U. S. Securities and Exchange Commission

Washington, D.C. 20549

Form 10-K

ANNUAL REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, ~~2009~~2010

Commission File Number 000-49848

MIDCAROLINA FINANCIAL CORPORATION

(Name of Issuer in Its Charter)


North Carolina		55-6144577
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

3101 South Church Street Burlington, North Carolina		27215
(Address of Principal Executive Offices)		(Zip Code)

(336) 538-1600

(Issuer’s Telephone Number, Including Area Code)

Securities Registered Under Section 12(b) of the Act: None

Securities Registered Under Section 12(g) of the Act: common stock, no par value ~~Title of Class~~

Title of Class

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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 x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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 definitions of “large accelerated filer”, “accelerated filer”, and smaller reporting company” in Rule 12b-2 of the exchange Act. (Check one).

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

The aggregate market value of the Registrant’s voting and non-voting common equity, held by non affiliates, computed by reference to the average bid and asked price of such common equity, as of the last business day of the Registrant’s most recently completed second fiscal quarter was $2415.73 million.

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date. 4,927,828 shares of common stock, no par value, as of ~~February~~ March 2410, ~~2010~~2011.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the ~~2010~~2011 Annual Meeting of Shareholders of MidCarolina Financial Corporation, ~~to be held on May 25, 2010 (the “Proxy Statement”),~~ are incorporated by reference into Part III.

~~Statement~~Disclaimer Regarding “Forward Looking Statements”

Statements in this ~~Report~~report and its exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors which include, but are not limited to, factors discussed in MidCarolina’s ~~our~~ Annual Report on Form 10-K and in other documents weit ~~file~~files with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the SEC’s Internet website at www.sec.gov or through ~~our~~MidCarolina Bank’s Internet website at www.midcarolinabank.com. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “feels,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of ~~our~~MidCarolina’s management about future events. Factors that could influence the accuracy of forward-looking statements in this report include, but are not limited to, (a) pressures on ~~the~~MidCarolina’s earnings, capital and liquidity ~~of financial institutions~~ resulting from current and future ~~adverse~~ conditions in the credit and capital markets, (b) continued or unexpected increases in credit losses in MidCarolina Bank’s loan portfolio, (c) continued adverse conditions in the economy and in the ~~banking~~real ~~industry~~estate market in ~~general~~MidCarolina Bank’s banking markets (particularly those conditions that affect its loan portfolio, the abilities of its borrowers to repay their loans, and the values of collateral that secures its loans),(bd) the financial success or changing strategies of ~~our~~ customers, (ce) actions of government regulators, or change in laws, regulations or accounting standards, that adversely affect MidCarolina’s business, (df) changes in the interest rate environment and the level of market interest rates, that reduce MidCarolina Bank’s net interest margins and/or the values of loans it makes and securities it holds, (eg) changes in ~~general~~competitive ~~economic~~pressures ~~conditions~~among depository and ~~real~~other ~~estate~~financial ~~values~~institutions or in ~~our~~MidCarolina ~~banking~~Bank’s ~~market~~ability ~~(particularly~~to ~~changes~~compete effectively ~~that~~against ~~affect~~other ~~our~~financial ~~loan~~institutions ~~portfolio,~~in ~~the~~its ~~abilities~~banking ofmarkets, ~~our~~and ~~borrowers~~(h) other todevelopments ~~repay~~or ~~their~~changes ~~loans,~~in ~~and~~our ~~the~~business ~~values~~that ofMidCarolina ~~loan~~does ~~collateral)~~not expect. Although weMidCarolina ~~believe~~believes that the expectations reflected in the forward-looking statements included in this report are reasonable, they represent ~~our~~ its management’s judgments only as of the date they are made, and weit cannot guarantee future results, levels of activity, performance or achievements. As a result, readers are cautioned not to place undue reliance on these forward-looking statements. All forward-looking statements attributable to usMidCarolina are expressly qualified in their entirety by the cautionary statements in this paragraph. WeMidCarolina ~~have~~has no obligation, and do does not intend, to update these forward-looking statements.

PART I

ITEM 1. ~~DESCRIPTION OF~~ BUSINESS

General

MidCarolina Financial Corporation (~~the~~ “~~Company~~MidCarolina”) is a North Carolina business corporation that was formed in 2002 to serve as a bank holding company for MidCarolina Bank ~~(the “Bank”)~~. ~~The~~Its Company is registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the bank holding company laws of North Carolina. The Company’s office is located at 3101 South Church Street, Burlington, North Carolina ~~27216.~~27215, ~~The~~and ~~Company’s~~its principal source of ~~income~~revenue is ~~earnings on loans and investments, including any~~ dividends ~~that~~it ~~are~~receives ~~declared~~from ~~and paid~~MidCarolina ~~by the~~ Bank on ~~its~~MidCarolina ~~capital~~Bank’s common stock held by MidCarolina.

~~The~~MidCarolina Bank ~~is incorporated under the laws of North Carolina and~~ began operations on August 14, 1997 as a North Carolina chartered commercial bank. ~~The~~It ~~Bank~~ is engaged in general commercial banking primarily in Alamance and Guilford Counties, North Carolina,. ~~and~~Its ~~operates~~main ~~under~~office ~~the~~is ~~banking~~located ~~laws~~in ofBurlington, North Carolina, and it has one full-service branch in Burlington, NC, one full-service branch in Graham, NC, two full-service branches in Greensboro, NC, and one full-service branch in Mebane, NC, and limited service offices in the ~~rules~~Alamance Regional Medical Center and ~~regulations~~the Village of ~~the~~Brookwood Retirement Center, both of which are located in ~~Federal~~Burlington. ~~Deposit~~Its ~~Insurance~~loans ~~Corporation~~and (deposits are generated primarily from the ~~“FDIC”)~~areas where its offices are located.

AsMidCarolina Bank’s aprimary ~~North~~sources ~~Carolina~~of ~~bank,~~revenue ~~the~~are ~~Bank~~interest isand ~~subject~~fee toincome ~~examination~~from ~~and~~its ~~regulation~~lending ~~by the~~activities. ~~FDIC~~These ~~and~~lending ~~the~~activities ~~North~~consist ~~Carolina~~principally ~~Commissioner~~ of ~~Banks~~originating ~~(the~~commercial ~~“Commissioner”).~~operating ~~The~~and ~~Bank~~working iscapital ~~further~~loans, ~~subject~~loans tosecured ~~certain~~by ~~regulations~~commercial real estate, residential mortgage loans, home equity lines of ~~the~~credit, ~~Federal~~and ~~Reserve~~other ~~governing~~consumer ~~reserve~~loans. ~~requirements~~Its current lending strategy is to beestablish ~~maintained~~market ~~against~~share ~~deposits~~throughout Alamance and ~~other~~Guilford ~~matters.~~Counties, ~~The business~~with ~~and~~an ~~regulation~~emphasis ofin ~~the~~Burlington, ~~Bank~~Graham, ~~are~~Greensboro ~~also~~and ~~subject~~Mebane. Interest toand ~~legislative~~dividend ~~changes~~income from ~~time~~investment toactivities ~~time.~~generally ~~See~~provide ~~“SUPERVISION~~its ~~AND~~second ~~REGULATION~~largest source of income.”

~~The~~Deposits ~~Bank’s~~are the primary ~~market~~source ~~area~~of isMidCarolina ~~Alamance~~Bank’s ~~County~~funds ~~and~~for ~~Guilford~~lending ~~County,~~and ~~North~~other ~~Carolina~~investment purposes. ~~The~~It ~~Bank’s~~attracts ~~main~~both ~~office~~short-term isand ~~located~~long-term indeposits ~~Burlington,~~from ~~North~~the ~~Carolina.~~general ~~The~~public ~~Bank~~by ~~also~~offering ~~has~~a ~~one~~variety ~~full-service~~of ~~branch~~accounts inand ~~Burlington~~rates, ~~NC,~~including ~~one~~statement ~~full-service~~savings ~~branch~~accounts, innegotiable ~~Graham,~~order ~~North~~of ~~Carolina~~withdrawal accounts, ~~two~~money ~~full-service~~market ~~branches~~demand ~~in Greensboro~~accounts, ~~North~~non-interest-bearing ~~Carolina~~accounts and ~~one~~fixed ~~full-service~~interest ~~branch~~rate incertificates ~~Mebane,~~with ~~North~~varying ~~Carolina~~maturities. ~~The~~MidCarolina Bank’s ~~has~~deposits ~~limited~~are ~~service~~obtained ~~offices~~primarily infrom ~~the~~its ~~Alamance~~primary market ~~Regional~~area, ~~Medical~~and ~~Center~~it uses traditional marketing methods to attract new customers and ~~the~~deposits, ~~Village~~including ~~of Brookwood~~print ~~Retirement~~media ~~Center~~advertising and direct mailings. However, ~~both~~it also utilizes alternative sources of ~~which~~funds, ~~are~~such ~~located~~as inbrokered ~~Burlington.~~certificates ~~The~~of deposit and borrowings from the Federal Home Loan Bank’s ~~loans~~of ~~and~~Atlanta. ~~deposits~~Deposit flows are ~~primarily~~greatly ~~generated~~influenced ~~from~~by economic conditions, the ~~areas~~general ~~where~~level ~~its~~of ~~offices~~interest ~~are~~rates, ~~located.~~competition and other factors

~~The~~Recent ~~Bank’s~~Developments primary sources of revenue are interest and fee income from its lending activities. These lending activities consist principally of originating commercial operating and working capital loans, residential mortgage loans, home equity lines of credit, other consumer loans and loans secured by commercial real estate. The Bank’s current lending strategy is to establish market share throughout Alamance and Guilford Counties, with an emphasis in Burlington, Graham, Greensboro and Mebane.

~~Interest~~On ~~and~~December 16, ~~dividend~~2010, ~~income~~MidCarolina ~~from~~announced ~~investment~~that it ~~activities~~had ~~generally~~entered ~~provide~~into ~~the second~~a ~~largest~~definitive ~~source~~agreement ofproviding ~~income~~for it to ~~the~~merger ~~Bank~~with ~~after~~American ~~interest~~National onBankshares, ~~loans~~Inc. ~~During~~(“American”) ~~2009~~headquartered in Danville, Virginia, in an all stock transaction. Under the ~~Bank~~terms ~~chose~~of tothe ~~manage~~agreement, ~~its~~holders ~~overall~~of MidCarolina ~~liquidity~~common ~~position~~stock bywould ~~re-deploying~~receive ~~its~~0.33 ~~funds~~shares ~~into~~of ~~shorter~~American’s ~~duration~~common ~~securities~~stock for each of their shares of MidCarolina common stock, and holders of MidCarolina’s Series A noncumulative perpetual preferred stock would receive on shares of American’s newly created preferred stock having terms, preferences and rights that are substantially identical to those of their MidCarolina stock.

~~Deposits~~Completion ~~are the primary source~~ of the ~~Bank’s~~merger ~~funds~~is ~~for~~subject ~~lending~~to ~~and~~approval ~~other~~by ~~investment~~MidCarolina’s ~~purposes.~~shareholders ~~The Bank attracts both short-term~~ and ~~long-term~~to ~~deposits from~~ the ~~general~~approval ~~public~~ by ~~offering~~American’s ashareholders ~~variety~~ of ~~accounts~~its ~~and~~issuance ~~rates.~~of ~~The~~shares ~~Bank offers statement savings accounts, negotiable order~~ of ~~withdrawal~~its ~~accounts,~~common ~~money~~stock ~~market~~in ~~demand~~the ~~accounts,~~merger ~~non-interest-bearing accounts and fixed interest rate~~to ~~certificates~~MidCarolina’s ~~with~~shareholders, ~~varying~~as ~~maturities.~~well ~~The Bank also utilizes alternative sources of funds such~~ as ~~brokered~~to ~~certificates~~receipt of ~~deposit~~required ~~and~~approvals ~~borrowings from the Federal Home Loan Bank (the “FHLB”)~~ of ~~Atlanta,~~bank ~~Georgia~~regulators.

~~The~~Memorandums Bank’s deposits are obtained primarily from its primary market area. The Bank uses traditional marketing methods to attract new customers and deposits including print media advertising and direct mailings. Deposit flows are greatly influenced by economic conditions, the general level of ~~interest rates, competition and other factors.~~ Understanding

During June 2010, MidCarolina Bank’s board of directors entered into an agreement called a Memorandum of Understanding (the “Memorandum”) with the FDIC and the North Carolina Commissioner of Banks which provides that MidCarolina Bank will move in good faith to take various actions designed to improve its lending procedures and other conditions related to its operations. The Memorandum provides generally for MidCarolina Bank’s board of directors to (i) review and formulate objectives relative to liquidity and growth, including a reduction in reliance on volatile liabilities, (ii) formulate plans for the reduction and improvement in adversely classified assets, (iii) review compliance with and, as necessary, modify written policies regarding asset/liability, investment and funds

~~The~~ management, ~~Bank is the sole banking subsidiary of the Company. Two trusts~~ (~~MidCarolina~~iv) oversee I and ~~MidCarolina~~enforce ~~Trust~~loan ~~II) were~~underwriting ~~formed~~procedures asand ~~subsidiaries~~implement ofpolicies ~~the~~regarding ~~Company~~other toreal ~~facilitate~~estate ~~the~~and ~~infusion~~an ofeffective ~~Trust~~loan ~~Preferred~~documentation ~~Securities~~system, as(v) not apay ~~form~~any ofdividend without ~~non-dilutive equity into~~ the ~~Company.~~approval ~~The trusts are not consolidated in these financial statements. The majority~~ of the ~~Company’s operations~~regulators, ~~are~~(vi) review ~~located~~officer atperformance ~~the~~and ~~Bank~~consider ~~level.~~additional ~~Throughout~~staffing ~~this Annual Report on Form 10-K~~needs, ~~results~~and of(vii) provide ~~operations~~progress ~~will~~reports beand ~~discussed~~submit onvarious aother ~~consolidated~~information ~~basis by referring~~ to the ~~Bank’s operations, unless a specific reference is made to the Company and its operating results apart from the Bank~~regulators.

~~The~~During ~~Company~~October ~~experienced~~2010, ~~steady~~MidCarolina’s ~~growth~~board ~~during~~of ~~its~~directors ~~formative~~entered ~~years~~into ~~since~~a ~~its~~separate ~~formation~~Memorandum inof ~~1997 through~~Understanding ~~2008.~~with ~~2009~~the ~~was~~Federal aReserve Bank ~~year~~ of ~~nominal~~Richmond ~~growth~~under ~~reflecting~~which ~~the~~MidCarolina ~~economic~~agreed ~~distresses~~that, ~~experienced~~among byother ~~the~~things, ~~financial~~and ~~industry~~without asits ~~a whole. The Bank~~regulator’s ~~assets~~prior ~~totaled~~written ~~$541.0 million~~approval, ~~$540.8~~it ~~million~~will ~~and~~not ~~$467.2~~(i) receive ~~million~~dividends asfrom ofMidCarolina ~~December 31~~Bank, ~~2009,~~(ii) pay ~~2008 and~~dividends ~~2007,~~on ~~respectively.~~MidCarolina’s ~~The Company had net income available to~~ common ~~shareholders~~or preferred ~~for~~stock ~~the~~or ~~year~~payments ~~ended~~on ~~December 31,~~trust ~~2009~~preferred ~~of $2.0 million~~securities, or(iii) incur ~~$0.40~~additional ~~per diluted share compared with $3.3 million~~debt, or ~~$0.66~~(iv) redeem ~~per~~any ~~diluted~~outstanding ~~share for the year ended December 31, 2008~~stock.

At December 31, 2009, the Company had total consolidated assets of $541.0 million, net loans of $430.7 million, deposits of $465.0 million, investment securities available-for-sale of $70.7 million and shareholders’ equity of $40.2 million.

Subsidiaries

~~Other~~MidCarolina ~~than~~Bank ~~the~~is ~~Bank,~~MidCarolina’s only bank subsidiary. MidCarolina also holds all of the ~~Company~~common ~~has~~trust securities of two ~~trust~~statutory business ~~subsidiaries:~~trusts, MidCarolina I and MidCarolina Trust II, which were formed by MidCarolina to facilitate the issuance of preferred trust securities to provide it with additional capital. ~~The~~ MidCarolina Bank’s only subsidiary, MidCarolina Investments, Inc., was dormant during ~~2009~~2010. ~~MidCarolina~~It ~~Investments~~previously ~~formerly~~made ~~engaged in~~ general securities brokerage, ~~and offered~~ insurance and other financial services available through a contract arrangement with a third-party ~~provider.~~broker-dealer ~~The~~and ~~Bank~~insurance ~~continues~~agency. toMidCarolina ~~offer~~Bank currently ~~these~~makes those services available through a similar contract arrangement with a third-party provider.

Employees

At December 31, ~~2009~~2010, ~~the~~MidCarolina Bank had 8277 full-time equivalent employees. MidCarolina itself has no separate employees.

~~Competition and~~ Market Area and Competition

~~The~~MidCarolina Bank’s primary market area is Alamance County and Guilford County, North Carolina, and it faces strong competition in that market, both in attracting deposits and making ~~real estate and other~~ loans. Its most direct competition for deposits comes from commercial banks, savings institutions and credit unions located in ~~its~~the ~~primary~~ market area, including large financial institutions that have greater financial and marketing resources available to them. AtCompetition has ~~June 30,~~increased ~~2009,~~as ~~there were 16 depository institutions with 50 offices in Alamance County. The Bank had~~ a ~~deposit~~result ~~market share~~ of ~~17.4%~~the inelimination ~~Alamance County. The Bank also faces additional significant competition for investors’ funds from short-term money market securities and other corporate and government securities. The ability~~ of ~~the~~restrictions ~~Bank to attract and retain savings deposits depends~~ on ~~its~~the ~~ability~~interstate tooperations ~~generally provide a rate~~ of ~~return,~~financial ~~liquidity and risk comparable to that offered by competing investment opportunities~~institutions.

~~The~~Based ~~Bank’s~~on data ~~competition~~published ~~for~~by ~~real estate~~the ~~loans~~FDIC isas ~~from~~of ~~savings~~June 30, ~~institutions~~2010, there were 16 depository institutions (excluding credit unions,) ~~commercial~~with ~~banks~~50 banking offices in Alamance County alone, and ~~mortgage~~MidCarolina ~~banking~~Bank ~~companies~~held 17.9% Itof ~~competes~~the ~~for~~total ~~loans~~deposits ~~primarily~~held ~~through~~by the ~~interest~~offices ~~rates~~of ~~and~~those institutions ~~loan~~in ~~fees~~that itcounty. ~~charges~~It ~~and~~held 4.5% of the ~~efficiency~~total ~~and~~deposits ~~quality~~held by offices of ~~services~~all itdepository ~~provides borrowers.~~institutions ~~Competition~~(other isthan ~~increasing~~credit asunions) located in Alamance and Guilford Counties on a ~~result~~combined ofbasis. ~~the~~MidCarolina ~~reduction~~Bank also faces significant competition for depositors’ funds from sellers of ~~restrictions~~short-term money market securities and other corporate and government securities. MidCarolina Bank’s ability to attract and retain interest-bearing deposits depends generally on ~~the~~its ~~interstate~~ability to ~~operations~~provide a rate of ~~financial~~return, ~~institutions~~liquidity and risk comparable to that offered by competing investment opportunities.

~~The~~Competition ~~Bank’s~~for ~~primary~~loans ~~market~~comes ~~area~~from issavings ~~Alamance~~institutions, ~~County.~~credit ~~The~~unions, ~~population~~commercial ~~of Alamance County is 148~~banks,~~053~~ and ~~the~~mortgage ~~median~~banking ~~household income is $41,922~~companies. ~~Alamance~~MidCarolina ~~County~~Bank ~~has~~competes afor ~~diverse~~loans ~~economy~~primarily ~~with~~through nothe ~~concentration~~interest inrates ~~any~~and ~~one~~loan ~~specific~~fees ~~industry.~~it ~~Major~~charges ~~businesses~~ and ~~industries in~~ the ~~area~~efficiency ~~include LabCorp, a laboratory that provides specialized testing services for the medical industry, Alamance Health Services, Elon University, Honda Power Equipment Manufacturing~~ and ~~GKN~~quality ~~Automotive, a manufacturer~~ of services ~~automobile~~it ~~drive~~provides ~~shafts~~to borrowers.

Supervision and Regulation

~~The Company~~MidCarolina’s and ~~the~~MidCarolina Bank’s business and operations are subject to extensive federal and state governmental regulation and supervision. The following is a summary of some of those ~~basic~~ basic statutes and regulations. However, it is not a complete discussion of all the laws that affect ~~the~~their ~~Company’s~~ business, and it is qualified in its entirety by reference to the particular statutory or regulatory provision ~~or proposal~~ being described.

General. MidCarolina is a bank holding company registered with the Federal Reserve Board (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). It is subject to supervision and examination by, and the regulations and reporting requirements of, the Federal Reserve. Under the BHCA, a bank holding company’s activities are limited to banking, managing or controlling banks, or engaging in other activities the Federal Reserve determines are closely related and a proper incident to banking or managing or controlling banks.

~~General.~~ The ~~Company~~BHCA isprohibits a bank holding company ~~registered~~from ~~with~~acquiring ~~the Federal~~direct ~~Reserve~~or ~~Board~~indirect ~~(the~~control ~~“FRB”)~~of ~~under~~more than 5.0% of the ~~Bank~~outstanding ~~Holding~~voting ~~Company~~stock, ~~Act~~or substantially all of ~~1956~~the assets, asof ~~amended~~any ~~(the~~financial ~~“BHCA”).~~institution, Itor ismerging ~~subject~~or toconsolidating ~~supervision~~with ~~and~~another ~~examination~~bank ~~by,~~holding ~~and~~company ~~the~~or ~~regulations~~savings ~~and~~bank ~~reporting~~holding ~~requirements of~~company, without the ~~FRB~~Federal Reserve’s prior approval. ~~Under~~Additionally, the BHCA, a generally prohibits bank holding ~~company’s~~companies ~~activities~~from ~~are~~engaging ~~limited~~in toa ~~banking~~nonbanking activity, ~~managing~~ or ~~controlling~~acquiring ~~banks,~~ownership or ~~engaging~~control of more than 5.0% of the outstanding voting stock of any company that engages in ~~other~~a ~~activities~~nonbanking activity, unless that activity is determined by the ~~FRB~~Federal ~~determines~~Reserve ~~are~~to be closely related and a proper incident to banking. In approving an application to engage in a nonbanking activity, the Federal Reserve must consider whether that activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or ~~managing~~gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or ~~controlling~~unfair ~~banks~~competition, conflicts of interest or unsound banking practices.

The ~~BHCA~~law ~~prohibits~~imposes a ~~bank~~number ~~holding~~of ~~company~~obligations ~~from~~and ~~acquiring~~restrictions ~~direct~~on orbank ~~indirect~~holding companies ~~control~~and oftheir ~~more~~insured ~~than~~bank ~~5.0%~~subsidiaries ofdesigned ~~the~~to ~~outstanding~~minimize ~~voting~~potential ~~stock,~~losses orto ~~substantially~~depositors ~~all of~~and the ~~assets,~~FDIC’s ofDeposit ~~any~~Insurance ~~financial~~Fund ~~institution,~~(the or“DIF”). ~~merging~~For orexample, ~~consolidating~~if ~~with~~a ~~another~~ bank holding company’s orinsured ~~savings~~ bank ~~holding~~subsidiary ~~company~~becomes “undercapitalized,” ~~without~~ the ~~FRB’s~~bank ~~prior~~holding ~~approval.~~company ~~Additionally,~~is ~~the~~required ~~BHCA~~to ~~generally~~guarantee ~~prohibits~~the bank’s ~~holding~~compliance ~~companies~~(subject ~~from engaging~~to incertain alimits) ~~nonbanking~~with ~~activity,~~the orterms ~~acquiring~~of ~~ownership~~any orcapital ~~control~~restoration ofplan ~~more~~filed ~~than~~with ~~5.0%~~its offederal ~~the~~banking ~~outstanding~~agency. ~~voting~~A ~~stock~~bank ofholding ~~any~~ company ~~that~~is required ~~engages~~to inserve as a ~~nonbanking~~source ~~activity,~~of ~~unless~~financial ~~that~~strength ~~activity~~to isits ~~determined~~bank bysubsidiaries ~~the~~and ~~FRB~~to commit resources to besupport ~~closely~~those ~~related~~banks ~~and~~in ~~a proper~~circumstances ~~incident~~in towhich, ~~banking.~~absent Inthat ~~approving~~policy, anit ~~application~~might tonot ~~engage~~do inso. aUnder ~~nonbanking~~the ~~activity~~BHCA, the ~~FRB~~Federal ~~must~~Reserve ~~consider~~may ~~whether~~require ~~that~~a ~~activity~~bank holding ~~can~~company ~~reasonably be expected~~ to ~~produce~~terminate ~~benefits~~any toactivity ~~the~~or ~~public,~~relinquish ~~such~~control asof ~~greater~~a ~~convenience,~~nonbank ~~increased~~subsidiary ~~competition, or~~if ~~gains~~the inFederal ~~efficiency,~~Reserve determines that ~~outweigh~~the ~~possible~~activity ~~adverse~~or ~~effects,~~control ~~such~~constitutes asa ~~undue~~serious ~~concentration~~risk ofto ~~resources,~~the ~~decreased~~financial orsoundness ~~unfair~~and ~~competition,~~stability ~~conflicts~~ of ~~interest~~a orbank ~~unsound~~subsidiary ~~banking~~of ~~practices~~the bank holding company.

~~The~~MidCarolina ~~law~~Bank ~~imposes~~is aan ~~number~~insured, ofNorth ~~obligations~~Carolina-chartered ~~and~~bank. ~~restrictions~~Its ondeposits ~~bank~~are ~~holding~~insured ~~companies~~under ~~and~~the FDIC’s ~~their~~DIF, ~~insured~~and ~~bank~~it ~~subsidiaries~~is ~~designed~~subject to ~~minimize~~supervision ~~potential~~and ~~losses to~~examination ~~depositors~~by, and the ~~FDIC~~regulations ~~insurance~~and ~~funds.~~reporting ~~For~~requirements ~~example~~of, ifthe aFDIC ~~bank~~and ~~holding~~the ~~company~~North Carolina Commissioner of Banks (the “NC Commissioner”). MidCarolina Bank’s ~~insured~~business ~~bank~~also is ~~subsidiary~~influenced ~~becomes~~by ~~“undercapitalized~~prevailing economic conditions and governmental policies,” both foreign and domestic, and by the ~~bank~~monetary ~~holding~~and ~~company~~fiscal policies of the Federal Reserve. MidCarolina Bank is ~~required~~not toa ~~guarantee~~member of the ~~bank’s~~Federal ~~compliance~~Reserve ~~(subject~~System. toHowever, ~~certain~~under the ~~limits)~~Federal ~~with~~Reserve’s ~~the~~regulations, ~~terms~~all ofFDIC-insured ~~any~~banks ~~capital~~must ~~restoration~~maintain ~~plan~~average ~~filed~~daily ~~with~~reserves ~~its~~against ~~federal~~their ~~banking~~transaction ~~agency~~accounts. ACurrently, ~~bank~~no ~~holding~~reserves ~~company~~are is required toon ~~serve~~the asfirst a$10.7 ~~source~~million of ~~financial~~transaction ~~strength~~accounts, tobut ~~its~~a bank ~~subsidiaries~~must ~~and~~maintain reserves equal to ~~commit~~3.0% ~~resources~~on toaggregate ~~support~~balances ~~those~~between ~~banks~~$10.7 ~~in circumstances~~million inand ~~which~~$58.8 million, ~~absent~~and ~~that~~reserves ~~policy,~~equal itto ~~might~~10.0% ~~not~~on doaggregate ~~so.~~balances ~~Under~~in ~~the~~excess ~~BHCA,~~of ~~the~~$58.8 ~~FRB~~million. The Federal Reserve may ~~require~~adjust athese ~~bank~~percentages ~~holding~~from ~~company~~time to ~~terminate~~time. ~~any~~Because MidCarolina ~~activity~~Bank’s orreserves ~~relinquish~~must ~~control~~be maintained in the form of vault cash or in an account at a ~~nonbank~~Federal ~~subsidiary~~Reserve ifBank or with a qualified correspondent bank, one effect of the ~~FRB~~reserve ~~determines~~requirement ~~that~~is to reduce the ~~activity~~amount orof ~~control~~MidCarolina Bank’s ~~constitutes~~assets athat ~~serious~~are ~~risk~~available for lending and other investment activities. The Federal Reserve’s actions and policy directives determine to ~~the~~a ~~financial~~significant ~~soundness~~degree the cost and ~~stability~~availability of afunds ~~bank~~MidCarolina ~~subsidiary~~Bank obtains from money market sources for lending and investing, and they also influence, directly and indirectly, the rates of ainterest ~~bank~~MidCarolina ~~holding~~Bank ~~company~~pays on its time and savings deposits and the rates it charges on commercial bank loans.

~~The~~As an insured bank, MidCarolina Bank is prohibited from engaging as a principal in an ~~insured, North~~activity ~~Carolina-chartered~~that ~~bank.~~is ~~Its~~not ~~deposits~~permitted ~~are~~for ~~insured~~national ~~under~~banks unless (i) the FDIC’s ~~Deposit~~determines ~~Insurance~~that ~~Fund,~~the ~~and~~activity itwould ispose ~~subject~~no significant risk to ~~supervision~~the DIF and ~~examination~~(ii) MidCarolina ~~by,~~Bank ~~and~~is ~~the~~in ~~regulations~~compliance ~~and~~with ~~reporting~~applicable ~~requirements~~capital ~~of,~~standards. ~~the~~Insured ~~FDIC~~banks ~~and~~also ~~the~~are ~~Commissioner.~~prohibited ~~The~~generally ~~Bank~~from isdirectly acquiring or ~~not~~retaining aany ~~member~~equity investment of ~~the~~a ~~Federal~~type ~~Reserve~~or ~~System~~in an amount not permitted for national banks.

AsThe anNC ~~insured~~Commissioner ~~bank,~~and the FDIC regulate all areas of MidCarolina Bank’s isbusiness, ~~prohibited~~including ~~from~~its ~~engaging~~payment asof adividends ~~principal~~and inother anaspects ~~activity~~of ~~that~~its ~~is not~~operations. ~~permitted~~They ~~for~~conduct ~~national~~regular ~~banks~~examinations ~~unless~~of ~~(1)~~ MidCarolina Bank, and it must furnish periodic reports to the NC Commissioner and the FDIC ~~determines~~containing ~~that~~detailed ~~the~~financial ~~activity~~and ~~would~~other ~~pose~~information noabout ~~significant~~its ~~risk~~affairs. toThe NC Commissioner and the ~~deposit~~FDIC ~~insurance~~have ~~fund~~broad powers to enforce laws and ~~(2) the~~regulations that apply to MidCarolina Bank isand into ~~compliance~~require ~~with~~corrective ~~applicable~~action ~~capital~~of ~~standards~~conditions that affect its safety and soundness. ~~Insured~~These ~~banks~~powers ~~also~~include, ~~are prohibited~~among ~~generally~~others, ~~from~~issuing ~~directly~~cease ~~acquiring~~and ordesist ~~retaining~~orders, ~~any~~imposing ~~equity~~civil ~~investment~~penalties, ofremoving aofficers ~~type~~and ordirectors, and otherwise intervening in anMidCarolina ~~amount~~Bank’s ~~not~~operation ~~permitted~~and ~~for~~management ~~national~~if ~~banks~~their examinations and the reports filed with them indicate the need to do so.

~~The~~Under ~~Commissioner~~North ~~and~~Carolina ~~the~~banking ~~FDIC~~laws, ~~regulate~~if ~~all~~a ~~areas of the Bank~~bank’s capital ~~business,~~stock ~~including~~becomes ~~its~~impaired ~~payment~~by oflosses ~~dividends~~or ~~and~~ other ~~aspects~~causes, ofand ~~its operations. They conduct regular examinations of~~ the ~~Bank,~~bank’s surplus and ~~the~~undivided ~~Bank~~profits ~~must~~are ~~furnish~~insufficient ~~periodic reports~~ to ~~the~~make ~~Commissioner~~good ~~and~~ the ~~FDIC~~impairment, ~~containing~~the ~~detailed~~NC ~~financial~~Commissioner ~~and~~may ~~other~~require ~~information~~the ~~about~~bank ~~its~~to ~~affairs.~~make ~~The~~the ~~Commissioner~~impairment ~~and~~good ~~the~~by ~~FDIC~~an ~~have~~assessment ~~broad~~upon ~~powers~~the bank’s tostockholders ~~enforce~~(or ~~laws~~on ~~and~~its ~~regulations~~sole ~~that~~shareholder ~~apply~~in to the ~~Bank~~case ~~and~~of toa ~~require~~bank ~~corrective~~owned ~~action~~by ~~of conditions~~a ~~that~~bank ~~affect~~holding ~~its safety and soundness~~company). ~~These~~If ~~powers~~any ~~include,~~stockholder ~~among~~does ~~others,~~not ~~issuing~~pay ~~cease~~the ~~and desist orders~~assessment, ~~imposing~~the ~~civil~~bank’s ~~penalties,~~board ~~removing~~of ~~officers~~directors ~~and~~must ~~directors,~~sell ~~and~~a ~~otherwise~~sufficient ~~intervening~~amount inof the ~~Bank~~bank’s ~~operation and management if~~stock ~~examinations~~held ofby ~~the~~that ~~Bank~~stockholder ~~and~~at ~~the~~public ~~reports~~auction itto ~~files~~make ~~indicate~~good the ~~need~~assessment toon dothat sostockholder.

Under North Carolina banking laws, if a North Carolina bank’s capital stock becomes impaired by losses or other causes, and the bank’s surplus and undivided profits are insufficient to make good the impairment, the Commissioner may require the bank to make the impairment good by an assessment upon the bank’s stockholders. If any stockholder does not pay such assessment, the bank’s board of directors must sell a sufficient amount of the bank’s stock held by that stockholder at public auction to make good the assessment on that stockholder.

The Bank’s business also is influenced by prevailing economic conditions and governmental policies, both foreign and domestic, and, though it is not a member bank of the Federal Reserve System, by the monetary and fiscal policies of the FRB. The FRB’s actions and policy directives determine to a significant degree the cost and availability of funds the Bank obtains from money market sources for lending and investing, and they also influence, directly and indirectly, the rates of interest the Bank pays on its time and savings deposits and the rates it charges on commercial bank loans.

Gramm-Leach-Bliley Act. ~~The~~Various federal laws governing the banking industry, as well as the securities and insurance industries, were changed during 1999 with the enactment of the Gramm-Leach-Bliley Act. ~~enacted~~It Act permitted bank holding companies to become “financial holding companies” and, in ~~1999~~general (1) expanded opportunities to affiliate with securities firms and insurance companies; (2) overrode certain state laws that prohibited certain banking and insurance affiliations; (3) expanded the activities in which banks and bank ~~“GLB~~holding ~~Act”~~companies could participate; (4) required ~~dramatically~~that ~~changed~~banks and bank holding companies engage in some activities only through affiliates owned or managed in accordance with specified requirements; and (5) reorganized responsibility among various federal ~~laws~~regulators ~~governing~~for ~~the~~oversight ~~banking,~~of certain securities activities conducted by banks and ~~insurance~~bank ~~industries~~holding companies.

~~The~~Dodd-Frank ~~GLB~~ Act ~~permitted~~. ~~bank~~During ~~holding companies to become “financial holding companies” and~~2010, inthe ~~general~~bank ~~(1) expanded~~regulatory ~~opportunities~~landscape towas ~~affiliate~~again ~~with~~dramatically ~~securities~~changed ~~firms~~by ~~and~~the ~~insurance~~Dodd-Frank ~~companies;~~Wall ~~(2) overrode certain state laws that would prohibit~~Street ~~certain~~Reform ~~banking~~ and ~~insurance~~Consumer ~~affiliations;~~Protection ~~(3) expanded~~Act (the ~~activities~~“Dodd-Frank inAct”) which ~~banks~~was ~~and~~signed ~~bank~~into ~~holding~~law ~~companies~~on ~~may participate; (4)~~July ~~requires~~21, ~~that~~2010 ~~banks~~ and ~~bank~~which ~~holding~~implements ~~companies~~far-reaching ~~engage~~regulatory inreform. ~~some~~Among ~~activities~~its ~~only~~more ~~through~~significant ~~affiliates~~provisions, ~~owned or~~the ~~managed~~Dodd-Frank inAct: ~~accordance with certain requirements; and (5) reorganized responsibility among various federal regulators for oversight of certain securities activities conducted by banks and bank holding companies.~~

~~Payment~~• ofestablished ~~Dividends. Under North Carolina law,~~ the ~~Company~~Financial isStability ~~authorized~~Oversight toCounsel ~~pay~~made ~~dividends~~up ~~as declared by its Board~~ of ~~Directors,~~ ~~provided that no such distribution results in~~ the ~~Company’s~~heads ~~insolvency~~of ~~on a going concern or balance sheet basis. However, although~~ the ~~Company~~various isbank aregulatory ~~legal entity separate~~ and ~~distinct~~other ~~from~~agencies ~~the~~to ~~Bank,~~identify ~~its~~and ~~principal~~respond ~~source~~to ofrisks ~~funds with which it can pay dividends~~ to ~~its~~U.S. ~~shareholders~~financial isstability ~~dividends~~arising ~~it receives~~ from ~~the~~ongoing ~~Bank.~~activities ~~For~~of ~~that~~large ~~reason,~~financial ~~the Company’s ability to pay dividends effectively is subject to the same limitations that apply to the Bank.~~ companies;

In• ~~general,~~established ~~the~~centralized ~~Bank~~responsibility ~~may~~for ~~pay~~consumer ~~dividends~~financial ~~only~~protection ~~from~~by ~~its~~creating ~~undivided~~a ~~profits.~~new ~~However,~~Consumer ifFinancial ~~its~~Protection ~~surplus~~Bureau iswhich ~~less~~will ~~than~~be ~~50%~~responsible offor ~~its paid-in capital stock~~implementing, ~~the Bank’s~~examining ~~directors~~and ~~may~~enforcing ~~not~~compliance ~~declare~~with ~~any~~federal ~~cash~~consumer ~~dividend~~financial ~~until~~laws itwith ~~has~~respect ~~transferred~~ to ~~surplus~~financial ~~25%~~institutions ofwith ~~its~~over ~~undivided~~$10 ~~profits~~billion ~~or any lesser percentage necessary to raise its surplus to an amount equal to 50% of its paid-~~in ~~capital stock.~~ assets;

~~Federal~~• ~~law~~required ~~prohibits the Bank from making any capital distributions, including paying a cash dividend, if it is, or after making the distribution it would become, “undercapitalized” as~~ that ~~term~~banking isagencies ~~defined~~establish infor ~~the~~most ~~Federal Deposit Insurance Act (the “FDIA”). Also, if in the FDIC’s opinion an insured~~ bank ~~under~~holding ~~its~~companies ~~jurisdiction is engaged in or is about to engage in an unsafe or unsound practice,~~ the ~~FDIC~~same ~~may~~leverage ~~require, after notice~~ and ~~hearing,~~risk-based ~~that~~capital ~~the~~requirements ~~bank~~as ~~cease~~apply ~~and~~to ~~desist~~insured ~~from~~depository ~~that~~institutions; ~~practice. The FDIC has indicated~~ that ~~paying dividends that deplete a~~ bank’s ~~capital~~holding ~~base~~companies toand anbanks ~~inadequate level would~~ be anwell-capitalized ~~unsafe~~ and ~~unsound~~ ~~banking~~well ~~practice.~~managed ~~(See~~in ~~“—Prompt~~order ~~Corrective~~to ~~Action”~~acquire ~~below.)~~banks ~~The~~located ~~FDIC~~outside ~~has~~their ~~issued~~home ~~policy~~states; ~~statements~~and, ~~which~~prohibits ~~provide~~bank ~~that~~holding ~~insured~~companies ~~banks~~from ~~generally~~including ~~should~~new ~~pay~~trust ~~dividends~~preferred ~~only~~securities ~~out~~in of their ~~current~~Tier ~~operating~~1 ~~earnings.~~capital ~~Also~~and, ~~under~~beginning ~~the FDIA~~with noa ~~dividend may be paid by an FDIC~~three-~~insured~~year ~~bank while it is~~ phase-in ~~default~~period on ~~any~~January ~~assessment~~1, ~~due the FDIC. The Bank’s payment of dividends also may be affected or limited by other factors~~2013, ~~such~~requires asbank ~~events~~holding orcompanies ~~circumstances~~with ~~that~~assets ~~lead~~over ~~the~~$15 ~~FDIC~~billion to ~~require~~ ~~the~~deduct ~~Bank~~existing totrust ~~maintain~~preferred ~~its~~securities ~~capital~~from ~~above~~their ~~regulatory~~Tier ~~guidelines.~~1 capital;

In• required the ~~future,~~FDIC ~~the~~to ~~Company’s~~set ~~ability~~a tominimum ~~declare~~DIF reserve ratio of 1.35% and ~~pay~~that ~~cash dividends~~the ~~will~~DIF reserve ratio be ~~subject~~increased to ~~its~~that ~~Board~~level by September 30, 2020; that FDIC off-set the effect of ~~Directors’~~the ~~evaluation~~higher minimum ratio on insured depository institutions with assets of ~~its~~less ~~operating~~than ~~results,~~$10 ~~capital~~billion; ~~levels~~and, ~~financial~~that ~~condition,~~FDIC ~~future~~change ~~growth~~the ~~plans,~~assessment ~~general~~base ~~business~~used ~~and~~for ~~economic~~calculating ~~conditions,~~insurance ~~and~~assessments ~~other~~from ~~relevant~~the ~~considerations.~~amount of insured deposits to average consolidated total assets minus average tangible equity;

~~Capital~~• ~~Adequacy. The~~established ~~Company~~a ~~and~~permanent ~~the~~$250,000 ~~Bank~~limit ~~are~~for ~~required~~federal todeposit ~~comply~~insurance; ~~with~~provided ~~the~~separate, ~~FRB’s~~unlimited ~~and~~federal ~~FDIC’s~~deposit ~~capital~~insurance ~~adequacy~~until ~~standards for~~December ~~bank~~31, ~~holding~~2012 ~~companies~~for ~~and~~noninterest-bearing ~~insured~~demand ~~banks.~~transaction ~~The~~accounts; ~~FRB~~ and, ~~FDIC~~repealed ~~have~~the ~~issued~~federal ~~risk-based~~prohibition ~~capital~~on ~~and~~the ~~leverage~~payment ~~capital~~of ~~guidelines~~interest ~~for~~on ~~measuring~~demand ~~capital adequacy~~deposits, ~~and~~thereby ~~all~~permitting ~~applicable~~depository ~~capital~~institutions ~~standards must be satisfied for us or the Bank~~ to bepay ~~considered in~~interest ~~compliance~~on ~~with~~business ~~regulatory~~transaction ~~capital~~and ~~requirements.~~other accounts;

~~Under~~• ~~the~~amended ~~risk-based capital guidelines,~~ the ~~minimum~~Electronic ~~ratio~~Fund ~~(“Total~~Transfer ~~Capital Ratio”)~~Act ~~of an entity’s total capital (“Total Capital”)~~ to ~~its risk-weighted assets (including certain off-balance-sheet items~~, ~~such~~among asother ~~standby letters of credit) is 8.0%. At least half of Total Capital must be composed of “Tier 1 Capital.” Tier 1 Capital includes common equity~~things, ~~undivided~~give ~~profits,~~the ~~minority~~Federal ~~interests~~Reserve in the ~~equity~~authority ~~accounts~~to ofestablish ~~consolidated~~rules ~~subsidiaries,~~regarding ~~qualifying~~interchange ~~noncumulative~~fees ~~perpetual~~charged ~~preferred~~for ~~stock,~~electronic ~~and~~debit atransactions ~~limited~~by ~~amount~~payment ofcard ~~cumulative perpetual~~issuers ~~preferred~~having ~~stock, less goodwill and certain other intangible~~ assets. ~~The~~over ~~remaining~~$10 ~~Total~~billion ~~Capital may consist of “Tier 2 Capital” which includes certain subordinated debt, certain hybrid capital instruments~~ and ~~other~~to ~~qualifying preferred~~enforce ~~stock, and~~ a ~~limited~~new ~~amount~~statutory ofrequirement ~~loan loss reserves. A bank or bank holding company~~ that ~~does~~those ~~not~~fees ~~satisfy minimum capital requirements may~~ be ~~required~~reasonable ~~to adopt~~ and ~~implement~~proportional ato ~~plan~~the ~~acceptable~~actual tocost ~~its~~of ~~federal~~a ~~banking~~transaction ~~regulator~~ to ~~achieve~~the ~~an adequate~~issuer; ~~level of capital.~~ and

~~Under~~• ~~the~~required ~~leverage~~implementation ~~capital measure, the minimum ratio (the “Leverage Capital Ratio”)~~ of ~~Tier 1 Capital to average assets, less goodwill and~~ various ~~other~~corporate ~~intangible~~governance ~~assets,~~processes isaffecting ~~3.0%~~areas ~~for~~such ~~entities~~as ~~that~~executive ~~meet~~compensation ~~specified~~and ~~criteria,~~proxy ~~including~~access ~~having~~by ~~the highest regulatory rating. All other entities generally are required to maintain an additional cushion of 100~~ shareholders;

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over time, making it difficult to anticipate the overall financial impact on financial institutions and consumers. Provisions in the legislation that affect the payment of interest on demand deposits and interchange fees are likely to increase the costs associated with deposits as well as reduce banks’ revenues.

Restrictions on Payment of Dividends. Under North Carolina law, MidCarolina is authorized to pay dividends as declared by its board of directors, provided that no such distribution results in MidCarolina’s insolvency on a going concern or balance sheet basis. However, although MidCarolina is a legal entity separate and distinct from MidCarolina Bank, its principal source of funds with which it can pay dividends to its shareholders and its separate expenses is dividends it receives from MidCarolina Bank. For that reason, MidCarolina’s ability to pay dividends effectively is subject to the same limitations that apply to MidCarolina Bank.

In general, MidCarolina Bank may pay dividends only from its undivided profits. However, if its surplus is less than 50% of its paid-in capital stock, its directors may not declare any cash dividend until it has transferred to surplus 25% of its undivided profits or any lesser percentage necessary to raise its surplus to an amount equal to 50% of its paid-in capital stock.

toAs ~~200~~described ~~basis points~~ above under the ~~stated~~caption ~~minimum.~~“- ~~The~~Memorandums ~~guidelines~~of ~~also~~Understanding,” MidCarolina’s ~~provide~~and ~~that~~MidCarolina ~~banks~~Bank’s ~~experiencing~~boards ~~internal~~of ~~growth~~directors orhave ~~making~~entered ~~acquisitions~~into ~~will~~agreements bewith, ~~expected~~respectively, tothe ~~maintain~~Federal ~~strong~~Reserve ~~capital~~Bank ~~positions substantially~~of ~~above~~Richmond and with the ~~minimum~~FDIC ~~levels~~and ~~without~~NC ~~significant~~Commissioner. ~~reliance~~MidCarolina’s onagreement ~~intangible~~provides ~~assets.~~that Ait ~~bank~~will not receive dividends from MidCarolina Bank, pay dividends on MidCarolina’s ~~“Tangible~~common ~~Leverage~~or ~~Ratio”~~preferred ~~(deducting~~stock ~~all~~or ~~intangibles)~~payments ~~and~~on ~~other~~trust ~~indicators~~preferred ofsecurities, ~~capital~~incur ~~strength~~additional ~~also~~debt, ~~will~~or beredeem ~~taken~~any ~~into~~outstanding ~~consideration~~stock, bywithout its regulator’s prior written ~~banking~~approval. ~~regulators~~MidCarolina inBank’s ~~evaluating~~agreement ~~proposals~~provides ~~for~~that ~~expansion~~it orwill ~~new~~not ~~activities~~pay any dividend to MidCarolina without its regulators’ approval.

~~The~~Federal ~~FRB~~law ~~and~~prohibits ~~the~~MidCarolina ~~FDIC~~Bank ~~also~~from ~~consider~~making ~~interest~~any ~~rate~~capital ~~risk~~distributions, ~~(when~~including paying a cash dividend, if it is, or after making the distribution it would become, “undercapitalized” as ~~interest~~that ~~rate~~term ~~sensitivity~~is ofdefined anin ~~institution’s~~the ~~assets~~Federal ~~does~~Deposit ~~not~~Insurance ~~match~~Act (the ~~sensitivity~~“FDIA”). ofAlso, ~~its~~if ~~liabilities~~in orthe FDIC’s opinion an insured bank under its ~~off-balance-sheet~~jurisdiction ~~position)~~is engaged in ~~evaluating~~or ~~capital~~is ~~adequacy.~~about ~~Banks~~to ~~with~~engage ~~excessive~~in ~~interest~~an ~~rate~~unsafe ~~risk~~or ~~exposure~~unsound ~~must~~practice, ~~hold~~the ~~additional~~FDIC may require, ~~amounts~~after ofnotice ~~capital~~and ~~against~~hearing, ~~their~~that ~~exposure~~the tobank ~~losses~~cease ~~resulting~~and desist from that ~~risk~~practice. The ~~regulators~~FDIC ~~also~~has ~~require~~indicated ~~banks~~that paying dividends that deplete a bank’s capital base to ~~incorporate~~an ~~market~~inadequate ~~risk~~level ~~components~~would ~~into~~be ~~their~~an ~~risk-based~~unsafe ~~capital~~and unsound banking practice. ~~Under~~(See “—Prompt ~~these~~Corrective ~~market~~Action” ~~risk~~below.) ~~requirements~~The FDIC has issued policy statements which provide that insured banks generally should pay dividends only out of their current operating earnings. Also, ~~capital~~under isthe ~~allocated~~FDIA tono dividend may be paid by an ~~support~~FDIC-insured bank while it is in default on any assessment due the ~~amount~~FDIC. MidCarolina Bank’s payment of ~~market~~dividends ~~risk~~also ~~related~~may be affected or limited by other factors, such as events or circumstances that lead the FDIC to arequire ~~bank’s~~it ~~trading~~to ~~activities~~maintain its capital above regulatory guidelines.

Capital ~~categories~~Adequacy. MidCarolina ofand ~~financial~~MidCarolina ~~institutions~~Bank are ~~determined~~ ~~only~~required ~~for~~to ~~the~~comply ~~purpose~~with ~~of applying~~ the ~~“prompt~~Federal ~~corrective~~Reserve’s ~~action”~~and ~~rules~~FDIC’s ~~described~~capital ~~below~~adequacy ~~which~~standards ~~have~~for ~~been~~bank ~~adopted~~holding bycompanies ~~the various federal banking regulators,~~ and ~~they~~insured dobanks. ~~not~~The ~~necessarily~~Federal ~~constitute~~Reserve anand ~~accurate~~FDIC ~~representation~~have ofissued ~~overall~~risk-based ~~financial condition~~capital orand ~~prospects~~leverage ~~for other purposes. A failure to meet~~ capital guidelines ~~could~~for ~~subject~~measuring capital ~~the the Bank to a variety of enforcement remedies under those rules~~adequacy, ~~including~~and ~~issuance~~all ofapplicable a capital ~~directive,~~standards ~~termination~~must ofbe ~~FDIC~~satisfied ~~deposit~~for ~~insurance,~~MidCarolina ~~a prohibition~~or onMidCarolina ~~taking brokered deposits, and other restrictions on the~~ Bank’s ~~business.~~to ~~As described below, substantial additional restrictions can~~ be ~~imposed~~considered onin ~~banks~~compliance ~~that~~with ~~fail~~regulatory ~~to meet applicable~~ capital requirements.

Under the risk-based capital guidelines, the minimum ratio (“Total Capital Ratio”) of an entity’s total capital (“Total Capital”) to its risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8.0%. At least half of Total Capital must be composed of “Tier 1 Capital.” Tier 1 Capital includes common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets. The remaining Total Capital may consist of “Tier 2 Capital” which includes certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, and a limited amount of loan loss reserves. A bank or bank holding company that does not satisfy minimum capital requirements may be required to adopt and implement a plan acceptable to its federal banking regulator to achieve an adequate level of capital.

Under the leverage capital measure, the minimum ratio (“Leverage Capital Ratio”) of Tier 1 Capital to average assets, less goodwill and various other intangible assets, is 3.0% for entities that meet specified criteria, including having the highest regulatory rating. All other entities generally are required to maintain an additional cushion of 100 to 200 basis points above the stated minimum. The guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum levels without significant reliance on intangible assets. A bank’s “Tangible Leverage Ratio” (deducting all intangibles) and other indicators of capital strength also will be taken into consideration by banking regulators in evaluating proposals for expansion or new activities.

The Federal Reserve and the FDIC also consider interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in evaluating capital adequacy. Banks with excessive interest rate risk exposure must hold additional amounts of capital against their exposure to losses resulting from that risk. The regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s trading activities.

Capital categories of financial institutions are determined only for the purpose of applying the “prompt corrective action” rules described below which have been adopted by the various federal banking regulators, and they do not necessarily constitute an accurate representation of overall financial condition or prospects for other purposes. A failure to meet capital guidelines could subject MidCarolina Bank to a variety of enforcement remedies under those rules, including issuance of a capital directive, termination of FDIC deposit insurance, a prohibition on taking brokered deposits, and other restrictions on MidCarolina Bank’s business. As described below, substantial additional restrictions can be imposed on banks that fail to meet applicable capital requirements.

Prompt Corrective Action. Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, the FDIC has established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”) and it is required to take various supervisory actions, and is authorized to take other discretionary actions, with respect to banks in the three undercapitalized categories. The severity of any actions taken will depend on the capital category in which a bank is placed. Generally, subject to a narrow exception, current federal law requires the FDIC to appoint a receiver or conservator for a bank that is critically undercapitalized.

Under the FDIC’s rules implementing the prompt corrective action provisions, an insured, state-chartered bank that (1) has a Total Capital Ratio of 10.0% or greater, a Tier 1 Capital Ratio of 6.0% or greater, and a Leverage Ratio of 5.0% or greater, and (2) is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the FDIC, is considered “well capitalized.” A bank with a Total Capital Ratio of 8.0% or greater, a Tier 1 Capital Ratio of 4.0% or greater, and a Leverage Ratio of 4.0% or greater, is considered “adequately capitalized.” A bank that has a Total Capital Ratio of less than 8.0%, a Tier 1 Capital Ratio of less than 4.0%, or a Leverage Ratio of less than 4.0%, is considered “undercapitalized.” A bank that has a Total Capital Ratio of less than 6.0%, a Tier 1 Capital Ratio of less than 3.0%, or a Leverage Ratio of less than 3.0%, is considered “significantly undercapitalized,” and a bank that has a tangible equity capital to assets ratio equal to or less than 2.0% is considered “critically undercapitalized.” For purposes of these rules, the term “tangible equity” includes core capital elements counted as Tier 1 Capital for purposes of the risk-based capital standards (see “—Capital Adequacy” above), plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets (with various exceptions). A bank may be deemed to be in a lower capitalization category than indicated by its actual capital position if it receives an unsatisfactory examination rating.

A bank categorized as “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to the FDIC. An “undercapitalized” bank also is generally prohibited from increasing its average total assets, making acquisitions, establishing new branches, or engaging in new lines of business, other than in accordance with an accepted capital restoration plan or with the FDIC’s approval. Also, the FDIC may treat an “undercapitalized” bank as being “significantly undercapitalized” if it determines that is necessary to carry out the purpose of the law. ~~On December 31, 2009, the Bank’s capital ratios were at levels to qualify it as “well capitalized.”~~

~~Reserve~~On ~~Requirements.~~December ~~Under the FRB’s regulations~~31, ~~all FDIC-insured banks must maintain average daily reserves against their transaction accounts. As of January 1,~~ 2010 ~~no reserves are required on the first $10.7 million of transaction accounts~~, ~~but~~MidCarolina a bank must maintain reserves equal to 3.0% on aggregate balances between $10.7 million and $55.2 million, and reserves equal to 10.0% on aggregate balances in excess of $55.2 million. The FRB may adjust these percentages from time to time. Because the Bank’s ~~reserves~~capital ~~must~~ratios bewere ~~maintained~~at inlevels ~~the~~to ~~form~~qualify ofit ~~vault~~as ~~cash or in an account at a~~“well ~~Federal~~capitalized” ~~Reserve~~under ~~Bank or with a qualified correspondent bank, one effect of~~ the ~~reserve requirement is to reduce the amount of the Bank~~FDIC’s ~~assets that are available for lending and other investment activities~~rules.

7Federal Deposit Insurance. MidCarolina Bank’s deposits are insured by the FDIC to the full extent provided in the Federal Deposit Insurance Act, and it pays assessments to the FDIC for that insurance coverage. Under the Act, the FDIC may terminate a bank’s deposit insurance if it finds that the bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated applicable laws, regulations, rules or orders.

~~Federal~~The ~~Deposit~~FDIC ~~Insurance.~~uses ~~The~~a ~~Bank’s~~risk-based ~~deposits~~assessment ~~are~~system ~~insured~~to bydetermine the ~~FDIC~~amount toof ~~the full~~MidCarolina ~~extent~~Bank’s ~~provided~~deposit ininsurance ~~the~~assessment ~~Federal~~based ~~Deposit~~on ~~Insurance~~an evaluation ~~Act,~~of ~~and~~ the probability that MidCarolina Bank ~~pays~~will ~~assessments~~cause a loss to the ~~FDIC~~DIF. ~~for~~That ~~that~~evaluation ~~insurance~~takes ~~coverage.~~into ~~Under~~consideration ~~the~~risks ~~Act,~~attributable ~~the~~to ~~FDIC~~different ~~may~~categories ~~terminate~~and ~~the~~concentrations of MidCarolina Bank’s ~~deposit~~assets ~~insurance~~and ifliabilities itand ~~finds~~any ~~that~~other factors the ~~Bank~~FDIC ~~has~~considers ~~engaged~~relevant, inincluding ~~unsafe and~~information ~~unsound~~obtained ~~practices,~~from isthe inNC anCommissioner. ~~unsafe~~A orhigher ~~unsound~~assessment ~~condition~~rate toresults ~~continue~~in ~~operations,~~an orincrease ~~has~~in ~~violated~~the ~~applicable~~deposit ~~laws,~~insurance ~~regulations,~~assessments ~~rules~~paid orby ~~orders~~MidCarolina Bank.

The ~~Federal~~FDIC ~~Deposit~~is ~~Insurance~~responsible ~~Reform~~for ~~Act~~maintaining the adequacy of ~~2005~~the ~~(“FDIRA”)~~DIF, ~~changed~~and the ~~Federal~~amount MidCarolina Bank pays for deposit insurance ~~system~~is influenced not only by the assessment of the risk it poses to the DIF, ~~among~~but ~~other~~also ~~things:~~by the adequacy of the insurance fund at any time to cover the risk posed by all insured institutions. Because the DIF reserve ratio had fallen below the minimum level required by law, during 2008 the FDIC adopted a restoration plan to return the reserve ratio to the minimum level and, during 2009, it imposed a special assessment on insured institutions, increased regular assessment rates, and required that insured institutions prepay their regular quarterly assessments through 2012. More recently, as required by the Dodd-Frank Act, the FDIC has set the minimum DIF reserve ratio at 1.35% which must be achieved by September 30, 2020. Although the Dodd-Frank Act requires the FDIC to off-set the effect of the higher minimum ratio on insured depository institutions with assets of less than $10 billion, FDIC insurance assessments paid by all insured depository institutions, including MidCarolina Bank, could be increased substantially in the future if the FDIC finds an increase to be necessary in order to adequately maintain the DIF.

• merging the Bank Insurance Fund and Savings Association Insurance Fund into a new Deposit Insurance Fund (the “DIF”);

• raising the level of Federal deposit insurance coverage for retirement accounts to $250,000;

• establishing a range of 1.15% to 1.50% within which the FDIC must set and maintain the required reserve ratio for the DIF;

• requiring that, if the DIF reserve ratio falls, or within six months is expected to fall, below the statutorily required minimum of 1.15%, the FDIC must adopt a restoration plan that provides for the DIF to be restored; and

• eliminating restrictions on premium rates based on the DIF reserve ratio, and giving the FDIC discretion to price deposit insurance according to the risk posed to the DIF by each insured institution, regardless of the DIF reserve ratio.

During October 2008, the Emergency Economic Stabilization Act of 2008 temporarily raised the basic limit on federal deposit insurance coverage for all accounts from $100,000 to $250,000 per depositor until December 31, 2009. During May 2009, that increased coverage was extended until December 31, 2013, at which time it will return to $100,000 for all accounts other than retirement accounts for which FDIRA permanently increased the basic coverage to $250,000.

FDIC Temporary Liquidity Guarantee Program. During 2008, the FDIC implemented its Temporary Liquidity Guarantee Program (TLGP), which applies to, among others, all U.S. depository institutions insured by the FDIC and all U.S. bank holding companies, unless they have opted out of the TLGP or the FDIC has terminated their participation. The Bank chose to participate in the TLGP. Under the original terms of the transaction account guarantee component of the TLGP, all noninterest-bearing transaction accounts would be insured in full by the FDIC until December 31, 2009, regardless of the standard maximum deposit insurance amount. During August 2009, the FDIC extended the transaction account guarantee component of the TLGP through June 30, 2010.

FDIC Insurance Assessments. Under FDIRA, the FDIC uses a risk-based assessment system to determine the amount of the Bank’s deposit insurance assessment based on an evaluation of the probability that the Bank will cause a loss to the DIF. That evaluation takes into consideration risks attributable to different categories and concentrations of the Bank’s assets and liabilities and any other factors the FDIC considers relevant, including information obtained from the Commissioner. A higher assessment rate results in an increase in the deposit insurance assessments paid by the Bank.

The FDIC is responsible for maintaining the adequacy of the DIF, and the amount the Bank pays for deposit insurance is influenced not only by the assessment of the risk it poses to the DIF, but also by the adequacy of the insurance fund at any time to cover the risk posed by all insured institutions. FDIC insurance assessments could be increased substantially in the future if the FDIC finds such an increase to be necessary in order to adequately maintain the insurance fund.

During 2008, and because the DIF reserve ratio had fallen below the minimum of 1.15% mandated by FDIRA, the Board of Directors of the FDIC adopted a restoration plan to return the reserve ratio to that minimum level required by FDIRA within five years. During February 2009, the Board amended its restoration plan to provide for the minimum DIF reserve ratio to be restored within seven years and voted to impose a special assessment on insured institutions of 20 basis points, and to increase regular assessment rates for 2009. However, during May 2009, the special assessment was reduced to 5 basis points on each insured institution’s assets minus its Tier 1 capital as of

~~June~~Restrictions on Transactions with Affiliates. ~~30,~~MidCarolina ~~2009,~~Bank ~~but~~is subject ~~not~~to ~~more~~the ~~than~~provisions 10of ~~basis~~Sections 23A ~~points~~and 23B of the ~~institution’s~~Federal ~~assessment~~Reserve ~~base~~Act ~~for~~which ~~the~~restrict ~~second~~certain ~~quarter~~transactions ofbetween ~~2009.~~a ~~The~~bank ~~special~~and ~~assessment~~its ~~was~~“affiliates,” ~~payable~~including onits ~~September 30,~~bank ~~2009~~holding company. Among other things, Section 23A limits the amount of:

During October 2009, the FDIC again amended its restoration plan to provide for the minimum DIF reserve ratio to be restored within eight years, and adopted a uniform 3 basis point increase in regular assessment rates effective January 1, 2011. During November 2009, the FDIC amended its regulations to require that insured institutions prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 on December 30, 2009.

Restrictions on Transactions with Affiliates. The Bank is subject to the provisions of Section 23A of the Federal Reserve Act which, among other things, limits the amount of:

•

a bank’s loans or extensions of credit to, or investment in, its affiliates;

• assets a bank may purchase from affiliates, except for real and personal property exempted by the ~~FRB~~Federal Reserve;

•

the amount of a bank’s loans or extensions of credit to third parties collateralized by securities or obligations of the bank’s affiliates; and

•

a bank’s issuance of a guarantee, acceptance or letter of credit for its affiliates.

The total amount of these transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates, to 20% of a bank’s capital and surplus. In addition to the ~~limitation on the~~ amount ~~of these transactions~~limitations, each of the above transactions must ~~also~~ meet specified collateral requirements. ~~The~~MidCarolina Bank also must comply with other provisions under Section 23A designed to prevent the Bank’s taking of low-quality assets from an affiliate.

~~The Bank also is subject to the provisions of~~ Section 23B ~~of the Federal Reserve Act which~~, among other things, ~~prohibit~~prohibits a bank or its subsidiaries generally from engaging in transactions with its affiliates unless those transactions are on terms substantially the same, or at least as favorable to the bank or its subsidiaries, as would apply in comparable transactions with nonaffiliated companies.

Federal law also restricts ~~the~~MidCarolina Bank’s ability to extend credit to its and ~~the Company~~MidCarolina’s executive officers, directors, principal shareholders and their related interests. These credit extensions: (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

~~Interstate~~• ~~Banking~~must ~~and~~be ~~Branching. The~~made ~~Bank~~on ~~Holding~~substantially ~~Company Act, as amended by~~ the ~~interstate~~same ~~banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Banking Law”)~~terms, ~~permits~~including ~~adequately~~interest ~~capitalized~~rates and managed bank holding companies to acquire control of the assets of banks in any state. Acquisitions are subject to provisions that cap at 10.0% the portion of the total deposits of insured depository institutions in the United States that a single bank holding company may controlcollateral, ~~and~~as ~~generally~~those ~~cap~~prevailing at ~~30.0%~~ the ~~portion~~time offor ~~the~~comparable ~~total deposits~~transactions ofwith ~~insured~~unrelated ~~depository~~third ~~institutions~~parties; ~~in a state that a single bank holding company may control. Under certain circumstances, states have the authority to increase or decrease the 30.0% cap,~~ and ~~states may set minimum age requirements of up to five years on target banks within their borders.~~

~~Subject~~• tomust ~~certain~~not ~~conditions,~~involve ~~the~~more ~~Interstate~~than Banking Law also permits interstate branching by allowing a bank in one state to merge with a bank located in a different state. Each state was allowed to prohibit interstate branching in that state by merger by enacting legislation to that effect. The Interstate Banking Law also permits banks to establish branches in other states by opening new branches or acquiring existing branches of other banks, provided the ~~laws~~normal ofrisk ~~those other states specifically permit that form~~ of ~~interstate~~repayment ~~branching. North Carolina has adopted statutes which, subject to conditions, authorize out-of-state bank holding companies and banks to acquire~~ or ~~merge~~present ~~with~~other ~~North~~unfavorable ~~Carolina banks and to establish or acquire branches in North Carolina~~features.

Community Reinvestment. Under the Community Reinvestment Act (the “CRA”), an insured bank has a ~~continuing~~ continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for banks, nor does it limit a bank’s discretion to develop, consistent with the CRA, the types of products and services it believes are best suited to its particular community. The CRA requires the federal banking regulators, in their examinations of insured banks, to assess the banks’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in their evaluations of various applications by those banks. All banks are required to make public disclosure of their CRA performance ratings. MidCarolina Bank received a “satisfactory” rating in its last CRA examination during 2010.

USA Patriot Act of 2001. The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in the United States on September 11, 2001. The Act strengthened the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The Act’s impact on all financial institutions has been significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency requirements and imposes various other regulatory requirements, including standards for verifying customer identification at account opening, and rules promoting cooperation among financial institutions, regulators and law enforcement agencies in identifying parties that may be involved in terrorism or money laundering.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 became effective on July 30, 2002. In general, it mandated important corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It established specific responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process, and it created a regulatory body to oversee auditors of public companies. It enhanced SEC enforcement tools, criminal penalties for federal mail, wire and securities fraud, and criminal penalties for document and record destruction in connection with federal investigations. It also lengthened the statute of limitations for securities fraud claims and provided new corporate whistleblower protection.

The economic and operational effects of the Sarbanes-Oxley Act on public companies, including MidCarolina, have been and will continue to be significant in terms of the time, resources and costs associated with compliance. Because the Sarbanes-Oxley Act, for the most part, applies equally to larger and smaller public companies, MidCarolina will continue to be presented with additional challenges as a smaller, community-oriented financial institution seeking to compete with larger financial institutions in its markets.

lending requirements or programs for banks, nor does it limit a bank’s discretion to develop, consistent with the CRA, the types of products and services it believes are best suited to its particular community. The CRA requires the federal banking regulators, in their examinations of insured banks, to assess the banks’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of various applications by those banks. All banks are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its last CRA examination during 2007.

USA Patriot Act of 2001. The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in the United States on September 11, 2001. The Act strengthened the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The Act’s impact on all financial institutions is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency requirements and imposes various other regulatory requirements, including standards for verifying customer identification at account opening, and rules promoting cooperation among financial institutions, regulators and law enforcement agencies in identifying parties that may be involved in terrorism or money laundering.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 became effective on July 30, 2002. It addressed accounting, corporate governance and disclosure issues and imposed significant requirements on all public companies. Some provisions of the Act became effective immediately while others are still being implemented.

In general, the Sarbanes-Oxley Act mandated important corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It established specific responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process, and it created a regulatory body to oversee auditors of public companies. It enhanced SEC enforcement tools, criminal penalties for federal mail, wire and securities fraud, and criminal penalties for document and record destruction in connection with federal investigations. It also lengthened the statute of limitations for securities fraud claims and provided new corporate whistleblower protection.

The economic and operational effects of the Sarbanes-Oxley Act on public companies, including the company, have been and will continue to be significant in terms of the time, resources and costs associated with compliance. Because the Act, for the most part, applies equally to larger and smaller public companies, the Company will continue to be presented with additional challenges as a smaller, community-oriented financial institution seeking to compete with larger financial institutions in its markets.

Available Information

~~The~~MidCarolina ~~Company~~ makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports available free of charge on ~~its~~MidCarolina ~~internet~~Bank’s internet website at www.midcarolinabank.com, as soon as reasonably practicable after the reports are electronically filed with the SEC. Any materials that the Company files with the SEC may be read and/or copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington DC 20549. Information on the operation of the Public Reference room may be obtained by calling the SEC at 1-800-SEC-0330. These filings ~~are~~ also are accessible on the SEC’s website at www.sec.gov.

ITEM 2.

DESCRIPTION OF PROPERTY

~~The~~MidCarolina Bank owns the facilities that house its main office, ~~which is~~ located at 3101 South Church Street in Burlington, as well as its full-service branch offices located at 5509-A West Friendly Avenue, Suite 102, in Greensboro, ~~North Carolina~~ and at 842 South Main Street, ~~Graham,~~in ~~North Carolina~~Graham. ~~The~~ ~~Bank~~It leases the facilities housing its full-service offices located at ~~Cum-Park Plaza,~~ 2214 North Church Street, in Burlington;, 703 Suite 101, Green Valley Road, in Greensboro;, and 1107 South Fifth Street, ~~Mebane,~~in ~~North Carolina~~Mebane. ~~The~~It ~~Bank~~ occupies space rent-free for its two limited service offices in Burlington located in the Alamance Regional Medical Center and in ~~Burlington~~the ~~from~~Village ~~which~~of itBrookwood Retirement ~~operates~~Center aunder ~~limited-service~~arrangements ~~office~~with asthe ~~well~~owners asof athose ~~limited-service~~facilities. ~~office~~MidCarolina ~~located~~Bank inalso ~~the~~rents ~~Village~~space offor ~~Brookwood~~its ~~Retirement~~loan ~~Center~~operations functions located at 3102 South Church Street in Burlington.

The total net book value of ~~the~~MidCarolina Bank’s furniture, fixtures, leasehold improvements, land, buildings and equipment at December 31, ~~2009~~2010 was approximately $76.17 million. All properties are considered by ~~the~~MidCarolina Bank’s management to be in good condition and adequately covered by insurance.

10Additional information regarding MidCarolina Bank’s properties is set forth in Note F in MidCarolina’s Notes to Consolidated Financial Statements contained in Item 8 of this report.

in good condition and adequately covered by insurance. Additional information about this property is set forth in Note (F) to the Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K, which note is incorporated herein by reference.

ITEM 3.

LEGAL PROCEEDINGS

~~As previously~~From ~~disclosed~~time into ~~our~~time ~~2008~~MidCarolina ~~Annual Report on Form 10-K, on July 22, 2008, the Company~~ and ~~the~~MidCarolina Bank ~~filed~~may abecome ~~civil~~involved ~~action~~in legal proceedings in the ~~Superior~~ordinary ~~Court~~course of ~~Alamance~~their ~~County,~~business. ~~North Carolina~~However, ~~against~~subject ~~their~~to ~~former~~the ~~President~~uncertainties ~~and~~inherent ~~Chief~~in ~~Executive~~any ~~Officer~~litigation, ~~whose employment was terminated for cause during 2007. The Company~~MidCarolina’s ~~lawsuit~~management ~~alleged~~believes ~~claims (which involved amounts~~ that ~~were~~, ~~not material to the Company’s financial condition or results of operations). On July~~at December 2431, ~~2008~~2010, ~~the former~~there ~~officer~~were ~~filed~~no amaterial ~~claim~~pending ~~for~~legal ~~arbitration~~proceeding ~~pursuant~~ to ~~his~~which ~~employment~~they ~~agreement~~or ~~with~~any ~~the~~of ~~Bank,~~their ~~disputing~~properties ~~that~~were ~~there~~subject, ~~was~~other ~~cause~~than ~~for~~ordinary ~~the~~routine ~~termination~~litigation ofincidental ~~his employment and seeking~~ to betheir ~~paid additional salary and benefits under the agreement and other compensatory agreements between him and the Bank~~business.

OnITEM ~~December 31, 2009, the former officer voluntarily dismissed the arbitration proceeding, with prejudice~~4. On January 19, 2010, the Bank voluntarily dismissed its civil action. Those dismissals resolved all matters between the parties that were the subject of those proceedings. No payments were made by either party to the other in connection with the dismissals. [RESERVED]

PART II

ITEM 5. MARKET FOR COMMON EQUITY, ~~AND~~ RELATED SHAREHOLDER MATTERS AND ~~SMALL BUSINESS~~ ISSUER PURCHASES OF EQUITY SECURITIES

~~There currently is a limited trading market for the Company~~MidCarolina’s common stock, ~~and there can be no assurance that a more active market will develop. The Company’s common stock~~ is traded in the over-the-counter markets, with prices for the stock being ~~published~~reported on the OTC Bulletin Board under the symbol “MCFI.” ~~There~~As of March 7, 2011, there were 1,~~671~~026 ~~stockholders~~holders of record as of ~~January 29,~~the ~~2010~~stock, ~~not including~~which ~~the~~excludes persons or entities whose stock is held inby ~~nominee~~banks, brokers or ~~“street”~~other ~~name~~nominee ~~and~~in by“street ~~various banks and brokerage firms~~name.”

The ~~table~~ ~~below~~following ~~presents~~table lists the high and low ~~closing~~sales prices for ~~the Company~~MidCarolina’s common stock as ~~published~~reported on the OTC Bulletin Board for each calendar quarter induring the years ended December 31, ~~2009~~2010 and ~~2008~~2009. ~~The prices in the table have been adjusted to reflect declared stock splits in the form of stock dividends in 2007.~~

	High		~~Low~~	Low
2009
2010
First quarter	$	75.50	$	~~4.05~~$	4.50
Second quarter	$	75.0050	$	~~4.50~~	4.00
Third quarter	$	74.1040	$	~~5.25~~	2.70
Fourth quarter	$	67.3500	$	~~4.00~~	2.80
2008
2009
First quarter	$	117.5550	$	~~10.00~~$	4.05
Second quarter	$	117.2000	$	~~8.57~~	4.50
Third quarter	$	107.10	$	~~8.00~~	5.25
Fourth quarter	$	96.6035	$	~~7.00~~	4.00

Since it was organized in 2002, MidCarolina has retained its earnings as additional capital to support growth in its earning assets, and it has not paid any cash dividends on its common stock. MidCarolina is a legal entity separate and distinct from MidCarolina Bank, but its principal source of funds with which it can pay dividends to its shareholders and its separate expenses is dividends it receives from MidCarolina Bank. For that reason, MidCarolina’s ability to pay dividends effectively is subject to the same limitations that apply to MidCarolina Bank. Information regarding regulatory restrictions on MidCarolina’s and MidCarolina Bank’s abilities to pay cash dividends is contained in this report under the caption “ITEM 1. DESCRIPTION OF BUSINESS - Supervision and Regulation” above, and in NOTE Q to MidCarolina consolidated financial statements included in this Report under Item 8.

As described above under the caption “ITEM 1. BUSINESS - Memorandums of Understanding,” MidCarolina’s and MidCarolina Bank’s boards of directors have entered into agreements called Memorandums of Understanding with, respectively, the Federal Reserve Bank of Richmond and with the FDIC and NC Commissioner. MidCarolina’s agreement provides that it will not receive dividends from MidCarolina Bank, pay dividends on MidCarolina’s common or preferred stock or payments on trust preferred securities, incur additional debt, or redeem any outstanding stock, without its regulator’s prior written approval. MidCarolina Bank’s agreement provides that it will not pay any dividend to MidCarolina without its regulators’ approval.

In the future, in addition to the regulatory considerations referenced above and general business and economic conditions, MidCarolina’s ability to declare and pay cash dividends will be subject to its board of directors’ evaluation of MidCarolina’s and MidCarolina Bank’s operating results, capital levels, financial condition, future growth plans, and other relevant considerations, as well as to changes in applicable statutes, regulations or regulatory policies that could have a material effect on their business.

MidCarolina did not repurchase any of its outstanding securities during the last quarter of the fiscal year ending December 31, 2010.

Since it was organized in 2002, the Company has retained its earnings as additional capital to support growth in its earning assets, and it has not paid any cash dividends on its common stock. Information regarding regulatory restrictions on the Company’s and the Bank’s abilities to pay cash dividends is contain in this report under the captions “ITEM 1. DESCRIPTION OF BUSINESS — Supervision and Regulation” above, and in NOTE P to the Company’s financial statements included in this Report under Item 8. Although the Company is a legal entity separate and distinct from the Bank, the Company’s principal source of funds with which it could pay cash dividends would be the dividends the Company receives from the Bank. For that reason, the Company’s ability to pay dividends effectively is subject to the same limitations that apply to the Bank. In the future, in addition to the regulatory considerations referenced above, the Company’s ability to declare and pay cash dividends will be subject to the Board of Directors’ evaluation of the Company’s and the Bank’s operating results, capital levels, financial condition, future growth plans, general business and economic conditions, and other relevant considerations, as well as to changes in applicable statutes, regulations or regulatory policies that could have a material effect on the Company’s and the Bank’s business.

Recent Repurchase of Company’s Securities

The Company did not repurchase any of its securities in the last quarter of the fiscal year ending December 31, 2009.

ITEM 6.

SELECTED FINANCIAL DATA

The following ~~table~~ table sets forth certain summary consolidated financial data, performance ratios and other data at, or for the periods indicated. As this information is only a summary, you should read it in conjunction with the historical financial statements (and related notes) of the Company and “Item 7. —- Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

MidCarolina Financial Corporation

Table 1

Selected Consolidated Financial Information and Other Data

($ in thousands, except per share and nonfinancial data)

	At or for the Year Ended December 31,
	2009			2008			2007			2006		2005
	2010				2009				2008			2007		2006		2005
Operating Data:
	(Amounts in thousands, except per share information)
Total interest income	$	27,583		$	29,616		$	31,053		$	27,061	$	19,208
Results of Operations:
Total interest expense		10,440			15,294			17,721			14,241		8,327
Interest income	$	25,726			$	27,583			$	29,616		$	31,053	$	27,061	$	19,208
Net interest income		17,143			14,322			13,332			12,820		10,881
Interest expense		8,123				10,440				15,294			17,721		14,241		8,327
Provision for loan losses		4,455			1,665			425			394		1,373
Net interest income		17,603				17,143				14,322			13,332		12,820		10,881
Net interest income after provision		12,688			12,657			12,907			12,426		9,508
Provision for loan losses		6,418				4,455				1,665			425		394		1,373
Noninterest income		2,787			2,220			2,627			2,304		2,683
Net interest income after provision for loan losses		11,185				12,688				12,657			12,907		12,426		9,508
Noninterest expense		12,281			9,462			8,305			9,077		8,546
Noninterest income		2,659				2,787				2,220			2,627		2,304		2,683
Income before income taxes		3,194			5,415			7,229			5,653		3,645
Noninterest expenses		12,881				12,281				9,462			8,305		9,077		8,546
Provision for income taxes		818			1,741			2,342			1,757		1,277
Income before income taxes		963				3,194				5,415			7,229		5,653		3,645
Net income		2,376			3,674			4,887			3,896		2,368
Income tax (benefit) \expense		(14	)			818				1,741			2,342		1,757		1,277
Dividends on preferred stock		417			417			417			417		104
Net income		977				2,376				3,674			4,887		3,896		2,368
Net income available to common shareholders	$	1,959		$	3,257		$	4,470		$	3,479	$	2,264
Dividends on preferred stock		364				417				417			417		417		104
Per Share Data (1):
Net income available to common shareholders	$	613			$	1,959			$	3,257		$	4,470	$	3,479	$	2,264
Earnings per common share - basic	$	0.40		$	0.66		$	0.98		$	0.80	$	0.53
Financial Condition:
Earnings per common share - diluted		0.40			0.66			0.92			0.73		0.48
Total Assets	$	531,200			$	541,004			$	540,847		$	467,186	$	420,850	$	370,440
Market price
Loans, net of unearned income		39,829				438,087				434,662			371,714		313,572		279,962
High		7.50			11.55			19.60			18.18		12.37
Securities		90,152				70,719				71,124			70,801		73,795		58,373
Low		4.00			7.00			9.00			10.51		8.44
Deposits		465,873				465,020				467,948			373,897		339,275		300,262
Close		4.62			7.50			9.50			15.80		10.36
Shareholders’ equity		40,424				40,185				37,196			33,150		28,259		23,093
Book value - common shares		7.23			6.57			6.13			5.20		4.25
Shareholders’ equity, tangible		40,424				40,185				37,196			33,150		28,259		23,093
Weighted average common shares outstanding
Per Share Data (4):
Basic		4,927,828			4,915,350			4,548,565			4,348,128		4,299,522
Earnings per common share, basic	$	0.12			$	0.40			$	0.66		$	0.98	$	0.80	$	0.53
Diluted		4,930,310			4,916,876			4,851,738			4,775,853		4,669,601
Earnings per common share, diluted		0.12				0.40				0.66			0.92		0.73		0.48
Selected Year-End Balance Sheet Data:
Cash dividends paid on common		—				—				—			—		—		—
Total assets	$	541,004		$	540,847		$	467,186		$	420,850	$	370,440
Book value		7.23				7.18				6.57			6.13		5.20		4.25
Loans, held to maturity		438,087			434,662			371,714			313,572		279,962
Book value, tangible		7.23				7.18				6.57			6.13		5.20		4.25
Allowance for loan losses		7,307			5,632			4,462			4,222		4,090
Weighted average shares outstanding, basic		4,927,828				4,927,828				4,915,350			4,548,565		4,348,128		4,299,522
Deposits		465,020			467,948			373,897			339,275		300,262
Weighted average shares outstanding, diluted		4,927,828				4,930,310				4,916,876			4,851,738		4,775,853		4,669,601
Short-term borrowings		520			—			19,000			25,000		10,000
Long-term debt		33,764			33,764			38,764			26,764		34,764
Shareholders’ equity		40,185			37,143			33,150			28,259		23,093
Selected Average Balances:
Total assets	$	550,607		$	506,581		$	447,442		$	397,514	$	329,395
Loans, net		441,704			405,119			344,620			301,405		252,914
Total interest-earning assets		523,692			486,979			427,142			379,168		309,935
Deposits		475,012			425,790			370,128			329,724		264,730
Total interest-bearing liabilities		467,372			432,436			380,288			338,283		280,412
Shareholders’ equity		38,614			35,830			29,901			24,550		19,743
Shareholders’ equity less average preferred equity		33,795			31,011			25,082			19,731		17,910

1312

MidCarolina Financial Corporation

Table 1

Selected Consolidated Financial Information and Other Data

($ in thousands, except per share and nonfinancial data)

	At or for the Year Ended December 31,
	2009			2008			2007			2006		2005
	2010				2009				2008			2007			2006			2005
Selected Performance Ratios:
	(Amounts in thousands, except per share information)
Return on average assets	0.43	%		0.73	%		1.09	%		0.98	%	0.72	%
Selected Ratios:
Return on average equity excluding preferred equity	5.80	%		10.50	%		17.82	%		17.63	%	12.64	%
Return on average assets		0.18	%			0.43	%			0.73	%		1.09	%		0.98	%		0.72	%
Net interest spread	3.03	%		2.54	%		2.61	%		2.93	%	3.23	%
Return on average common equity (1)		1.70	%			5.80	%			10.50	%		17.82	%		17.63	%		12.64	%
Net interest margin	3.27	%		2.94	%		3.12	%		3.38	%	3.51	%
Return on average tangible equity (1)(2)		1.70	%			5.80	%			10.50	%		17.82	%		17.63	%		12.64	%
Noninterest income to total net revenue	13.98	%		16.14	%		16.46	%		15.23	%	19.78	%
Common stock dividend payout ratio		0.00	%			0.00	%			0.00	%		0.00	%		0.00	%		0.00	%
Noninterest income to average assets	0.51	%		0.54	%		0.59	%		0.58	%	0.81	%
Efficiency ratio (2)		63.57	%			61.62	%			57.20	%		52.04	%		60.02	%		63.01	%
Noninterest expense to average assets	2.23	%		1.97	%		1.86	%		2.28	%	2.59	%
Net interest margin		3.34	%			3.27	%			2.94	%		3.12	%		3.38	%		3.51	%
Asset Quality Ratios:
Nonperforming loans to period-end loans	1.68	%		0.72	%		0.19	%		0.25	%	0.08	%
Allowance for loan losses to period end loans		2.31	%			1.67	%			1.30	%		1.20	%		1.35	%		1.46	%
Allowance for loan losses to period-end loans	1.67	%		1.30	%		1.20	%		1.35	%	1.46	%
Allowance for loan losses to period end non-performing loans		123.57	%			99.50	%			180.34	%		637.43	%		531.74	%		1725.74	%
Allowance for loan losses to nonperforming loans	99.50	%		180.34	%		637.43	%		531.74	%	1725.74	%
Non-performing assets to total assets		2.87	%			1.89	%			0.88	%		0.21	%		0.74	%		0.83	%
Nonperforming assets to total assets	1.89	%		0.88	%		0.21	%		0.74	%	0.83	%
Net charge-offs to average loans		1.07	%			0.63	%			0.12	%		0.05	%		0.05	%		0.09	%
Net loan charge-offs to average loans	0.63	%		0.12	%		0.05	%		0.05	%	0.09	%
Capital Ratios:
Capital Ratios:
Total risk-based capital ratio		13.04	%			11.93	%			11.19	%		11.48	%		11.28	%		11.34	%
Total risk-based capital	11.93	%		11.19	%		11.48	%		11.28	%	11.34	%
Tier 1 risk-based capital ratio		11.78	%			10.67	%			9.97	%		10.37	%		10.12	%		9.90	%
Tier 1 risk-based capital	10.67	%		9.97	%		10.37	%		10.12	%	9.90	%
Tier 1 leverage ratio		9.03	%			8.79	%			8.68	%		8.95	%		8.73	%		8.64	%
Leverage ratio	8.79	%		8.68	%		8.95	%		8.73	%	8.64	%
Equity to assets ratio (3)		6.71	%			6.54	%			5.98	%		6.06	%		5.57	%		4.93	%
Equity to assets ratio	7.43	%		6.87	%		7.10	%		6.71	%	6.23	%
Other Data:
Number of banking offices	8			8			8			8		6
Number of full time equivalent employees	82			79			77			71		69

(1) ~~All~~Return ~~per~~on ~~share~~average ~~data~~tangible ~~has~~common ~~been~~equity ~~restated~~is tocalculated ~~reflect~~by ~~the~~dividing ~~effects~~net ofincome aavailable ~~stock~~to ~~split~~common ~~effected~~shareholders inless ~~the~~amortization ~~form~~ of aintangibles ~~25%~~by ~~stock~~averate ~~dividend~~common inequity ~~2005,~~less aaverage ~~stock split effected in the form of a 10% stock dividend in 2006 and a 25% split effected dividend in January 2007~~intangibles.

14(2) The efficiency ratio is calculated by dividing noninterest expense by the sum of net interest income plus noninterest income.

(3)	Equity to assets ratio is calculated by dividing period-end common equity less period-end intangibles by period-end assets less period-end intangibles.

(4)	All per share data has been restated to reflect stock splits effected in the form of a 25% and 10% stock dividend in 2007 and 2006, respectively.

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion and analysis that follows is intended to assist readers in the understanding and evaluation of the financial condition and results of operations of ~~the Company~~MidCarolina. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K and the supplemental financial data appearing throughout this discussion and analysis. Because the ~~Company~~MidCarolina’s primary asset is the Bank, the discussion that follows focuses on the Bank’s business and operations.

EXECUTIVE OVERVIEW

Significant accomplishments. In the opinion of its management, MidCarolina’s most significant accomplishments during 2010, which are discussed in more detail in this Item 7, were as follows:

In• ~~the~~Remained ~~opinion~~profitable ~~of its management, the Company’s most significant accomplishments~~ during ~~2009,~~a ~~which~~difficult ~~are~~economic ~~discussed~~environment infor ~~more~~the ~~detail~~community inbank ~~this Item 7, were as follows:~~ industry

• Reduced concentration of wholesale funding by $2435.1 million or 1119.62%

• Reduced concentration of construction loan portfolio by 2635.40% or $2423.37 million

• ~~Average~~Improved ~~non-~~interest ~~bearing~~margin ~~deposits~~to ~~increased~~3.34% 18from 3.227%

•Challenges. ~~Improved~~The ~~interest~~Bank ~~margin~~has toachieved 3significant growth without acquisitions or mergers since first opening its doors in 1997.~~27%~~ ~~from~~The 2financial industry in general is faced with many uncertainties and challenges.~~94%~~ As management plans its strategic goals and objectives, future expectations of economic activity, and how these uncertainties could impact MidCarolina’s performance, must be taken into consideration. The challenges that we believe are most likely to have an impact on the operations of MidCarolina in the foreseeable future are presented below:

Challenges.

The Bank has achieved significant growth without the advent of acquisitions or mergers since first opening its doors in 1997. The financial industry in general is faced with many uncertainties and challenges. As management plans its strategic goals and objectives, future expectations of economic activity, and how these uncertainties could impact the Company’s performance, must be taken into consideration. The challenges that we believe are most likely to have an impact on the operations of the Company in the foreseeable future are presented below:

•

Sustaining profitable growth

•

Managing margins in an abnormally low interest rate environment

•

Competition from bank and non-bank entities, including fierce price competition

•

Uncertainty of real estate values

• Obtaining adequate funding of asset growth

•

Maintaining liquidity during an uncertain economic environment

•

Managing equity in an unpredictable capital market

•

Managing asset quality during a period of economic uncertainty

SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

Selected Consolidated Financial Information and Other Data are presented in Table 1 of Item 6. The information in this table is derived in part from the audited consolidated financial statements and notes thereto of the Company. The information in this table does not purport to be complete and should be read in conjunction with the Company’s consolidated financial statements that are included in this Annual Report on Form 10-K.

FINANCIAL CONDITION

DECEMBER 31, ~~2009~~2010 AND ~~2008~~2009

The ~~Company~~MidCarolina’s total assets ~~totaled~~ were $~~541~~531.02 million at year-end ~~2009~~2010, a ~~modest~~decrease ~~increase~~ of $~~157~~9.9 million,~~000,~~ or 1.0383%, when compared to year-end ~~2008~~2009. Loans, excluding those held for sale, ~~increased~~decreased by $338.43 million, or 08.7873%, from $~~434~~438.71 million at the beginning of the year to $~~438~~399.18 million at year end. The change in loans was composed principally of ~~increases~~decreases of $1823.67 million in ~~commercial~~construction ~~mortgage~~ loans, $71.80 million in ~~residential~~home ~~mortgage~~equity ~~loans~~lines ~~(including~~of ~~income~~credit, ~~producing properties) and~~ $~~934,000~~1.7 million in commercial ~~and~~mortgage ~~industrial~~ loans, ~~offset by decreases of~~ $249.40 million in ~~construction~~residential mortgage loans and $~~923,000~~2.9 million in ~~loans~~commercial toand ~~individuals~~industrial loans, all of which are segments of lending ~~the~~MidCarolina ~~Company~~ targets and intends to continue targeting in differing magnitudes in the future. Investment securities ~~decreased~~increased by $~~405~~19.4 million,~~000,~~ or 027.5748%, from $7170.1 7 million to $7090.72 million. Liquid assets, consisting of cash and demand balances due from banks, interest-earning deposits in other banks and investment securities, were 1419.8256% of total assets, at December 31, ~~2009~~2010 and 1614.0582% at December 31, ~~2008~~2009. The Bank, as a member of the FHLB of Atlanta, has an investment of $2.31 million in FHLB stock. The Bank’s investment in life insurance used to offset the cost of employee benefit plans, increased by $~~286~~335 thousand during 2010 to $8.5 million. The increase was due to an increase in the cash surrender value of the policies. Other assets increased $4.2 million over 2009. Other real estate owned (OREO) was the component of other assets that incurred significant change. OREO increased $4.4 million or 154.1% over 2009 year-end, reflecting the distressed economy affecting the industry.

Deposits increased a modest $853,000 during 2010. However, the mix of deposits showed significant improvement as total transactional accounts comprised of noninterest-bearing demand accounts and interest-bearing demand accounts increased $80.4 million or 50.89%, from $186.5 million at December 31, 2009 to $266.9 million at December 31, 2010. Individually, noninterest-bearing demand accounts decreased $2.7 million, or 6.49%, interest

bearing demand accounts increased $83.1 million, or 57.38%, savings accounts increased $5.9 million or 71.75%, and time deposits decreased $85.5 million, or 31.63%, over the amount of these deposits at December 31, 2009. The Bank also used wholesale brokered certificates of deposit and advances from the FHLB of Atlanta, Georgia as funding sources during 2010 to serve as a secondary source of funding asset growth. Borrowings from the FHLB decreased $10.0 million to $15.0 million at December 31, 2010. Wholesale brokered certificates of deposit decreased $1.2 million or 1.16% and comprised approximately 21.73% of total deposit balances. Typically brokered certificates of deposit have similar terms to retail certificates of deposit issued in the Bank’s local markets, with rates marginally lower than local market certificate of deposit rates.

Total shareholders’ equity increased by $239,000, or 0.59%, during 2010. All capital ratios continue to place MidCarolina and the Bank in excess of the minimum required to be a well-capitalized institution by regulatory measures. The MidCarolina issued $4.8 million in Non-Cumulative Perpetual Preferred Stock on August 15, 2005 and $8.5 million in Trust Preferred Securities during prior years, so as to remain “well capitalized” under regulatory capital guidelines without diluting existing shareholders’ ownership. The Trust Preferred Securities and Preferred Stock should provide sufficient capital to retain a “well-capitalized” designation as defined by regulatory capital guidelines for the foreseeable future. The Trust Preferred Securities qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a qualifying security in a consolidated subsidiary. The junior subordinated debentures issued to guarantee the Trust Preferred Securities do not qualify as Tier 1 regulatory capital.

Net Interest Income. Similar to most financial institutions, the primary component of earnings for the Bank is net interest income. Net interest income is the difference between interest income, principally from the loan and investment securities portfolios, and interest expense, principally on deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, “volume” refers to the average dollar level of interest-earning assets and interest-bearing liabilities, “spread” refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and “margin” refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. During the years ended December 31, 2010, 2009 and 2008, average interest-earning assets were $526.8 million, $523.7 million and $487.0 million, respectively. During these same years, the Bank’s net yields on average interest-earning assets were 3.34%, 3.27% and 2.94%, respectively. The increase in net yields from 2009 to 2010 is a reflection of decreases in interest rates over the year. An overall increase in spread which is the difference between yields earned on interest bearing assets less the interest paid on interest bearing liabilities was strongly influenced by the Bank’s concerted effort to increase transactional accounts during 2010. The Bank’s balance sheet is well positioned for changes in interest rates. When interest rates change, the Bank’s earnings and net yields remain stable as the Bank’s ratio of interest-earning assets to interest-bearing liabilities is well matched under all interest rate environments and time periods measured by the Bank.

Table 2 following this discussion presents an analysis of the Bank’s net interest income for 2010, 2009 and 2008.

Table 3 following this discussion shows the amounts of changes in net interest income due to changes in volume and rates and illustrates that the change in the average rate of loans was offset by the decrease in average deposit rates. These two variables were the predominant factors in the higher amount of net interest income realized by the Bank in 2010, when compared to 2009.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2010 AND 2009

Overview. MidCarolina reported net income available to common shareholders of $613,000, or $0.12 per diluted common share, for the year ended December 31, 2010, compared to net income available to shareholders of $2.0 million, or $0.40 per diluted common share, for 2009, a decrease of $1.3 million or $0.28 per diluted share.

Net Interest Income. Net interest income increased to $17.6 million for the year ended December 31, 2010, a $468,000 or 2.73% increase from the $17.1 million earned in 2009. Total interest income benefited from moderate growth in the level of average earning assets offset by significantly lower rates paid on liabilities caused by abnormally low interest rates during the year. The rates earned on a significant portion of the Bank’s loans adjust immediately when indexes like the prime rate change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and bank borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the Bank’s interest income on loans, with a more delayed

~~thousand~~impact ~~during~~on ~~2009~~interest toexpense ~~$8.3~~because ~~million~~reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. ~~The~~Interest ~~increase~~rate ~~was~~increases ~~due~~will togenerally result in an immediate increase in the ~~cash~~Bank’s ~~surrender~~interest ~~value~~income on loans, with a more delayed impact on interest expense because increases in interest costs will only occur upon renewals of ~~the~~certificates ~~policies~~of deposit or borrowings. ~~Other~~Average total interest-earning assets increased $43.61 million, or 0.59%, during 2010 compared to 2009, while the average yield decreased by 39 basis points from 5.27% to 4.88%. As interest rates remained very low during 2010, the average rate on loans repriced and decreased year over ~~2008~~year. The ~~components~~average ofrate ~~other assets~~on ~~that~~investment ~~incurred~~securities ~~significant~~decreased ~~change~~in ~~include~~2010 ~~other~~compared ~~real~~to ~~estate~~2009 ~~owned~~reflecting ~~which~~the lower reinvestment yields available for securities purchased or reinvested during the year. Average total interest-bearing liabilities increased by $12.3 million, or ~~78.~~0.48%, ~~over~~a ~~2008~~slightly ~~year~~lower growth rate than average interest-~~end,~~earning ~~reflecting~~asset balances. The average cost of interest-bearing liabilities decreased by 50 basis points from 2.23% to 1.73%. With the ~~distressed~~cost ~~economy~~on ~~affecting~~interest bearing liabilities decreasing more significantly than the ~~industry;~~yield ~~prepaid~~on ~~expense~~earning assets, the Bank’s net interest margin increased $by 7 basis points. For the year ended December 31, 2010, the net interest margin was 3.034%, ~~million~~while ~~from~~for ~~2008~~the year~~-end~~ ended December 31, ~~resulting~~2009, ~~from~~the anet interest margin was 3~~-year~~.27%. ~~prepayment~~Table of3 ~~FDIC~~following ~~insurance~~this ~~premiums~~discussion ~~paid~~reflects ~~December~~the volume and rate variances from 2010 as compared to 2009.

~~Deposits~~Provision ~~decreased~~for aLoan ~~modest~~Losses. The Bank recorded $6.4 million in the provision for loan losses in 2010, an increase of $2.90 million ~~during~~from the $4.5 million provision made in 2009. ~~However~~Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the ~~mix~~portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of ~~deposits~~any ~~showed~~underlying collateral, prevailing economic conditions and other relevant factors. For 2010, large provisions were made each quarter in response to the weakened economy and real estate market. Specifically, builder/construction loans experienced a significant ~~improvement~~deterioration asin ~~total~~their ~~transactional~~collateral values ~~accounts~~and ~~comprised~~many developers experienced decreased rates of ~~noninterest~~building lot inventory turn-~~bearing~~over. ~~demand~~Although ~~accounts~~the ~~and~~Bank ~~interest-bearing~~reduced ~~demand~~its ~~accounts~~total ~~increased~~exposure to construction loans by $6523.17 million or 5335.600%, from $~~121~~67.46 million at December 31, ~~2008~~2009 to $~~186~~43.59 million at December 31, ~~2009. Individually~~2010, ~~noninterest-bearing~~significant ~~demand~~risk ~~accounts~~to ~~decreased~~property $1value depreciation continues to persist in the MidCarolina’s construction loan portfolio.4 ~~million,~~Real orestate 3developers’ ability to service debt for extended time periods remains tentative as cash flows have deteriorated.~~34%~~ Total loans outstanding, ~~interest~~net ~~bearing~~of ~~demand~~loans ~~accounts~~held ~~increased~~for ~~66.5 million~~sale, ordecreased 84$38.~~94%,~~3 ~~savings~~million ~~accounts~~ in 2010 and increased $23.54 million orin 422009.~~91%~~ At December 31, ~~and~~2010, ~~time~~the ~~deposits~~allowance ~~decreased~~for loan losses was $709.52 million, an increase of $1.9 million, or 2026.6927%, ~~over~~from the ~~amount~~$7.3 ofmillion ~~these~~at ~~deposits~~the atend ~~December 31,~~of ~~2008~~2009. The ~~Bank~~allowance ~~also~~represented ~~used~~2.31% ~~wholesale~~and ~~brokered~~1.67%, ~~certificates~~respectively, of ~~deposit~~loans ~~and~~outstanding ~~advances~~at ~~from~~ the ~~FHLB~~end of ~~Atlanta~~2010 and 2009, ~~Georgia~~ asnet ~~funding~~of ~~sources~~loans ~~during~~held ~~2009~~for tosale. ~~serve~~The asincrease ain ~~secondary~~the ~~source~~allowance is reflective of ~~funding~~the on ~~asset~~going ~~growth.~~economic ~~Borrowings~~and ~~from~~real ~~the~~estate ~~FHLB~~market ~~remained~~deterioration ~~unchanged~~experienced atlocally ~~$25.0~~as ~~million~~well atas nationally and internationally. At December 31, ~~2009.~~2010, ~~Wholesale~~the ~~brokered~~Bank ~~certificates~~had ~~of deposit decreased~~ $219.01 million or ~~17.03%~~in ~~and~~non-accrual ~~comprised~~loans. ~~approximately~~In ~~22.02%~~2009, ofthe ~~total~~Bank ~~deposit~~had ~~balances~~$7.3 ~~Typically~~million ~~brokered~~in ~~certificates~~non-accrual ofloans. For ~~deposit~~a ~~have~~more ~~similar~~detailed ~~terms~~discussion toof ~~retail~~the ~~certificates~~provision of ~~deposit~~loan ~~issued~~losses inand the ~~Bank’s~~established ~~local markets~~reserve, ~~with~~see ~~rates~~the ~~marginally~~section ~~lower~~entitled ~~than~~“Analysis ~~local market~~of ~~certificates~~Allowance offor ~~deposit~~Loan ~~rates~~Losses.”

~~Total~~Non-Interest ~~shareholders’~~Income. ~~equity~~Non-interest ~~increased~~income bydecreased to $32.07 million, orfor ~~8.04%, during 2009. All capital ratios continue to place~~ the ~~Company~~year ~~and~~ended ~~the~~December 31, ~~Bank~~2010 incompared ~~excess of the minimum required~~ to ~~be a well-capitalized institution by regulatory measures. The Company issued~~ $42.8 million infor ~~Non-Cumulative~~the ~~Perpetual~~year ~~Preferred~~ended ~~Stock on August~~December 1531, ~~2005~~2009, ~~and~~a decrease of $~~8.5 million~~128,000 inor ~~Trust~~4.59%. ~~Preferred~~A ~~Securities~~significant ~~during~~factor ~~prior~~in ~~years,~~the sodecrease asin tototal ~~remain~~non-interest ~~“well~~income ~~capitalized”~~was ~~under~~the ~~regulatory~~reduction ~~capital~~in ~~guidelines~~service ~~without~~charges ~~diluting~~levied ~~existing~~on ~~shareholders’~~deposit ~~ownership~~accounts. The ~~Trust~~banking ~~Preferred~~industry ~~Securities~~is ~~and~~reevaluating ~~Preferred~~the ~~Stock should~~methodology ~~provide~~in ~~sufficient~~which ~~capital~~overdrawn todeposit ~~retain~~account customers aare ~~“well-capitalized”~~service ~~designation~~charged. asThe ~~defined~~restructuring byof ~~regulatory~~service ~~capital~~charge ~~guidelines~~routines ~~for~~in ~~the~~part ~~foreseeable~~caused ~~future.~~by ~~The~~newly ~~Trust~~implemented ~~Preferred~~Regulation ~~Securities~~E, ~~qualify~~effective ~~as Tier~~ July 1, ~~regulatory~~2010, ~~capital~~caused ~~and~~the ~~are~~company ~~reported~~to ~~in Federal~~incur ~~Reserve regulatory reports as~~ a ~~qualifying~~$198,000 ~~security~~decrease in aservice ~~consolidated~~charge ~~subsidiary.~~income ~~The~~from ~~junior~~$910,000 ~~subordinated~~in ~~debentures issued~~ 2009 to ~~guarantee~~$712,000 ~~the~~for ~~Trust~~2010, ~~Preferred~~or ~~Securities~~21.76%. doMortgage ~~not~~operations ~~qualify~~income asdecreased ~~Tier~~to 1$786,000 ~~regulatory~~in ~~capital. On July 2~~2010, ~~2003,~~from ~~the Federal Reserve issued a letter~~$800,000 SRin ~~03-13~~2009, ~~stating~~reflecting ~~that~~the ~~notwithstanding~~impact ~~any~~of ~~potential~~the ~~implications~~discontinuance ~~FASB~~of ~~Accounting~~government ~~Standards~~initiated ~~Codification™~~first ~~(ASC)~~time ~~Topic~~home ~~810~~buyer ~~may~~incentives. ~~have~~During on2010 ~~reporting~~the ~~trust~~portion ~~preferred~~of ~~securities~~OTTI expense on(other ~~financial~~than ~~statements,~~temporary ~~trust~~impairment) ~~preferred securities~~that ~~will~~was ~~continue~~determined to be ~~included~~credit-related inand ~~Tier~~thus 1recognized ~~capital~~in ~~until~~earnings ~~notice~~as isan ~~given~~expense towas ~~the~~$29,000, ~~contrary.~~a ~~There~~decrease ~~can~~of be$119,000 noor ~~assurance~~80.41% ~~that~~compared ~~the~~to ~~Federal~~$148,000 ~~Reserve~~OTTI ~~will~~expense ~~continue~~for to2009. ~~allow~~Other ~~institutions to include trust~~non-~~preferred~~interest ~~securities in Tier I capital for~~income ~~regulatory~~decreased ~~capital~~$75,000 ~~purposes.~~in In2010 reflecting the ~~event~~absence of a ~~disallowance,~~one-time ~~there~~insurance ~~would~~claim berecognized ~~a reduction~~ in ~~the~~2009. ~~Company’s~~Table ~~consolidated~~4, ~~capital~~following ~~ratios.~~this ~~However~~discussion, ~~the~~is ~~Company~~a ~~believes~~comparative ~~that~~analysis of the ~~Bank~~components ~~would~~of ~~remain~~non-interest ~~“well~~income ~~capitalized”~~for ~~under~~2010, ~~FDIC~~2009 ~~guidelines~~and 2008.

~~NET~~Non-Interest ~~INTEREST~~Expenses. ~~INCOME~~Non-interest expenses totaled $12.9 million for the year ended December 31, 2010, an increase of $572,000 over the $12.3 million reported for 2009. Salaries and employee benefits decreased $365,000 primarily resulting from down sizing 5 staff positions during 2010. Professional and other services decreased $236,000 or 32.15% primarily due to a reduction in expenses incurred related to legal proceedings completed during 2009. Other outside services increased $368,000 or 98.40% resulting from expenses incurred during 2010 for merger related activities. Deposit and other insurance expense decreased $27,000 or 2.11% because of increased FDIC premiums. Occupancy and equipment expense decreased by $76,000 due to decreases in software licensure expenses that were absorbed by a third party information technology vendor resulting from the transfer of

Similar to most financial institutions, the primary component of earnings for the Bank is net interest income. Net interest income is the difference between interest income, principally from the loan and investment securities portfolios, and interest expense, principally on deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, “volume” refers to the average dollar level of interest-earning assets and interest-bearing liabilities, “spread” refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and “margin” refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. During the years ended December 31, 2009, 2008 and 2007, average interest-earning assets were $523.7 million, $487.0 million and $427.1 million, respectively. During these same years, the Bank’s net yields on average interest-earning assets were 3.27%, 2.94% and 3.12%, respectively. The increase in net yields from 2008 to 2009 is a reflection of the dramatic decrease in interest rates over the year. An overall increase in spread which is the difference between yields earned on interest bearing assets less the interest paid on interest bearing liabilities was strongly influenced by the Bank’s concerted effort to increase lower cost transactional accounts during 2009. The Bank’s balance sheet is well positioned for changes in interest rates. When interest rates change, the Bank’s earnings and net yields remain stable as the Bank’s ratio of interest-earning assets to interest-bearing liabilities is well matched under all interest rate environments and time periods measured by the Bank.

Table 2, following this discussion, “Average Balances and Net Interest Income”, presents an analysis of the Bank’s net interest income for 2009, 2008 and 2007.

~~Table~~ related 3management, ~~following~~hardware ~~this~~and ~~discussion,~~software ~~“Volume~~information ~~and~~technology ~~Rate~~responsibilities. ~~Variance~~Data ~~Analysis”,~~processing ~~shows~~and ~~the~~other ~~amounts~~outside ~~of changes~~services inincreased ~~net~~$278,000, ~~interest~~or ~~income~~29.86%, due primarily to ~~changes~~costs inassociated ~~volume~~with the ~~and~~reconfiguration ~~rates~~ and ~~illustrates~~relocation ~~that~~of the ~~change~~Bank’s indata ~~the~~processing ~~average~~servers ~~rate~~as well as the implementation of ~~loans~~a ~~was~~significantly ~~offset~~enhanced bybusiness ~~the~~and ~~decrease~~disaster inrecovery ~~average~~plan. ~~deposit~~Advertising ~~rates~~expense decreased $10,000. ~~These~~Loss ~~two~~on ~~variables~~sale ~~were~~of ~~the~~OREO ~~predominant~~increased $269,000 ~~factors~~from $339,000 in 2009 to $618,000 in 2010, reflecting continued activity related to the ~~higher~~disposition ~~amount~~ of ~~net~~foreclosed ~~interest~~real ~~income~~estate. ~~realized~~Table by5, following this discussion, presents a comparative analysis of the ~~Bank~~components inof ~~2009,~~non-interest ~~when~~expenses for ~~compared~~2010, to2009 and 2008.

Income Taxes. An income tax benefit of $14,000 was recognized in 2010 and a provision for income tax expense in the amount of $818,000 was recognized in 2009. The effective tax rates were (1.45%) and 25.6%, respectively, on income before income taxes. The decrease in the effective tax rate for 2010 reflects an increase in the proportion of tax-exempt income to total income for 2010 over 2009.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2009 AND 2008

Overview. ~~The~~MidCarolina ~~Company~~ reported net income available to common shareholders of $2.0 million, or $0.40 per diluted common share, for the year ended December 31, 2009, compared with net income available to shareholders of $3.3 million, or $0.66 per diluted common share, for 2008, a decrease of $1.3 million or $0.26 per diluted share.

Net Interest Income. Net interest income increased to $17.1 million for the year ended December 31, 2009, a $2.8 million or 19.70% increase from the $14.3 million earned in 2008. Total interest income benefited from moderate growth in the level of average earning assets offset by significantly lower ~~liability~~rates ~~yields~~paid on liabilities caused by historically low interest rates during the year. The rates earned on a significant portion of the Bank’s loans adjust immediately when indexes like the prime rate change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the Bank’s interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Interest rate increases will generally result in an immediate increase in the Bank’s interest income on loans, with a more delayed impact on interest expense because increases in interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning assets increased $36.7 million, or 7.53%, during 2009 compared to 2008, while the average yield decreased by 81 basis points from 6.08% to 5.27%. As interest rates remained very low during 2009, the average rate on loans repriced and decreased year over year. The average rate on investment securities decreased in 2009 compared to 2008 reflecting the lower reinvestment yields available for securities purchased or reinvested during the year. Average total interest-bearing liabilities increased by $34.9 million, or 8.07%, a slightly higher growth rate than average interest-earning asset balances. The average cost of interest-bearing liabilities decreased by 131 basis points from 3.54% to 2.23%. With the cost on interest bearing liabilities decreasing more significantly than the yield on earning assets, the Bank’s net interest margin increased by 33 basis points. For the year ended December 31, 2009, the net interest margin was 3.27%, while for the year ended December 31, 2008, the net interest margin was 2.94%. Table 3 following this discussion reflects the volume and rate variances from 2009 ~~vs.~~as compared to 2008.

Provision for Loan Losses. The Bank recorded $4.5 million in the provision for loan losses in 2009, an increase of $2.8 million from the $1.7 million provision made in 2008. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. For 2009, large provisions were made each quarter in response to the weakened economy and real estate market. Specifically, builder/construction loans experienced a significant deterioration in their collateral values and many developers experienced decreased rates of building lot inventory turn-over. Although the ~~bank~~Bank reduced its total exposure to construction loans by $24.3 million or 26.4% from $91.9 million at December 31, 2008 to $67.6 million at December 31, 2009, significant risk to property value depreciation continues to persist in the Company’s construction loan portfolio. Real estate developers’ ability to service debt for extended time periods remains tentative as cash flows have deteriorated. Total loans outstanding, net of loans held for sale, increased by $3.4 million in 2009 and by $62.9 million in 2008. At December 31, 2009, the allowance for loan losses was $7.3 million, an increase of $1.7 million, or 29.74%, from the $5.6 million at the end of 2008. The allowance represented 1.6667% and 1.30%, respectively, of loans outstanding at the end of 2009 and 2008, net of loans held for sale. The increase in the allowance is reflective of the on going economic and real estate market deterioration experienced locally as well as nationally and internationally. At December 31, 2009, the Bank had $7.3 million in non-accrual loans. In 2008, the Bank had $3.1 million in non-accrual loans. For a more detailed discussion of the provision of loan losses and the established reserve, see the section entitled “Analysis of Allowance for Loan Losses.”

Non-Interest Income. Non-interest income increased to $2.8 million for the year ended December 31, 2009 compared to $2.2 million for the year ended December 31, 2008, an increase of $567,000 or 25.54%. A significant factor in the increase in total non-interest income was the reduction in Other Than Temporary Impairment (OTTI) of private label collateralized mortgage obligation securities. OTTI recognized in 2009 was $148,000, which is a decrease of $342,000, a 69.79% improvement compared to the 2008 OTTI write down of $490,000. The decrease in

~~the~~locally ~~determination~~as ofwell ~~OTTI was influenced by the adoption of ASC Topic 320-10-65-1 (formerly referred to~~ as ~~FSP~~nationally ~~FAS 115-2) effective January 1, 2009. Prior to January 1, 2009, if an investment was determined to be other than temporarily impaired, then the difference between the book value~~ and ~~market value was recognized as an OTTI loss in earnings~~internationally. ~~Beginning~~At ~~January~~December 131, 2009, ~~if an investment in a debt security was deemed to be other than temporarily impaired, then~~ the ~~difference~~Bank ~~between~~had ~~the book value and market value was further evaluated to identify the portion that related to credit deterioration~~$7.3 ~~Only~~million ~~the portion related to credit deterioration is recognized through earnings. The cumulative effect of the change~~ in ~~accounting principle was an opening adjustment of $211,000, net of tax, to increase retained earnings. During 2009 the portion of OTTI that was determined to be credit~~non-~~related~~accrual ~~and thus recognized in earnings was $148,000~~loans. ~~Mortgage~~In ~~operations income increased to $800 thousand in 2009, from $571 thousand in~~ 2008, ~~reflecting~~ the ~~impact~~Bank ofhad ~~government initiated first time home buyer incentives and attractive refinancing rates available in the mortgage origination market. Service charges on deposit accounts in 2009 were~~ $~~910,000, a decrease of $242,000, or 21~~3.~~01%, compared to $~~1.2 million in ~~2008 reflecting the competitive market for attracting and retaining demand deposit accounts. Other~~ non-~~interest~~accrual ~~income~~loans. ~~increased~~For ~~$272,000~~a inmore detailed ~~2009~~discussion ~~reflecting~~of athe ~~receipt~~provision of aloan ~~one~~losses ~~time~~and ~~insurance~~the ~~claim~~established ~~for $252~~reserve,~~000.~~ ~~Table~~see 4,the ~~following~~section ~~this~~entitled ~~discussion,~~“Analysis ~~is a comparative analysis~~ of ~~the~~Allowance ~~components of non-interest income~~ for ~~2009,~~Loan ~~2008 and 2007~~Losses.”

Non-Interest ~~Expenses~~Income. Non-interest ~~expenses~~income ~~totaled~~increased to $122.38 million for the year ended December 31, 2009, ancompared ~~increase~~to of $2.82 million ~~over~~for the ~~$9.5~~year ~~million~~ended ~~reported~~December 31, ~~for~~ 2008., ~~Noninterest~~an increase ~~expense~~ of $12567,000 or 25.354%. ~~million,~~A ~~excluding~~significant factor in the ~~effect~~increase ofin total non-interest income was the ~~$349,000~~reduction ~~loss~~in onOther ~~sale~~Than Temporary Impairment (OTTI) of ~~other~~private ~~real~~label ~~estate~~collateralized ~~increased~~mortgage $1obligation securities.9 ~~million~~OTTI ~~for~~recognized in 2009 was $148,000, ~~compared~~which tois ~~noninterest~~a ~~expense~~decrease of $9342,000, a 69.579% ~~million, excluding~~improvement compared to the ~~effect~~2008 ofOTTI ~~the~~write down of $~~536~~490,000. ~~gain~~The ondecrease ~~sale~~in the determination of ~~other~~OTTI ~~real~~was ~~estate~~influenced inby ~~2008~~the adoption of ASC Topic 320-10-65-1 (formerly referred to as FSP FAS 115-2) effective January 1, 2009. ~~Salaries~~Prior ~~and~~to ~~employee~~January 1, ~~benefits~~2009, ~~increased~~if ~~$239~~an investment was determined to be other than temporarily impaired,~~000~~ ~~primarily~~then ~~resulting~~the ~~from~~difference ~~increases~~between inthe ~~fair~~book value ~~expenses~~and ofmarket ~~Stock~~value ~~Options~~was ~~issued~~recognized inas ~~2009.~~an ~~Professional~~OTTI ~~and~~loss ~~other~~in earnings. ~~services~~Beginning ~~increased~~January 1, ~~$184~~2009,~~000~~ orif ~~33.45%~~an ~~primarily~~investment ~~due~~in toa ~~expenses~~debt ~~incurred~~security was deemed to ~~increases~~be inother ~~audit~~than ~~and~~temporarily ~~legal~~impaired, ~~fees~~then ~~and~~the ~~proceedings.~~difference ~~Deposit~~between the book value and ~~other~~market ~~insurance~~value ~~expense~~was ~~increased~~further ~~$848,000~~evaluated orto ~~196.30%~~identify ~~because~~the ofportion ~~increased~~that ~~FDIC~~related ~~premiums~~to ~~and~~credit deterioration. Only the ~~special assessment~~portion ~~imposed~~related ~~during~~to ~~2009.~~credit ~~Occupancy~~deterioration ~~and~~is ~~equipment~~recognized ~~expense~~through ~~increased~~earnings. byThe ~~$449,000~~cumulative ~~due~~effect toof ~~increases~~the change in ~~maintenance~~accounting ~~costs~~principle ~~and~~was ~~additional~~an ~~lease~~opening ~~expense~~adjustment ~~incurred~~of ~~with~~$211,000, net of tax, to increase retained earnings. During 2009 the ~~relocation~~portion of ~~our~~OTTI ~~Green~~that ~~Valley~~was ~~Office~~determined ~~located~~to inbe ~~Greensboro~~credit-related and ~~new~~thus ~~software licensure~~recognized ~~expenses.~~in ~~Data~~earnings ~~processing~~was ~~and~~$148,000. ~~other~~Mortgage ~~outside~~operations ~~services~~income increased to $~~144~~800,000, orin ~~18.30%~~2009, ~~due~~from ~~primarily~~$571 tothousand ~~costs~~in ~~associated~~2008, ~~with~~reflecting the ~~reconfiguration~~impact of government initiated first time home buyer incentives and ~~relocation~~attractive ofrefinancing rates available in the ~~Bank’s~~mortgage ~~data~~origination ~~processing~~market. ~~servers~~Service ascharges ~~well~~on asdeposit ~~the~~accounts ~~implementation~~in of2009 were $910,000, a decrease of $242,000, or 21.01%, compared to $1.2 million in 2008 reflecting the ~~significantly~~competitive ~~enhanced~~market ~~business~~for attracting and ~~disaster~~retaining ~~recovery~~demand ~~plan~~deposit accounts. ~~Advertising~~Other ~~expense~~non-interest ~~decreased~~income increased $49272,000 in 2009 reflecting ~~new~~a ~~marketing~~receipt ~~strategies~~of ~~and~~a ~~programs~~one ~~during~~time ~~2009~~insurance claim for $252,000. Table 54, following this discussion, ~~presents~~is a comparative analysis of the components of non-interest ~~expenses~~income for 2009, 2008 and 2007.

Non-Interest Expenses. Non-interest expenses totaled $12.3 million for the year ended December 31, 2009, an increase of $2.8 million over the $9.5 million reported for 2008. Noninterest expense of $12.3 million, excluding the effect of the $349,000 loss on sale of other real estate, increased $1.9 million for 2009, compared to noninterest expense of $9.5 million, excluding the effect of the $536,000 gain on sale of other real estate in 2008. Salaries and employee benefits increased $239,000 primarily resulting from increases in fair value expenses due to Stock Options issued in 2009. Professional and other services increased $184,000 or 33.45% primarily due increases in audit and legal fees and proceedings. Deposit and other insurance expense increased $848,000 or 196.30% because of increased FDIC premiums and the special assessment imposed during 2009. Occupancy and equipment expense increased by $449,000 due to increases in maintenance costs and additional lease expense incurred with the relocation of our Green Valley Office located in Greensboro and new software licensure expenses. Data processing and other outside services increased $144,000, or 18.30%, due primarily to costs associated with the reconfiguration and relocation of the Bank’s data processing servers as well as the implementation of a significantly enhanced business and disaster recovery plan. Advertising expense decreased $49,000 reflecting new marketing strategies and programs during 2009. Table 5, following this discussion, presents a comparative analysis of the components of non-interest expenses for 2009, 2008 and 2007.

Income Taxes. The provision for income tax was $818,000 in 2009 and $1.7 million in 2008. The effective tax rates were 25.6% and 32.2%, respectively, on income before income taxes. The decrease in the effective tax rate for 2009 reflects an increase in the proportion of tax-exempt income to total income for 2009 over 2008.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2008 AND 2007

Overview. The Company reported net income available to common shareholders of $3.3 million, or $0.66 per diluted common share, for the year ended December 31, 2008, compared with net income available to shareholders of $4.5 million, or $0.92 per diluted common share, for 2007, a decrease of $1.2 million or $0.26 per diluted share. Results for the 12 months ended December 31, 2008 included a one-time after tax adjustment of $248,000 related to Other Than Temporary Impairment of Mortgage Backed Securities. Results for the 12 months ended December 31, 2007 included a one-time after-tax adjustment of $579,000 related to the reversal of accrued benefits for a former executive officer. Excluding the effect of these adjustments, our diluted earnings per common share for 2008 would have been $0.71, compared to $0.80 for 2007.

Net Interest Income. Net interest income increased to $14.3 million for the year ended December 31, 2008, a $990,000 or 7.4% increase from the $13.3 million earned in 2007. Total interest income benefited from strong growth in the level of average earning assets offset by lower asset yields caused by the decrease in interest rates during the year. The rates earned on a significant portion of the Bank’s loans adjust immediately when indexes like the prime rate change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the Bank’s interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Interest rate increases will generally result in an immediate increase in the Bank’s interest income on loans, with a more delayed impact on interest expense because increases in interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning assets increased $59.8 million, or 14.0%, during 2008 compared to

2007, while the average yield decreased by 119 basis points from 7.27% to 6.08%. As interest rates decreased during 2008, the average rate on loans decreased year over year. The average rate on investment securities increased in 2008 compared to 2007, reflecting management’s decision to purchase higher yielding securities during 2008 taking advantage of the unusual extremes in mortgaged backed securities prices in 2008. Average total interest-bearing liabilities increased by $52.1 million, or 13.7%, consistent with the increase in interest-earning assets. The average cost of interest-bearing liabilities decreased by 113 basis points from 4.66% to 3.53%. With the yield on earning assets decreasing more significantly than the cost of interest bearing liabilities, the Bank’s net interest margin decreased by 18 basis points. For the year ended December 31, 2008, the net interest margin was 2.94%, while for the year ended December 31, 2007, the net interest margin was 3.12%. Table 3 reflects the volume and rate variances from 2008 vs. 2007.

Provision for Loan Losses. The Bank recorded $1.7 million in the provision for loan losses in 2008, an increase of $1.2 million from the $425,000 provision made in 2007. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. For 2008 the provision to loan losses was made in response to the weakened economy and real estate market experienced during 2008, large provisions were made each quarter during the year, total loans outstanding, net of loans held for sale, increased by $62.9 million in 2008 and by $58.1 million in 2007. At December 31, 2008, the allowance for loan losses was $5.6 million, an increase of $1.2 million, or 26.22%, from the $4.5 million at the end of 2007. The allowance represented 1.30% and 1.20%, respectively, of loans outstanding at the end of 2008 and 2007, net of loans held for sale. At December 31, 2008, the Bank had $3.1 million in non-accrual loans. In 2007, the Bank had $700,000 in non-accrual loans. It is management’s opinion that reserve levels are adequate.

Non-Interest Income. Non-interest income decreased to $2.2 million for the year ended December 31, 2008 compared to $2.6 million for the year ended December 31, 2007, a decrease of $407,000 or 15.49%. An Other Than Temporary Impairment of private label collateralized mortgage obligation securities in the amount of $490,000, was recognized in 2008. Excluding the Other Than temporary Impairment, non-interest income increased $83,000 or 3.2% for 2008. Mortgage operations income decreased to $571 thousand in 2008, from $600 thousand in 2007, reflecting a softening in the overall mortgage origination market. Service charges on deposit accounts in 2008 were $1.2 million, an increase of $94,000, or 8.9%, compared to $1.1 million in 2007 reflecting the positive results of a focused marketing effort to increase demand deposit accounts. Table 4, following this discussion, is a comparative analysis of the components of non-interest income for 2008, 2007 and 2006.

Non-Interest Expense. Non-interest expense totaled $9.5 million for the year ended December 31, 2008, an increase of $1.2 million over the $8.3 million reported for 2007. Adjusting non-interest expense for a one-time adjustment of $905,000 related to the reversal of accrued benefits for a former executive officer, non-interest expense for 2007 would have totaled $9.2 million, reflecting an increase of $252,000 or 2.73% for 2008. Substantially all of this increase resulted from the Bank’s growth and development during 2008 and 2007. Personnel costs after the one-time adjustment of $905 thousand related to the reversal of accrued benefits for a former executive officer increased by $3,000 in 2008. Professional and other services increased $74,000 or 15.6% primarily due to expenses incurred related to the preparation of anticipated regulatory changes and increases in legal fees and proceedings. Deposit and other insurance expense increased $80,000 or 22.7% because of increased FDIC premiums. Occupancy and equipment expense increased by $51,000 due to increases in maintenance costs and additional lease expense incurred with the relocation of our Green Valley Office located in Greensboro, NC. Data processing and other outside services decreased $19,000, or 1.7%, due to the renegotiation of our bank platform operating system contract. Advertising expense increased $131,000 reflecting new marketing strategies and programs during 2008. A gain on sale of other real estate was recognized in the amount of $536 and $481 respectively for 2008 and 2007. Table 5, following this discussion, presents a comparative analysis of the components of non-interest expenses for 2009, 2008 and 2007.

Income Taxes. The provision for income tax was $1.7 million in 2008 and $2.3 million in 2007. The effective tax rates were 32.2% and 32.4%, respectively, on income before income taxes.

LIQUIDITY

The Bank’s sources of liquidity are customer deposits, cash and demand balances due from other banks, interest-earning deposits in other banks and investment securities available for sale. These funds, together with loan and securities repayments, are used to fund loans and continuing operations. At December 31, ~~2009~~2010, the Bank had credit availability with the Federal Reserve Bank of $51.1 million and the FHLB of $165.4 million, with $15.0 million outstanding.

Total deposits were $465.9 million and $465.0 million at December 31, 2010 and 2009, respectively. The Bank’s deposits increased 0.18% in 2010. Because the Bank’s organic deposit growth was sufficient in amount to meet the total funding needs of the Bank, the Bank reduced its exposure to alternative funding sources during 2010. The Bank reduced its total wholesale funding sources in 2010 by $35.1 million or 19.21%. Total wholesale funding was $183.0 million at December 31, 2009 compared to $147.8 million at December 31, 2010. The Bank will

~~availability~~18 ~~with the Federal Reserve Bank of $74.6 million and the FHLB of $167.2 million, with $25.0 million outstanding.~~

~~Total deposits were $465.0 million and $467.9 million at December 31, 2009 and 2008, respectively. The Bank’s deposits decreased 0.63% in 2009. Because the Bank’s organic deposit growth was~~ sufficient in amount to meet the total funding needs of the Bank’s asset growth, the Bank reduced its exposure to alternative funding sources during 2009. The Bank reduced its total wholesale funding sources in 2009 by $24.0 million or 11.60%. Total wholesale funding was $183.0 million at December 31, 2009 compared to $207.1 million at December 31, 2008. The Bank will continue to evaluate all funding sources for cost, accessibility, dependability and efficiency. Brokered certificates of deposits decreased $211.02 million during ~~2009~~2010, from $~~123~~102.4 million in ~~2008~~ 2009 to $~~102~~101.42 million in ~~2009~~2010, a decrease of 171.0316%. Brokered certificates of deposits as a percent of assets decreased from 2218.8292% in ~~2008~~2009 to 18.9256% in ~~2009~~2010.

At December 31, ~~2009~~2010 and ~~2008~~2009, time deposits represented 5839.1167% and 6358.012%, respectively, of the Bank’s total deposits. Certificates of deposit of $100,000 or more represented 4834.81% and 5948.98%, respectively, of the Bank’s total deposits at December 31, ~~2009~~2010 and ~~2008~~2009. At December 31, ~~2009~~2010, the Bank had $2026.84 million in public deposits and $~~102~~101.42 million in brokered time deposits. These sources of funds are generally considered to be less stable than deposits from the Bank’s local markets. However, management believes that other non-traditional funding time deposits are relationship oriented. While the Bank appreciates the need to pay competitive rates to retain these deposits, other subjective factors also influence deposit retention. Based upon prior experience, the Bank anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity. The Bank’s aggregate wholesale funding comprised of brokered CD’s, wholesale NOW accounts, FHLB advances, FRB discount window borrowings and CDARS accounts (Certificate of Deposit Account Registry Service) as a percentage of total assets decreased to 3331.97% in ~~2009~~ 2010 from 3833.39% in ~~2008~~2009. The wholesale funding aggregate decrease is due primarily to an increase in traditional deposits resulting from our customer base’s recognition of MidCarolina’s consistent performance during a difficult economic period.

Management anticipates that the Bank will continue to utilize non-local market funding sources such as wholesale NOW accounts, CDARS, FHLB advances, FRB advances and brokered certificates of deposits as a less costly diversified funding source to complement the Bank’s local market deposits. Deposits, loan repayments, mortgage-backed securities prepayments, bond maturities, FHLB advances, FRB discount window borrowings and current earnings will be employed to provide liquidity, generate loans, purchase securities, procure fixed assets and meet other operating needs incurred in normal banking activities.

In the normal course of business there are various outstanding contractual obligations of the Bank that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit that may or may not require future cash outflows. Table 6, following this discussion, ~~“Contractual Obligations and Commitments”,~~ summarizes the Bank’s contractual obligations and commitments as of December 31, ~~2008~~2010.

CAPITAL RESOURCES

At December 31, ~~2009~~2010 and ~~2008~~2009, shareholders’ equity ~~of the Company~~ totaled $40.24 million and $3740.2 million, respectively. ~~The~~ ~~Company~~MidCarolina’s equity to asset ratio on those dates was 7.4261% and 67.942%, respectively, reflecting ~~the Company~~MidCarolina’s moderate negative asset growth during ~~2009~~2010. ~~The~~MidCarolina ~~Company~~ and the Bank are subject to minimum capital requirements. See “PART 1, ITEM 1 - - DESCRIPTION OF BUSINESS — SUPERVISION AND REGULATION.” Because ~~the Company~~MidCarolina’s only significant asset is its investment in the Bank, information concerning capital ratios is essentially the same for the ~~Company~~MidCarolina and the Bank.

All capital ratios place the Bank in excess of minimum requirements to be classified as “well capitalized’ by regulatory measures. The Bank’s Tier-~~1leverage~~1 leverage ratio was 89.6703% at December 31, ~~2009~~2010.

Note PQ to the accompanying consolidated financial statements presents an analysis of the Bank’s regulatory capital position as of December 31, ~~2009~~2010 and ~~2008~~2009. Management anticipates that the Bank will remain “well-capitalized” for regulatory purposes throughout ~~2009~~2011.

ASSET/LIABILITY MANAGEMENT

The Bank’s results of operations depend substantially on its net interest income. Like most financial institutions, the Bank’s interest income and cost of funds are affected by general economic conditions and by competition in the market place. The purpose of asset/liability management is to provide stable net interest income growth by protecting the Bank’s earnings from undue interest rate risk, which arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk and capital adequacy. The Bank maintains, and has complied with, an asset/liability management policy approved by the board of directors of MidCarolina and the Bank that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence, portfolio maturities, maturing assets and maturing liabilities. The Bank’s policy is to control the exposure of its

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~~the Bank’s~~ earnings from undue interest rate risk, which arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk and capital adequacy. The Bank maintains, and has complied with, an asset/liability management policy approved by the Board of Directors of the Company and the Bank that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence, portfolio maturities, maturing assets and maturing liabilities. The Bank’s policy is to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a range around an “earnings neutral position,” which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.

When suitable lending opportunities are not sufficient to utilize available funds, the Bank has generally invested such funds in securities, primarily securities issued by U.S. governmental agencies, mortgage-backed securities and securities issued by local governmental municipalities. The securities portfolio contributes to the Bank’s profits and plays an important part in the overall interest rate management. However, management of the securities portfolio alone cannot balance overall interest rate risk. The securities portfolio must be used in combination with other asset/liability techniques to actively manage the balance sheet. The primary objectives in the overall management of the securities portfolio are safety, liquidity, yield, asset/liability management (interest rate risk) and investing in securities that can be pledged for public deposits or as collateral for FHLB advances.

In reviewing the needs of the Bank with regard to proper management of its asset/liability program, the Bank’s management estimates its future needs, taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases (due to increased demand through marketing) and forecasted interest rate changes. A number of measures are used to monitor and manage interest rate risk, including income simulations and interest sensitivity (gap) analyses. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include prepayments on loan and loan-backed assets, cash flows and maturities of other investment securities, loan and deposit volumes and pricing. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

Based on the results of the income simulation model, as of December 31, ~~2009~~2010, due to the extremely low interest rate environment, the Bank would expect a decrease in net interest income of $~~376~~709,000 if interest rates increase from current rates by an instantaneous 100 basis points and an increase in net interest income of $~~547~~23,000 thousand if interest rates decrease from current rates by an instantaneous 100 basis points.

The analysis of an institution’s interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is another standard tool for the measurement of the exposure to interest rate risk. Management believes that because interest rate gap analysis does not address all factors that can affect earnings performance, it should be used in conjunction with other methods of evaluating interest rate risk.

Table 7, following this discussion, ~~“Interest Rate Sensitivity Analysis”,~~ sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, ~~2009~~2010, which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts are considered rate sensitive and are placed in the shortest period. Negotiable order of withdrawal or other transaction accounts are also assumed to be rate sensitive and are placed in the shortest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates are used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments that will be received throughout the lives of the loans. The interest rate sensitivity of the Bank’s assets and liabilities illustrated in the table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.

Table 7 illustrates that if assets and liabilities reprice in the time intervals indicated in the table, the Bank is ~~asset~~liability sensitive within three months, liability sensitive over three months to twelve months, ~~asset~~liability sensitive within twelve months and asset sensitive thereafter. As stated above, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. For instance, while the table is based on the assumption that money market accounts are immediately sensitive to movements in rates, the Bank expects that in a changing rate environment the amount of the adjustment in interest rates for such accounts would be less than the adjustment in categories of assets that are considered to be immediately sensitive. The same is true for

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on other types may lag behind changes in market interest rates. For instance, while the table is based on the assumption that money market accounts are immediately sensitive to movements in rates, the Bank expects that in a changing rate environment the amount of the adjustment in interest rates for such accounts would be less than the adjustment in categories of assets that are considered to be immediately sensitive. The same is true for all other interest-bearing transaction accounts. Additionally, certain assets have features that restrict changes in the interest rates of such assets both on a short-term basis and over the lives of such assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates. Due to these shortcomings, the Bank places primary emphasis on its income simulation model when managing its exposure to changes in interest rates. The Bank does not normally make interest rate predictions, or take undue risk on potential changes in interest rate direction. ~~The Bank is currently neutral in its rate sensitivity. Should interest rates increase or decrease, the Bank’s earnings, margins and spreads would be positively impacted.~~

LENDING ACTIVITIES

General. The Bank provides to its customers a full range of short- to medium-term commercial, mortgage, construction and personal loans, both secured and unsecured. The Bank also makes real estate mortgage and construction loans.

The Bank’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the types of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Bank, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the ~~Board~~board of ~~Directors~~directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan audits by internal loan examiners and outside professionals experienced in loan review work. The Bank has focused its portfolio lending activities on typically higher yielding commercial, construction and consumer loans. The Bank also originates 1one-4to-four family mortgages that are typically sold into the secondary market, servicing released.

Table 8, ~~“Loan Portfolio Composition”,~~ following this discussion, provides an analysis of the Bank’s loan portfolio composition by type of loan as of the end of each of the last five years.

Table 9, ~~“Loan Maturities”,~~ following this discussion, presents, at December 31, ~~2009~~2010, (i) the aggregate maturities or re-pricings of commercial, industrial and commercial mortgage loans and of real estate constructions loans and (ii) the aggregate amounts of such loans by variable and fixed rates.

Commercial and Industrial Loans. At December 31, ~~2009~~2010, the Bank’s commercial and industrial loan portfolio equaled $6461.2 million, or 1415.63% of total loans, as compared with $6364.2 million, or 14.6% of total loans, at December 31, ~~2008~~2009. Commercial and industrial loans include both secured and unsecured loans for working capital, expansion and other business purposes. Short-term working capital loans generally are secured by accounts receivable, inventory and/or equipment. The Bank also makes term commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment.

Commercial and industrial loans generally provide greater yields and reprice more frequently than other types of loans, such as real estate loans, as most commercial loan yields are tied to the prime rate index. Therefore, yields on most commercial loans adjust with changes in the prime rate.

Real Estate Loans. Real estate loans are originated for the purpose of purchasing, constructing or refinancing one -to -four family, five -or -more family and commercial properties. The Bank offers fixed and adjustable rate options. The Bank provides customers access to long-term conventional real estate loans through its mortgage loan department which makes Federal National Mortgage Association (“FNMA”), ~~and~~ Federal Home Loan Mortgage Company (“FHLMC”) and Government National Mortgage Association (“GNMA”)— conforming loans that are originated with a commitment from a correspondent ~~bank~~ Bank to purchase the loan within 30- to 45 days of closing.

Residential 1one-to-four 4 family loans are classified into two categories: conforming loans, that are originated under the underwriting guidelines established by FNMA, FHLMC or GNMA and held for sale and nonconforming loans that are originated and retained in the Bank’s loan portfolio. The terms “conforming” and “nonconforming” do not refer to credit quality, but rather to whether the loan is underwritten so that it can be sold in the secondary market. At December 31, 2010, the Bank had $3.0 million in loans held for sale, while nonconforming loans held in the Bank’s permanent portfolio amounted to $425,000. The Bank’s permanent residential mortgage loans are generally secured by properties located within the Bank’s market area. Most of the one-to-four family residential mortgage loans that the Bank makes are conforming loans and are sold within 30 days of closing to a correspondent

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~~are originated and retained in the~~ Bank~~’s loan portfolio~~. The ~~terms “conforming” and “nonconforming” do not refer to credit quality, but rather to whether the loan is underwritten so that it can be sold in the secondary market. At December 31, 2009, the~~ Bank had $228,000 loans held for sale while nonconforming loans held in the Bank’s permanent portfolio amounted to $442,000. The Bank’s permanent residential mortgage loans are generally secured by properties located within the Bank’s market area. Most of the one to four family residential mortgage loans that the Bank makes are conforming loans and are sold within 30 days of closing to a correspondent bank. The Bank originated ~~288~~233 loans in the amount of $5135.58 million for sale in the secondary market during ~~2009~~2010. The Bank receives a fee for each loan originated, with fees aggregating $~~800~~786,000 for the year ended December 31, ~~2009~~ 2010 and $~~571~~800,000 for the year ended December 31, ~~2008~~2009. The Bank anticipates that it will continue to be an active originator of residential loans. Nonconforming residential mortgage loans that are retained in the Bank’s loan portfolio generally have rate terms of five years or less, with amortizations up to 20 years.

The Bank has made, and ~~anticipates~~may ~~continuing~~continue to make, under qualifying circumstances, commercial real estate loans. Commercial real estate ~~loans~~loan outstandings amounted to $~~174~~173.93 million at December 31, ~~2009~~2010. These loans are secured principally by commercial buildings for office, storage and warehouse space, commercial and byresidential real estate developments and agricultural properties. Generally in underwriting commercial real estate loans, the Bank requires the personal guarantee of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate usually involve a greater degree of risk than 1one-4to-four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.

The Bank originates 1one-to-four 4 family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of pre-sold homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside entity prior to financing the construction of pre-sold homes. The Bank lends to builders who have demonstrated a favorable record of performance and profitable operations and who are building in markets that management believes it understands and in which it is comfortable with the economic conditions. The Bank also makes commercial real estate construction loans, generally for owner-occupied properties. The Bank further endeavors to limit its construction lending risk through adherence to established underwriting procedures. The Bank generally requires documentation for all draw requests and utilizes loan officers to inspect the project prior to honoring draw requests from the builder. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment on construction loans.

Consumer Loans and Home Equity Lines of Credits. Loans to individuals include automobile loans, boat and recreational vehicle financing, home equity and home improvement loans and miscellaneous secured and unsecured personal loans. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Bank attempts to manage the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

Loan Approvals. The Bank’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the type of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Bank, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the ~~Board~~board of ~~Directors~~directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan audits by independent, outside professionals experienced in loan review analysis.

Responsibility for loan production rests with the Senior Commercial Lending Officer in each market. The responsibility for loan underwriting, loan processing and approval is with the Chief Credit Officer. The ~~Board~~board of ~~Directors~~directors of the Bank reviews the President’s lending authority annually. The ~~Board~~board, in turn delegates loan authority to the Chief Credit Officer and other loan officers of the Bank. Delegated authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authority as determined by the board ~~Board~~ of ~~Directors~~directors or the President.

The President and the Chief Credit Officer each have the authority to approve loans up to $400 ~~thousand~~,000. The President in conjunction with the Chief Credit Officer have the combined authority to approve loans up to $2.0 million which is the maximum staff, in-house lending limit set by the ~~Board~~board of ~~Directors~~directors. The ~~Board~~board’s Loan Committee approves all loans in excess of the staff’s in-house lending limit. The Committee consists of the President, the Chairman and Vice Chairman of the Bank’s board and six outside directors as appointed by the board

23Additionally, all loans of $50,000 or greater and all loans with relationship exposure of $200,000 or above

~~Chairman~~22 ~~and Vice Chairman of the Bank’s Board and six outside directors as appointed by the Board of the Bank~~

~~Additionally, all loans of $50 thousand or greater and all loans with relationship exposure of $200,000 or above~~ are reviewed by the Management Loan Committee comprised of the President, Chief Credit Officer, and the Senior Commercial Loan Officers for Alamance County and Guilford County. The Bank’s Loan Committee reviews all loans with total exposure of $1.0 million or greater and approves all loans with total exposure of $2.0 million or greater. The Bank’s legal lending limit was $1314.96 million at December 31, ~~2009~~2010. The Bank seldom makes loans approaching its legal lending limit.

COMMITMENTS TO EXTEND CREDIT

In the ordinary course of business, the Bank enters into various types of transactions that include commitments to extend credit that are not included in loans receivable, net, presented on ~~the Company~~MidCarolina’s consolidated balance sheets. The Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The Bank’s exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. See Note OP to the accompanying consolidated financial statements and Table 6 following this discussion.

ASSET QUALITY

The Bank considers asset quality to be of primary importance, and employs a formal internal loan review process to ensure adherence to the lending policy as approved by the Bank’s ~~Board~~board of ~~Directors~~directors. It is the responsibility of each loan officer to assign an appropriate risk grade to loans when originated. Credit Administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality changes, it is the responsibility of Credit Administration to change the borrower’s risk grade accordingly. The process of determining the allowance for loan losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to historical loan loss experience, the value and adequacy of collateral, economic conditions in the Bank’s market area and other factors. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. At December 31, ~~2009~~2010 the Bank had 2453 impaired loans ~~on the Loan Watch List~~ totaling $820.32 million comprised of 815 ~~Builder~~builder/construction loans totaling $49.13 ~~Million~~million, 817 commercial and industrial loans for $39.71 million and 821 residential mortgage loans for $~~551,000~~1.8. The allowance for loan losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio.

The Bank’s policy regarding past due loans normally requires a prompt charge-off to the allowance for loan losses following timely collection efforts and a thorough review. Further efforts are then pursued through various means available. Loans carried in a non-accrual status are generally collateralized and are considered in the determination of the allowance for loan losses.

NONPERFORMING ASSETS

~~The Company~~MidCarolina’s total nonperforming assets increased $5.4.6 million to $1014.27 million at December 31, ~~2009~~2010, from $410.82 million at December 31, ~~2008~~2009, reflecting the distressed economy mentioned previously. Non -accrual loans, a subset of nonperforming assets , comprised ~~71.9~~56% of total nonperforming assets or $79.31 million. Other real estate owned comprised the remaining significant component of nonperforming assets in the amount of $27.92 million or ~~28.0~~44% of total nonperforming assets. ~~Restructured~~Nonperforming restructured loans at December 31, ~~2009~~2010, which were ~~not~~ included in total nonperforming assets, consisted of ~~two~~three construction loans in the amount of $656,000 and one home equity line of credit in the amount of $73,000. Performing restructured loans at December 31, 2010 which were not included in nonperforming assets, consisted of eight construction loans in the amount of $3.3 million and one commercial mortgage loan in the amount of $710,000.

Table 10~~, “Nonperforming~~ ~~Assets”,~~ following this discussion, sets forth, for the last five years, information with respect to the Bank’s nonperforming assets.

~~The Company~~MidCarolina’s consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless a loan is placed on non-accrual basis. ~~Loans~~ For all classes of loans, loans are accounted for on a non-accrual basis when management has serious concerns about the collectibility of principal or interest. Generally, the Bank’s policy is to place a loan on non-accrual status when the loan becomes 90 days past due. Loans are also placed on non-accrual status in cases where management is uncertain whether the

2423

~~placed on non-accrual status in cases where management is uncertain whether the~~ borrower can satisfy the contractual terms of the loan agreement. Payments received on non-accrual loans generally are applied to principal first, and then to interest after all principal payments have been satisfied. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. The Bank accrues interest on restructured loans at the restructured rate when management anticipates that no loss of original principal will occur. Potential problem loans are defined as loans currently performing that are not included in non-accrual or restructured loans, but are loans ~~that~~as to which management has concerns as to the borrower’s ability to comply with present repayment terms. These loans could potentially deteriorate to non-accrual, past due or restructured loans status. Therefore, management quantifies the risk associated with problem loans in assessing the adequacy of the allowance for loan losses. At December 31, ~~2008~~ 2010, the Bank identified $79.81 million in non-accrual loans. At December 31, ~~2008~~2009, the Bank identified $37.14 million in non-accrual loans.

Other real estate owned consists of foreclosed, repossessed and idled properties. At December 31, ~~2009~~2010, there were $27.92 million assets classified as real estate owned. At December 31, ~~2008~~2009, there were $12.69 million in assets classified as real estate owned.

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance when management believes that the ~~collectibility~~collectability of principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.

The allowance for loan losses relating to loans that are determined to be impaired ~~under SFAS No. 114~~ is based on discounted cash flows using the loan’s initial effective interest rate or the estimated fair value of the collateral, less costs to sell, for certain collateral ~~dependent~~ dependent loans. Large groups of smaller balance homogeneous loans that are collectively evaluated for impairment (such as residential mortgage and consumer installment loans) are excluded from impairment evaluation, and their allowance for loan losses is calculated in accordance with the allowance for loan losses policy described below.

The provision for loan losses charged to operating expense is based on factors which, in management’s judgment, deserve current recognition in estimating probable loan losses. Such factors considered by management include growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans, historical charge off activity, current and probable future local, regional and national economic conditions and an in depth assessment of the status of certain individual borrowers’ ability to meet repayment obligations. While management uses the best information available to make evaluations, this evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The provision contributed to the allowance for loan losses segregated by major loan category during 2010 is:

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.


Loan Category	Contribution (in $000)		% of Total Provision
Construction loans	$	3,209		50.00
Commercial mortgage loans		1,284		20.00
Home equity lines of credit		385		6.00
Residential mortgage loans		642		10.00
Commercial and Industrial loans		834		13.00
Consumer loans		64		1.00

~~Growth~~In ~~in loans outstanding has~~addition, ~~throughout the Bank’s history, been~~various ~~the~~regulatory primary reason for increases in the Bank’s allowance for loan losses and the resultant provisions for loan losses necessary to provide for those increases. This growth has been spread among the Bank’s major loan categoriesagencies, ~~with the concentrations of major loan categories being relatively consistent. Between December 31, 2008 and December 31, 2009, the range of each major category of loans~~ as a percentage of total loans outstanding is as follows: residential mortgage loans – 16.9% to 18.7%; commercial mortgage loans – 36.0% to 39.9%; construction loans – 21.1% to 15.4%; commercial and industrial loans – 14.6% to 14.6%; loans to individuals – 1.4% to 1.2%; and home equity lines of credit – 10.0% to 10.2%. For the past five fiscal years through 2009, the Bank’s loan loss experience has been similar to that of other peer banks in North Carolina, with net loan charge-offs in each year of ranging from 0.05% to 0.63% of average loans outstanding. Charge offs are typically recognized when it is the opinion of management that all or a portion of an ~~outstanding~~integral ~~loan~~part ~~becomes uncollectible. Loan repayment may be realized through a contractual agreement, or through liquidation~~ of ~~assets~~their ~~pledged~~examination ~~as collateral. Net charge-offs totaled $495~~process,~~000~~ orperiodically ~~0.12%~~review ~~of outstanding loans for 2008 and $2.8 million or 0.63% of outstanding loans for 2009. The Bank~~MidCarolina’s allowance for loan losses ~~at December 31, 2008 of $5~~.6 ~~million represents~~Such ~~1.30%~~agencies ofmay ~~total~~require ~~loans~~the ~~outstanding,~~MidCarolina ~~net~~to ofrecognize ~~loans~~adjustments ~~held~~to ~~for~~the ~~sale. The Bank’s~~ allowance ~~for~~based ~~loan~~on ~~losses~~their atjudgments ~~December 31, 2009 was $7.3 million or 1.67%~~ of ~~outstanding loans, net of loans held for sale. The allowance for loan losses as~~ ainformation ~~percentage~~available ~~of loans outstanding increased in 2009 compared~~ to ~~2008~~them ~~due~~at ~~to an increase in loans outstanding as well as increases in non performing loans reflecting~~ the ~~decline~~time inof ~~the~~their ~~local,~~examination. ~~national and international~~

25Growth in loans outstanding has, throughout the Bank’s history, been the primary reason for increases in the Bank’s allowance for loan losses and the resultant provisions for loan losses necessary to provide for those increases. This growth has been spread among the Bank’s major loan categories, with the concentrations of major loan categories being relatively consistent. Between December 31, 2009 and December 31, 2010, the range of each major category of loans as a percentage of total loans outstanding is as follows: residential mortgage loans – 18.7% to 18.0%; commercial mortgage loans – 39.9% to 43.0%; construction loans – 15.4% to 10.9%; commercial and industrial loans – 14.6% to 15.2%; loans to individuals – 1.2% to 1.3%; and home equity lines of credit – 10.2% to 10.8%. Net loan charge-offs in the past five years ranged from 0.05% to 1.07% of average loans outstanding. In

~~economic~~24 environment. Non performing loans increased $4.2 million during 2009 to $7.3 million compared to $3.1 million at December 31, 2008. $6.9 million of the non performing loans at December 31, 2009, or 93.6%, were concentrated in commercial real estate.

~~Table~~ 2009 11and 2010, ~~“Allocation~~net ~~for~~charge ~~the~~offs ~~Allowance~~were of.63% ~~Loan Losses”,~~and ~~following~~1.07% ~~this~~of ~~discussion~~average loans, ~~presents~~respectively, reflecting the ~~allocation~~deterioration of ~~the~~economic ~~allowance~~conditions. ~~for~~Charge ~~loan~~offs ~~losses~~are attypically ~~the~~recognized ~~end~~when it is the opinion of ~~each~~management that all or a portion of ~~the~~an ~~last~~outstanding ~~five~~loan ~~years~~becomes uncollectible. ~~The~~Loan ~~allocation~~repayment ismay ~~based~~be onrealized anthrough ~~evaluation~~a contractual agreement, or through liquidation of ~~defined~~assets ~~loan~~pledged ~~problems,~~as ~~historical~~collateral. ~~ratios~~Net ofcharge-offs ~~loan~~totaled ~~losses~~$2.8 ~~and other~~million ~~factors~~or ~~that~~0.63% of ~~may~~outstanding ~~affect~~loans ~~future~~for ~~loan~~2009 ~~losses~~and in$4.5 ~~the~~million ~~categories~~or 1.07% of outstanding loans ~~shown~~for 2010. Charge-offs incurred by major loan category during 2010 are:

Table 12, “Loan Loss and Recovery Experience”, following this discussion, sets forth for each of the last five years information regarding changes in the Bank’s allowance for loan losses.


Loan Category	Charge-offs (in $000)		% of Charge-offs
Construction loans	$	2,388		49.65
Commercial mortgage		965		20.07
Commercial and industrial loans		611		12.71
Residential mortgage loans		462		9.61
Home equity Lines of credit		319		6.64
Consumer loans		65		1.36

The Bank’s allowance for loan losses at December 31, 2009 of $7.3 million represents 1.67% of total loans outstanding, net of loans held for sale. The Bank’s allowance for loan losses at December 31, 2010 was $9.2 million or 2.31% of outstanding loans, net of loans held for sale. The allowance for loan losses as a percentage of loans outstanding increased in 2010 compared to 2009 due to increases in net charge offs as well as nonperforming loans, reflecting the decline in the local, national and international economic environment. The ending balance of the allowance for loan losses (ALLR) by major loan category and the major category’s ALLR balance as a percentage of its outstanding loan balance at December 31, 2010 are:


Loan Category	ALLR balance (in $000)		ALLR as % of category loan balance outstanding
Construction loans	$	2,079		4.74
Commercial mortgage		3,239		1.87
Commercial and industrial loans		1,397		2.29
Residential mortgage loans		1,563		2.19
Home equity Lines of credit		810		1.86
Consumer loans		138		2.56

Nonperforming loans increased $122,000 during 2010 to $7.5 million compared to $7.3 million at December 31, 2009 and $4.9 million of the non performing loans at December 31, 2010, or 65.2%, were concentrated in commercial real estate.

Table 11 following this discussion presents the allocation of the allowance for loan losses at the end of each of the last five years. The allocation is based on an evaluation of defined loan problems, historical ratios of loan losses and other factors that may affect future loan losses in the categories of loans shown.

Table 12 following this discussion sets forth for each of the last five years information regarding changes in the Bank’s allowance for loan losses.

INVESTMENT ACTIVITIES

The Bank’s portfolio of investment securities, all of which are available for sale, consists primarily of U.S. government agency securities, mortgage-backed securities, government sponsored enterprise collateralized mortgage obligations, private label collateralized mortgage obligations and securities issued by local governments. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value, with any unrealized gains or losses reflected as an adjustment to stockholders’ equity. Securities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates and/or significant prepayment risks. It is the Bank’s policy to classify its investment securities as available for sale. Table 13, ~~“Securities Portfolio Composition”,~~ following this discussion, summarizes investment securities by type at December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008.

Table 14, ~~“Securities Portfolio Composition”,~~ following this discussion, summarizes the amortized costs, fair values and weighted average yields of the Bank’s investment securities at December 31, ~~2009~~2010, by contractual maturity groups.

The Bank does not engage in, nor does it presently intend to engage in, securities trading activities and therefore does not maintain a trading account. At December 31, ~~2009~~2010, there were no securities of any issuer (other ~~than governmental agencies) held in the Bank’s portfolio that exceeded 10% of the Company’s shareholders’ equity.~~

than governmental agencies) held in the Bank’s portfolio that exceeded 10% of MidCarolina’s shareholders’ equity.

SOURCES OF FUNDS

Deposit Activities. The Bank provides a range of deposit services, including non-interest-bearing checking accounts, interest-bearing checking and savings accounts, money market accounts and certificates of deposit. These accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. As described inunder the caption “-Liquidity” above, the Bank uses wholesale deposits as a funding source. However, the Bank strives to establish customer relations to attract core deposits in non-interest-bearing transactional accounts and thus to reduce the Bank’s costs of funds.

Table 15, ~~“Average Deposits”,~~ following this discussion, sets forth for the for the years ended December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008 the average balances outstanding and average interest rates for each major category of deposits.

Table 16, ~~“Maturities~~following ~~of Time Deposits of $100,000 or More”, which follows~~ this discussion, presents maturities of certificates of deposit with balances of $100,000 or more at December 31, ~~2009~~2010.

Borrowings. As additional sources of funding, the Bank uses advances from the FHLB under a line of credit equal to 30% of the Bank’s total assets, subject to qualifying collateral. The available aggregate line of credit was $~~167~~165.24 million at December 31, ~~2009~~2010. Outstanding advances at December 31, ~~2009~~2010 totaled $2515.0 million, ~~$10.0 million maturing in 2010, bearing interest at a weighted average rate~~ of ~~4.70%,~~which $5.0 million ~~maturing~~ matures in 2011 at 2.37% and $10 million ~~maturing~~matures in 2018 at 2.98%. The Bank had no daily rate credit advances outstanding at December 31, ~~2009~~2010. Pursuant to collateral agreements with the FHLB, at December 31, ~~2009~~2010, advances are secured by ~~loans~~ loans with a carrying amount of $~~110~~50.82 million, which approximates market value. Advances outstanding at December 31, ~~2008~~2009 totaled $25.0 million.

The Bank also has a line of credit with the FRB through their discount window in the amount of $7451.61 million. No borrowings were outstanding at December 31, ~~2009~~2010. The line of credit is secured by loans with a carrying amount of $9562.4 8 million, which approximates market value.

26In addition to FHLB advances, MidCarolina has issued $8.8 million of junior subordinated debentures to its wholly owned capital trusts, MidCarolina I and MidCarolina Trust II, to fully and unconditionally guarantee the preferred securities issued by the Trusts. These long term obligations, which currently qualify as Tier I capital for MidCarolina, constitute a full and unconditional guarantee by MidCarolina of the Trusts’ obligations under the capital trust securities.

In addition to FHLB advances, the Company issued $8.8 million of junior subordinated debentures to its wholly owned capital trusts, MidCarolina I and MidCarolina Trust II, to fully and unconditionally guarantee the preferred securities issued by the Trusts. These long term obligations, which currently qualify as Tier I capital for the Company, constitute a full and unconditional guarantee by the Company of the Trusts’ obligations under the Capital Trust Securities.

CRITICAL ACCOUNTING POLICIES

We have established various accounting policies that govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Significant accounting policies are described in Note B to the audited consolidated financial statements. A critical accounting policy is one that is both very important to the portrayal of the MidCarolina’s financial condition and results, and requires management’s most difficult, subjective or complex judgments. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. These policies may involve significant judgments and estimates that have a material impact on the carrying value of certain assets and liabilities. Different assumptions made in the application of these policies could result in material changes in our financial position and results of operations.

Allowance for Loan Losses. ~~The Company~~MidCarolina’s most significant critical accounting policy is the determination of the Bank’s allowance for loan losses. A critical accounting policy is one that is both very important to the portrayal of the Company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. If the mix and amount of future write-offs differ significantly from those assumptions used in making a determination, the allowance for loan losses and provision for loan losses on the income statement could be materially affected. For further discussion of the allowance for loan losses and a detailed description of the methodology used in determining the adequacy of the allowance, see the sections of this discussion titled “Asset Quality,” “Analysis of Allowance for Loan Losses” and Note B to the consolidated financial statements contained in this Annual Report.

Other Than Temporary Impairment. We evaluate securities for other-than-temporary impairment at least on a monthly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the anticipated outlook for changes in the general level of interest rates, (4) whether, for debt securities, it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, and (5) whether, for equity securities, our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

~~Off-Balance~~26 Sheet Arrangements. The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect of the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

~~RISKS~~ rates, ~~ASSOCIATED~~(4) whether, ~~WITH~~for ~~THE~~debt ~~BANK~~securities, ~~AND~~it ~~THE~~is ~~COMPANY~~more likely than not that we will be required to sell the security before recovery of its amortized cost basis, and (5) whether, for equity securities, our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Concentration of Operations. The Bank’s operations are concentrated in the Piedmont region of North Carolina. As a result of this geographic concentration, the Bank’s results may correlate to the economic conditions in this area. A deterioration in economic conditions in this market area, particularly in the industries on which these geographic areas depend, may adversely affect the quality of the Bank’s loan portfolio and the demand for the Bank’s products and services, and accordingly, its results of operations.

Risks Associated with Loans. A significant source of risk for the Bank arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Bank has underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the Bank’s loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect results of operations. A dramatic fluctuation in real estate prices may affect loan collateral values as well as credit extension decisions related to homebuilding and construction segments of the Bank’s real estate loan portfolio.

Competition with Larger Financial Institutions. The banking and financial services business in the Bank’s market area continues to be a competitive field and is becoming more competitive as a result of:

• changes in regulations;

• changes in technology and product delivery systems; and

• the accelerating pace of consolidation among financial services providers.

It may be difficult to compete effectively in the Bank’s market, and results of operations could be adversely affected by the nature or pace of change in competition. The Bank competes for loans, deposits and customers with various bank and non-bank financial services providers, many of which are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services.

Trading Volume. The Company’s trading volume is relatively low when compared with more seasoned companies listed on the Nasdaq Capital Market, the Nasdaq Global & Global Select Market System, the New York Stock Exchange or other consolidated reporting systems or stock exchanges. The market in the Company’s common stock may be limited in scope relative to other companies. The Company cannot guarantee that a more active and liquid trading market for the Company’s common stock will develop in the future.

Technological Advances. The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Bank’s future success will depend, in part, on its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in the Bank’s operations. Many of our competitors have substantially greater resources than the Company and the Bank to invest in technological improvements.

Government Regulations. Current and future legislation and the policies established by federal and state regulatory authorities will affect the Company’s and the Bank’s operations. The Bank is subject to supervision and periodic examination by the FDIC and the Commissioner. The Company is subject to the supervision and regulation of the Federal Reserve and the Commissioner. Banking regulations, designed primarily for the protection of depositors, may limit the Company’s and the Bank’s growth and the return to our shareholders by restricting certain of the Company’s and the Bank’s activities, such as:

• the payment of dividends to the Company’s shareholders;

• possible mergers with or acquisitions of or by other institutions;

• investment policies;

• loans and interest rates on loans;

• interest rates paid on deposits;

• expansion of branch offices; and/or

• the possibility to provide or expand securities or trust services.

The Company cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that any changes may have on future business and earnings prospects. The cost of compliance with regulatory requirements may adversely affect the Company’s and the Bank’s ability to operate profitably.

MidCarolina Financial Corporation

Table 2

Average Balances and Net Interest Income (1)

($ in thousands)

	Year Ended December 31, 2009								Year Ended December 31, 2008									Year Ended December 31, 2007
	Year Ended December 31, 2010										Year Ended December 31, 2009										Year Ended December 31, 2008
	AverageBalance			Interest		~~AverageRate~~	AverageRate		~~AverageBalance~~		AverageBalance		~~Interest~~		Interest	~~AverageRate~~		~~AverageBalance~~AverageRate			~~Interest~~AverageBalance			~~AverageRate~~	Interest		AverageRate
Interest-earning assets:
Loans, net	$	441,704		$	24,160	5.47	%		$	405,119			$	25,763		6.36	%	$	344,620		$	27,037		7.85	%
Loans, net (1)	$	421,947		$	22,943			5.44	%		$	441,704			$	24,160			5.47	%	$	405,119			$	25,763		6.36	%
Investment securities		70,289			3,378	4.81	%			69,728				3,561		5.11	%		72,013			3,581		4.97	%
Investment securities (2)		76,114			2,706			3.56	%			70,289				3,378			4.81	%		69,728				3,561		5.11	%
Interest-earning cash deposits		926,~~387~~468			2148	~~0.22~~	%	0.18	%	~~9,678~~		9,387		~~131~~		~~1.35~~21	%		~~8,080~~0.22	%		~~264~~9,678		~~3.27~~	%	131		1.35	%
Other		2,~~312~~250			2429	~~1.04~~	%	1.29	%	~~2,454~~		2,312		~~161~~		~~6.56~~24	%		~~2,429~~1.04	%		~~171~~2,454		~~7.04~~	%	161		6.56	%
Total interest-earning assets		~~523~~526,~~692~~779			2725,~~583~~726	~~5.27~~	%	4.88	%	~~486,979~~		523,692		~~29,616~~		~~6.08~~27,583	%		~~427,142~~5.27	%		31486,~~053~~979		~~7.27~~	%	29,616		6.08	%
Other assets		2625,~~915~~439								~~19,602~~		26,915							~~20,300~~			19,602
Total assets	$	~~550~~552,~~607~~218							$	~~506,581~~	$	550,607						$	~~447,442~~		$	506,581
Interest-bearing liabilities:
Deposits:
Demand deposits		~~112~~208,~~438~~977			12,~~510~~733	~~1.34~~	%	1.31	%	~~74,531~~		112,438		~~1,275~~		1~~.71~~,510	%		~~80,529~~1.34	%		274,~~796~~531		~~3.47~~	%	1,275		1.71	%
Savings deposits		611,~~663~~691			2078	~~0.30~~	%	0.67	%	~~5,772~~		6,663		29		~~0.50~~20	%		~~6,024~~0.30	%		605,772		~~1.00~~	%	29		0.50	%
Fixed maturity deposits		~~312~~219,~~282~~836			74,~~648~~344	~~2.45~~	%	1.98	%	~~308,562~~		312,282		~~12,192~~		~~3.95~~7,648	%		~~249,096~~2.45	%		12308,~~501~~562		~~5.02~~	%	12,192		3.95	%
Short term borrowed funds		~~2,225~~—			15—	~~0.67~~	%	—		~~9,807~~		2,225		~~288~~		~~2.94~~15	%		~~16,636~~0.67	%		19,~~094~~807		~~6.58~~	%	288		2.94	%
Long term borrowed funds		3329,~~764~~106			~~1,247~~968	~~3.69~~	%	3.33	%	~~33,764~~		33,764		~~1,510~~		~~4.47~~1,247	%		~~28,003~~3.69	%		133,~~270~~764		~~4.54~~	%	1,510		4.47	%
Total interest-bearing liabilities		~~467~~469,~~372~~610			108,~~440~~123	~~2.23~~	%	1.73	%	~~432,436~~		467,372		~~15,294~~		~~3.54~~10,440	%		~~380,288~~2.23	%		17432,~~721~~436		~~4.66~~	%	15,294		3.54	%
Noninterest-bearing deposits		4340,~~629~~545								~~36,925~~		43,629							~~34,479~~			36,925
Other liabilities		~~992~~1,137								~~1,390~~		992							~~2,774~~			1,390
Stockholders’ equity		3840,~~614~~926								~~35,830~~		38,614							~~29,901~~			35,830
Total liabilities and stockholders’ equity	$	~~550~~552,~~607~~218							$	~~506,581~~	$	550,607						$	~~447,442~~		$	506,581
Net interest income and interest rate spread				$	17,143	3.03	%						$	14,322		2.54	%				$	13,332		2.61	%
Net interest income and interest rate spread (3)				$	17,603			3.15	%						$	17,143			3.03	%					$	14,322		2.54	%
Net yield on average interest-earning assets						3.27	%									2.94	%							3.12	%
Net interest margin (4)								3.34	%										3.27	%								2.94	%
Ratio of average interest-earning assets to average interest-bearing liabilities		112.0517	%							~~112.61~~	%	112.05	%						~~112.32~~	%		112.61	%

(1) ~~includes~~Average ~~nonaccrual~~loans ~~and~~include ~~nonperforming~~non-accruing loans, ~~the~~and ~~impact~~loans ofheld ~~which~~for ~~is not significant~~sale. ~~Tax exempt income is not computed on a tax equivalent basis.~~

29(2) Tax exempt income is not computed on a tax equivalent basis.

(3)	Interest rate spread equals the earning asset yield minus the interest-bearing liability rate.

(4)	Net interest margin is computed by dividing net interest income by total earning assets.

MidCarolina Financial Corporation

Table 3

Volume and Rate Variance Analysis

(In Thousands)

	Year Ended December 31, 2009 vs. 2008									Year Ended December 31, 2008 vs. 2007
	Year Ended December 31, 2010 vs. 2009									Year Ended December 31, 2009 vs. 2008
	Increase (Decrease) Due to									Increase (Decrease) Due to
	Volume			Rate			Total			Volume			Rate			Total
Interest income:
Loans, net	$	2,164		$	(3,767	)	$	(1,603	)	$	4,297		$	(5,571	)	$	(1,274	)
Loans, net (1)	$	(1,077	)	$	(140	)	$	(1,217	)	$	2,164		$	(3,767	)	$	(1,603	)
Investment securities		28			(211	)		(183	)		(115	)		95			(20	)
Investment securities (2)		244			(916	)		(672	)		28			(211	)		(183	)
Interest-earning cash deposits		(235	)		(~~108~~8	)		~~(110~~27	)		37(2	)		(~~170~~108	)		(~~133~~110	)
Other		(51	)		~~(132~~6	)		~~(137~~5	)		2(5	)		(12132	)		(10137	)
Total interest income		~~2,185~~(799	)		(41,~~218~~058	)		(21,~~033~~857	)		42,~~221~~185			(54,~~658~~218	)		(12,~~437~~033	)
Interest expense:
Deposits
Demand deposits		~~579~~1,280			(~~344~~57	)		~~235~~1,223			~~(155~~579	)		(~~1,366~~344	)		~~(1,521~~235	)
Savings deposits		424			~~(13~~34	)		(958	)		(24	)		(2913	)		(319	)
Fixed maturity deposits		~~119~~(2,045	)		(41,~~663~~259	)		(43,~~544~~304	)		~~2,667~~119			(24,~~976~~663	)		(~~309~~4,544	)
Short term borrowed funds		(~~137~~15	)		~~(136~~0	)		(~~273~~15	)		(~~325~~137	)		(~~481~~136	)		(~~806~~273	)
Long term borrowed funds		—(163	)		(~~263~~116	)		(~~263~~279	)		~~259~~—			(19263	)		~~240~~(263	)
Total interest expense		~~565~~(919	)		(51,~~419~~398	)		(42,~~854~~317	)		~~2,444~~565			(45,~~871~~419	)		(24,~~427~~854	)
Net interest income increase (decrease)	$	~~1,620~~120		$	~~1,201~~340		$	~~2,821~~460		$	1,~~777~~620		$	~~(787~~1,201	)	$	~~990~~2,821

3029

MidCarolina Financial Corporation

Table 4

Noninterest Income

(In thousands)

Year Ended December 31,

2009

2008

2007

2010

2009

2008

Service charges on deposit accounts

~~910~~712

~~1,152~~910

1,~~058~~152

Mortgage operations

~~800~~786

~~571~~800

~~600~~571

Investment brokerage fees

~~245~~248

~~300~~245

~~288~~300

Increase in cash surrender value of life insurance

~~286~~335

~~299~~286

~~290~~299

Core noninterest income

2,~~241~~081

2,~~322~~241

2,~~236~~322

Securities gains (losses), net

Securities gains, net

Impairment on investment securities

(~~148~~29

)

(~~490~~148

)

—(490

)

Other noninterest income

~~631~~556

~~359~~631

~~383~~359

Total noninterest income

2,~~787~~659

2,~~220~~787

2,~~627~~220

3130

MidCarolina Financial Corporation

Table 5

Noninterest Expenses

(In thousands)

	Year Ended December 31,
	2009		2008			2007
	2010			2009			2008
Salaries	$	4,~~564~~313	$	~~4,338~~$	4,564	$	~~4,085~~$	4,338
Employee benefits		~~1,062~~948		~~1,049~~	1,062		~~1,299~~	1,049
Reversal of accrued employee benefits		—		—			(905	)
Total salaries and benefits		5,261			5,626			5,387
Total salaries and benefits		5,626		5,387			4,479
Occupancy expense		1,003			979			699
Occupancy expense		979		699			428
Equipment expense		503			603			434
Equipment expense		603		434			425
Other outside services		742			374			307
Other outside services		374		307			357
Data processing		1,209			931			787
Data processing		931		787			774
Office supplies and postage		346			341			350
Office supplies and postage		341		350			317
Deposit and other insurance		1,253			1,280			432
Deposit and other insurance		1,280		432			352
Professional and other services		498			734			550
Professional and other services		734		550			476
Advertising		328			338			387
Advertising		338		387			256
Other real estate owned related costs, net		734			349			(536	)
(Gain) loss on sale of Other real estate		349		(536	)		(481	)
Other		1,004			726			665
Other		726		665			922
Total noninterest expenses	$	12,881		$	12,281		$	9,462
Total noninterest expenses	$	12,281	$	9,462		$	8,305

3231

MidCarolina Financial Corporation

Table 6

Contractual Obligations and Commitments

($ in thousands)

	Payments Due by Period
Contractual Obligations	Total		~~On Demandor Within1 Year~~	On Demandor Within1 Year		~~After 1 yearthrough3 Years~~		2 -3 Years	~~After 3 yearsthrough5 Years~~		~~After5~~4 -5 Years		After5 Years
Short-term borrowings	$	~~520~~—	$	~~520~~$	—	$	—	$	$—	—	$	—	$	—
Long-term debt		3323,764		~~10,000~~	5,000		~~5,000~~		—	~~10,000~~		810,~~764~~000		8,764
Operating leases		3,~~050~~269		~~388~~	417		~~688~~		808	~~658~~		~~1,316~~728		1,316
Total contractual cash obligations excluding deposits		3727,~~334~~033		~~10,908~~	5,417		~~5,688~~		808	~~10,658~~		10,~~080~~728		10,080
Time deposits		~~340~~184,~~751~~781		~~326,322~~	133,644		~~14,429~~		51,137	—		—		—
Total contractual cash obligations	$	~~378~~211,~~085~~814	$	~~337,230~~$	139,061	$	~~20,117~~	$	$51,945	~~10,658~~	$	10,~~080~~728	$	10,080
	Amount of Commitment Expiration Per Period
Commercial Commitments	TotalAmountsCommitted		~~On Demandor Within 1Year~~	Within1 Year		~~After 1 yearthrough 3Years~~		2 -3 Years	~~After 3 yearsthrough 5Years~~		~~After~~4 ~~5Years~~-5 Years		After5 Years
Lines of credit and loan commitments (1)	$	67,649	$	30,394		$	3,614		$	—		33,641
				$	—
Lines of credit and loan commitments (1)	$	59,474		$	25,000			$	2,739		$	31,735		—

(1)	includes financial standby letters of credit, net

3332

MidCarolina Financial Corporation

Table 7

Interest Rate Sensitivity Analysis

($ in thousands)

	At December 31, 2009
	At December 31, 2010
	3 Monthsor Less			Over 3 Monthsto 12 Months			Total Within12 Months			Over 12Months			Total
Interest-earning assets:
Loans and loans held for sale	$	~~254~~226,~~171~~321		$	6553,~~466~~285		$	~~319~~279,~~637~~606		$	~~118~~120,~~678~~223		$	~~438~~399,~~315~~829
Securities available for sale		1,~~407~~536			79,~~892~~926			911,~~299~~462			6178,~~420~~690			7090,~~719~~152
Other earning assets		1015,~~170~~154			—			1015,~~170~~154			—			1015,~~170~~154
Total interest-earning assets	$	~~265~~243,~~748~~011		$	7363,~~358~~211		$	~~339~~306,~~106~~222		$	~~180~~198,~~098~~913		$	~~519~~505,~~204~~135
Interest-bearing liabilities
Fixed maturity deposits	$	1042,~~560~~971		$	~~112~~90,~~440~~694		$	~~123~~133,~~000~~665		$	~~147~~51,~~260~~116		$	~~270~~184,~~260~~781
All other deposits		~~153~~242,~~094~~141			—			~~153~~242,~~094~~141			—			~~153~~242,~~094~~141
Borrowings		2813,~~020~~500			—			2813,~~020~~500			610,264			3423,~~284~~764
	$	~~191~~298,~~674~~612		$	~~112~~90,~~440~~694		$	~~304~~389,~~114~~306		$	~~153~~61,~~524~~380		$	~~457~~450,~~638~~686
Interest sensitivity gap	$	74(55,~~074~~601	)	$	(3927,~~082~~483	)	$	34(83,~~992~~084	)	$	26137,~~574~~533		$	6154,~~566~~449
Cumulative interest sensitivity gap		74(55,~~074~~601	)		34(83,~~992~~084	)		34(83,~~992~~084	)		6154,~~566~~449			6154,~~566~~449
Cumulative interest sensitivity gap as a percent of total interest-earning assets		14-11.2701	%		6-16.7445	%		6-16.7445	%		1110.8678	%		1110.8678	%
Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities		~~138~~81.6538	%		~~111~~78.5166	%		~~111~~78.5166	%		~~113~~112.4508	%		~~113~~112.4508	%

3433

MidCarolina Financial Corporation

Table 8

Loan Portfolio Composition

($ in thousands)

	At December 31,
	2009						2008							2007							2006						2005
	2010							2009								2008								2007							2006
	Amount			% ofTotalLoans			~~Amount~~	Amount			~~% ofTotalLoans~~	% ofTotalLoans		~~Amount~~		Amount		~~% ofTotalLoans~~		% ofTotalLoans	~~Amount~~			Amount	~~% ofTotalLoans~~		~~Amount~~% ofTotalLoans			~~% ofTotalLoans~~	Amount			% ofTotalLoans
Real Estate:
Construction loans	$	6743,~~635~~934		~~15.43~~	%10.99	%	$	~~91,933~~$	67,635		~~21.15~~	%	15.44	$%	~~80,051~~	$	91,933	~~21.49~~	%		$21.15	~~71,348~~%		$	~~22.61~~80,051	%	$	~~67,170~~21.53	%	~~23.92~~	%$	71,348			22.75	%
Commercial mortgage loans		~~174~~173,~~926~~275		~~39.92~~	%43.35	%		~~156,333~~	174,926		~~35.97~~	%	39.94	%	~~140,198~~		156,333	~~37.63~~	%		35.97	~~124,385~~%			~~39.41~~140,198	%		~~100,292~~37.71	%	~~35.71~~	%	124,385			39.67	%
Home equity lines of credit		4443,~~627~~611		~~10.18~~	%10.91	%		~~43,290~~	44,627		~~9.96~~	%	10.19	%	~~41,479~~		43,290	~~11.13~~	%		9.96	~~33,090~~%			~~10.49~~41,479	%		~~30,072~~11.16	%	~~10.71~~	%	33,090			10.55	%
Residential mortgage loans		8172,~~377~~370		~~18.56~~	%18.10	%		~~73,595~~	81,377		~~16.93~~	%	18.57	%	~~57,342~~		73,595	~~15.39~~	%		16.93	~~37,163~~%			~~11.78~~57,342	%		~~38,656~~15.42	%	~~13.76~~	%	37,163			11.85	%
Residential mortgage loans held for sale		228		0.05	%			—			0.00	%			823			0.22	%			2,016			0.63	%		893		0.32	%
Total real estate loans		333,190			83.35	%			368,565				84.13	%			365,151				84.01	%			319,070			85.83	%			265,986			84.82	%
Total real estate loans		368,793		84.14	%			365,151			84.01	%			319,893			85.86	%			268,002			84.92	%		237,083		84.42	%
Commercial and industrial loans		61,230			15.31	%			64,173				14.65	%			63,239				14.55	%			46,893			12.61	%			38,965			12.43	%
Commercial and industrial loans		64,173		14.64	%			63,239			14.55	%			46,893			12.59	%			38,965			12.35	%		38,929		13.86	%
Loans to individuals for household, family and other personal expenditures		5,398			1.34	%			5,383				1.22	%			6,306				1.44	%			5,796			1.55	%			8,625			2.75	%
Loans to individuals for household, family and other personal expenditures		5,383		1.22	%			6,306			1.44	%			5,796			1.55	%			8,625			2.73	%		4,836		1.72	%
Loans, gross		399,818			100.00	%			438,121				100.00	%			434,696				100.00	%			371,759			100.00	%			313,576			100.00	%
Loans, gross		438,349		100.00	%			434,696			100.00	%			372,582			100.00	%			315,592			100.00	%		280,848		100.00	%
Less net deferred loan origination (fees) costs		11							(34	)							(34	)							(45	)						(4	)
Less unamortized net deferred loan origination (fees) costs		(34	)					(34	)						(45	)						(4	)					7
Residential mortgage loans held for sale		2,958			0.74	%			228				0.05	%			—				0.00	%			823			0.22	%			2,016			0.63	%
Total loans	$	~~438~~402,~~315~~787					$	~~434,662~~$	438,315					$	~~372,537~~	$	434,662				$	~~315,588~~		$	372,537		$	~~280,855~~			$	315,588

3534

MidCarolina Financial Corporation

Table 9

Loan Maturities

($ In thousands)

	At December 31, 2009
	At December 31, 2010
	Due withinone year					~~Due after oneyear but within five~~		Due after oneyear but within five			~~Due afterfive years~~				Due afterfive years		~~Total~~					Total
	Amount		~~Yield~~	Yield		~~Amount~~		Amount	~~Yield~~		~~Amount~~Yield			~~Yield~~	Amount		~~Amount~~		Yield	~~Yield~~		Amount		Yield
By loan type:
Construction	$	6039,~~118~~899	~~4.76~~	%	4.87	$%	~~6,870~~	$	~~5.71~~3,229	%	$	~~647~~5.94	%	~~4.56~~	%$	806	$	~~67,635~~		4.8664	%	$	43,934		4.94	%
Commercial mortgage		54,960	4.62	%			107,790		6.33	%		12,176		6.62	%			174,926		5.81	%
Commercial and industrial and commercial mortgage		82,910			4.61	%			146,523			5.51	%			5,071				6.59	%		234,505		4.92	%
Commercial and industrial		40,983	4.45	%			20,563		5.88	%		2,627		5.75	%			64,173		4.96	%
Total	$	122,809			4.69	%		$	149,753			5.52	%		$	5,877				6.32	%	$	278,439		4.92	%
Total	$	156,061	4.63	%		$	135,223		6.23	%	$	15,450		4.56	%		$	306,734		5.42	%
By interest rate type:
By interest rate type:
Fixed rate loans	$	86,222						$	149,000						$	5,877						$	241,098
Fixed rate loans	$	99,195				$	134,421				$	15,450					$	249,066
Variable rate loans		36,588							753							—							37,341
Variable rate loans		56,866					802					—						57,668
	$	122,809						$	149,753						$	5,877						$	278,439
	$	156,061				$	135,223				$	15,450					$	306,734

The above table is based on contractual scheduled maturities. Early repayment of loans or renewals at maturity are not considered in this table.

3635

MidCarolina Financial Corporation

Table 10

Nonperforming Assets

($ in thousands)

	At December 31,
	2009			2008			2007			2006			2005
	2010			2009			2008			2007			2006
Nonperforming loans
Contruction	$	4,301		$	188		$	700		$	794		$	237
Construction	$	3,383		$	4,301		$	188		$	700		$	794
Commercial mortgage		24,~~557~~868			2,~~547~~557			—2,547			—			—
Residential mortgage		486			362			—			—			—
Home equity lines of credit		221
Commercial and industrial		—			26			—			—			—
Residential mortgage		455			486			362			—			—
Loans to individuals		—			—			—			—			—
Commercial and industrial		99			—			26			—			—
Total nonperforming loans		7,344			3,123			700			794			237
Individual		53			—			—			—			—
Repossessed Assets		14			47			—			—			19
Total nonperforming loans		9,079			7,344			3,123			700			794
Other real estate owned		2,862			1,608			264			2,337			2,803
Repossessed Assets		4			14			47			—			—
Total nonperforming assets	$	10,220		$	4,778		$	964		$	3,131		$	3,059
Other real estate owned		7,244			2,862			1,608			264			2,337
Total nonperforming assets	$	16,327		$	10,220		$	4,778		$	964		$	3,131
Accruing loans past due 90 days or more	$	—		$	—		$	—		$	—		$	—
Allowance for loan losses		79,~~307~~226			57,~~632~~307			45,~~462~~632			4,~~222~~462			4,~~090~~222
Nonperforming loans to year end loans		12.6827	%		01.7268	%		0.1972	%		0.2519	%		0.8025	%
Allowance for loan losses to year end loans		12.6731	%		1.3067	%		1.2030	%		1.3520	%		1.4635	%
Nonperforming assets to loans and other real estate owned		2.32	%		1.11	%		0.27	%		0.99	%		1.08	%
Nonperforming assets to loans and other real estate		4.01	%		2.32	%		1.11	%		0.27	%		0.99	%
Nonperforming assets to total assets		13.8918	%		01.8889	%		0.2188	%		0.7421	%		0.8374	%
Allowance for loan losses to nonperforming loans		99101.5062	%		~~180~~99.3450	%		~~637~~180.4334	%		~~531~~637.7443	%		~~1725~~531.74	%
Restructured loans in accrual status, not included above	$	2,619		$	—		$	—		$	—		$	—
Restructured loans not include in the categories above		4,014			2,619			—			—			—

3736

MidCarolina Financial Corporation

Table 11

Allocation of the Allowance for Loan Losses

($ In thousands)

	2009					2008					2007						2006					2005
	2010							2009							2008							2007						2006
	Amount		~~% of TotalLoans (1)~~	% of TotalLoans (1)		~~Amount~~		Amount	~~% of TotalLoans (1)~~		~~Amount~~% of TotalLoans (1)			~~% of TotalLoans (1)~~	Amount		~~Amount~~		% of TotalLoans (1)	~~% of TotalLoans (1)~~		Amount		~~% of TotalLoans (1)~~	% of TotalLoans (1)			Amount		% of TotalLoans (1)
Real estate loans:
Construction loans	$	12,~~127~~079	~~15.43~~	%	10.99	$%	~~1,191~~	$	~~21.15~~1,127	%	$	~~959~~15.44	%	~~21.49~~	%$	1,191	$	~~954~~		2221.6115	%	$	~~978~~961	~~23.92~~	%	21.53	%	$	961		22.75	%
Commercial mortgage loans		23,~~918~~239	~~39.93~~	%	43.36	%	~~2,026~~		~~35.97~~2,918	%		~~1,679~~39.94	%	~~37.63~~	%	2,026		~~1,664~~		3935.4197	%		1,~~461~~683	~~35.71~~	%	37.71	%		1,675		39.67	%
Home equity lines of credit		~~744~~810	~~10.18~~	%	10.91	%	~~561~~		~~9.96~~744	%		~~497~~10.19	%	~~11.13~~	%	561		~~443~~		109.4996	%		~~438~~498	~~10.71~~	%	11.16	%		446		10.55	%
Residential mortgage loans		1,~~358~~563	~~18.56~~	%	18.10	%	~~954~~		~~16.93~~1,358	%		~~670~~18.57	%	~~15.02~~	%	933		~~487~~		1116.7856	%		~~563~~678	~~13.76~~	%	15.42	%		500		11.85	%
Residential mortgage loans held for sale		—	0.00	%			—		0.00	%		—		0.00	%			—		0.00	%		—	0.00	%
Total real estate loans		7,691			83.35	%			6,147			84.13	%			4,711				84.01	%		3,820			85.83	%		3,582		84.82	%
Total real estate loans		6,147	84.14	%			4,732		84.01	%		3,805		85.86	%			3,548		84.92	%		3,440	84.42	%
Commercial and industrial loans		1,397			15.31	%			1,071			14.65	%			832				14.55	%		661			12.61	%		623		12.43	%
Commercial and industrial loans		1,071	14.64	%			819		14.55	%		575		12.59	%			619		12.35	%		665	13.86	%
Loans to individuals		138			1.34	%			89			1.22	%			81				1.44	%		69			1.55	%		116		2.75	%
Loans to individuals		89	1.22	%			81		1.44	%		69		1.55	%			115		2.73	%		70	1.72	%
	$	9,226			100.00	%		$	7,307			100.00	%		$	5,632				100.00	%	$	4,462			100.00	%	$	4,222		100.00	%
	$	7,307	100.00	%		$	5,632		100.00	%	$	4,462		100.00	%		$	4,222		100.00	%	$	4,090	100.00	%

(1)	Represents total of all outstanding loans in each category as a percent of total loans outstanding

3837

MidCarolina Financial Corporation

Table 12

Loan Loss and Recovery Experience

($ in thousands)

	At or for the Year Ended December 31,
	2009			2008			2007			2006			2005
	2010			2009			2008			2007			2006
Loans held to maturity, outstanding at the end of the year	$	~~438~~399,~~087~~829		$	~~434~~438,~~662~~087		$	~~371~~434,~~714~~662		$	~~313~~371,~~572~~714		$	~~279~~313,~~962~~572
Average loans outstanding during the year	$	~~441~~421,~~704~~947		$	~~405~~441,~~119~~704		$	~~344~~405,~~620~~119		$	~~301~~344,~~405~~620		$	~~252~~301,~~914~~405
Allowance for loan losses at beginning of year	$	57,~~632~~307		$	45,~~462~~632		$	4,~~222~~462		$	4,~~090~~222		$	24,~~865~~090
Provision for loan losses		46,~~455~~418			14,~~665~~455			~~425~~1,665			~~394~~425			~~1,373~~394
		10,087			6,127			4,647			4,484			4,238
		13,725			10,087			6,127			4,647			4,484
Loans charged off:
Real estate loans		(14,~~502~~134	)		(~~411~~1,502	)		(~~268~~411	)		(~~214~~268	)		—(214	)
Commercial and industrial loans		(~~1,396~~611	)		(~~106~~1,396	)		—(106	)		~~(87~~—	)		(~~137~~87	)
Loans to individuals		(~~127~~65	)		(16127	)		(2816	)		(1728	)		(4417	)
Total charge-offs		(34,~~025~~810	)		(~~533~~3,025	)		(~~296~~533	)		(~~318~~296	)		(~~181~~318	)
Recoveries of loans previously charged off:
Real estate loans		32158			1132			6611			266			—2
Commercial and industrial loans		~~208~~103			26208			3826			4638			2646
Loans to individuals		550			15			71			87			78
Total recoveries		~~245~~311			38245			~~111~~38			56111			3356
Net charge-offs		(24,~~780~~499	)		(~~495~~2,780	)		(~~185~~495	)		(~~262~~185	)		(~~148~~262	)
Allowance for loan losses at end of year	$	79,~~307~~226		$	57,~~632~~307		$	45,~~462~~632		$	4,~~222~~462		$	4,~~090~~222
Ratios:
Net charge-offs as a percent of average loans		01.6307	%		0.1263	%		0.0512	%		0.0905	%		0.0609	%
Allowance for loan losses as a percent of loans at end of year		12.6731	%		1.3067	%		1.2030	%		1.3520	%		1.4635	%

3938

MidCarolina Financial Corporation

Table 13

Securities Portfolio Composition

(In thousands)

	At December 31
	2009		2008			2007
	2010			2009				2008
Securities available for sale:
U. S. Government agencies	$	1210,~~057~~505	$	~~2,533~~$	12,057	$	~~19,372~~	$	2,533
Mortgage-backed securities		2439,~~917~~214		~~50,431~~	24,917		~~31,986~~		50,431
State and municipal governments		2830,~~449~~704		~~17,607~~	28,449		~~19,275~~		17,607
Private label CMO’s		4,976		—			—
GSE CMO’s		8,693			—				—
Subordinated debentures		320		553			168
Private label CMO’s		726			4,976				—
Total securities available for sale	$	70,719	$	71,124		$	70,801
Other		310			320				553
Total securities available for sale	$	90,152		$	70,719			$	71,124

4039

MidCarolina Financial Corporation

Table 14

Securities Portfolio Composition

($ in thousands)

	At December 31, 2009
	AmortizedCost			FairValue				BookYield
	AmortizedCost		FairValue			BookYield
Securities available for sale:
Securities available for sale:
U. S. Government agencies
U. S. Government agencies
Due within one year	$	6,566		$	6,451				1.10	%
Due within one year	$	1,013	$	1,012		1.26	%
Due after one but within five years		3,024			3,075				1.90	%
Due after one but within five years		11,100		11,045		2.70	%
Due after five but within ten years		1,000			979				3.00	%
		12,113		12,057		2.58	%
		10,590			10,505				1.51	%
State and municipal securities
Due within one year		—		—	—	—			—
Due after one but within five years		57,~~083~~398		~~4,949~~	7,178	~~5.45~~	%		5.59	%
Due after five but within ten years		1011,~~892~~638		~~10,675~~	11,474	~~5.71~~	%		5.38	%
Due after ten years		1312,~~404~~768		~~12,825~~	12,052	~~5.92~~	%		5.78	%
		29,379		28,449		5.76	%
		31,804			30,704				5.59	%
Other
Due after ten years		500		320		3.75	%
Due after five but within ten years		500			310				4.03	%
		500		~~320~~	310	~~3.75~~	%		4.03	%
Total securities available for sale
Due within one year		16,~~013~~566		~~1,012~~	6,451	~~1.26~~	%		1.10	%
Due after one but within five years		1610,~~183~~422		~~15,994~~	10,253	~~3.55~~	%		4.48	%
Due after five but within ten years		1013,~~892~~138		~~10,675~~	12,763	~~5.71~~	%		5.16	%
Due after ten years		1312,~~904~~768		~~13,145~~	12,052	~~5.87~~	%		5.78	%
Private label collateralized mortgage obligations		5,683		4,975		5.71	%
GSE CMO’s		8,757			8,693				2.78	%
Mortgage-backed securities		23,690		24,918		5.14	%
Private label collateralized mortgage obligations		810			726				7.25	%
	$	71,365	$	70,719		4.99	%
Mortgage-backed securities		39,278			39,214				2.49	%
	$	91,739		$	90,152				3.44	%

Yields on tax exempt securities are stated on a federal tax equivalent basis.

4140

MidCarolina Financial Corporation

Table 15

Average Deposits

($ in thousands)

	For the Year Ended December 31,
	2009					2008					2007
	2010							2009							2008
	AverageAmount		~~AverageRate~~	AverageRate		~~AverageAmount~~		AverageAmount	~~AverageRate~~		~~AverageAmount~~AverageRate			~~AverageRate~~	AverageAmount		AverageRate
Demand deposits	$	~~112~~208,~~438~~977	~~1.34~~	%	1.31	$%	~~74,531~~	$	~~1.71~~112,438	%	$	~~80,529~~1.34	%	~~3.47~~	%$	74,531		1.71	%
Savings deposits		611,~~663~~691	~~0.30~~	%	0.67	%	~~5,772~~		~~0.50~~6,663	%		~~6,024~~0.30	%	~~1.00~~	%	5,772		0.50	%
Fixed maturity deposits		~~312~~219,~~282~~836	~~2.45~~	%	1.98	%	~~308,562~~		~~3.95~~312,282	%		~~249,096~~2.45	%	~~5.02~~	%	308,562		3.95	%
Total interest-bearing deposits		~~431~~440,~~383~~504	~~2.13~~	%	1.62	%	~~388,865~~		~~3.47~~431,383	%		~~335,649~~2.13	%	~~4.58~~	%	388,865		3.47	%
Noninterest-bearing deposits		4340,~~629~~545	—		—		~~36,925~~		—43,629			~~34,479~~—		—		36,925		—
Total deposits	$	~~475~~481,~~012~~049	~~1.93~~	%	1.49	$%	~~425,790~~	$	~~3.17~~475,012	%	$	~~370,128~~1.93	%	~~4.15~~	%$	425,790		3.17	%

4241

MidCarolina Financial Corporation

Table 16

Maturities of Time Deposits of $100,000 or More

(In thousands)

At December 31, 2009

At December 31, 2010

3 Monthsor Less

~~Over 3 Monthsto 6 Months~~

Over 3 Monthsto 6 Months

~~Over 6 Monthsto 12 Months~~

Over 6 Monthsto 12 Months

~~Over 12Months~~

~~Total~~Over 12Months

Total

Time Deposits of $100,000 or more

3936,~~540~~856

~~40,674~~$

47,635

~~39,213~~

$25,858

~~107,706~~

~~227~~48,~~133~~478

158,827

4342

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. Our market risk arises primarily from interest rate risk inherent in our lending and deposit-taking activities. The structure of our loan and deposit portfolios is such that a significant change in interest rates may adversely impact net market values and net interest income. We do not maintain a trading account nor are we subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of the Bank’s Asset/Liability Management function.

See the section entitled Asset/Liability Management for a more detailed discussion of market risk.

4443

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

MidCarolina Financial Corporation and Subsidiary

Burlington, North Carolina

We have audited the accompanying consolidated statements of financial condition of MidCarolina Financial Corporation and Subsidiary (hereinafter referred to as the “Company”) as of December 31, ~~2009~~2010 and ~~2008~~2009, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, ~~2009~~2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MidCarolina Financial Corporation and Subsidiary as of December 31, ~~2009~~2010 and ~~2008~~2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, ~~2009~~2010, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note C to the consolidated financial statements, effective January 1, 2009 the Company changed its method of accounting for other-than-temporary impairment of debt securities as a result of adopting new accounting guidance.

/s/ Dixon Hughes PLLC

Raleigh, North Carolina

~~February~~March 2515, ~~2010~~2011

4544

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31, ~~2009~~2010 and ~~2008~~2009

	2009			2008
	2010			2009
	(Amounts in thousands,except share data)
Assets
Cash and due from banks	$	1,~~581~~510		$	1,~~694~~581
Federal funds sold and interest-earning deposits		712,~~848~~196			147,~~040~~848
Investment securities:
Available for sale		7090,~~719~~152			7170,~~124~~719
Loans held for sale		~~228~~2,958			—228
Loans		~~438~~399,~~087~~829			~~434~~438,~~662~~087
Allowance for loan losses		(79,~~307~~226	)		(57,~~632~~307	)
Net loans		~~430~~390,~~780~~603			~~429~~430,~~030~~780
Investment in stock of Federal Home Loan Bank of Atlanta		2,~~322~~075			12,~~969~~322
Investment in life insurance		8,~~179~~514			78,~~893~~179
Premises and equipment, net		76,~~063~~652			7,~~455~~063
Other assets		1216,~~284~~540			712,~~642~~284
Total assets	$	~~541~~531,~~004~~200		$	~~540~~541,~~847~~004
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing demand deposits	$	4138,~~655~~951		$	4341,~~104~~655
Interest-bearing demand deposits		~~144~~227,~~839~~944			78144,~~309~~839
Savings		814,~~266~~197			58,~~784~~266
Time		~~270~~184,~~260~~781			~~340~~270,~~751~~260
Total deposits		465,~~020~~873			~~467~~465,~~948~~020
Short-term borrowings		~~520~~—			—520
Long-term debt		3323,764			33,764
Accrued expenses and other liabilities		1,~~515~~139			1,~~939~~515
Total liabilities		~~500~~490,~~819~~776			~~503~~500,~~651~~819
Shareholders’ equity:
Noncumulative, perpetual preferred stock, no par value, 20,000,000 shares authorized; 5,000 shares issued and outstanding at December 31, 2009 and 2008		4,819			4,819
Noncumulative, perpetual preferred stock, no par value, liquidation value of $1,000 per share, 20,000,000 shares authorized; 5,000 shares issued and outstanding at December 31, 2010 and 2009, respectively		4,819			4,819
Common stock, no par value; 80,000,000 shares authorized; 4,927,828 shares issued and outstanding at December 31, 2009 and 2008, respectively		14,958			14,626
Common stock, no par value; 80,000,000 shares authorized; 4,927,828 shares issued and outstanding at December 31, 2010 and 2009, respectively		15,162			14,958
Retained earnings		2021,~~805~~418			1820,~~635~~805
Accumulated other comprehensive loss		(~~397~~975	)		(~~884~~397	)
Total shareholders’ equity		40,~~185~~424			3740,~~196~~185
Total liabilities and shareholders’ equity	$	~~541~~531,~~004~~200		$	~~540~~541,~~847~~004

See accompanying notes to consolidated financial statements.

4645

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

	2009			2008			2007
	2010			2009			2008
	(Amounts in thousands, exceptper share data)
	(Amounts in thousands, except per share data)
Interest Income
Loans	$	2422,~~160~~943		$	2524,~~763~~160		$	2725,~~037~~763
Investment securities:
Taxable		21,~~248~~539			2,~~725~~248			2,~~556~~725
Tax-exempt		1,~~130~~167			~~836~~1,130			~~1,025~~836
Federal funds sold and interest-earning deposits		2148			~~131~~21			~~264~~131
Other		2429			~~161~~24			~~171~~161
Total interest income		2725,~~583~~726			2927,~~616~~583			3129,~~053~~616
Interest Expense
Demand deposits		12,~~510~~733			1,~~275~~510			21,~~796~~275
Savings deposits		2078			2920			6029
Time deposits		74,~~648~~344			127,~~192~~648			12,~~501~~192
Short-term borrowings		15—			~~288~~15			~~1,094~~288
Long-term debt		~~1,247~~968			1,~~510~~247			1,~~270~~510
Total interest expense		108,~~440~~123			1510,~~294~~440			1715,~~721~~294
Net Interest Income		17,~~143~~603			1417,~~322~~143			1314,~~332~~322
Provision for loan losses		46,~~455~~418			14,~~665~~455			~~425~~1,665
Net interest income after provision for loan losses		1211,~~688~~185			12,~~657~~688			12,~~907~~657
Noninterest Income
Service charges on deposit accounts		~~910~~712			~~1,152~~910			1,~~058~~152
Mortgage operations		~~800~~786			~~571~~800			~~600~~571
Investment services		~~245~~248			~~300~~245			~~288~~300
Increase in cash surrender value of life insurance		~~286~~335			~~299~~286			~~290~~299
Gain on sale of available for sale investments		~~189~~51			29189			829
Impairment on nonmarketable investments		~~(126~~—	)		—(126	)		—
Total other-than-temporary impairment loss		(~~456~~110	)		(~~490~~456	)		—(490	)
Portion of loss recognized in other comprehensive income		~~308~~81			—308			—
Net impairment loss recognized in earnings		(~~148~~29	)		(~~490~~148	)		—(490	)
Other		~~631~~556			~~359~~631			~~383~~359
Total noninterest income		2,~~787~~659			2,~~220~~787			2,~~627~~220
Noninterest Expense
Salaries and employee benefits		5,~~626~~261			5,~~387~~626			5,~~384~~387
Reversal of accrued employee benefits		—			—			(905	)
Occupancy and equipment		1,506			1,582			1,133
Occupancy and equipment		1,582			1,133			853
Other outside services		742			374			307
Other outside services		374			307			357
Data processing		1,209			931			787
Data processing		931			787			774
Office supplies and postage		346			341			350
Office supplies and postage		341			350			317
Deposit and other insurance		1,253			1,280			432
Deposit and other insurance		1,280			432			352
Professional and other services		498			734			550
Professional and other services		734			550			476
Advertising		328			338			387
Advertising		338			387			256
Other real estate owned related costs, net		734			349			(536	)
(Gain) loss on sale of other real estate owned		349			(536	)		(481	)
Other		1,004			726			972
Other		726			972			922
Total noninterest expense		12,881			12,281			9,462
Total noninterest expense		12,281			9,462			8,305
Income before income taxes		963			3,194			5,415
Income before income taxes		3,194			5,415			7,229
Provision for income tax expense (benefit)		(14	)		818			1,741
Provision for income taxes		818			1,741			2,342
Net income		977			2,376			3,674
Net income		2,376			3,674			4,887
Dividends on preferred stock		(364	)		(417	)		(417	)
Dividends on preferred stock		(417	)		(417	)		(417	)
Net income available to common shareholders	$	613		$	1,959		$	3,257
Net income available to common shareholders	$	1,959		$	3,257		$	4,470
Net Income Per Common Share:
Basic	$	.4012		$	.6640		$	.9866
Diluted	$	.4012		$	.6640		$	.9266

See accompanying notes to consolidated financial statements.

4746

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years Ended December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

	2009			2008			2007
	2010			2009			2008
	(Amounts in thousands)
Net income	$	~~2,376~~977		$	32,~~674~~376		$	43,~~887~~674
Other comprehensive income (loss):
Securities available for sale:
Change in unrealized holding gains (losses) on available for sale securities, net of actual gains		~~1,485~~(839	)		(1,~~350~~485	)		~~232~~(1,350	)
Tax effect		~~(573~~324	)		~~521~~(573	)		~~(89~~521	)
Reclassification of impairment on private label collateralized mortgage obligations		~~148~~29			~~490~~148			—490
Tax effect		(5711	)		(~~189~~57	)		—(189	)
Reclassification of gains recognized in net income		(189	)		(29	)		(8	)
Reclassification of gains recognized innet income		(51	)		(189	)		(29	)
Tax effect		7320			1073			310
Portion of other-than-temporary impairment loss recognized in other comprehensive income		(~~308~~81	)		—(308	)		—
Tax effect		~~119~~31			—119			—
Total other comprehensive income (loss)		~~698~~(578	)		~~(547~~698	)		~~138~~(547	)
Comprehensive income	$	~~3,074~~399		$	3,~~127~~074		$	53,~~025~~127

See accompanying notes to consolidated financial statements.

4847

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Years Ended December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

										Retainedearnings			Accumulatedother com-prehensiveloss				Totalshareholders’equity
																		Accumulated
	Preferred stock					Common stock
																		other			Total
	Shares		Amount			Shares	Amount
	Preferred stock							Common stock						Retained				comprehensive			shareholders’
	(Amounts in thousands, except share data)
	Shares				Amount			Shares			Amount			earnings				loss			equity
Balance at December 31, 2006	5,000		$	4,819		3,619,786	$	13,007		$	10,908		$	(475	)		$	28,259
	(Amounts in thousands, except share data)
Net income	—			—		—		—			4,887			—				4,887
Balance at December 31, 2007		5,000			$	4,819			4,618,528		$	13,290		$	15,378			$	(337	)	$	33,150
Other comprehensive income	—			—		—		—			—			138				138
Net income		—				—			—			—			3,674				—			3,674
Effect of 5-for-4 stock split	—			—		904,481		(10	)		—			—				(10	)
Other comprehensive loss		—				—			—			—			—				(547	)		(547	)
Preferred dividends paid	—	—		—		—		—	—		~~(417~~	)—		—	(417	)		~~(417~~	)—			(417	)
Stock options exercised	—	—		—		~~94,137~~—		~~279~~	309,300		—	792		—	—			~~279~~	—			792
Expense recognized in connection with stock awards and stock options	—			—		124		14			—			—				14
Current income tax benefit		—				—			—			498			—				—			498
Balance at December 31, 2007	5,000			4,819		4,618,528		13,290			15,378			(337	)			33,150
Expense recognized in connection with stock awards and stock options		—				—			—			46			—				—			46
Net income	—			—		—		—			3,674			—				3,674
Balance at December 31, 2008		5,000				4,819			4,927,828			14,626			18,635				(884	)		37,196
Other comprehensive loss	—			—		—		—			—			(547	)			(547	)
Cumulative effect of accounting method change		—				—			—			—			211				(211	)		—
Preferred dividends paid	—			—		—		—			(417	)		—				(417	)
Net income		—				—			—			—			2,376				—			2,376
Stock options exercised	—			—		309,300		792			—			—				792
Other comprehensive income		—				—			—			—			—				698			698
Current income tax benefit	—			—		—		498			—			—				498
Preferred dividends paid		—				—			—			—			(417	)			—			(417	)
Expense recognized in connection with stock awards and stock options	—	—		—		—		46	—		—	332		—	—			46	—			332
Balance at December 31, 2008	5,000			4,819		4,927,828		14,626			18,635			(884	)			37,196
Balance at December 31, 2009		5,000				4,819			4,927,828			14,958			20,805				(397	)		40,185
Cumulative effect of accounting method change	—			—		—		—			211			(211	)			—
Net income		—				—			—			—			977				—			977
Net income	—			—		—		—			2,376			—				2,376
Other comprehensive loss		—				—			—			—			—				(578	)		(578	)
Other comprehensive income	—			—		—		—			—			698				698
Preferred dividends paid		—				—			—			—			(364	)			—			(364	)
Preferred dividends paid	—			—		—		—			(417	)		—				(417	)
Expense recognized in connection with stock awards and stock options		—				—			—			204			—				—			204
Expense recognized in connection with stock awards and stock options	—			—		—		332			—			—				332
Balance at December 31, 2010		5,000			$	4,819			4,927,828		$	15,162		$	21,418			$	(975	)	$	40,424
Balance at December 31, 2009	5,000		$	4,819		4,927,828	$	14,958		$	20,805		$	(397	)		$	40,185

See accompanying notes to consolidated financial statements.

4948

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

	2009			2008			2007
	2010			2009			2008
	(Amounts in thousands)
Operating Activities
Net income	$	~~2,376~~977		$	32,~~674~~376		$	43,~~887~~674
Depreciation and amortization		~~567~~758			~~481~~567			~~458~~481
Provision for loan losses		46,~~455~~418			14,~~665~~455			~~425~~1,665
Stock option expense		~~332~~204			46332			1446
Deferred income tax (liability) benefit		(1,114	)		(573	)		138
Deferred income tax benefit		(1,201	)		(1,114	)		(573	)
Impairment of nonmarketable investments		~~126~~—			—126			—
Gain on sale of investment securities available for sale		(~~189~~51	)		(29189	)		(829	)
Impairment of investment securities available for sale		~~148~~29			~~490~~148			—490
(Gain) loss on sale of other real estate owned		349			(536	)		(481	)
Other real estate owned related costs, net		734			349			(536	)
Gain on sale of loans		(~~800~~786	)		(~~571~~800	)		(~~598~~571	)
Origination of loans held for sale		(4235,~~750~~779	)		(2142,~~489~~750	)		(2721,~~280~~489	)
Proceeds from sales of loans held for sale		4333,~~322~~835			2243,~~883~~322			2922,~~071~~883
Increase in cash surrender value life insurance		(~~286~~335	)		(~~299~~286	)		(~~290~~299	)
Changes in assets and liabilities:
Prepayment of FDIC insurance assessment		(31,~~134~~029	)		—(2,654	)		—
(Increase) decrease in other assets		604			572			(1,877	)
Decrease in other assets		296			124			572
Increase (decrease) in accrued expenses and other liabilities		~~(731~~12	)		(93731	)		~~729~~(93	)
Net cash provided by operating activities		36,~~275~~116			63,~~221~~275			56,~~188~~221
Investing Activities
Purchases of investment securities available for sale		(4486,~~174~~008	)		(5144,~~091~~174	)		(3351,~~316~~091	)
Maturities and calls of investment securities available for sale		85,~~855~~060			258,855			~~1,447~~25
Principal paydowns on investment securities available for sale		~~750~~7,493			~~4,793~~750			34,~~398~~793
Sales of investment securities available for sale		3652,~~162~~901			4436,~~570~~162			3144,~~677~~570
Net increase in loans from originations and principal repayments		(10,187	)		(65,347	)		(58,591	)
Net (increase) decrease in loans from originations and principal repayments		25,613			(10,187	)		(65,347	)
(Purchase) redemption of FHLB stock		~~(353~~247	)		~~997~~(353	)		~~(290~~997	)
Purchases of premises and equipment		(~~185~~146	)		(~~1,065~~185	)		(~~632~~1,065	)
Improvement costs on other real estate owned		~~(134~~—	)		(16134	)		—(16	)
Proceeds from sale of other real estate owned		23,~~511~~032			12,~~112~~511			21,~~818~~112
Net cash provided (used) by investing activities		68,~~755~~192			~~(66~~6,~~022~~755	)		(5366,~~489~~022	)
Financing Activities
Net increase (decrease) in deposits		~~(2,928~~853	)		94(2,~~051~~928	)		3494,~~622~~051
Net increase (decrease) in short-term borrowings		(520	)		~~(19,000~~520	)		(619,000	)
Proceeds from (repayment of) long-term debt		—(10,000	)		~~(5,000~~—	)		12(5,000	)
Non-cumulative perpetual preferred stock dividends paid		(~~417~~364	)		(417	)		(417	)
Purchase of fractional shares		—			—			(10	)
Proceeds from stock options exercised		—			—			792
Proceeds from stock options exercised		—			792			279
Tax benefit from exercise of stock options		—			—			498
Tax benefit from exercise of stock options		—			498			—
Net cash provided (used) by financing activities		(10,031	)		(2,825	)		70,924
Net cash provided (used) by financing activities		(2,825	)		70,924			40,474
Net increase (decrease) in cash and cash equivalents		4,277			(6,305	)		11,123
Net increase (decrease) in cash and cash equivalents		(6,305	)		11,123			(7,827	)
Cash and cash equivalents, beginning of year		9,429			15,734			4,611
Cash and cash equivalents, beginning of year		15,734			4,611			12,438
Cash and cash equivalents, end of year	$	13,706		$	9,429		$	15,734
Cash and cash equivalents, end of year	$	9,429		$	15,734		$	4,611
Supplemental Cash Flow Disclosure
Interest paid on deposits and borrowed funds	$	108,~~697~~265		$	1510,~~305~~697		$	1715,~~614~~305
Income taxes paid		1,~~621~~096			21,~~349~~621			12,~~573~~349
Summary of Noncash Investing and Financing Activities
Unrealized gain (loss) on investment securities available for sale, net of tax effect	$	~~698~~(578	)	$	~~(547~~698	)	$	~~138~~(547	)
Transfer of loans to other real estate owned		38,~~982~~146			13,~~904~~982			~~264~~1,904

See accompanying notes to consolidated financial statements.

5049

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~ 2008

Note A - Organization and Operations

In April 2002, the shareholders of MidCarolina Bank (the “Bank”) approved an Agreement and Plan of Reorganization pursuant to which the Bank became a wholly owned banking subsidiary of MidCarolina Financial Corporation (the “Company”), a North Carolina corporation formed as a holding company for the Bank. At the closing of the holding company reorganization, one share of the Company’s no par value common stock was exchanged for each of the outstanding shares of the Bank’s common stock.

The Bank was incorporated and began operations on August 14, 1997. The Bank is engaged in general commercial banking primarily in Alamance and Guilford Counties, North Carolina, and operates under the banking laws of North Carolina and the Rules and Regulations of the Federal Deposit Insurance Corporation. The Bank undergoes periodic examinations by those regulatory authorities.

Note B - Summary of Significant Accounting Policies

Basis of Consolidation

The consolidated financial statements include the accounts and transactions of the Company, the Bank, and the Bank’s wholly owned subsidiary, MidCarolina Investments, Inc. The Company wholly owns the capital trusts used to issue trust preferred securities. The trusts are not consolidated as a part of these financial statements. All intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

Preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses.

Cash and Cash Equivalents

For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and interest-earning deposits. Federal regulations require institutions to set aside specified amounts of cash as reserves against transactions and time deposits. As of December 31, ~~2009~~2010, the daily average gross reserve requirement was $3139,000.3 ~~million.~~ Due from bank balances are maintained in other financial institutions. Federal funds sold are generally purchased and sold for one-day periods, but may from time to time have longer terms.

Investment Securities

Investment securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Investment securities held for current resale are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. The Company currently has no such securities. Investment securities not classified either as securities held to maturity or trading securities are classified as available for sale and reported at fair value, with net unrealized gains and losses net of related taxes excluded from earnings and reported as accumulated other comprehensive income in shareholders’ equity. The classification of investment securities as held to maturity, trading or available for sale is determined at the date of purchase. Realized gains and losses from sales of investment securities are determined based upon the specific identification method on a trade-date basis. Premiums and discounts are recognized in interest income using the interest method over the terms of the securities.

~~Loans~~50 ~~and Interest Income~~

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their unpaid principal balances, less unearned income and net of any deferred loan fees and costs. Interest income is recorded as earned on an accrual basis. The Company discontinues the recognition of

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

~~interest~~Loans income when, in the opinion of management, collection of such interest is doubtful. It is the general policy of the Company to discontinue the accrual of interest on loans, including loans impaired when principal or interest payments are contractually delinquent 90 days or more. Any unpaid amounts previously accrued on these loans are reversed from income, and ~~thereafter~~Interest ~~interest~~Income ~~is recognized only to the extent payments are received.~~

ALoans ~~loan~~that ~~is considered impaired when, in~~ management’s ~~judgment,~~has ~~based~~the onintent ~~current information~~ and ~~events,~~ability itto ishold ~~probable~~for ~~that~~ the ~~Company~~ ~~will~~foreseeable befuture ~~unable~~or tountil ~~collect~~maturity ~~the~~or ~~scheduled~~pay-off ~~payments~~generally ofare ~~principal~~reported orat ~~interest~~their ~~when~~unpaid ~~due~~principal ~~according~~balances, toless ~~the~~unearned ~~contractual~~income ~~terms~~and net of any ~~the~~deferred loan ~~agreement.~~origination ~~Factors~~fees ~~considered~~and bycosts. ~~management~~Loan inorigination ~~determining~~fees ~~impairment include payment status, collateral value,~~ and ~~the~~certain ~~probability~~direct oforigination ~~collecting~~costs ~~scheduled~~are ~~principal~~capitalized and ~~interest~~recognized ~~payments~~as ~~when~~an ~~due.~~adjustment ~~Management~~of ~~determines~~the ~~when~~yield ~~loans~~of ~~become~~the ~~impaired~~related ~~through its normal~~ loan. ~~administration~~Interest ~~and~~income ~~review~~is ~~functions.~~recorded ~~Loans identified~~ as ~~troubled~~earned ~~debt~~on ~~restructurings (TDRs)~~an ~~are~~accrual ~~considered impaired~~basis. ~~Loans~~The Company ~~identified~~discontinues asthe ~~substandard~~recognition orof ~~doubtful~~interest asincome awhen, ~~result~~in of the ~~loan~~opinion ~~review~~of ~~process~~management, ~~are~~collection ~~potentially~~of ~~impaired~~such ~~loans.~~interest ~~Loans~~is ~~that~~doubtful. ~~experience~~It ~~insignificant~~is ~~payment~~the ~~delays~~general ~~and~~policy ~~payment~~of ~~shortfalls~~the ~~generally~~Company ~~are~~to ~~not~~discontinue ~~classified as~~the ~~impaired,~~accrual ~~provided~~of ~~that~~interest ~~management~~on ~~expects to collect all amounts due~~loans, including ~~interest~~loans ~~accrued~~impaired when atprincipal ~~the~~or ~~contractual~~ interest ~~rate~~payments ~~for~~are ~~the~~contractually ~~period~~delinquent of90 ~~delay.~~days ~~Impairment~~or ismore. ~~measured~~Any onunpaid aamounts ~~loan~~previously byaccrued ~~loan~~on ~~basis~~these ~~for~~loans ~~commercial~~are ~~and~~reversed ~~construction~~from ~~loans~~income. ~~by either~~When ~~the~~interest ~~present~~accrual ~~value~~is ofdiscontinued, ~~expected~~all ~~future~~unpaid ~~cash~~accrued ~~flows~~interest ~~discounted~~is atreversed. ~~the~~Interest income ~~loan’s~~is ~~effective~~subsequently ~~interest~~recognized ~~rate,~~only to the ~~loan’s~~extent ~~obtainable~~cash ~~market~~payments ~~price,~~are orreceived ~~the~~in ~~fair~~excess ~~value~~ of ~~the~~principal ~~collateral~~due. ifLoans ~~the~~are ~~loan~~returned isto ~~collateral~~accrual ~~dependent.~~status ~~Interest~~when ~~revenue~~all ~~on impaired~~the ~~loans~~principal isand ~~discontinued~~interest ~~when~~amounts ~~the~~contractually ~~loans~~due ~~meet~~are ~~the~~brought ~~criteria~~current ~~for~~and ~~nonaccrual~~future ~~status~~payments are ~~described~~reasonably ~~above~~assured.

A loan is considered impaired when, in management’s judgment, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines when loans become impaired through its normal loan administration and review functions. Loans identified as troubled debt restructurings (TDRs) are considered impaired. Loans identified as substandard or doubtful as a result of the loan review process are potentially impaired loans. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired, provided that management expects to collect all amounts due, including interest accrued at the contractual interest rate for the period of delay. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Interest revenue on impaired loans is discontinued when the loans meet the criteria for nonaccrual status described above.

Loans Held for Sale

The Company originates single family, residential first mortgage loans on a presold basis. Loans held for sale are carried at the lower of cost or fair value in the aggregate as determined by outstanding commitments from investors. At closing, these loans, together with their servicing rights, are sold to other financial institutions under prearranged terms. The Company recognizes certain origination and servicing release fees upon the sale which are classified as mortgage operations on the consolidated statements of operations.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance when management believes that the collectibility of principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

~~The~~51 allowance consists of general and specific reserves. The general reserves are determined by applying loss percentages to the portfolio that are based on recent historical loss experience and management’s evaluation and “risk grading” of the loan portfolio. Additionally, the general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, the findings of internal and external credit reviews and results from external bank regulatory examinations are included in this evaluation. The specific reserves are determined on a loan-by-loan basis based on management’s evaluation of the Company’s exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. These are loans classified by management as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

The Company’s allowance for possible loan losses consists of three elements: (i) specific valuation allowance determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general conditions and other qualitative risk factors both internal and external to the Company.

The general reserves are determined by applying loss percentages to the portfolio that are based on recent historical loss experience and management’s evaluation and “risk grading” of the loan portfolio. The historical loss experience is a weighted average calculation using a rolling 12-quarters worth of net charge-offs and weighted to the most recent quarter using the sum of the year’s digits. Additionally, the general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, the findings of internal and external credit reviews and results from external bank regulatory examinations are included in this evaluation. The specific reserves are determined on a loan-by-loan basis based on management’s evaluation of the Company’s exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. These are loans classified by management as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.

Premises and Equipment

Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation and amortization is calculated on the straight-line method over the estimated useful lives of the respective assets as follows:


Buildings		15 - 40 years
Leasehold improvements		Shorter of lease term or 15 years
Furniture and equipment		3 - 10 years

Other Real Estate Owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management to ensure the assets are carried at fair value less cost to sell. If there are subsequent declines in fair value, the assets are written down to its then current fair value through a charge to operations. Revenue and expenses from operations and the impact of any subsequent changes in the carrying value are included in other noninterest expense.

Stock in Federal Home Loan Bank of Atlanta

As a requirement for membership, the Company invests in stock of the Federal Home Loan Bank of Atlanta (“FHLB”). At December 31, ~~2009~~2010 and ~~2008~~2009, the balance of FHLB stock held by the Company was $2.31 million and $2.03 million, respectively. Due to the redemption provisions of the FHLB, the Company estimated that fair value equals cost and that this investment was not impaired at December 31, ~~2009~~2010.

Income Taxes

Deferred income taxes are recognized for the tax consequences of temporary differences between financial statement carrying amounts and the tax bases of existing assets and liabilities that will result in taxable or deductible amounts in future years. These temporary differences are multiplied by the enacted income tax rate expected to be in effect when the taxes become payable or receivable. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based on available evidence.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

when the taxes become payable or receivable. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based on available evidence.

Accumulated Other Comprehensive Income (Loss)

Comprehensive income is defined as the change in equity during a period for non-owner transactions and is composed of net income and other comprehensive income (loss). Other comprehensive income includes revenues, expenses, gains and losses that are excluded from earnings under current accounting standards. As of and for the years presented, the components of other comprehensive income for the Company consisted of the unrealized gains and losses, net of taxes, in the Company’s available for sale securities portfolio.

Accumulated other comprehensive income (loss) at December 31, ~~2009~~2010 and ~~2008~~2009 consists of the following:

	2009			2008
	2010			2009
	(Amounts in thousands)
Unrealized holding losses - securities available for sale	$	(~~645~~1,587	)	$	(~~1,438~~645	)
Deferred income taxes		~~248~~612			~~554~~248
Net unrealized holding losses - securities available for sale		(~~397~~975	)		(~~884~~397	)
Total other accumulated other comprehensive loss	$	(~~397~~975	)	$	(~~884~~397	)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2009, 2008 and 2007

Stock Compensation Plans

U.S. Generally Accepted Accounting Principals (GAAP) requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (usually the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. GAAP also requires that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company awarded 99,500 options in 2009 and recognized stock compensation expense of $332,000. No stock options were exercised during 2009. or 2010. Cash flows provided by financing activities from the exercise of stock options amounted to $~~0, $~~1.3 million ~~and~~for ~~$279~~the year ended December 31,~~000~~ ~~for~~2008. There were no cash flows provided by financing activities from the exercise of stock options for the years ended December 31, ~~2009,~~2010 ~~2008~~ and ~~2007 respectively~~2009.

Net Income Per Common Share

Basic and diluted net income per share has been computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for all applicable declared stock splits effected in the form of stock dividends. Diluted net income per share reflect additional shares of common stock that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Stock options that have exercise prices greater than the average market price of the common shares are considered antidilutive. At December 31, 2010, 2009 and ~~December 31,~~ 2008 there were 371,504, 269,774 and 148,228 antidilutive options respectively. ~~At December 31, 2007 there were no antidilutive options.~~

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

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

	2009		2008	2007
	2010			2009		2008
Weighted average number of common shares used in computing basic net income per share	~~4,927,828~~	4,927,828	~~4,915,350~~	~~4,548,565~~	4,927,828		4,915,350
Effect of dilutive stock options	~~2,482~~	—	~~1,526~~	~~303,172~~	2,482		1,526
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share	~~4,930,310~~	4,927,828	~~4,916,876~~	~~4,851,738~~	4,930,310		4,916,876

Segment Reporting

GAAP requires management to report selected financial and descriptive information about reportable operating segments. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Generally, disclosures are required for segments internally identified to evaluate performance and resource allocation. In all material respects, the Company’s operations are entirely within the commercial banking segment, and the consolidated financial statements presented herein reflect the results of that segment. Also, the Company has no foreign operations or customers.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2009, 2008 and 2007

Reclassification

~~Prior~~There ~~period~~were ~~amounts~~no ~~may~~reclassifications ~~have~~made ~~been~~to ~~reclassified~~prior ~~for~~period ~~proper~~amounts presentation. For the year-ended December 31, 2009, loss on the sale of other real estate owned was classified as a non-interest expense item. To remain consistent with the presentation and classification of the items included in ~~the~~order ~~consolidated statements of operations, for the years ended December 31, 2008 and 2007, gain on sale of other real estate was reclassified from~~to ~~non-interest~~conform ~~income~~ to ~~non-interest~~reclassifications ~~expense.~~used ~~The~~in ~~reclassification has no effect on net income available to common shareholders for either period presented~~2010.

Subsequent Events

Subsequent events have been evaluated through February 25, 2010, which is the date of financial statement issuance.

Recent Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140, which was subsequently codified by the FASB under ASC Topic 860 (“Topic 860”). Topic 860 seeks to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. Specifically, Topic 860 eliminates the concept of a qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferor’s interest in transferred financial assets. SFAS No. 166 as codified under ASC Topic 860 is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009. The ~~Company~~ ~~does not anticipate that the~~ adoption of this statement ~~will~~did not have a material impact on ~~its~~the Company’s consolidated financial statements.

In54 June 2009 the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), which was subsequently codified by the FASB as ASC Topic 810 (“Topic 810-10”). Topic 810 amends FASB Interpretation No. 46(R), Variable Interest Entities, for determining whether an entity is a variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. Under Topic 810, an enterprise has a controlling financial interest when it has (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. Topic 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance. Topic 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. SFAS No. 167 as codified under ASC Topic 810 is effective as of the beginning of fiscal years beginning after November 15, 2009 and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments. The Company does not anticipate that the adoption of this statement will have a material impact on its consolidated financial statements.

InNOTES ~~January 2010 the FASB issued Accounting Standards Update No. 2010-06,~~TO ~~Fair~~CONSOLIDATED ~~Value~~FINANCIAL ~~Measurements~~STATEMENTS Disclosures, which amends Subtopic 820-10 of the FASB Accounting Standards Codification to require new disclosures for fair value measurements and provides clarification for existing disclosures requirements. More specifically, this update will require (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This update clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning

December 31, 2010, 2009 and 2008

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), which was subsequently codified by the FASB as ASC Topic 810 (“Topic 810-10”). Topic 810 amends FASB Interpretation No. 46(R), Variable Interest Entities, for determining whether an entity is a variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. Under Topic 810, an enterprise has a controlling financial interest when it has (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. Topic 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance. Topic 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. SFAS No. 167 as codified under ASC Topic 810 is effective as of the beginning of fiscal years beginning after November 15, 2009, and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Fair Value Measurements Disclosures, which amends Subtopic 820-10 of the FASB Accounting Standards Codification to require new disclosures for fair value measurements and provides clarification for existing disclosures requirements. More specifically, this update will require (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This update clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company has included the required disclosures within the consolidated financial statements

In July 2010, the FASB issued Accounting Standards Update No 2010-20, Receivables (“ASC 310-30”): Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The objective of this ASU is for an entity to provide disclosures that facilitate financial statement users’ evaluation of the following:

•

The nature of credit risk inherent in the entity’s portfolio of financing receivables;

•

How that risk is analyzed and assessed in arriving at the allowance for credit losses; and

•

The changes and reasons for those changes in the allowance for credit losses.

To achieve these objectives, an entity should provide disclosures on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financing receivable. The ASU makes changes to existing disclosure requirements and includes additional disclosure requirements about financing receivables, including:

•

Credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables;

•

The aging of past due financing receivables at the end of the reporting period by class of financing receivables; and

•

The nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

~~after~~For ~~December 15,~~public ~~2009~~entities, ~~except for~~ the disclosures ~~about~~as ~~purchases,~~of ~~sales, issuances and settlements in~~ the ~~roll~~end ~~forward~~of ~~activity~~a inreporting ~~Level~~period 3are ~~fair~~effective ~~value~~for ~~measurements.~~interim ~~Those disclosures are~~and ~~effective~~annual ~~for~~reporting ~~fiscal~~periods ~~years~~ending ~~beginning~~on or after December 15, 2010,. ~~and~~The ~~for~~disclosures ~~interim~~about ~~periods~~activity ~~within~~that ~~those~~occurs ~~fiscal~~during ~~years.~~a ~~The~~reporting ~~Company~~period ~~does~~are ~~not~~effective ~~anticipate~~for ~~that~~interim ~~the~~and ~~adoption~~annual ofreporting ~~this~~periods ~~statement~~beginning ~~will~~on ~~materially~~or ~~expand~~after ~~its~~December 15, ~~consolidated~~2010. ~~financial statement~~These ~~footnote~~ disclosures have been included in year-end 2010 reporting as applicable.

From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

Note C - Investment Securities

The following is a summary of investment securities by major classification at December 31, ~~2009~~2010 and ~~2008~~2009:

	December 31, 2009
	December 31, 2010
	Amortizedcost		~~Grossunrealizedgains~~	Grossunrealizedgains		~~Grossunrealizedlosses~~		Grossunrealizedlosses	~~Fairvalue~~		Fair value
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	1210,~~113~~590	$	13$	45	$	69	$	$130	~~12,057~~	$	10,505
Mortgage-backed securities		2339,~~690~~278		~~1,246~~	299		19		363	~~24,917~~		39,214
Private label CMO’s		5,683		6			713			4,976
GSE CMO’s		8,757			29				93			8,693
State and municipal		29,379		191			1,121			28,449
Private label CMO’s		810			—				84			726
Subordinated debentures		500		—			180			320
State and municipal		31,804			72				1,172			30,704
Total	$	71,365	$	1,456		$	2,102		$	70,719
Subordinated debentures		500			—				190			310
Total	$	91,739		$	446			$	2,032		$	90,152

	December 31, 2008
	December 31, 2009
	Amortizedcost		~~Grossunrealizedgains~~	Grossunrealizedgains		~~Grossunrealizedlosses~~		Grossunrealizedlosses	~~Fairvalue~~		Fair value
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	212,~~500~~113	$	33$	13	$	—	$	$69	~~2,533~~	$	12,057
Mortgage-backed securities		5023,~~066~~690		~~669~~	1,246		~~304~~		19	~~50,431~~		24,917
State and municipal		19,293		—			1,686			17,607
Private label CMO’s		5,683			6				713			4,976
Subordinated debentures		703		—			150			553
State and municipal		29,379			191				1,121			28,449
Total	$	72,562	$	702		$	2,140		$	71,124
Subordinated debentures		500			—				180			320
Total	$	71,365		$	1,456			$	2,102		$	70,719

Information pertaining to securities with gross unrealized losses at December 31, ~~2009~~2010 and ~~2008~~2009, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

	2009
	2010
	Less Than 12 Months					~~12 Months or More~~		12 Months or More			~~Total~~			Total
	Fairvalue		Unrealizedlosses			Fairvalue			Unrealizedlosses		Fairvalue		Unrealizedlosses
	Fair			Unrealized				Fair			Unrealized			Fair		Unrealized
	(Amounts in thousands)
	value			losses				value			losses			value		losses
Securities available for sale:
	(Amounts in thousands)
U.S. government agency securities	$	7,095	$	69		$	—		$	—	$	7,095	$	69
Securities available for sale:
Mortgage-backed securities		2,039		19			—			—		2,039		19
U.S. government agency securities	$	7,434		$	130			$	—		$	—		$	7,434	$	130
Private label CMO’s		—		—			2,295			405		2,295		405
Mortgage-backed securities		17,236			363				—			—			17,236		363
State and municipal		9,042		273			7,384			848		16,426		1,121
GSE CMO’s		4,031			93				—			—			4,031		93
Subordinated debentures		—		—			320			180		320		180
Private label CMO’s		—			—				—			—			—		—
Total temporarily impaired securities	$	18,176	$	361		$	9,999		$	1,433	$	28,175	$	1,794
State and municipal		23,177			811				2,415			361			25,592		1,172
Other than temporary impairment
Subordinated debentures		—			—				310			190			310		190
Private label CMO’s	$	1,051	$	153		$	729		$	155	$	1,780	$	308
Total temporarily impaired securities	$	51,878		$	1,397			$	2,725		$	551		$	54,603	$	1,948
Total other than temporarily impaired securities	$	1,051	$	153		$	729		$	155	$	1,780	$	308
Other than temporary impairment Private label CMO’s	$	—		$	—			$	726		$	84		$	726	$	84
Total other than temporarily impaired securities	$	—		$	—			$	726		$	84		$	726	$	84

	2008
	2009
	Less Than 12 Months					~~12 Months or More~~		12 Months or More			~~Total~~			Total
	Fairvalue		Unrealizedlosses			Fairvalue			Unrealizedlosses		Fairvalue		Unrealizedlosses
	Fair			Unrealized				Fair			Unrealized			Fair		Unrealized
	(Amounts in thousands)
	value			losses				value			losses			value		losses
Securities available for sale:
	(Amounts in thousands)
U.S. government agency securities	$	—	$	—		$	—		$	—	$	—	$	—
Securities available for sale:
Mortgage-backed securities		6,095		283			576			21		6,671		304
U.S. government agency securities	$	7,095		$	69			$	—		$	—		$	7,095	$	69
State and municipal		16,690		1,366			917			320		17,607		1,686
Mortgage-backed securities		2,039			19				—			—			2,039		19
Subordinated debentures		350		150			—			—		350		150
Private label CMO’s		—			—				2,295			405			2,295		405
Total temporarily impaired securities	$	23,135	$	1,799		$	1,493		$	341	$	24,628	$	2,140
State and municipal		9,042			273				7,384			848			16,426		1,121
Subordinated debentures		—			—				320			180			320		180
Total temporarily impaired securities	$	18,176		$	361			$	9,999		$	1,433		$	28,175	$	1,794
Other than temporary impairment Private label CMO’s	$	1,051		$	153			$	729		$	155		$	1,780	$	308
Total other than temporarily impaired securities	$	1,051		$	153			$	729		$	155		$	1,780	$	308

The Company had 3354 securities with gross unrealized losses at December 31, ~~2009~~2010. These securities include ~~three~~four U.S. government agency bonds, ~~one~~nine mortgage-backed securities, ~~seven~~three government sponsored enterprise collateralized mortgage obligations, one private label collateralized mortgage ~~obligations~~obligation, 2136 state and municipal securities and one subordinated debenture. The government sponsored enterprise collateralized mortgage obligations were comprised of GNMA issues. Management feels that the unrealized loss is attributable to a limited market for trading these types of securities and the interest rate spreads. None of the unrealized losses identified on temporarily impaired securities as of December 31, ~~2009~~2010 or ~~2008~~2009 relate to the issuer’s ability to honor redemption obligations or the marketability of the securities. The bond ratings of the municipal securities include two AAA rated bonds, twenty-nine AA rated bonds and five A rated bonds. No municipal securities have a rating below A. The municipal securities portfolio is geographically diversified. It is not more likely than not that these securities will have to be sold prior to recovery.

The aggregate amortized cost and fair value of debt securities at December 31, 2009, by remaining contractual maturity, are shown below. Actual expected maturities for may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

	Available for Sale
	Amortizedcost		Fairvalue
	(Amounts in thousands)
U.S. agency securities:
Due in 1 year or less	$	—	$	—
Due in 1 year through 5 years		1,013		1,012
Due after 5 years through 10 years		11,100		11,045
Due after 10 years		—		—
State and municipal securities:
Due in 1 year or less		—		—
Due in 1 year through 5 years		5,083		4,949
Due after 5 years through 10 years		10,892		10,675
Due after 10 years		13,404		12,825
Subordinated debentures:
Due after 10 years		500		320
Other equity securities		—		—
Private label CMO’s		5,683		4,976
Mortgage-backed securities		23,690		24,917
Total	$	71,365	$	70,719

The aggregate amortized cost and fair value of debt securities at December 31, 2010, by remaining contractual maturity, are shown below. Actual expected maturities for may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Proceeds from sales of investment securities available for sale amounted to $36.2 million, $44.7 million and $31.7 million for the years ended December 31, 2009, 2008 and 2007, respectively. Aggregate gross realized gains from the sales of investment securities available for sale amounted to $406,000, $29,000 and $8,000 for the years ended December 31, 2009, 2008 and 2007, respectively. Gross realized losses from the sale of investment securities available for sale amounted to $217,000, $0, and $0 for the year-s ended December 31, 2009, 2008 and 2007. Realized losses from the impairment of private label mortgage backed securities amounted to $148,000 for the year ended December 31 2009 and $490,000 for the year ended December 31, 2008, resulting from increased default rates on underlying collateral payments and credit rating deterioration.


	Available for Sale
	Amortized cost		Fair value
	(Amounts in thousands)

U.S. agency securities:
Due in 1 year or less	$	6,566	$	6,451
Due in 1 year through 5 years		3,024		3,075
Due after 5 years through 10 years		1,000		979
Due after 10 years		—		—
State and municipal securities:
Due in 1 year or less		—		—
Due in 1 year through 5 years		7,398		7,178
Due after 5 years through 10 years		11,638		11,474
Due after 10 years		12,768		12,052
Subordinated debentures:
Due after 5 years through 10 years		500		310
Other equity securities		—		—
Government service enterprise CMO’s		8,757		8,693
Private label CMO’s		810		726
Mortgage-backed securities		39,278		39,214


Total	$	91,739	$	90,152

~~Debt~~Proceeds from sales of investment securities ~~were~~available ~~divided~~for ~~into~~sale ~~two~~amounted ~~groups~~to $52.9 million, ~~those~~$36.2 ~~rated~~million ~~investment grade~~and by$44.6 atmillion for ~~least~~the ~~one~~years ~~nationally-recognized~~ended ~~rating~~December 31, ~~agency~~2010, 2009 and ~~those~~2008, ~~rated~~respectively. ~~below~~Aggregate ~~investment~~gross ~~grade~~realized bygains ~~all~~from ~~nationally-recognized~~the ~~agencies.~~sales ~~Impairment~~ of ~~debt~~investment securities ~~consistently~~available ~~rated~~for ~~investment~~sale ~~grade~~amounted isto ~~considered~~$954,000, ~~temporary~~$406,000 ~~unless~~and ~~specific~~$29,000 for the years ended December 31, 2010, ~~contrary~~2009 ~~information~~and is2008, ~~identified~~respectively. ~~None~~Gross ofrealized losses from the ~~debt~~sale of investment securities ~~consistently~~available ~~rated~~for ~~investment~~sale ~~grade~~amounted ~~were~~to ~~considered~~$903,000, $217,000, and $0 for the years ended December 31, 2010, 2009 and 2008. Realized losses from the impairment of private label mortgage backed securities amounted to be$29,000 ~~other-than-temporarily~~for ~~impaired~~the atyear ended December 31, 2010, $148,000 for the year ended December 31 2009 and $490,000 for the year ended December 31, 2008, resulting from increased default rates on underlying collateral payments and credit rating deterioration.

AtDebt ~~December 31,~~securities ~~2009~~were ~~approximately~~divided ~~$2.7~~into ~~million~~two ~~(based~~groups, onthose ~~amortized~~rated ~~cost~~investment ~~before~~grade by ~~impairment~~at ~~charges)~~least ofone ~~our taxable portfolio, (consisting of two private label mortgage~~nationally-~~backed~~recognized ~~securities~~rating agency and ~~one subordinated~~those ~~debenture) was~~ rated below investment grade by all nationally-recognized ~~rating~~ agencies. ~~Five~~Impairment ~~municipal securities with a total amortized cost~~ of ~~$4.8~~debt ~~million,~~securities ~~and~~consistently ~~which previously were AAA~~ rated ~~had~~investment ~~become~~grade ~~non-rated~~is asconsidered atemporary ~~result~~unless ofspecific contrary ~~insurance~~information ~~guarantors’~~is ~~credit quality concerns~~identified. AtNone ~~December 31,~~of ~~2009,~~ the ~~aggregate~~debt ~~unrealized loss on the private label mortgage-backed~~ securities, ~~subordinated~~consistently ~~debenture and municipal securities totaled $1.3 million before recognition of any other-than-temporary impairment charges. Impairment of securities~~ rated ~~below~~ investment grade were ~~evaluated~~considered to ~~determine~~be ifother-than-temporarily weimpaired ~~expect~~at to recover the entire amortized cost basis of the security. This evaluation for the private label CMO’s was based on projections of estimated cash flows based on individual loans underlying each security using current and anticipated increases in unemployment and default ratesDecember 31, ~~decreases~~2010 ~~in housing prices~~ and ~~increases in loss severity at foreclosure. The evaluation of the subordinated debentures and municipal securities was based on an analysis of the issuers financial statements~~December 31, ~~debt service reserves, past debt service performance as well as other factors~~2009.

At December 31, 2010 approximately $1.3 million (based on amortized cost before impairment charges) of our taxable portfolio, (consisting of one private label mortgage-backed security and one subordinated debenture) was rated below investment grade by all nationally-recognized rating agencies. At December 31, 2010, the aggregate unrealized loss on the private label mortgage-backed security and subordinated debenture totaled $274,000 before recognition of any other-than-temporary impairment charges. Impairment of securities rated below investment grade were evaluated to determine if we expect to recover the entire amortized cost basis of the security. This evaluation for the private label CMO was based on projections of estimated cash flows based on individual loans underlying each security using current and anticipated increases in unemployment and default rates, decreases in housing prices and increases in loss severity at foreclosure. The evaluation of the subordinated debentures was based on an analysis of the issuer’s financial statements, debt service reserves, past debt service performance as well as other factors.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

The primary assumptions used in this evaluation were:

Prepayments -– starting with current refinancing and payoff prepayment vector statistics based on information derived from the trustee. The ~~bonds’~~ bond’s prepayment ~~vectors~~vector (VPR) anticipates 86 VPR for 152 months and then ~~returning~~returns to historical norms of 4 VPR to maturity.

Default rate – The model takes the consumer default rate from the mortgage backed ~~bonds~~bond’s 2 month average default rate from 5.4% ~~for~~and ~~one~~ramps ~~private~~it ~~label~~up ~~CMO~~to ~~and 15~~17.5% ~~for~~over the ~~second~~next ~~private~~12 ~~label~~months, ~~CMO~~where ~~over~~it ~~the~~remains ~~next~~for another 12 months and down to 34.70% through maturity.

Loss severity – ~~estimated~~Recoveries ~~foreclosure~~on ~~rates~~liquidation ~~are~~collateral ~~35%~~ for ~~one~~this ~~private~~bond ~~label~~have ~~CMO~~been ~~and~~relatively ~~45%~~high for Alternative A collateral in the ~~second~~current economic ~~private~~environment, ~~label~~most ~~CMO~~likely ~~for~~due to the ~~next~~low ~~twelve~~initial ~~months. After~~loan-to-value 12and ~~months~~geographic adiversity ~~reversion~~in tothis adeal. ~~more~~During ~~typical~~the ~~25%~~past two quarters severity ~~rate~~was ~~for~~37%, ~~one~~therefore, ~~CMO~~estimated ~~and~~foreclosure rate assumptions are 35% ~~for~~over the ~~second~~life ~~CMO.~~of the instrument. Loss severity includes estimated holding and disposal expenses.

Discount rates – estimated cash flows were discounted at ~~rates that range from 5.50% to~~ 6.00% based on our purchase ~~yields~~yield of the ~~two~~ private label CMO’s analyzed.

The evaluation uses an adjusted loan to value ratio as part of our evaluation of whether the unrealized losses on ~~these~~this ~~securities~~security are temporary or other-than-temporary. The adjusted loan to value ratio is based on the original loan to value ratio inherent in the security, adjusted for changes in housing prices, prepayment speeds, default rates and credit enhancements. A higher adjusted loan to value ratio indicates a greater likelihood that projected cash flows may result in losses. A shortfall between our current amortized cost and the present value of expected cash flows we are likely to collect, based on all available information, is referred to as the credit loss, which is the amount recognized in net income.

The evaluation of previously recognized other-than-temporary impairment at December 31, 2008 was $490,000. In accordance with the provision set forth in ASC 320-10-65-1 of the other-than-temporary impairment charge recognized in 2008, $343,000 was determined to relate to other non-credit-related factors in the market place. This resulted in an adjustment to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income in the amount of $211,000, net of tax effect.

Based on our evaluation, ~~two~~one ~~securities~~security ~~were~~was identified with other-than-temporary impairment at December 31, ~~2009~~2010. For the year-ended December 31, 2010 total other than temporary impairment losses totaled $110,000 and of this amount estimated credit losses totaled $29,000 on this security, which was charged against earnings. For the year-ended December 31, 2009 total other than temporary impairment losses totaled $456,000 and of this amount estimated credit losses totaled $148,000 on ~~these securities~~this security, which ~~were~~was charged against earnings. The difference between total unrealized losses and estimated credit losses on these securities was charged against accumulated other comprehensive income, net of deferred taxes.

The following table shows a roll forward of the amount related to credit losses recognized on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.

	Twelve Months EndedDecember 31, 2009
	Twelve Months Ended December 31,
	(Amounts in thousands)
	2010		2009
Balance of credit losses on debt securities at the beginning of the period	$	147
	(Amounts in thousands)		(Amounts in thousands)
Additional increase related to the credit loss for which an other-than-temporary impairment was previously recognized		148
Balance of credit losses on debt securities at the beginning of the period	$	148	$	—
Balance of credit losses on debt securities at the end of the current period	$	295
Additional increase related to the credit loss for which an other-than-temporary impairment was previously recognized		29		148
Balance of credit losses on debt securities at the end of the current period	$	177	$	148

At December 31, 2009, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Company is $2.3 million. On March 25, 2009 and May 8, 2009, FHLB announced that it would not pay a dividend for the fourth

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

~~quarter~~At ~~of 2008 or first quarter of 2009~~December 31, ~~respectively~~2010, ~~reflecting~~the abalance ~~conservative~~of ~~financial~~Federal ~~management~~Home ~~approach~~Loan inBank ~~light~~(“FHLB”) of ~~continued~~Atlanta ~~volatility~~stock held inby the ~~financial~~Company ~~markets~~is $2.2 million. On ~~February~~May 2711, ~~2009~~ 2010, the FHLB announced that it would ~~increase~~pay a dividend for the ~~Subclass~~first B1quarter ~~membership~~of ~~stock~~2010. ~~requirement~~On ~~cap~~June 30, ~~from~~2010, ~~$25~~the ~~million~~FHLB also announced its intentions of repurchasing up to $26300 million ~~and~~of ~~approve~~its stockholders’ ~~excess~~capital ~~activity-based~~that ~~stock~~its ~~repurchases~~“members” onowned ain ~~quarterly~~excess ~~review~~of ~~cycle~~amounts ~~instead~~the ofmembers ~~daily~~are inrequired ~~order~~ to ~~facilitate capital~~own. ~~management~~This repurchase was transacted on July 15, 2010. On ~~August~~July 1229, ~~2009~~2010, the FHLB announced anthat ~~annualized~~it ~~dividend~~would ~~rate~~pay ofa ~~0.84~~dividend ~~percent,~~for ~~which~~the second ~~was~~quarter ~~paid~~of ~~on August 14, 2009~~2010. On October 3029, ~~2009~~2010, the FHLB announced anthat ~~annualized~~it ~~dividend~~would ~~rate~~pay a dividend for the third quarter ~~ended September~~of 2010. The FHLB also announced on October 3029, ~~2009~~2010 its intentions of ~~0.41~~repurchasing ~~percent~~up ~~which~~to ~~was~~$300 ~~credited~~million toof ~~member~~its stockholders’s ~~accounts~~capital that its “members” owned in excess of amounts the members are required to own. This repurchase did take place on November 215, ~~2009~~2010. Given ~~all~~ this, management believes that its investment in FHLB stock was not other-than-temporarily impaired as of December 31, ~~2009 or December 31, 2008~~2010. ~~Further~~However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not cause a decrease in the value of the FHLB stock held by the Company.

Investment securities with amortized cost of $2325.90 million and fair value of $2324.07 million at December 31, ~~2009~~2010 were pledged to secure both financing from the FHLB and for public monies on deposit as required by law.

Note D - Loans

Following is a summary of loans at December 31, ~~2009~~2010 and ~~2008~~2009:

	2009			2008
	2010			2009
	(Amounts in thousands)
Real estate:
Construction loans	$	6743,~~635~~934		$	9167,~~933~~635
Commercial mortgage loans		~~174~~173,~~926~~275			~~156~~174,~~333~~926
Home equity lines of credit		4443,~~627~~611			4344,~~290~~627
Residential mortgage loans		8172,~~377~~370			7381,~~595~~377
Total real estate loans		~~368~~333,~~565~~190			~~365~~368,~~151~~565
Commercial and industrial loans		6461,~~173~~230			6364,~~239~~173
Loans to individuals for household, family and other personal expenditures		5,~~383~~398			65,~~306~~383
Unamortized net deferred loan origination (fees) costs		~~(34~~11	)		(34	)
Total loans	$	~~438~~399,~~087~~829		$	~~434~~438,~~662~~087

The recorded investment in loans on nonaccrual status was $7.35 million and $37.13 million as of December 31, ~~2009~~2010 and ~~2008~~2009, respectively. At December 31, ~~2009~~2010 and ~~2008~~2009, the recorded investment in loans considered impaired totaled $1120.02 million and $411.0 million, respectively. Impaired loans of $86.27 million and $38.32 million at December 31, ~~2009~~2010 and ~~2008 had~~2009 had corresponding valuation allowances of $695,000 and $1.2 million, respectively. At December 31, 2010, $4.6 million of the $20.2 million of impaired loans was attributed to twelve troubled debt restructurings (TDRs) and represented $~~520~~273,000 of the $695,000 ~~respectively~~valuation allowance. Eight of the twelve TDRs are accruing interest as of December 31, 2010. At December 31, 2009, $2.6 million of the $811.20 million of impaired loans was attributed to two troubled debt restructurings (TDRs) and represented $597,000 of the $1.2 valuation allowance. The two TDRs are accruing interest as of December 31, 2009. ~~There were no TDRs at December 31, 2008.~~ Impaired loans of $213.84 million and $~~704,000~~2.8 million at December 31, ~~2009~~2010 and ~~2008~~2009 had no valuation allowances. For the years ended December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008, the average recorded investment in impaired loans was approximately $523.71 million, $25.97 million and $12.19 million, respectively. The amount of interest recognized on impaired loans during the portion of the year that they were impaired was $1.0 million for 2010 and was not material for 2009 and 2008.

The Company’s lending is concentrated primarily in Alamance and Guilford Counties and the surrounding areas. The Company had loan and deposit relationships with most of its directors and executive officers and with companies with which certain directors and executive officers are associated. The following is a reconciliation of loans directly outstanding to executive officers, directors and their affiliates (amounts in thousands):

Balance at December 31, 2008	$	9,788
New loans		1,905
Principal repayments		(2,034	)
Balance at December 31, 2009	$	9,659

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, ~~2009~~2010, ~~2008~~2009 and ~~2007~~2008

AsLoan aOrigination/Risk ~~matter~~Management. ofThe ~~policy,~~Company ~~these~~has ~~loans~~certain lending policies and ~~credit~~procedures ~~lines~~in place that are ~~approved~~designed byto ~~the~~maximize ~~Bank’s~~loan ~~Board~~income ofwithin ~~Directors and~~an ~~are~~acceptable ~~made~~level ~~with~~of ~~interest~~risk. ~~rates,~~Management ~~terms,~~reviews and ~~collateral~~approves ~~requirements~~these ~~comparable~~policies toand ~~those~~procedures ~~required~~on ofa ~~other~~regular ~~borrowers~~basis. InA reporting system supplements the ~~opinion~~review ofprocess by providing management with frequent reports related to loan production, ~~these~~loan ~~loans~~quality, doconcentrations ~~not~~of ~~involve~~credit, ~~more~~loan ~~than~~delinquencies and non-performing and potential problem loans. Diversification in the ~~normal~~loan ~~risk~~portfolio is a means of ~~collectibility~~managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrowers’ ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable, inventory or equipment and usually incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of the funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate and commercial mortgage loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in real estate markets or the general economy. The properties securing the Corporation’s commercial real estate portfolio are diverse in terms of type. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2010, approximately 22.1% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Corporation may originate from time to time, the Company generally requires the borrower to have an existing relationship with Company and have a proven record of success. Commercial and Residential Construction loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with the repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Most residential mortgage loans originated by the Company are sold into the secondary market adhering to secondary market underwriting requirements. However, residential mortgage loans retained in-house are underwritten with a bias toward first liens against the borrowers’ primary residence, generally located in the Company’s target market area. In-house residential mortgages must meet loan-to-value appraisal and debt ratio guidelines.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

The Company originates consumer loans utilizing a computer based credit score analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimize risk. Additionally, trend and outlook reports are viewed by management on a regular basis.

Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 90%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

The Company maintains an independent loan review function that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process compliments and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Concentrations of Credit. Most of the Company’s lending activity occurs within the counties of Alamance and Guilford counties in the state of North Carolina as well as other markets. The majority of the Company’s loan portfolio consists of commercial and industrial and commercial real estate loans. As of December 31, 2010 and 2009, there was no concentration of loans related to any single industry in excess of 11% of total loans.


Balance at December 31, 2009	$	9,659
New loans		3,190
Principal repayments		(2,694	)


Balance at December 31, 2010	$	10,155

As a matter of policy, these loans and credit lines are approved by the Bank’s Board of Directors and are made with interest rates, terms, and collateral requirements comparable to those required of other borrowers. In the opinion of management, these loans do not involve more than the normal risk of collectability.

Non-Accrual and Past Due Loans. The following past due and nonaccrual policy applies to all classes of loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all principal and interest amounts contractually are brought current and future payments are reasonably assured.

Charge-off of Uncollectible Loans. When any loan or portion thereof becomes uncollectible, the loan will be charged down or charged off against the allowance for loan and lease losses. Residential mortgages are charged-off or written down to fair value when the loan has been foreclosed and the balance exceeds the market value of the collateral. Home equity lines of credit are either charged-off or written down to fair value, when determined that there is not sufficient equity in the loan to cover the Company’s exposure. Loans in any portfolio may be charged-off prior to the policies described above when a loss confirming event occurred, such as bankruptcy (unsecured), continued delinquency, or receipt of an asset valuation indicating collateral deficiency for an asset serving as sole source of repayment.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Age Analysis of Past Due Loans

As of December 31, 2010 (in thousands)


	30- 89 Days Past Due		Greater than 90 Days Past Due (1)		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Loans:
Commercial construction loans	$	195	$	—	$	195	$	9,214	$	9,409	$	—
Commercial mortgage loans		362		4,868		5,230		168,045		173,275		—
Commercial and industrial loans		311		99		410		60,820		61,230		—
Residential construction loans		—		3,383		3,383		31,142		34,525		—
Residential mortgage loans		807		455		1,262		71,119		72,381		—
Consumer loans		184		53		237		5,161		5,398		—
Home equity lines of credit		33		221		254		43,357		43,611		—


Total	$	1,892	$	9,079	$	10,971	$	388,858	$	399,829	$	—

(1)	As the Company has no loans past due 90 or more days and still accruing, this category only includes non-accrual loans.

Impaired Loans. The following impaired loan policy applies to all classes of loans. Impaired loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectable. Year-end impaired loans are set forth in the following table.

For the twelve months ended December 31, 2010 (in thousands)


	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial construction loans	$	—	$	—	$	—	$	—	$
Commercial mortgage Loans		6,382		6,382		—		7,332		289
Commercial and industrial loans		3,365		3,365		—		4,549		144
Residential construction loans		3,013		3,013		—		3,635		172
Residential mortgage Loans		362		362		—		402		26
Consumer Loans		75		75		—		69		5
Home equity lines of credit		223		223		—		446		20

Subtotal		13,420		13,420		—		16,433		656

With a related allowance recorded:
Commercial construction Loans		—		—		—		—		—
Commercial mortgage loans		1,907		1,907		352		1,796		92
Commercial and Industrial Loans		1,640		1,640		40		1,784		98
Residential construction loans		2,032		2,032		253		2,038		100
Residential mortgage loans		1,152		1,152		46		1,059		72
Consumer Loans		7		7		4		—		—
Home Equity Lines of credit		—		—		—		—		—

Subtotal		6,738		6,738		695		6,677		362

Totals
Commercial construction loans		—		—		—		—		—
Commercial mortgage loans		8,289		8,289		352		9,129		381
Commercial and Industrial Loans		5,005		5,005		40		6,333		242
Residential construction loans		5,045		5,045		253		5,673		272
Residential mortgage loans		1,514		1,514		46		1,461		98
Consumer loans		82		82		4		69		5
Home equity lines of credit		223		223		—		445		20

Grand total	$	20,158	$	20,158	$	695	$	23,110	$	1,018

Of the $13.4 million of impaired loans with no related allowance recorded, $7.0 million is recorded at fair value after previous recognition of $2.1 million of charge-offs prior to year-end.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted –average risk grade commercial loans, (ii) the level of classified commercial loans, (iii) net charge-offs, (iv) non-performing loans (see details above) and (v) the general economic conditions in the state of North Carolina.

The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 grades is as follows:

•

Grade 1 – Virtually no risk – Credits in this grade are virtually risk-free. Credits are secured by assignment of certificates of deposits issued by the Company, US Treasury notes or properly margined, readily marketable securities. Positive control must be maintained by the Company. The repayment program is well-defined and achievable and repayment sources numerous.

•

Grade 2 – Minimal credit risk – This grade is reserved for new and existing loans where the borrower has documented significant overall financial strength. A liquid financial statement with substantial liquid assets, particularly relative to the debts. Borrowers are required to show excellent sources of repayment, with no significant identifiable risk of collection.

•

Grade 3 – Average credit risk – These loans have excellent sources of repayment, with no significant identifiable risk of collection. The borrowers have documented historical cash flow that meets or exceeds required minimum Company’s guidelines. The borrower must have adequate secondary sources to liquidate the debt, or liquidation value for the net worth of the borrower or guarantor.

•

Grade 4 – Average credit risk – These loans have adequate sources of repayment, with little identifiable risk of collection.

•

Grade 5 – Above average credit risk – These loans show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.

•

Grade 6 – Special mention – These loans have clearly defined weaknesses in primary source of repayment that, if not corrected, could cause a loss to the Company. The loans constitute an undue and unwarranted credit risk to the Company, but are not considered so severe as to meet the definition of Substandard.

•

Grade 7 – Substandard – This grade includes loans that are inadequately protected by the current net worth and paying capacity of the obligator or of the collateral pledged. The loans have well defined weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

•

Grade 8 – Doubtful – This category has the weaknesses inherent in substandard loans and the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. The loans are not yet graded as loss because certain events may occur that could salvage the outstanding debt such as the injection of capital, alternative financing is obtained, or the pledging of additional collateral. Doubtful is a temporary grade where loss is anticipated but is not quantified with any degree of accuracy.

•

Grade 9 – Loss – These loans are considered uncollectable and of such little value that their continuance as a bankable asset is not warranted. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Commercial Credit Exposure

Credit Risk Profile by Internally Assigned Grade


Code	Commercial Construction		Commercial Mortgage		Commercial and Industrial
Virtually no credit risk	$	—	$	—	$	692
Minimal credit risk		—		—		983
Good credit risk		—		11,364		9,808
Acceptable credit risk		2,061		94,969		30,997
Above average credit risk		3,954		43,906		13,857
Special mention		1,567		12,911		3,443
Substandard		1,827		10,125		1,450
Doubtful		—		—		—
Loss		—		—		—


	$	9,409	$	173,275	$	61,230

Consumer Credit Exposure

Credit Risk Profile by Creditworthiness Category


Grade	Residential Construction		Residential Mortgage		Consumer		Home Equity Lines of Credit

Virtually no credit risk	$	—	$	—	$	—	$	—
Minimal credit risk		—		639		70		26
Good credit risk		967		708		207		444
Acceptable credit risk		6,300		43,131		4,800		40,660
Above average credit risk		12,644		21,407		294		1,886
Special mention		8,575		4,496		26		456
Substandard		6,039		1,989		1		139
Doubtful		—		—		—		—
Loss		—		—		—		—


	$	34,525	$	72,370	$	5,398	$	43,611

Consumer and Commercial Credit Exposure

Credit Risk Profile Based on Payment History


Status	Construction		Commercial Mortgage		Home Equity Lines of Credit		Residential Mortgage		Commercial and Industrial		Consumer

Performing	$	40,551	$	168,407	$	43,390	$	71,915	$	61,131	$	5,345
Nonperforming		3,383		4,868		221		455		99		53


	$	43,934	$	173,275	$	43,611	$	72,370	$	61,230	$	5,398

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Note E - Allowance for Loan Losses

AnThe allowance for loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that have been ~~analysis~~incurred within the existing portfolio of ~~activity~~loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for possible loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, Receivables and allowance allocations calculated in accordance with ASC Topic 450, Contingencies. Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The corporation’s process for determining the appropriate level of the allowance for possible loan losses is designed to account for credit deterioration as it occurs. The provision for possible loan losses reflects loan quality trends, including the ~~years~~levels ~~ended~~of ~~December 31~~and trends related to non-accrual loans, ~~2009~~past due loans, potential ~~2008~~problem loans, criticized loans and ~~2007~~net ~~follows:~~charge-offs or recoveries, among other factors. The provision for possible loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for possible loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

	2009			2008			2007
	(Amounts in thousands)
Balance at beginning of year	$	5,632		$	4,462		$	4,222
Provision for loan losses		4,455			1,665			425
Charge-offs		(3,025	)		(533	)		(296	)
Recoveries		245			38			111
Net charge-offs		(2,780	)		(495	)		(185	)
Balance at end of year	$	7,307		$	5,632		$	4,462

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, resent economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The allowance established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things; (i) obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 7 or higher a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for possible loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based on the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similar risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating among other things; (i) the experience, ability and effectiveness of the Bank’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks: and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then input into a “general allocation matrix” to determine an appropriate general valuation allowance.

Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy exceptions that exceed specified risk grades.

Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirement.

An analysis of activity in the allowance for loan losses for the years ended December 31, 2010, 2009 and 2008 follows:


	2010			2009			2008
	(Amounts in thousands)
Balance at beginning of year	$	7,307		$	5,632		$	4,462
Provision for loan losses		6,418			4,455			1,665

Charge-offs		(4,810	)		(3,025	)		(533	)
Recoveries		311			245			38


Net charge-offs		(4,499	)		(2,780	)		(495	)


Balance at end of year	$	9,226		$	7,307		$	5,632

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Allowance for Loan Losses and Recorded Investment in Loans

For the Twelve Months Ended December 31, 2010 (in thousands)


	Real Estate
	Construction Loans		Commercial Mortgage Loans		Home Equity Lines of Credit		Residential Mortgage Loans		Commercial and Industrial Loans		Consumer Loans		Total
Allowance for loan losses
Beginning balance	$	1,127	$	2,918	$	744	$	1,358	$	1,071	$	89	$	7,307
Charge-offs		2,388		965		319		462		611		65		4,810
Recoveries		131		2		—		25		103		50		311
Provision		3,209		1,284		385		642		834		64		6,418

Ending balance	$	2,079	$	3,239	$	810	$	1,563	$	1,397	$	138	$	9,226


Portion of ending balance:
Individually evaluated for impairment	$	253	$	352	$	—	$	46	$	40	$	4	$	695
Collectively evaluated for impairment		1,826		2,887		810		1,517		1,357		134		8,531

Total loans evaluated for impairment	$	2,079	$	3,239	$	810	$	1,563	$	1,397	$	138	$	9,226


Loans
Ending balance	$	43,934	$	173,275	$	43,611	$	72,381	$	61,230	$	5,398	$	399,829


Portion of ending balance:
Individually evaluated for impairment	$	5,045	$	8,289	$	223	$	1,514		5,005	$	82	$	20,158
Collectively evaluated for impairment		38,889		164,986		43,388		70,867		56,225		5,316		379,671

Total loans evaluated for impairment	$	43,934	$	173,275	$	43,611

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