	%	N/A		N/A
Risk Weighted Assets		1,853,076
Average Assets for Tier 1		2,359,401

	Capital Ratios at December 31, 2014
	Actual					For Capital Adequacy Purposes					Well Capitalized Requirement
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
The Bank
Total capital (to risk-weighted assets)	$	224,579		13.11	%	$	137,089		8.00	%	$	171,361		10.00	%
Tier 1 capital (to risk-weighted assets)		216,110		12.61	%		68,544		4.00	%		102,817		6.00	%
Tier 1 capital (to average assets)		216,110		9.56	%		90,394		4.00	%		112,993		5.00	%
Risk Weighted Assets		1,713,612
Average Assets for Tier 1		2,259,856
The Company
Total capital (to risk-weighted assets)	$	239,557		13.95	%	$	137,360		8.00	%		171,700		10.00	%
Tier 1 capital (to risk-weighted assets)		231,088		13.46	%		68,680		4.00	%		103,020		6.00	%
Tier 1 capital (to average assets)		231,088		10.17	%		90,931		4.00	%		113,664		5.00	%
Risk Weighted Assets		1,717,003
Average Assets for Tier 1		2,273,275

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 2014 Audited Financial Statements. As part of ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities (“SPE”s), which generally are established for facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of June 30, 2015, we were not involved in any unconsolidated SPE transactions.

Impact of Inflation and Changing Prices

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

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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 June 30, 2015 from those disclosed or incorporated in Part II, Item 7A. “Quantitative and Qualitative Disclosures about Market Risk.” presented our 2014 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 second fiscal quarter of 2015 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 2014 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 June 30, 2015:

Period	(a) Total Number of Shares Purchased (1)		(b) Average Price Paid per Share (1)		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (2)
Repurchases from April 1, 2015 through April 30, 2015		26,118	$	6.89		11,796		2,184,404
Repurchases from May 1, 2015 through May 31, 2015		121,487		6.65		112,738		2,071,666
Repurchases from June 1, 2015 through June 30, 2015		21,570		6.67		21,275		2,050,391
Total		169,175	$	6.69		145,809		2,050,391

(1) Included in the total number of shares purchased are 14,322, 8,749, and 295 shares of the Company’s Common Stock acquired by the Company in connection with satisfaction of tax withholding obligations on vested restricted stock in April, May and June, respectively.

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

During the three months ended June 30, 2015, the Company did not have any unregistered sales of equity securities.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

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Item 6. Exhibits

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

Exhibit Number	Description of Exhibits
3.1	Articles of Incorporation of the Company, as amended, incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q (File No. 001-35032) filed May 9, 2014
3.2	Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014; (ii) Condensed Consolidated Statements of Income for the three and six months ended June 30, 2015 and 2014; (iii) Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2015 and 2014; (v) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014; 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: August 7, 2015	By:	/s/ James C. Cherry
		James C. Cherry
		Chief Executive Officer (authorized officer)
Date: August 7, 2015	By:	/s/ David L. Gaines
		David L. Gaines
		Chief Financial Officer

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Exhibit Index

Exhibit Number	Description of Exhibits
3.1	Articles of Incorporation of the Company, as amended. incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q (File No. 001-35032) filed May 9, 2014
3.2	Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014; (ii) Condensed Consolidated Statements of Income for the three and six months ended June 30, 2015 and 2014; (iii) Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2015 and 2014; (v) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014; 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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