NORTH STATE BANCORP - FORM 10-Q/A

Attached files

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EX-31.2 - EXHIBIT 31.2 - NORTH STATE BANCORP	ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - NORTH STATE BANCORP	ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - NORTH STATE BANCORP	ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - NORTH STATE BANCORP	ex32-2.htm

U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q/A

(Amendment No. 1)

[ X ] Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2011

[ ] Transition Report Pursuant to Section 13

or 15(d) of the Securities Exchange Act of 1934

For the transition period ended

Commission File Number - 000-49898

NORTH STATE BANCORP

(Exact name of small business issuer as specified in its charter)

NORTH CAROLINA		65-1177289
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification Number)

6204 FALLS OF THE NEUSE ROAD, RALEIGH, NORTH CAROLINA 27609

(Address of principal executive office)

(919) 787-9696

(Issuer’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes _____ No _____

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

Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] (Do not check if a smaller reporting company) Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12 b-2 of the Exchange Act): Yes _____ No __X _

As of May 11, 2011, 7,297,495 shares of the registrant’s common stock, no par value per share, were outstanding. The registrant has no other classes of securities outstanding.

Explanatory Note

The purpose of this Amendment No. 1 to North State Bancorp's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2011, filed with the U.S. Securities and Exchange Commission on May 13, 2011 (the “Form 10-Q”), is to furnish an up-to-date and final version of the filing. An early version of the Form 10-Q was mistakenly filed, and should not be relied upon.


			Page No.
Part I.	FINANCIAL INFORMATION

Item 1 -	Financial Statements (Unaudited)

		Consolidated Balance Sheets
		March 31, 2011 and December 31, 2010	3

		Consolidated Statements of Operations
		Three Months Ended March 31, 2011 and 2010	4

		Consolidated Statements of Comprehensive Income
		Three Months Ended March 31, 2011 and 2010	5

		Consolidated Statement of Shareholders’ Equity
		Three Months Ended March 31, 2011 and 2010	6

		Consolidated Statements of Cash Flows
		Three Months Ended March 31, 2011 and 2010	7

		Notes to Consolidated Financial Statements	8

Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations		30

Item 3 -	Quantitative and Qualitative Disclosures About Market Risk		41

Item 4 -	Controls and Procedures		41

Part II.	OTHER INFORMATION

Item 6 -	Exhibits		42

- 2 -

Part I. FINANCIAL INFORMATION

Item 1 - Financial Statements

NORTH STATE BANCORP

CONSOLIDATED BALANCE SHEETS

	March 31, 2011 (Unaudited)			December 31, 2010*
	(Dollars in thousands)

ASSETS

Cash and due from banks	$	8,555		$	5,974
Interest-earning deposits with banks		95,729			43,859
Certificates of deposit with banks		-			198
Investment securities available for sale, at fair value		30,020			9,234
Investment securities held to maturity, at amortized cost		250			250
Loans held-for-sale		11,848			51,472

Loans		480,165			499,523
Less allowances for loan losses		9,346			9,935
NET LOANS		470,819			489,588
Accrued interest receivable		1,560			1,654
Stock in the Federal Home Loan Bank of Atlanta, at cost		1,273			1,273
Premises and equipment, net		14,660			14,801
Foreclosed assets		4,842			5,296
Prepaid FDIC insurance		3,349			3,646
Other assets		6,679			6,620
TOTAL ASSETS	$	649,584		$	633,865

LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits:
Demand	$	137,068		$	117,840
Savings, money market and NOW		263,028			250,469
Time		177,610			194,439
TOTAL DEPOSITS		577,706			562,748
Accrued interest payable		1,058			1,181
Short-term borrowings		4,524			3,615
Long-term borrowings		27,263			27,269
Accrued expenses and other liabilities		1,320			1,550
TOTAL LIABILITIES		611,871			596,363
Commitments

Shareholders’ equity:
Preferred stock, no par value, 1,000,000 shares authorized, none issued
Common stock, no par value; 10,000,000 shares authorized 7,427,976 shares issued and outstanding March 31, 2011 and December 31, 2010		21,661			21,636
Retained earnings		16,130			15,926
Accumulated other comprehensive loss		(78	)		(60	)

TOTAL SHAREHOLDERS’ EQUITY		37,713			37,502

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	649,584		$	633,865

*Derived from audited consolidated financial statements.

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

	Three Months Ended March 31,
	2011		2010
	(Dollars in thousands, except per share data)
INTEREST INCOME
Loans	$	6,660	$	7,101
Loans held for sale		274		60
Investments		103		210
Dividends and interest-earning deposits		43		229
TOTAL INTEREST INCOME		7,080		7,600

INTEREST EXPENSE
Money market, NOW and savings deposits		480		545
Time deposits		770		1,386
Short-term borrowings		1		6
Long-term debt		231		220
TOTAL INTEREST EXPENSE		1,482		2,157

NET INTEREST INCOME		5,598		5,443

PROVISION FOR LOAN LOSSES		1,015		1,250
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		4,583		4,193

NON-INTEREST INCOME
Merchant and other loan fees		26		30
Service charges and fees on deposits		98		98
Gain on sale of investment securities		-		232
Fees from mortgage operations		497		169
Other		122		57
TOTAL NON-INTEREST INCOME		743		586

NON-INTEREST EXPENSE
Salaries and employee benefits		2,303		1,637
Occupancy and equipment		703		711
Professional fees		82		95
Advertising and promotion		29		50
Data processing and other outsourced services		470		353
FDIC insurance		332		364
Net cost of foreclosed assets		491		327
Other		592		366
TOTAL NON-INTEREST EXPENSE		5,002		3,903

INCOME BEFORE INCOME TAXES		324		876

INCOME TAXES		120		362
NET INCOME	$	204	$	514
NET INCOME PER COMMON SHARE
Basic	$	.03	$	.07
Diluted	$	.03	$	.07
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic		7,427,976		7,257,980
Diluted		7,433,773		7,319,626

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

	Three Months Ended March 31,
	2011			2010
	(Dollars in thousands)

Net income	$	204		$	514

Other comprehensive loss:
Securities available for sale:
Unrealized holding gains on available for sale securities		(29	)		35
Tax effect		11			(13	)
Reclassification of net gain recognized in net income		-			(232	)
Tax effect		-			89
Net of tax amount		(18	)		(121	)

Total other comprehensive loss		(18	)		(121	)

Comprehensive income	$	186		$	393

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)

							Accumulated
							other			Total
	Common stock				Retained		comprehensive			shareholders'
	Shares		Amount		Earnings		income (loss)			equity
	(Dollars in thousands)

Balance as of December 31, 2009		7,198,513	$	20,865	$	14,902	$	399		$	36,166
Net income		-		-		514		-			514
Other comprehensive loss, net of tax		-		-		-		(121	)		(121	)
Stock based compensation		-		26		-		-			26
Stock options exercised including income tax benefit of $15		76,177		203		-		-			203

Balance as of March 31, 2010		7,274,690	$	21,094	$	15,416	$	278		$	36,788

Balance as of December 31, 2010		7,427,976	$	21,636	$	15,926	$	(60	)	$	37,502
Net income		-		-		204		-			204
Other comprehensive loss, net of tax		-		-		-		(18	)		(18	)
Stock based compensation		-		25		-		-			25

Balance as of March 31, 2011		7,427,976	$	21,661	$	16,130	$	(78	)	$	37,713

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Three Months Ended March 31,
	2011			2010
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	204		$	514
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Depreciation and amortization		231			237
Net amortization (accretion) of premiums and discounts on investment securities		-			(6	)
Amortization of investment accounted for under the cost method		20			9
Net realized gain on sale of investment securities available for sale		-			(232	)
Originations of loans held-for-sale		(76,535	)		(24,353	)
Proceeds from sales of loans held-for-sale		115,462			2,575
Provision for loan losses		1,015			1,250
Provision for foreclosed assets		470			233
Loss on sale of foreclosed assets		28			31
Stock based compensation		25			26
Change in assets and liabilities:
Decrease in accrued interest receivable		94			100
Decrease in other assets		926			1,998
(Decrease) increase in accrued interest payable		(123	)		71
Decrease in accrued expenses and other liabilities		(230	)		(50	)

NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES		41,587			(17,597	)

CASH FLOWS FROM INVESTING ACTIVITIES
Net change in certificates of deposit with banks		198			8,406
Proceeds from maturities and repayments of investment securities available for sale		5,811			1,235
Proceeds from sales of investment securities available for sale		-			4,885
Purchases of investment securities available for sale		(26,626	)		(4,990	)
Purchases of premises and equipment		(90	)		(49	)
Net decrease (increase) in loans		17,335			(2,141	)
Proceeds from sales of foreclosed property		438			1,996
Capital expenditures on foreclosed property		(63	)		(69	)

NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES		(2,997	)		9,273

CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		14,958			21,162
Net increase (decrease) in short-term borrowings		909			(163	)
Repayments on long-term borrowings		(6	)		(5	)
Exercise of stock options		-			203

NET CASH PROVIDED BY FINANCING ACTIVITIES		15,861			21,197

NET INCREASE IN CASH AND CASH EQUIVALENTS		54,451			12,873

CASH AND CASH EQUIVALENTS, BEGINNING		49,833			59,083

CASH AND CASH EQUIVALENTS, ENDING	$	104,284		$	71,956

See accompanying notes.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE A - BASIS OF PRESENTATION

In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of March 31, 2011 and December 31, 2010 and for the three-month periods ended March 31, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of North State Bancorp (the “Company”) and its wholly-owned subsidiary, North State Bank (the “Bank”). North State Bank Mortgage (“NSB Mortgage”), a division of the Bank, began operations during February 2010 for the purpose of originating and selling single family, residential first mortgage loans.

All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three-month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011.

The organization and business of the Company, accounting policies followed by the Company and other relevant information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2010 Annual Report on Form 10-K for the year ended December 31, 2010. This quarterly report should be read in conjunction with the Annual Report.

NOTE B – RECENT ACCOUNTING PRONOUNCEMENTS

On April 12, 2011, the FASB issued A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring providing additional guidance on whether certain loan modifications constitute troubled debt restructurings. It will assist creditors in determining whether a modified receivable is to be considered a troubled debt restructuring, including the impact on impairment and disclosures. The disclosures are effective for interim and annual periods beginning on or after June 15, 2011.

During the first quarter of 2010, additional guidance was issued under the Fair Value Measurements and Disclosures topic of the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, requiring disclosures of significant transfers in and out of Levels 1 and 2 fair value and the reasons for the transfers. Certain additional disclosures are now required in interim and annual periods to discuss the inputs and valuation technique(s) used to measure fair value. The adoption of the new accounting disclosures did not have a material effect on the Company’s financial position or results of operations.

On July 21, 2010, the FASB issued Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses with the main objective to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. The ASC amends current guidance and requires significant additional disclosures in an entity’s financial statements, including the requirement to provide a greater level of disaggregated data, as it relates to exposure to credit losses. The extensive new disclosures of information are included for both interim and annual reporting periods ending after December 15, 2010. Disclosures about Troubled Debt Restructurings, or TDRs, required by the update have been deferred by an update issued by FASB in early 2011. The TDR disclosures are anticipated to be effective for periods ending after June 15, 2011. See Note E for detail.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE B – RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

NOTE C - INVESTMENT SECURITIES

Available for sale securities are reported at fair value and consist of debt instruments not classified as trading securities or as held to maturity securities. Unrealized holding gains and losses on available for sale securities are reported, net of related tax effect, in other comprehensive income. Gains and losses on the sale of available for sale securities are determined using the specific-identification method. Bonds and mortgage-backed securities for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using a method that approximates the interest method over the period to maturity. Declines in the fair value of available for sale and held to maturity securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. If the Company does not intend to sell the security prior to recovery and it is more likely than not the Company will not be required to sell the impaired security prior to recovery, the credit loss portion of the impairment is recognized in earnings and the remaining impairment is recognized in other comprehensive income. Otherwise, the full impairment loss is recognized in earnings. The classification of securities is generally determined at the date of purchase.

The amortized cost and fair value of securities available for sale and securities held to maturity, with gross unrealized gains and losses, follows:

	As of March 31, 2011
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
	cost		gains		losses		value
	(Dollars in thousands)
Securities available for sale:
U. S. government securities and obligations of U.S. government agencies	$	1,000	$	-	$	-	$	1,000
Government-sponsored residential mortgage-backed securities		29,144		96		220		29,020
Total securities available for sale	$	30,144	$	96	$	220	$	30,020

Securities held to maturity:
Corporate securities	$	250	$	-	$	39		211
Total securities held to maturity	$	250	$	-	$	39	$	211

	As of December 31, 2010
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
	cost		gains		losses		value
		(Dollars in thousands)
Securities available for sale:
U. S. government securities and obligations of U.S. government agencies	$	5,500	$	-	$	-	$	5,500
Government-sponsored residential mortgage-backed securities		3,829		28		123		3,734
Total securities available for sale	$	9,329	$	28	$	123	$	9,234

Securities held to maturity:
Corporate securities	$	250	$	-	$	39		211
Total securities held to maturity	$	250	$	-	$	39	$	211

The following table shows as of March 31, 2011 and December 31, 2010 gross unrealized losses on and fair values of the Company’s investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position. All unrealized losses on investment securities are considered by management to be temporary given the credit ratings on these

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE C - INVESTMENT SECURITIES (Continued)

investment securities and the Company’s intent and ability to hold its securities to maturity. The unrealized losses as of March 31, 2011 relate to five government-sponsored residential mortgage-backed securities. The unrealized losses as of December 31, 2010 relate to one government-sponsored residential mortgage-backed security. The unrealized losses on held to maturity corporate securities as of March 31, 2011 and December 31, 2010 relate to one corporate security. The unrealized losses are not likely to reverse unless and until market interest rates decline to the levels that existed when the securities were purchased. Since the Company does not intend to sell the securities prior to recovery and it is more likely than not the Company will not be required to sell the impaired securities prior to recovery, none of the securities are deemed to be other than temporarily impaired.

	As of March 31, 2011
	Less than 12 months				12 months of more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	13,481	$	220	$	-	$	-	$	13,481	$	220
Total temporarily impaired securities	$	13,481	$	220	$	-	$	-	$	13,481	$	220

Securities held to maturity:
Corporate securities	$	-	$	-	$	211	$	39	$	211	$	39
Total securities held to maturity	$	-	$	-	$	211	$	39	$	211	$	39

	As of December 31, 2010
	Less than 12 months				12 months of more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	2,879	$	123	$	-	$	-	$	2,879	$	123
Total temporarily impaired securities	$	2,879	$	123	$	-	$	-	$	2,879	$	123

Securities held to maturity:
Corporate securities	$	-	$	-	$	211	$	39	$	211	$	39
Total securities held to maturity	$	-	$	-	$	211	$	39	$	211	$	39

The amortized cost and fair values of securities available for sale and securities held to maturity as of March 31, 2011 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE C - INVESTMENT SECURITIES (Continued)

	As of March 31, 2011
	Amortized		Fair
	Cost		Value
	(Dollars in thousands)
Securities available for sale:
U. S. government securities and obligations of U.S. government agencies
Due within one year	$	1,000	$	1,000
		1,000		1,000
Government-sponsored residential mortgage-backed securities
Due within one year		162		165
Due after one but within five years		382		397
Due after five but within ten years		5,003		4,956
Due after ten years		23,597		23,502
		29,144		29,020

Total Securities available for sale:
Due within one year	$	1,162	$	1,165
Due after one but within five years		382		397
Due after five but within ten years		5,003		4,956
Due after ten years		23,597		23,502
	$	30,144	$	30,020
Securities held to maturity:
Corporate Securities
Due after five but within ten years	$	250	$	211
	$	250	$	211

Securities with a carrying value of $8.3 million and $8.8 million as of March 31, 2011 and December 31, 2010, respectively, were pledged to secure securities sold under agreements to repurchase and public deposits.

There were no security sales during the three months ended March 31, 2011. For the three months ended March 31, 2010 proceeds from sales of investment securities of $4.9 million resulted in gross gains of $232,000.

NOTE D - COMMITMENTS

As of March 31, 2011, loan commitments were as follows:

(Dollars in thousands)

Commitments to extend credit	$	28,749
Undisbursed lines of credit		17,250
Letters of credit		1,669
Commitments to originate mortgage loans,
fixed and variable rate		77,879

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS

Following is a summary of loans segregated by category:

	March 31, 2011						December 31, 2010
				% of						% of
				Total						Total
	Amount			Loans			Amount			Loans
	(Dollars in thousands)
Real estate loans:
Residential construction	$	47,240			9.8	%	$	51,058			10.2	%
Commercial construction		74,621			15.5	%		82,136			16.5	%
Residential real estate		102,717			21.4	%		98,450			19.7	%
Commercial real estate		215,576			44.9	%		221,604			44.3	%
		440,154			91.6	%		453,248			90.7	%
Non-real estate loans:
Commercial and industrial		36,666			7.7	%		42,884			8.6	%
Consumer and other		3,437			0.7	%		3,644			0.7	%
		40,103			8.4	%		46,528			9.3	%
		480,257			100.0	%		499,776			100.0	%

Unamortized net deferred loan fees		(92	)					(253	)

Total loans	$	480,165					$	499,523

Loans are primarily funded in Wake County and New Hanover County in North Carolina. Real estate loans can be affected by the condition of the local real estate market. Commercial and installment loans can be affected by local, regional and national economic conditions.

The following describe the risk characteristics relevant to each of the portfolio segments.

Real estate construction

Commercial and residential construction loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the project as completed. 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, 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, general economic condition, the availability of long-term financing and government regulation of real property. As of March 31, 2011 and December 31, 2010, residential construction and commercial construction loans represented 9.8% and 15.5% and 10.2% and 16.5%, respectively, of our loans outstanding.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

Commercial and residential real estate

Commercial and residential real estate secured loans are subject to underwriting similar to real estate construction loans. These loans are either cash flow loans or development loans paid from the real estate sale and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher risk and 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 Company’s commercial real estate portfolio are principally secured by owner-occupied buildings including professional practices, office and church properties and single family rental properties. Management monitors and evaluates commercial real estate loans based on collateral, market area and risk grade criteria. As a general rule, the Company avoids non-owner occupied commercial 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 within its market areas. Residential real estate properties are typically secured by the primary residence of the borrower and the combined loan-to-value ratio is usually 90% or less. As of March 31, 2011 and December 31, 2010, commercial and residential real estate represented 44.9% and 21.4% and 44.3% and 19.7%, respectively, of our loans outstanding.

Commercial and industrial

Non-real estate secured 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. Management examines current and projected cash flows of the borrower to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the indentified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower and tertiary, as applicable, the guarantors. 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 guaranty. In the case of loans secured by accounts receivable, the availability of the funds for repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. As of March 31, 2011 and December 31, 2010, commercial and industrial loans represented 7.7% and 8.6% of the Company’s loans outstanding.

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 and the board of directors. The loan review process complements and reinforces the risk identification and assessment decisions made by bankers and credit personnel, as well as the Company’s policies and procedures.

The Company also originates single-family, residential mortgage loans that have been approved by secondary investors which are included on the consolidated balance sheet under the caption “loans held for sale.” The Company recognizes certain origination and service release fees from sale, which are included in non-interest income on the consolidated statements of operations. As of March 31, 2011 and December 31, 2010 mortgage loans held for sale were $11.8 million and $51.5 million, respectively.

Nonperforming assets and potential problem loans

A summary of total nonperforming assets and detail of nonaccrual loans, troubled debt restructured (“TDR”) loans, foreclosed assets and potential problem loans by loan category as of March 31, 2011 and December 31, 2010 are as follows:

- 13 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

	March 31, 2011			December 31, 2010
	(Dollars in thousands)

Nonaccrual loans	$	18,072		$	10,972
TDR nonaccrual loans		4,431			520
Total nonaccrual loans		22,503			11,492

Foreclosed assets		4,842			5,296
Total nonperforming assets	$	27,345		$	16,788

Accruing loans past due 90 days or more	$	132		$	131
TDR accruing loans	$	9,138		$	11,741
Potential problem loans	$	176		$	1,184
Allowance for loan losses	$	9,346		$	9,935

Nonaccrual loans to period end loans		4.69	%		2.30	%
Allowance for loan losses to period end loans		1.95	%		1.99	%
Nonperforming assets to total assets		4.21	%		2.65	%
Ratio of allowance for loan losses to nonaccrual loans		0.42	x		0.86	x

	As of March 31, 2011
	Nonaccrual		Nonaccrual TDR		Total Nonaccrual		Foreclosed Assets		Total Nonperforming Assets		Potential Problem Loans		Accruing TDR
	(Dollars in thousands)

Commercial and industrial	$	1,107	$	461	$	1,568	$	-	$	1,568	$	-	$	616
Commercial real estate loans:
Commercial real estate construction		4,396		2,887		7,283		1,829		9,112		-		2,252
Commercial real estate - other		1,962		570		2,532		1,459		3,991		-		3,291
		6,358		3,457		9,815		3,288		13,103		-		5,543

Residential real estate loans:
Residential real estate construction		8,352		-		8,352		665		9,017		-		2,021
Residential real estate - other		2,245		468		2,713		889		3,602		176		939
		10,597		468		11,065		1,554		12,619		176		2,960

Consumer		10		45		55		-		55		-		19
	$	18,072	$	4,431	$	22,503	$	4,842	$	27,345	$	176	$	9,138

	As of December 31, 2010
	Nonaccrual		Nonaccrual TDR			Total Nonaccrual		Foreclosed Assets		Total Nonperforming Assets		Potential Problem Loans	Accruing TDR
	(Dollars in thousands)

Commercial and industrial	$	1,544	$	54	$	1,598	$	-	$	1,598	$	461	$	1,078
Commercial real estate loans:
Commercial real estate construction		2,875		-		2,875		1,484		4,359		523		4,752
Commercial real estate - other		255		-		255		1,868		2,123		-		3,870
		3,130		-		3,130		3,352		6,482		523		8,622

Residential real estate loans:
Residential real estate construction		4,056		-		4,056		813		4,869		-		2,021
Residential real estate - other		2,231		466		2,697		1,131		3,828		200		-
		6,287		466		6,753		1,944		8,697		200		2,021

Consumer		11		-		11		-		11		-		20
	$	10,972	$	520	$	11,492	$	5,296	$	16,788	$	1,184	$	11,741

- 14 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

All classes of loans are classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans that are current or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt (as determined by the contractual terms of the note). Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms.

Past due loans

An aged analysis of past due loans segregated by loan category as of March 31, 2011 and December 31, 2010 are as follows:

	As of March 31, 2011
											Accruing
											Loans 90 or
	30 - 89 Days		Over 90		Total Past				Total		More Days
	Past Due		Days		Due		Current		Loans		Past Due
	(Dollars in thousands)

Commercial and industrial	$	248	$	1,568	$	1,816	$	34,850	$	36,666	$	-
Commercial real estate loans:
Commercial real estate construction		644		4,983		5,627		68,994		74,621		-
Commercial real estate - other		100		2,431		2,531		209,822		212,353		-
		744		7,414		8,158		278,816		286,974		-

Residential real estate loans:
Residential real estate construction		1,948		3,818		5,766		41,474		47,240		-
Residential real estate - other		1,835		2,300		4,135		101,805		105,940		132
		3,783		6,118		9,901		143,279		153,180		132

Consumer		45		10		55		2,958		3,013		-
Other		-		-		-		332		332		-
Total	$	4,820	$	15,110	$	19,930	$	460,235	$	480,165	$	132

	As of December 31, 2010
											Accruing
											Loans 90 or
	30 - 89 Days		Over 90		Total Past				Total		More Days
	Past Due		Days		Due		Current		Loans		Past Due
	(Dollars in thousands)

Commercial and industrial	$	1,797	$	602	$	2,399	$	40,485	$	42,884	$	-
Commercial real estate loans:
Commercial real estate construction		4,801		2,462		7,263		74,873		82,136		-
Commercial real estate - other		1,554		438		1,992		219,612		221,604		-
		6,355		2,900		9,255		294,485		303,740		-

Residential real estate loans:
Residential real estate construction		1,274		3,079		4,353		46,705		51,058		-
Residential real estate - other		2,510		1,863		4,373		94,077		98,450		131
		3,784		4,942		8,726		140,782		149,508		131

Consumer		11		-		11		3,165		3,176		-
Other		-		-		-		215		215		-
Total	$	11,947	$	8,444	$	20,391	$	479,132	$	499,523	$	131

- 15 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

Impaired loans

For all classes of impaired loans, interest payments are applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Accrual of interest is continued for restructured loans when the borrower is performing prior to the loan restructuring and there is reasonable assurance of repayment and continued performance under the modified terms. Accrual of interest on restructured loans in nonaccrual status is resumed when the borrower has established a sustained period of performance under the restructured terms of at least six months. Information regarding impaired loans segregated by loan category as of and for the three months ended March 31, 2011 and year ended December 31, 2010, respectively, are as follows.

- 16 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

	As of and for the three months ended March 31, 2011
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in thousands)
Impaired with no related allowance recorded:
Commercial and industrial	$	-	$	275	$	-	$	42	$	-
Commercial real estate loans:
Commercial real estate construction		6,332		6,678		-		5,328		-
Commercial real estate - other		1,420		1,474		-		1,216		-
		7,752		8,152		-		6,544		-

Residential real estate loans:
Residential real estate construction		3,305		3,546		-		3,033		-
Residential real estate - other		1,699		2,571		-		1,911		-
		5,004		6,117		-		4,944		-

Consumer		10		24		-		10		-
Total	$	12,766	$	14,568	$	-	$	11,540	$	-

Impaired accruing restructured loans with
no related allowance recorded:
Commercial and industrial	$	620	$	616	$	-	$	770	$	7
Commercial real estate loans:
Commercial real estate construction		2,264		2,252		-		2,305		28
Commercial real estate - other		3,299		3,291		-		3,487		37
		5,563		5,543		-		5,792		65

Residential real estate loans:
Residential real estate construction		2,022		2,021		-		2,021		27
Residential real estate - other		940		939		-		682		25
		2,962		2,960		-		2,703		52

Consumer		19		19		-		19		-
Total	$	9,164	$	9,138	$	-	$	9,284	$	124

Impaired with a related allowance recorded:
Commercial and industrial	$	1,568	$	2,372	$	715	$	1,552	$	-
Commercial real estate loans:
Commercial real estate construction		952		987		190		937		-
Commercial real estate - other		1,112		1,112		401		781		-
		2,064		2,099		591		1,718		-

Residential real estate loans:
Residential real estate construction		5,047		5,047		122		2,612		-
Residential real estate - other		1,013		1,013		588		931		-
		6,060		6,060		710		3,543		-
Consumer		45		45		45		30		-
Total	$	9,737	$	10,576	$	2,061	$	6,843	$	-

Total impaired
Commercial	$	17,567	$	19,057	$	1,307	$	16,418	$	72
Residential		14,026		15,137		709		11,190		52
Consumer		74		88		45		59		-
Total	$	31,667	$	34,282	$	2,061	$	27,667	$	124

- 17 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

	As of and for the year ended December 31, 2010
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in thousands)

Impaired with no related allowance recorded:
Commercial and industrial	$	54	$	204	$	-	$	130	$	-
Commercial real estate loans:
Commercial real estate construction		2,554		2,589		-		1,980		-
Commercial real estate - other		54		54		-		48		-
		2,608		2,643		-		2,028		-

Residential real estate loans:
Residential real estate construction		1,350		1,433		-		1,013		-
Residential real estate - other		989		989		-		873		-
		2,339		2,422		-		1,886		-

Consumer		11		25		-		17		-
Total	$	5,012	$	5,294	$	-	$	4,061	$	-


Impaired accruing restructured loans with
no related allowance recorded:
Commercial and industrial	$	1,089	$	1,078	$	-	$	1,081	$	56
Commercial real estate loans:
Commercial real estate construction		4,787		4,752		-		4,760		204
Commercial real estate - other		3,879		3,870		-		4,451		217
		8,666		8,622		-		9,211		421

Residential real estate loans:
Residential real estate construction		2,025		2,021		-		2,020		96
Residential real estate - other		-		-		-		-		-
		2,025		2,021		-		2,020		96

Consumer		20		20		-		22		2
Total	$	11,800	$	11,741	$	-	$	12,334	$	575

Impaired with a related allowance recorded:
Commercial and industrial	$	1,544	$	1,934	$	697	$	845	$	-
Commercial real estate loans:
Commercial real estate construction		321		321		96		350		-
Commercial real estate - other		201		201		111		98		-
		522		522		207		448		-

Residential real estate loans:
Residential real estate construction		2,706		2,763		188		2,283		-
Residential real estate - other		1,708		1,708		1,009		875		-
		4,414		4,471		1,197		3,158		-
Consumer		-		-		-		-		-
Total	$	6,480	$	6,927	$	2,101	$	4,451	$	-

Total impaired
Commercial	$	14,483	$	15,003	$	904	$	13,743	$	477
Residential		8,778		8,914		1,197		7,064		96
Consumer		31		45		-		39		2
Total	$	23,292	$	23,962	$	2,101	$	20,846	$	575

- 18 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

All loans risk rated “substandard”, “doubtful” and “loss” are reviewed to determine if they are impaired loans. If a loan is determined to be impaired it is removed from its homogeneous group and individually analyzed for impairment. Other groups of loans based on facts and circumstances may also be selected for impairment review. If a loan is impaired, a specific reserve allowance is established if necessary. Interest payments on impaired loans are typically applied to principal. Impaired loans are charged off in full or in part when losses are confirmed. As of March 31, 2011, the recorded investment in loans considered impaired totaled $31.7 million. The Company provided for probable losses through specific reserve allowances of $2.1 million with corresponding outstanding loan balances of $9.7 million. Management analyzed and determined the collateral on loan balances of approximately $1.7 million to be adequate and no additional specific reserve allowance is necessary after recording approximately $387,000 in related partial charge-offs. Included in the impaired loans as of March 31, 2011 are $9.2 million of restructured but still accruing loans and 13 restructured nonaccrual loans for $4.4 million, for a TDR balance amounting to $13.6 million. The loans were primarily restructured to forgive accrued interest due to financial difficulties of the borrower.

As of December 31, 2010, the recorded investment in loans that management considered impaired totaled $23.3 million including $11.8 million of restructured but still accruing loans and six restructured nonaccrual loans for $520,000, for a TDR balance of $12.3 million. The Company provided for probable losses through specific reserve allowances of $2.1 million with corresponding outstanding loan balances of $6.5 million. There was no corresponding allowance with the remaining $740,000 of loan balances analyzed for impairment after recording approximately $366,000 in related charge-offs. In addition, the Company identified $1.2 million of potential problem loans with $290,000 in allocated reserves included in the allowance for loan losses.

Credit Quality Indicators

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management examines certain credit quality indicators which consider the risk of payment performance, overall portfolio quality utilizing weighted-average risk rating, general economic factors, net charge-offs, non-performing loans and the level of classified loans. All loans risk rated “substandard”, “doubtful” and “loss” are reviewed on an individual basis for probable losses.

A description of our credit quality indicators follows:

Pass – loans with acceptable credit quality and moderate risk.

Special mention – This grade is intended to be temporary and includes loans (1) with potential weaknesses which if left uncorrected could result in deterioration or (2) classified as substandard accruing or substandard nonaccruing where the borrowers made improvements to their financial profile but do not yet meet the definition of a pass grade.

Substandard, accruing – These loans have a well defined weakness where the accrual of interest has not been stopped. The defined weakness may make default or principal exposure likely but not certain. These loans are likely to be dependent on collateral liquidation or a secondary source of repayment.

- 19 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

Substandard, nonaccruing – These assets have well defined weaknesses that jeopardize the liquidation of the debt and are past due over 90 days. The institution may sustain loss if the weaknesses are not corrected. These loans are inadequately protected by the paying capacity of the borrower and/or any guarantors or by the pledged collateral. These loans are individually analyzed for impairment.

Doubtful – These loans have all the weaknesses of substandard, nonaccruing plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values highly questionable and improbable.

Loss – These loans are considered uncollectable and of such little value that their continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off these loans even though partial recovery may be affected in the future.

Information regarding the Company’s credit risk by internally assigned risk grades as of March 31, 2011 and December 31, 2010 follows:

	As of March 31, 2011
	Real Estate Loans								Non-Real Estate Loans
	Construction
	Residential		Commercial		Residential		Commercial		Commercial & Industrial		Consumer		Other		Total
	(Dollars in thousands)

Pass	$	26,933	$	49,149	$	89,335	$	197,497	$	33,325	$	2,924	$	332		399,495
Special mention		3,132		11,933		8,010		3,818		1,773		23		-		28,689
Substandard accruing		8,823		9,004		5,881		8,506		-		11		-		32,225
Substandard nonaccruing		8,352		4,535		2,223		2,385		1,388		55		-		18,938
Doubtful		-		-		491		147		180		-		-		818
Loss		-		-		-		-		-		-		-		-
Total by exposure	$	47,240	$	74,621	$	105,940	$	212,353	$	36,666	$	3,013	$	332	$	480,165

	As of December 31, 2010
	Real Estate Loans								Non-Real Estate Loans
	Construction
	Residential		Commercial		Residential		Commercial		Commercial & Industrial		Consumer		Other		Total
	(Dollars in thousands)

Pass	$	28,520	$	59,248	$	86,490	$	210,372	$	38,616	$	3,066	$	215		426,527
Special mention		4,424		8,171		6,532		3,013		1,366		28		-		23,534
Substandard accruing		14,058		11,842		2,240		7,817		1,075		71		-		37,103
Substandard nonaccruing		4,056		2,875		2,697		255		1,598		11		-		11,492
Doubtful		-		-		491		147		180		-		-		818
Loss		-		-		-		-		49		-		-		49
Total by exposure	$	51,058	$	82,136	$	98,450	$	221,604	$	42,884	$	3,176	$	215	$	499,523

- 20 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE F – ALLOWANCE FOR LOAN LOSSES

An analysis of the allowance for loan losses follows:

	Three Months Ended
	March 31,
	2011			2010
	(Dollars in thousands)

Allowance for loan losses beginning of period	$	9,935		$	8,581

Provision for loan losses		1,015			1,250

Loans charged off		1,743			1,910
Recoveries		(139	)		-
Net charge-offs		1,604			1,910

Allowance for loan losses end of period	$	9,346		$	7,921

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense for estimated loan losses inherent in the loan portfolio. The allowance is maintained at a level which management considers adequate to provide for probable loan losses based on our assessment of various factors affecting the loan portfolio. Additional information regarding the Company’s policies and methodology used to estimate the allowance for possible loan losses is presented in Note B- Summary of Significant Accounting Policies of the Company’s 2010 Annual Report on Form 10-K.

The table below details activity in the allowance for loan losses by segregated loan category for the three months ended March 31, 2011 and year ended December 31, 2010. Allocation of a portion of the allowance to one class of loan does not preclude its availability to absorb losses in other categories.

	For the Three Months Ended March 31, 2011
	Real Estate Loans												Non-Real Estate Loans
	Construction
	Residential			Commercial			Residential			Commercial			Commercial & Industrial			Consumer			Other			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	1,475		$	2,269		$	2,339		$	2,464		$	1,354		$	30		$	4		$	9,935
Charge-offs		(118	)		(96	)		(873	)		(468	)		(177	)		(11	)		-			(1,743	)
Recoveries		12			-			1			11			88			27			-			139
Provision		(145	)		(21	)		549			603			4			26			(1	)		1,015
Ending balance	$	1,224		$	2,152		$	2,016		$	2,610		$	1,269		$	72		$	3		$	9,346

Ending balance, individually evaluated
for impairment	$	122		$	190		$	588		$	401		$	715		$	45		$	-		$	2,061

Ending balance, collectively evaluated
for impairment	$	1,102		$	1,962		$	1,428		$	2,209		$	554		$	27		$	3		$	7,285

Loans:
Ending balance	$	47,240		$	74,621		$	105,940		$	212,353		$	36,666		$	3,013		$	332		$	480,165
Ending balance, individually evaluated
for impairment	$	10,374		$	9,548		$	3,652		$	5,831		$	2,188		$	74		$	-		$	31,667
Ending balance, collectively evaluated
for impairment	$	36,866		$	65,073		$	102,288		$	206,522		$	34,478		$	2,939		$	332		$	448,498

- 21 -

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE F – ALLOWANCE FOR LOAN LOSSES (Continued)

	For the Year Ended December 31, 2010
	Real Estate Loans												Non-Real Estate Loans
	Construction
	Residential			Commercial			Residential			Commercial			Commercial & Industrial			Consumer			Other			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	1,753		$	2,604		$	1,276		$	2,023		$	870		$	42		$	13		$	8,581
Charge-offs		(3,152	)		(1,293	)		(765	)		(364	)		(1,224	)		(34	)		-			(6,832	)
Recoveries		34			34			7			10			6			-			-			91
Provision		2,840			924			1,821			795			1,702			22			(9	)		8,095
Ending balance	$	1,475		$	2,269		$	2,339		$	2,464		$	1,354		$	30		$	4		$	9,935

Ending balance, individually evaluated
for impairment	$	188		$	96		$	1,009		$	111		$	697		$	-		$	-		$	2,101

Ending balance, collectively evaluated
for impairment	$	1,287		$	2,173		$	1,330		$	2,353		$	657		$	30		$	4		$	7,834

Loans:
Ending balance	$	51,058		$	82,136		$	98,450		$	221,604		$	42,884		$	3,176		$	215		$	499,523
Ending balance, individually evaluated
for impairment	$	6,081		$	7,662		$	2,697		$	4,134		$	2,687		$	31		$	-		$	23,292
Ending balance, collectively evaluated
for impairment	$	44,977		$	74,474		$	95,753		$	217,470		$	40,197		$	3,145		$	215		$	476,231

NOTE G - NET INCOME PER SHARE

Basic earnings per share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares 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. Potential common shares that may be issued by the Company relate to outstanding stock options. Basic and diluted net income per common share have been computed based upon net income 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.

The weighted average number of shares outstanding or assumed to be outstanding are summarized below:

	Three Months Ended March 31,
	2011	2010

Weighted average number of common shares used in computing basic net income per share	7,427,976	7,257,980
Effect of dilutive stock options	5,797	61,646

Weighted average number of common shares and dilutive potential shares used in computing diluted net income per share	7,433,7733	7,319,6266

Due to the exercise price exceeding the average market price, the following anti-dilutive shares were excluded from the calculation of total dilutive weighted average shares. Anti-dilutive shares for the three months ended March 31, 2011 were 105,787. For the corresponding prior year period there were 112,537 anti-dilutive shares.

NOTE H - STOCK OPTION PLANS

During 2000, the Bank adopted, with shareholder approval, an Employee Stock Option Plan and a Non-Employee Director Stock Option Plan. The Company assumed these plans in July 2002 as part of the

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE H - STOCK OPTION PLANS (Continued)

Bank’s holding company reorganization. In 2003, the Company adopted, with shareholder approval, the 2003 Stock Plan. The 2003 Stock Plan replaced the two prior plans. All shares available for issuance under the prior plans, plus any shares covered by outstanding options that are forfeited under the prior plans, were transferred to the 2003 Plan. An aggregate of 1,239,827 shares of the Company’s common stock was initially reserved for options under the stock option plans. Certain of the options granted to directors in 2000 vested immediately at the time of grant. All other options granted vest 20% annually. All unexercised options expire ten years after the date of grant.

The fair market value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. In valuing options under Black-Scholes, the risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the expected life of the option grant. Expected volatility is based on the Company’s historical stock price. The expected term of the options is based upon the maximum life of the issued stock options. The expected dividend yield is based upon current yield on date of grant. No post-vesting restrictions exist for these options.

The following table illustrates the assumptions for the Black-Scholes model used in determining the fair value of options granted to employees for the three-month period ended March 31, 2010. No options were granted to employees for the three months ended March 31, 2011.

		Three Months Ended March 31, 2010
Estimated fair value of options granted			$2.11

Assumptions in estimating option values:
	Risk-free interest rate		2.41%
	Dividend yield		0.00%
	Volatility		41.0%
	Expected life	6.5 years

A summary of option activity under the stock option plans as of March 31, 2011 and changes during the three-month period ended March 31, 2011 is presented below:

			Weighted Average
	Shares		Exercise Price		Remaining Contractual Term	Aggregate Intrinsic Value
						(In thousands)

Outstanding as of December 31, 2010		140,498	$	8.51	5.19 years	$	9
Granted		-		-
Exercised		-		-
Forfeited		-		-
Expired		-		-
Outstanding as of March 31, 2011		140,498	$	8.51	4.94 years	$	24
Exercisable as of March 31, 2011		105,975	$	8.01	4.12 years	$	23

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE H - STOCK OPTION PLANS (Continued)

Range of Exercise Prices	Number of		Number of
	options		options
	outstanding		exercisable
$3.22 - $5.15		65,298		52,285
$6.37 - $12.25		48,700		37,790
$17.00 - $18.50		26,500		15,900
		140,498		105,975

Nonvested Shares				Weighted
				Average Grant
	Shares			Date Fair Value
Nonvested, December 31, 2010		38,532		$	9.64
Granted		-		$	-
Vested		(4,000	)	$	6.30
Forfeited		-		$	-
Nonvested, March 31, 2011		34,532		$	10.02

There were no options exercised or granted during the three-month period ended March 31, 2011. For the same period in 2010, the intrinsic value of options exercised was approximately $177,000 and 10,000 shares were granted. Cash received from option exercises under share-based payment arrangements for the three-month period ended March 31, 2010 was approximately $203,000. The fair value of options vested during the three-month periods ended March 31, 2011 and 2010 was approximately $25,000 and $26,000, respectively. As of March 31, 2011 and 2010, approximately $128,000 and $220,000, respectively, of share-based compensation expense remained to be recognized over a period of 4.25 and 5 years, respectively, for the current and prior year periods stated.

NOTE I – FAIR VALUES OF ASSETS AND LIABILITIES

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value

other assets on a nonrecurring basis, such as impaired loans. The nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

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

· Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. Treasury, other U.S. government and agency mortgage-backed securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

· Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party services for identical or comparable assets or liabilities.

· Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE I – FAIR VALUES OF ASSETS AND LIABILITIES (Continued)

on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

The following is a description of valuation methodologies used by the Company for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Mortgage Banking Activity

The Company enters into written loan commitments and commitments to sell mortgages. Changes in the written loan commitments subjected to recurring fair value adjustments are affected by the changes in the balances of locked mortgage loan commitments, changes in the fall out rates and changes in the prevailing secondary market prices for like-kind mortgage loans. The fall out rate measures the likelihood that an interest rate lock commitment will ultimately not become a closed loan held for sale. Fall out rates as of March 31, 2011 averaged 19.7%. The fair value adjustment associated with these written commitments was $462,500, which was included in other assets. As of December 31, 2010, fall out rates averaged 21.6% and the amount of fair value associated with written loan commitments was $411,000. Commitments to sell mortgages are generally equal and offsetting to the interest rate lock commitment. These fair values were deemed to be immaterial as of December 31, 2010 and March 31, 2011.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with accounting standards. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. As of March 31, 2011, a portion of the Company’s impaired loans was evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE I – FAIR VALUES OF ASSETS AND LIABILITIES (Continued)

Foreclosed Assets

Foreclosed assets are adjusted to fair value, less cost to sell, upon transfer of the loans to other real estate owned. Subsequently, other real estate owned assets are carried at fair value less costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis.

	As of March 31, 2011
	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Securities available for sale:
U. S. government securities and obligations of U.S. government agencies	$	1,000	$	-	$	1,000	$	-
Government-sponsored residential mortgage-backed securities		29,020		-		29,020		-
Written loan commitments		463		-		-		463
Total securities available for sale	$	30,483	$	-	$	30,020	$	463

	As of December 31, 2010
	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Securities available for sale:
U. S. government securities and obligations of U.S. government agencies	$	5,500	$	-	$	5,500	$	-
Government-sponsored residential mortgage-backed securities		3,734		-		3,734		-
Written loan commitments		411		-		-		411
Total securities available for sale	$	9,645	$	-	$	9,234	$	411

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the first three months of 2011. There were no Level 3 assets during the corresponding prior year period.

	Interest Rate
	Lock Commitments
	(Dollars in thousands)

Balance, December 31, 2010	$	411
Included in earnings		52
Balance, March 31, 2011	$	463

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.

The table below presents the balances of assets and liabilities measured at fair value on a nonrecurring basis.

	As of March 31, 2011
	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)

Impaired loans	$	9,340	$	-	$	987	$	8,353
Foreclosed assets	$	4,842	$	-	$	352	$	4,490

	As of December 31, 2010
	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)

Impaired loans	$	5,119	$	-	$	727	$	4,392
Foreclosed assets	$	5,296	$	-	$	-	$	5,296

There were no further market driven discounts applied to the year-end 2010 impaired loans that required transfers between Level 2 and Level 3 as of March 31, 2011.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE J - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS

Financial instruments include cash and due from banks, interest-earning deposits with banks, certificates of deposit with banks, federal funds sold, investments, accrued interest, loans, written loan commitments, deposit accounts and borrowings. Accounting standards require the disclosure of the estimated fair value of financial instruments. The Company has recorded certain assets at fair value. Fair value estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no active market readily exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Due from Banks, Interest-Earning Deposits with Banks, and Federal Funds Sold

The carrying amounts are a reasonable estimate of fair value for cash and due from banks, interest-earning deposits with banks, and federal funds sold because of the short maturities of those instruments.

Certificates of Deposit with Banks

The fair values are based on discounting expected cash flows at the interest rate for certificates of deposit with the same or similar remaining maturity.

Investment Securities

Fair value for investment securities available for sale equals quoted market price if such information is available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Fair value for investment securities held to maturity is determined using discounted cash flow analysis.

Loans and Loans Held for Sale

The fair value of loans is based on estimated cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, less a credit component. The carrying amount of loans held for sale is a reasonable estimate of fair value since they will be sold in a short period. This does not include consideration of liquidity that market participants would use to value such loans.

Stock in Federal Home Loan Bank of Atlanta

The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the Federal Home Loan Bank.

Deposits

The fair value of demand, savings, money market and NOW deposits is the amount payable on demand at the reporting date. The fair value of time deposits and borrowings is estimated by discounting expected cash flows using the rates currently offered for instruments of similar remaining maturities.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE J - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)

Borrowings

The fair values are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Written Loan Commitments

The Company enters into interest rate lock commitments and commitments to sell mortgages. As of March 31, 2011, the amount of fair value associated with these written loan commitments was approximately $463,000, which is included in other assets. As of December 31, 2010, the amount of fair value associated with written loan commitments was approximately $411,000. Commitments to sell mortgages are generally equal and offsetting to interest rate lock commitments and were not material as of March 31, 2011 and December 31, 2010.

Financial Instruments with Off-Balance Sheet Risk

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

The following table presents the carrying values and estimated fair values of the Company's financial instruments as of March 31, 2011 and December 31, 2010.

	March 31, 2011				December 31, 2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(Dollars in thousands)				(Dollars in thousands)
Financial assets:
Cash and due from banks	$	8,555	$	8,555	$	5,974	$	5,974
Interest-earning deposits with banks		95,729		95,729		43,859		43,859
Certificates of deposit with banks		-		-		198		198
Investment securities available for sale		30,020		30,020		9,234		9,234
Investment securities held to maturity		250		211		250		211
Loans held for sale		11,848		11,848		51,472		51,472
Loans, net		470,819		469,787		489,588		490,131
Accrued interest receivable		1,560		1,560		1,654		1,654
Stock in the Federal Home Loan Bank		1,273		1,273		1,273		1,273
Written loan commitments		463		463		411		411

Financial liabilities:
Deposits	$	577,706	$	578,662	$	562,748	$	562,640
Short-term borrowings		4,524		4,524		3,615		3,615
Long-term debt		27,263		27,219		27,269		27,253
Accrued interest payable		1,058		1,058		1,181		1,181

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE K – BUSINESS SEGMENT INFORMATION

The Company has three reportable business segments, the Bank, NSB Mortgage and the parent Company. The Bank is engaged in general commercial and retail banking in central and coastal North Carolina. The Bank operates six full-service banking offices located in Wake County and one full-service office in Wilmington, New Hanover County, North Carolina. NSB Mortgage, a division of the Bank, originates and sells single-family, residential first mortgage loans. The remaining segment consists of activities of the parent Company. The table also includes eliminations necessary to accurately report the operations of the Company. Segment reporting disclosure was not required for the three months ended March 31, 2010 as the mortgage division was not established until February 2010.

	As of or for the Three Months Ended March 31, 2011
	Bank		NSB Mortgage		Parent Company			Eliminations			Total Company
	(Dollars in thousands)

Total interest income	$	6,712	$	365	$	7		$	(4	)	$	7,080
Total interest expense		1,375		-		111			(4	)		1,482
Net interest income		5,337		365		(104	)		-			5,598
Provision for loan losses		1,015		-		-			-			1,015
Net interest income after provision
for loan losses		4,322		365		(104	)		-			4,583
Noninterest income		240		503		300			(300	)		743
Noninterest expense		4,201		759		42			-			5,002
Income before income taxes		361		109		154			(300	)		324
Income taxes		130		40		(50	)		-			120
Net income	$	231	$	69	$	204		$	(300	)	$	204

Total assets	$	629,318	$	19,745	$	52,932		$	(52,411	)	$	649,584
Net loans		470,819		-		-			-			470,819
Loans held for sale		-		11,848		-			-			11,848
Goodwill		-		141		-			-			141

	As of December 31, 2010
	Bank		NSB Mortgage		Parent Company		Eliminations			Total Company
	(Dollars in thousands)

Total assets	$	579,400	$	53,505	$	52,985	$	(52,025	)	$	633,865
Net loans		489,588		-		-		-			489,588
Loans held for sale		-		51,472		-		-			51,472
Goodwill		-		141		-		-			141

- 29 -

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

This report contains forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as we “believe,” “anticipate,” “expect” or words of similar meaning. Similarly, statements that describe our future plans, objectives or goals are also forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those currently anticipated, including: general and local economic conditions; changes in real estate values; changes in interest rates, deposit flows, and loan demand; changes in legislation or regulation including regulatory assessments; our ability to manage growth; changes in accounting principles, policies or guidelines; competition; other competitive, technological, governmental and regulatory factors affecting our operations, pricing, products, and services; and factors set out in our Annual Report on Form 10-K for the year ended December 31, 2010 and our other filings with the Securities and Exchange Commission.

Management’s discussion and analysis is intended to assist readers in the understanding and evaluation of our financial condition and results of operations. You should read this discussion in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.

Recent Market Developments in the Banking Industry

The economy and business activity within our markets generally continued to be sluggish during the first three months of 2011. The effects of the prolonged recession continues to wear on our customers through continued high unemployment rates, further declines in real estate prices in some areas on homes and commercial real estate, as well as continued increases in foreclosures.

Our financial performance is directly tied to the ability of our borrowing customers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans is highly dependent upon the business environment in the markets where we operate in Wake and New Hanover Counties, in North Carolina. Due to the state of the economy in our market areas and the resultant potential impact on our loan portfolio, we continue to closely monitor our loan portfolio, nonperforming assets and allowance for loan losses. See the discussions on “Provision for Loan Losses” and “Allowance for Loan Losses and Asset Quality.” The business environment in North Carolina and the markets in which we operate may continue to see some deterioration for the foreseeable future which could continue to adversely impact our earnings in the future. Further, newly enacted and potential further imposition of new laws and regulations and regulatory assessments from the U.S. government could significantly impact our operations in the future.

Overview

We are a commercial bank holding company that was incorporated on June 5, 2002. We have one subsidiary, North State Bank, which we acquired on June 28, 2002 as part of the formation and reorganization of our bank holding company. In March 2004, we established a subsidiary trust, North State Statutory Trust I, which we refer to as Trust I, to issue trust preferred securities. In December 2005, we established a second subsidiary trust, North State Statutory Trust II, which we refer to as Trust II and in November 2007 we established a third subsidiary trust, North State Statutory Trust III, which we refer to as Trust III. Our only business is the ownership and operation of North State Bank and its three subsidiary trusts.

North State Bank is a North Carolina chartered banking corporation. The Bank, which offers a full array of commercial and retail banking services, opened for business on June 1, 2000. Through the Bank, we currently operate six full-service banking offices located in Raleigh and Garner, North Carolina and one full-service banking office located in Wilmington, North Carolina. Our principal customers consist of professional firms, professionals, churches, property management companies, non-profits and individuals who value a mutually beneficial banking relationship. The Bank has a subsidiary, North State Financial Services, Inc., which offers brokerage services and wealth management. In February 2010, we acquired the operations of a Raleigh-based mortgage company, Affiliated Mortgage, LLC, creating North State Bank Mortgage, or NSB Mortgage, as a division of the Bank for the purpose of originating and selling single-family residential first mortgages.

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Comparison of Financial Condition as of March 31, 2011 and December 31, 2010

Total assets as of March 31, 2011 were $649.6 million, up $15.7 million or 2.5% over December 31, 2010. Our portfolio loans continued to decline due to charge-offs, transfers to foreclosed assets and a continued slow-down in new loan demand. Portfolio loans were $480.2 million as of March 31, 2011, down $19.4 million from December 31, 2010 and a slow-down in mortgage loan originations decreased loans held for sale to $11.8 million, down $39.6 million from year-end 2010. Funds from these earning assets were redeployed into interest-earning deposits in banks and purchases of investment securities in our available for sale securities portfolio. Our deposits were up overall $15.0 million or 2.7% to $577.7 million as of March 31, 2011, compared to total deposits of $562.7 million as of December 31, 2010. We continued to have improvements in our deposit mix with an increase of $32.1 million in core deposit growth since year-end 2010 primarily in noninterest-bearing demand and lower costing interest-bearing transaction accounts with simultaneous declines in non-relationship, single service time deposits as part of our plan to reduce or eliminate non-relationship deposits. Our property management division, “CommunityPLUS” continues to be the key driver in our success in growing our core deposits. Emphasis on building core deposits continues to provide us with the opportunity to fund our assets without the necessity of non-traditional deposit funds such as wholesale-brokered time deposits and internet deposits. Year-end 2010 internet deposits of $5.2 million were eliminated by purposely not renewing the maturing time deposits during the first three months of 2011.

Excess funds due to lower loan demand and fewer mortgage originations were in part utilized for new purchases of available for sale investment securities as well as an increase in our interest-earning deposits with banks. As of March 31, 2011, our interest-earning deposits with banks included $93.3 million in excess overnight funds in our Federal Reserve account and $2.4 million held at correspondent banks compared to $42.4 million and $1.5 million, respectively, as of December 31, 2010. Our available for sale investment portfolio grew to $30.0 million as of March 31, 2011 from $9.2 million as of December 31, 2010. Maturities of $5.8 million in U.S. Treasury notes and cash flow from Government-sponsored residential mortgage-backed securities were re-deployed into available for sale investment purchases. In total, we purchased $26.6 million in Government-sponsored residential mortgage-backed securities during the first three months of 2011. All of our investments are accounted for as available for sale and are presented at their fair market value with the exception of $250,000 in corporate bonds that are accounted for as held to maturity and are carried at book value.

Our portfolio loans decreased $19.4 million or 3.9% to $480.2 million as of March 31, 2011 compared to $499.5 million as of December 31, 2010. The decline in the loan portfolio reflects a continued cycle of higher levels of loan payoffs over new loan volume, $1.6 million of net charge-offs as well as $419,000 of transfers to foreclosed assets. New loan demand remains slow due to the continued effects of the sluggish economy as well as our strategic focus on lending only to relationship customers within our targeted customer groups. There have been slight changes in our loan composition since year-end 2010, however the portfolio remains primarily secured by real estate at $440.2 million or 91.6% of loans outstanding as of March 31, 2011. Real estate values are generally affected by changes in economic conditions, fluctuations in interest rates, the availability of loans to potential purchasers as well as changes in tax and other laws. A further downturn in the real estate markets in which we operate, specifically New Hanover and Wake Counties, could have an adverse effect on our business, financial condition and results of operations because of loans in these markets secured by real estate. Borrowers may not be able to make current payments on or repay real estate loans and the value of the collateral securing these loans may decline, which would reduce the security for these loans.

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As part of our long-term strategy to minimize construction and land development lending, real-estate-secured construction and land development loans decreased $11.3 million to 25.3% of loans outstanding from 26.7% as of year-end 2010 as construction projects were paid off or completed and moved to longer-term financing. Our concentration in commercial real estate remains high at $290.2 million or 60.4% of the loan portfolio and exposes us to more credit and regulatory risk than other types of loans and has become a focal point of the federal banking regulators. Our concentration in these loans has and could possibly subject us to adverse comment or action by our federal and state banking regulators, including the FDIC, the Federal Reserve and the North Carolina Commissioner of Banks. Properties securing these loans are located within our New Hanover County market, representing approximately 8.8%, and Wake County, representing approximately 91.2%. Residential real-estate loans including construction loans represented approximately 31.2% of the loan portfolio at $150.0 million as of March 31, 2011 compared to 29.9% of the loan portfolio as of year-end 2010. Non-real estate commercial and industrial loans declined to $36.7 million or 7.6% of loans from 8.6% as of year-end 2010. Loan originations within our NSB Mortgage division declined during the first three months of 2011 as the volume of loan refinances declined sharply and new loans from home sales continued to be slow during this period. As of March 31, 2011, mortgage loans held for sale were $11.8 million compared to $51.5 million as of year-end 2010.

The following table is a summary of our loans outstanding by major category for the total Bank, New Hanover County and Wake County.

							New Hanover County						Wake County
	March 31, 2011						March 31, 2011						March 31, 2011
	Amount			% of Total Loans			Amount			% of Total Bank Loans			Amount			% of Total Loans
	(Dollars in thousands)
Real estate loans:
Residential construction	$	47,240			9.8	%	$	5,201			1.1	%	$	42,039			8.8	%
Commercial construction		74,621			15.5	%		19,586			4.1	%		55,035			11.5	%
Residential real estate		102,717			21.4	%		11,858			2.4	%		90,859			18.9	%
Commercial real estate		215,576			44.9	%		22,830			4.8	%		192,746			40.1	%
		440,154			91.6	%		59,475			12.4	%		380,679			79.3	%
Non-real estate loans:
Commercial and industrial		36,666			7.7	%		5,644			1.2	%		31,022			6.4	%
Consumer and other		3,437			0.7	%		730			0.1	%		2,707			0.6	%
		40,103			8.4	%		6,374			1.3	%		33,729			7.0	%
		480,257			100.0	%		65,849			13.7	%		414,408			86.3	%

Unamortized net deferred loan fees		(92	)					(37	)					(55	)
Total loans	$	480,165					$	65,812					$	414,353

The allowance for loan losses was $9.3 million as of March 31, 2011 compared to $9.9 million as of December 31, 2010, representing 1.95% and 1.99%, respectively, of loans outstanding at each date. The allowance is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. The level of the allowance relative to gross loans declined primarily as a result of $1.6 million in net charge-offs during the first three months of 2011 and a $19.4 million decline in loans. Also impairment analysis of the collateral securing new additions to impaired loans concluded the value of the collateral was sufficient, requiring minimal additional impairment reserves as of March 31, 2011. Management further considered the $7.1 million decline in 30-89 day past due loans since year-end 2010 in the evaluation of the allowance for loan losses. We established the allowance for loan losses at a level management considers adequate to provide for probable loan losses based on our assessment of our loan portfolio as of March 31, 2011. We monitor the allowance monthly.

Our premises and equipment remained substantially unchanged from year-end 2010 at $14.7 million. Foreclosed assets declined to $4.8 million as of March 31, 2011 from $5.3 million as of December 31, 2010 reflecting $419,000 of additional properties, sales of $438,000, capital expenditures on foreclosed properties of $63,000 and valuation adjustments on foreclosed properties of $470,000 during the three months ended March 31, 2011. Additional discussion regarding foreclosed assets is included in the section “Allowance for Loan Losses and Asset Quality.”

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As of March 31, 2011 our deposits were $577.7 million, an increase of $15.0 million from $562.7 million as of December 31, 2010 due to significant growth in core deposits primarily funded through our property management division “CommunityPLUS”. Traditional core deposits grew $32.1 million effectively reducing non-relationship deposits such as time deposits greater than $100,000 by $9.3 million and eliminating entirely non-core internet deposits which were $5.2 million as of year-end 2010. As was the same for year-end 2010, our time deposits as of March 31, 2011 also do not include any wholesale brokered certificates of deposit.

Our deposit mix continues to improve as we emphasize relationship deposits with individuals and entities within our market areas and from our “CommunityPLUS” customers within North Carolina and six other states including Maryland, South Carolina and New Mexico. Noninterest-bearing demand deposits and low-cost interest-bearing transaction accounts increased to 23.7% and 45.5%, respectively, of total deposits as of March 31, 2011 compared to 20.9% and 44.5%, respectively, as of year-end 2010. Simultaneously for the same periods, higher costing time deposits declined to 30.7% of total deposits compared to 34.6%. In total, our core deposits increased $32.1 million over year-end 2010 representing 81.3% compared to 78.0%, respectively, of our total deposits as of March 31, 2011 and year-end 2010. A key factor to our success in core deposit growth is through our “CommunityPLUS” division, dedicated to growing deposits specifically in the property management industry. This division experienced deposit growth of approximately $37.2, million growing to approximately $237.7 million as of March 31, 2011 compared to $200.4 million as of year-end 2010. As of March 31, 2011, deposits within this division represented approximately 41.1% of our total deposits, up from 36.0% of total deposits as of year-end 2010.

Non-interest bearing deposits increased $19.2 million or 16.2% to $137.1 million as of March 31, 2011 compared to $117.8 million as of year-end 2010 while interest-bearing transaction deposits grew to $263.0 million, an increase of $12.6 million or 5.0%. Our “CommunityPLUS” division contributed approximately $18.4 million and $14.0 million, respectively, of the increases in these deposit fund categories. Conversely, time deposits decreased $16.8 million to $177.6 million as of March 31, 2011 down from $194.4 million as of year-end 2010. The decline in these deposits was, for the most part, intentional as strategic decisions regarding profitability and/or non-relationship accounts led to the intentional reduction in generally more volatile time deposits over $100,000, which declined $9.3 million from year-end 2010 in addition to the purposeful elimination of $5.2 million of non-relationship internet deposits. Time deposits through participation in the Certificate of Deposit Account Registry Service, or CDARS, program decreased $2.6 million to $23.5 million as of March 31, 2011. The CDARS program provides full FDIC insurance on deposit balances greater than posted FDIC limits by exchanging larger depository relationships with other CDARS members. The balance of generally more relationship generated time deposits less than $100,000 remained substantially unchanged from year-end 2010 at $69.8 million as of March 31, 2011.

Our focus for the future will be to continue to grow traditional core deposits with our customers with whom we aim to obtain the customers’ primary borrowing and deposit relationship as well as from “CommunityPLUS”. Continued success in these efforts are expected to continue to eliminate or reduce any future reliance on wholesale brokered time deposits and other non-traditional funding sources such as internet deposits.

Strong core deposit growth continues to minimize our need for short-term borrowings. Short-term borrowings as of March 31, 2011, consisting solely of securities sold under repurchase agreements, were $4.5 million, compared to $3.6 million as of year-end 2010. Long-term borrowings remained unchanged from year-end 2010 at $27.3 million consisting primarily of $11.0 million of subordinated notes and $15.5 million in junior subordinated debentures.

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Total shareholders’ equity increased $211,000 to $37.7 million as of March 31, 2011. The increase was primarily provided by net income of $204,000.

Comparison of Results of Operations for the Three-Month Periods Ended March 31, 2011 and 2010

Net Income. For the three-month period ended March 31, 2011, net income was $204,000 compared to $514,000 for the corresponding three-month period of 2010, representing a decrease of $310,000 or 60.3%. On a diluted share basis, earnings were $.03 and $.07 per share, respectively, for the three-month periods ended March 31, 2011 and 2010. The length and depth of the recession and its sluggish recovery continues to affect real estate and business activity in the markets we serve and continues to restrain our overall results of operations compared to pre-recession results. Lower earnings continue to be driven by higher loan loss provision, up $235,000, and additional foreclosed asset valuation adjustments, up $237,000. The effect of these additional costs were minimized through strong core earnings generated by favorable changes in deposit mix, which provided increased net interest income of $155,000, additional mortgage income of $328,000 from our mortgage division, as well as a continuation of expense reduction initiatives begun early in 2009. In addition the first three months of 2010 included net gains of $232,000 from sales of investment securities while there was no such gain in the first three months of 2011. For the three months ended 2011 return on average assets was .30% compared to .49% for the prior year period while for the same periods return on average equity was 5.60% compared to 9.28%.

Net Interest Income. Interest income for the three months ended March 31, 2011 decreased $520,000 or 6.8% over the prior year period while for the same period interest expense decreased $675,000 or 31.3% resulting in a net increase of $155,000 in net interest income over the prior year three-month period. Net interest income was $5.6 million for the three-month period ended March 31, 2011 compared to $5.4 million for the prior year period, up 2.8%. Our focus on developing and maintaining our core deposit relationships while simultaneously reducing non-core deposits brought beneficial changes to our deposit mix with a corresponding decrease in interest expense. The favorable change in deposit mix was the primary factor for the increase in net interest income over the prior year period.

Interest income is affected by changes in the mix and volume of average earning assets, interest rates and also by the level of loans on nonaccrual status. Interest income for the three months ended March 31, 2011 was $7.1 million compared to $7.6 million for the prior year period, a decrease of $520,000 primarily due to a $27.3 million decrease in volume of average loans, our highest yielding earning asset. The decline in average loan volume effectively reduced interest income by approximately $383,000. In addition, the level of nonaccrual loans averaged approximately $576,000 higher than the previous year period reducing interest income approximately $24,000. Declines in volume of lower-yielding average investment securities and certificates of deposit with banks effectively reduced interest income by approximately $258,000 while a $23.8 million higher level of average mortgage loans held for sale provided additional interest income of approximately $261,000. In total, lower yields on average-interest earning assets effectively reduced interest income by approximately $151,000.

Our efforts in improving our deposit mix and repricing time deposits at lower rates were the primary factors for the overall decrease in interest expense. Interest expense for the three months ended March 31, 2011 was $1.5 million compared to $2.2 million for the prior year three-month period, a decrease of $675,000. Average time deposits decreased $71.1 million from the previous year period primarily in non-core wholesale brokered, internet and single-service certificates of deposit. These higher-costing and generally more volatile deposits were replaced with lower costing interest checking, money market and non-interest-bearing transaction deposits which grew in total an average of $34.5 million, of which $22.3 million were in non-interest-bearing demand deposits. The decrease in average time deposits decreased interest expense by approximately $340,000 while lower interest rates paid on overall interest-bearing deposits reduced total interest expense by approximately $360,000.

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The yield on our earning assets averaged 4.78% during the first three months of 2011 compared to 4.83% during the first three months of 2010. During the same period, the cost of our interest-bearing liabilities averaged 1.28% compared to 1.65%. Overall our net interest margin, excluding average nonaccrual loans, increased 32 basis points to 3.78% during the first three months of 2011 compared to 3.46% for prior year period.

The following table contains information relating to our average balance sheet and reflects the average yield on assets and cost of liabilities for the periods indicated. Such annualized yields and costs are derived by dividing annualized income or expense by the average balances of assets or liabilities, respectively, for the periods presented.

	Three Months Ended							Three Months Ended
	March 31, 2011							March 31, 2010
	Average				Average			Average				Average
	Balance		Interest		Rate			Balance		Interest		Rate
	(Dollars in thousands)
Interest-earning assets:
Loans (1)	$	476,386	$	6,660		5.67	%	$	503,653	$	7,101		5.72	%
Loans held for sale		28,674		274		3.88	%		4,852		60		5.02	%
Investments available for sale		15,504		100		2.62	%		23,518		201		3.47	%
Investments held to maturity		250		3		4.87	%		750		9		4.87	%
Other interest-earning assets		80,408		43		0.22	%		105,724		229		0.88	%
Total interest-earning assets		601,222		7,080		4.78	%		638,497		7,600		4.83	%

Other assets		44,788							45,787

Total assets	$	646,010						$	684,284

Interest-bearing liabilities:
Deposits:
Savings, NOW & money market	$	250,598	$	480		0.78	%	$	238,411	$	545		0.93	%
Time deposits over $100,000		91,580		424		1.88	%		128,589		750		2.37	%
Other time deposits		95,116		346		1.48	%		129,193		636		2.00	%
Short-term borrowings		4,440		1		0.09	%		6,059		6		0.40	%
Long-term debt		27,265		231		3.44	%		27,287		220		3.27	%
Total interest-bearing liabilities		468,999		1,482		1.28	%		529,539		2,157		1.65	%

Demand deposits		136,936							114,622
Other liabilities		2,120							2,884
Shareholders' equity		37,955							37,239

Total liabilities and shareholders' equity	$	646,010						$	684,284

Net interest income and interest rate spread			$	5,598		3.49	%			$	5,443		3.18	%

Net yield on average interest-earning assets						3.78	%						3.46	%

Ratio of average interest-earning assets
to average interest-bearing liabilities						128.19	%						120.58	%

Net yield on average interest-earning assets including nonaccrual loans						3.66	%						3.36	%

(1) Nonaccrual loans are excluded in loan amounts.

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Provision for Loan Losses. The provision for loan losses was $1.0 million for the three months ended March 31, 2011, $235,000 lower than in the prior year three-month period. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level considered appropriate by our management. The decline in the provision for the three-month period ended March 31, 2011 is principally due to fewer charge-offs compared to the prior year period. The allowance for loan losses was $9.3 million as of March 31, 2011 or 1.95% of loans outstanding compared to $9.9 million or 1.99% of loans outstanding as of year-end 2010. See “Allowance for Loan Losses and Asset Quality” for additional detail.

Non-interest Income. Non-interest income increased $157,000 or over 26.8% to $743,000 for the three months ended March 31, 2011 over the prior year period due to higher fee income generated from our mortgage division. Fees from mortgage operations were $497,000 for the three months ended 2011, compared to $169,000 during the prior year three months. We did not begin operating our mortgage division until after our acquisition of Affiliated Mortgage in mid-February 2010 thereby less income was generated during the first three months of 2010 from this division. Fees from annuity sales and other fees generated from our wealth management services division provided $86,000 in non-interest income, up $66,000 or over 300% over the prior year period. Our successful restructure of our wealth management services division and the appointment of a new director for this division during the second quarter of 2010 continues to generate higher levels of income over periods prior to the division restructure. We expect fees from this division as well as fees from our mortgage division to be key sources of noninterest income in the future. Service charges and fees on deposit accounts and merchant and other loan fees were comparable to the prior year period at $124,000 for the three months ended March 31, 2011. Non-interest income for the three months ended March 31, 2010 included net security gains from our available for sale portfolio of $232,000. We did not have any sales of investment securities for the current year three-month period. As a percentage of average assets, non-interest income increased to .47% for the three months ended March 31, 2011 compared to .35% for the prior period.

Non-interest Expense. Non-interest expense for the three months ended March 31, 2011 increased $1.1 million or 28.2% to $5.0 million from $3.9 million for the prior year period. The increase is primarily attributable to additional valuation adjustment to foreclosed assets, up $237,000, over the prior year period as well as additional personnel costs attributable to our mortgage division which was operational for only a portion of the first three months of 2010. Due to the continued uncertainty regarding the longevity of the current economic downturn in our markets and its effects on the business activity of our borrowing customers, we determined it prudent to continue expense reducing initiatives that we began in early 2009 with the exception of corporate board fees which we re-instated early in 2011. These fees had been previously suspended for the past two years.

Salaries and other personnel expense represent our largest expense category at $2.3 million for the three months ended March 31, 2011, up over $600,000 or 40.7% from $1.6 million for the prior year period. Approximately $466,000 of the increase is attributable to our mortgage division by means of commissions paid to mortgage loan originators as well as additional costs for support personnel within this division. Personnel expense within our wealth management services division is also primarily fee driven. Higher fee income resulted in higher commission expense, up approximately $68,000 over the prior year period. We continued to temporarily suspend 401k matching benefits, incentive bonuses as well as merit increases as part of the cost savings initiatives we began in 2009. As a percentage of average assets, personnel expense increased to 1.36% for the three months ended March 31, 2011 compared to .95% for the prior year period.

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Occupancy and equipment costs remained substantially unchanged at $703,000 for the three months ended March 31, 2011 and 2010. Other non-interest expenses increased $441,000 or 28.4% over the prior year period primarily due to increased expenses related to foreclosed assets. Subsequent to foreclosure, valuations are periodically performed on the properties. Due to continued downturn in the markets we serve, specifically New Hanover and Wake County, revaluations of foreclosed properties resulted in valuation losses of $470,000 for the three months ended March 31, 2011, up $237,000 or 101.7% over the prior year period. General costs to maintain foreclosed properties net of rental income received were down approximately $73,000 over the prior year period. As a percent of average assets, net foreclosed asset costs were .29% for the three months ended March 31, 2011 compared to .19% for the prior year period. FDIC insurance premiums were down $32,000 from the prior year period due to a lower deposit base. Our outsourced services expense is related to data processing and other services for our customers’ accounts. These services are primarily volume driven and increase as we add new offices and products with corresponding increases in loan, deposit and other customer-based accounts. In total, outsourced data processing fees were up $117,000 over the prior year period, substantially in response to outsourced software services due to increased volume from customers of our “CommunityPLUS” division. There were no other significant changes in other noninterest expenses. Including additional net costs related to foreclosed assets and additional personnel expense as a result of our mortgage division, our non-interest expense as a percentage of average assets was 3.14% for the three months ended March 31, 2011 compared to 2.31% for the prior year period.

Allowance for Loan Losses and Asset Quality

Nonperforming assets as of March 31, 2011 were comprised of $22.5 million nonaccrual loans, and foreclosed assets of $4.8 million. Included in nonaccrual loans were $4.4 million restructured loans considered troubled debt restructurings, or TDRs. Not included in nonperforming assets were accruing TDRs of $9.1 million, $132,000 of accruing loans past due 90 days or more and accruing potential problem loans of $176,000. Concessions we have granted to customers experiencing cash flow difficulties resulting in a TDR include reduction in interest rate, forgiveness of interest or modification of payment terms.

Our level of 30 to 89 day past due loans was $4.8 million as of March 31, 2011, down from $11.9 million as of year-end 2010. Total nonaccrual loans increased to $22.5 million or 4.69% of period-end loans as of March 31, 2011, up from $11.5 million or 2.3% of period-end loans as of December 31, 2010. Our borrowers tied to the residential and commercial real estate industry continued to experience slow business activity resulting from the recession. The business activity of our customers in the markets we serve, particularly those involved in residential real estate, have experienced increased restriction on cash-flows during the first three months of 2011 resulting from seasonal low real estate sales. Consequently, loans that may have been past due as of December 31, 2010, were moved to nonaccrual status as of March 31, 2011. A decline in past due loans as of March 31, 2011 may indicate a possible downward trend in nonaccrual loans as was reflected in our level of nonaccrual loans throughout 2010.

The tables below present for the dates indicated summary information regarding our non-performing assets, TDRs, potential problem loans and loans 90 days or more past due. For further detail by loan category, see Note E to our consolidated financial statements.

	March 31, 2011			December 31, 2010
	(Dollars in thousands)

Nonaccrual loans	$	18,072		$	10,972
Troubled debt restructured nonaccrual loans		4,431			520
Total nonaccrual loans		22,503			11,492

Foreclosed assets		4,842			5,296
Total nonperforming assets	$	27,345		$	16,788

Accruing loans past due 90 days or more	$	132		$	131
Troubled debt restructured accruing loans	$	9,138		$	11,741
Potential problem loans	$	176		$	1,184
Allowance for loan losses	$	9,346		$	9,935

Nonaccrual loans to period end loans		4.69	%		2.30	%
Allowance for loan losses to period end loans		1.95	%		1.99	%
Nonperforming assets to total assets		4.21	%		2.65	%
Ratio of allowance for loan losses to nonaccrual loans		0.42	x		0.86	x

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As of March 31, 2011, 92.8% of our nonaccrual loans were real-estate secured, with 33.5% represented within our New Hanover County market. Real-estate secured construction and land development loans comprised 69.5% of nonaccrual loans, all residential construction loans were located in our Wake County market, while 10.7% of commercial construction loans were located in Wake County and 21.7% in New Hanover County. In total, $7.7 million or 34.4% of the $22.5 million nonaccrual loans as of March 31, 2011 were located in our New Hanover County market area with the remaining 65.6% represented throughout our locations in Wake County.

The following table is a summary of our nonaccrual loans by major category for the total Bank, New Hanover County and Wake County as of March 31, 2011.

	Nonaccrual Loan Composition as of March 31, 2011
	Total Bank					New Hanover County					Wake County
	Amount		% of Total Nonaccrual Loans			Amount		% of Total Nonaccrual Loans			Amount		% of Total Nonaccrual Loans
	(Dollars in thousands)
Real estate loans:
Residential construction	$	8,352		37.1	%	$	-		0.0	%	$	8,352		37.1	%
Commercial construction		7,283		32.4	%		4,873		21.7	%		2,410		10.7	%
Residential real estate		2,713		12.1	%		802		3.6	%		1,911		8.5	%
Commercial real estate		2,532		11.2	%		1,874		8.3	%		658		2.9	%
		20,880		92.8	%		7,549		33.6	%		13,331		59.2	%
Non-real estate loans:
Commercial and industrial		1,568		7.0	%		180		0.8	%		1,388		6.2	%
Consumer and other		55		0.2	%		10		0.0	%		45		0.2	%
		1,623		7.2	%		190		0.8	%		1,433		6.4	%
Total nonaccrual loans	$	22,503		100.0	%	$	7,739		34.4	%	$	14,764		65.6	%

An aggregate of $13.4 million of the nonaccrual loans as of March 31, 2011 is attributable to eight borrowers for various residential and commercial construction and commercial and industrial loans, of which $5.2 million of the construction loans are located in our New Hanover County market area and $6.5 million are located in our Wake County market area. Commercial and industrial loans of $1.5 million were to borrowers in Wake County and $184,000 non-owner occupied commercial real estate loan in Wake County. The average loan exposure for these borrowers is approximately $1.9 million with the largest exposure to any one borrower included in our nonaccrual loans at $4.5 million for residential construction. Each specific loan in these customer relationships was analyzed for impairment and our management concluded specific impairment reserves aggregating $436,000 on these loans were necessary in addition to $808,000 of partial charge-offs. Our impairment analysis on the remaining $9.1 million of nonaccrual loans resulted in additional impairment reserves of $1.6 million in addition to life to date partial charge-offs of $1.8 million. Included in the above nonaccrual loans are 11 residential and commercial real estate loans totaling $4.4 million which were restructured to forgive all accrued interest due to financial difficulties of the borrower. See Note E to our consolidated financial statements for additional detail regarding loans, nonaccrual loans and credit quality.

Our loan loss allowance is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. Net charge-offs were $1.6 million for the three-month period ended March 31, 2011 compared to net charge-offs of $1.9 million for the prior year period. Approximately $1.5 million or 95.4% of the loans charged off for the three months ended March 31, 2011 were real estate secured loans, and 80.4% were properties located in our Wake County market. Overall, residential real estate property represented 54.4% and commercial real estate property represented 28.5% of the charge-offs for the first three months of 2011. Our loan loss allowance as a percentage of loans was 1.95% as of March 31, 2011 and 1.99% as of December 31, 2010. The decrease in the level of the loan loss allowance relative to gross loans resulted primarily from the $1.6 million of charge-offs during the first three months of 2011 net of increased reserves allocated to specific loans and an increase in the general reserve due to increases in risk factors.

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The following table is a summary of our net charge-offs by major category for the total Bank, New Hanover County and Wake County as of March 31, 2011.

	Net Charge-off Composition as of March 31, 2011
	Total Bank						New Hanover County						Wake County
				% of						% of						% of
				Net						Bank Net						Bank Net
	Amount			Charge-offs			Amount			Charge-offs			Amount			Charge-offs
	(Dollars in thousands)
Real estate loans:
Residential construction	$	106			6.6	%	$	(12	)		-0.7	%	$	118			7.4	%
Commercial construction		96			6.0	%		-			0.0	%		96			6.0	%
Residential real estate		872			54.4	%		201			12.5	%		671			41.8	%
Commercial real estate		457			28.5	%		53			3.3	%		404			25.2	%
		1,531			95.5	%		242			15.1	%		1,289			80.4	%
Non-real estate loans:
Commercial and industrial		89			5.5	%		(37	)		-2.3	%		126			7.8	%
Consumer and other		(16	)		-1.0	%		3			0.2	%		(19	)		-1.2	%
		73			4.5	%		(34	)		-2.1	%		107			6.6	%
Total loans	$	1,604			100.0	%	$	208			13.0	%	$	1,396			87.0	%

Liquidity and Capital Resources

Our liquidity is a measure of our ability to fund loans, withdrawals and maturities of deposits, and other cash outflows in a cost effective manner. Our principal sources of liquidity are deposits, scheduled payments and prepayments of loan principal, maturities of investment securities, access to liquid assets, and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Liquid assets (consisting of cash and due from banks, interest-earning deposits with other banks, certificates of deposit with banks, Federal funds sold, investment securities and loans classified as held for sale) comprised $146.2 million or 22.5% and $110.7 million or 17.5%, respectively, of our total assets as of March 31, 2011 and December 31, 2010.

As a member of the FHLB, we may obtain advances of up to 10% of our Bank’s assets. We are also authorized to borrow from the Federal Reserve Bank’s “discount window”. As of March 31, 2011, we had pledged specific collateral for potential borrowing of up to $160.7 million from the “discount window.” As another source of short-term borrowings, we also utilize securities sold under agreements to repurchase. As of March 31, 2011, our short-term borrowings consisted of securities sold under agreements to repurchase of $4.5 million. As of March 31, 2011, overnight excess funds of $93.3 million were invested in our account at the Federal Reserve.

Total deposits were $557.7 million and $562.7 million, respectively, as of March 31, 2011 and December 31, 2010. Time deposits, which are the only deposit accounts that have stated maturity dates, are generally considered to be rate sensitive. Time deposits represented 30.7% and 34.6%, respectively, of total deposits as of March 31, 2011 and December 31, 2010. Time deposits of $100,000 or more represented 12.1% and 12.3%, respectively, of our total deposits as of March 31, 2011 and December 31, 2010. As of March 31, 2011 and year-end 2010, we had no wholesale brokered certificates of deposit. Under FDIC regulations governing brokered deposits, well capitalized institutions are not subject to brokered deposit limitations. To be categorized as well capitalized, the Bank must maintain a minimum ratio of total risk-based capital of 10.0% among other ratios. As of March 31, 2011, the Bank was “well capitalized” with a total risk-based capital ratio of 13.92%. Deposits generated through an internet subscription service of $5.2 million as of year-end 2010, were purposely eliminated as of March 31, 2011. We believe that most of our time deposits are relationship-oriented. While we will need to pay competitive rates to retain deposits at their maturities, there are other subjective factors that we believe will determine their continued retention and we will continue to focus on developing full banking relationships with our customers. Based upon prior experience, we anticipate that a substantial portion of outstanding certificates of deposit will renew upon maturity. We closely monitor and evaluate our overall liquidity position on an ongoing basis and adjust our position as management deems appropriate. We believe our liquidity position as of March 31, 2011 is adequate to meet our operating needs.

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Short and long-term borrowings as of March 31, 2011 and December 31, 2010 are as follows:

	March 31, 2011		December 31, 2010
	(Dollars in thousands)
Short-term borrowings
Repurchase agreements	$	4,524	$	3,615
	$	4,524	$	3,615

Long-term borrowings
FHLB advances	$	798	$	804
Subordinated debentures		11,000		11,000
Junior subordinated debentures		15,465		15,465
	$	27,263	$	27,269

A description of the trust preferred securities and related junior subordinated debentures outstanding as of March 31, 2011 and December 31, 2010 is as follows:

	March 31, 2011		December 31, 2010		Maturity	Interest
	(Dollars in thousands)				Date	rate
North State Statutory Trust I	$	5,155	$	5,155	4/17/2034	3 mo LIBOR plus 2.79%, resets quarterly
North State Statutory Trust II		5,155		5,155	4/15/2035	3 mo LIBOR plus 1.65%, resets quarterly
North State Statutory Trust III		5,155	$	5,155	12/15/2037	3 mo LIBOR plus 2.75%, resets quarterly
	$	15,465	$	15,465

A description of the subordinated notes outstanding as of March 31, 2011 and December 31, 2010 is as follows:

	March 31, 2011		December 31, 2010		Maturity	Interest
	(Dollars in thousands)				Date	rate
Floating rate subordinated notes	$	11,000	$	11,000	6/30/2018	3 mo LIBOR plus 3.50%, resets quarterly

As of March 31, 2011, our equity to assets ratio was 5.25%. The Bank's tier 1 leverage and tier 1 risk based capital ratios and its total risk based capital ratios were 7.92%, 10.42% and 13.92%, respectively, as of March 31, 2011 compared to 8.04%, 9.64% and 12.99% as of December 31, 2010. As of March 31, 2011, the Bank exceeded the minimum requirements of a "well capitalized" institution as defined by federal banking regulations. Based on the current economic and regulatory environment, the Bank’s board of directors has decided to maintain a Tier I leverage ratio of 8% or more and a total risk based capital ratio of 12% or more. As of March 31, 2011 our total risk based capital ratio was above 12% and while we were marginally below the Tier I leverage ratio of 8%, we anticipate exceeding that threshold by the end of June 2011.

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Item 3. Quantitative and Qualitative Disclosures 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.

The largest component of our earnings is net interest income which can fluctuate widely, directly impacting our overall earnings. Significant interest rate movements occur due to differing maturities or repricing intervals of our interest-earning assets and interest-bearing liabilities and the fact that rates on these financial instruments do not change uniformly. Management is responsible for minimizing our exposure to interest rate risk. This is accomplished by developing objectives, goals and strategies designed to enhance profitability and performance while minimizing our overall interest rate risk.

We use several modeling techniques to measure interest rate risk. Our primary method is the simulation of net interest income under varying interest rate scenarios. We believe this methodology is reliable in that it takes into account the pricing strategies we would undertake in response to rate changes, whereas other methods such as interest rate shock or balance sheet gap analysis do not take these into consideration. Our balance sheet remains asset-sensitive, which means that more assets than liabilities are subject to immediate repricing as market rates change. During periods of rising rates, this should result in increased interest income. The opposite would be expected during periods of declining rates.

In addition to simulation of net interest income, we utilize a discounted net present value of cash flow analysis called Economic Value of Equity or “EVE”. This methodology aids management in identifying long-term interest rate risk. Additional discussion of EVE is presented in Item 7, under “Asset/Liability Management” of our Annual Report on Form 10-K for the year ended December 31, 2010.

Our hedging strategy is generally intended to take advantage of opportunities to reduce, to the extent possible, unpredictable cash flows. We may use a variety of commonly used derivative products that are instruments used by financial institutions to manage interest rate risk. The products that may be used as part of a hedging strategy include swaps, caps, floors and collars. We previously have used a stand-alone derivative financial instrument, in the form of an interest rate floor, in our asset/liability management program. Additional discussion of derivatives is presented in Note L to our consolidated financial statements included under Item 8 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2010.

Item 4. Controls and Procedures

(a)

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)) pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31, 2011.

(b)

No change in our internal control over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II. OTHER INFORMATION

Item 6.

Exhibits

Exhibit #

Description

31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)

31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)

32.1	Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2	Certification by the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

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

	NORTH STATE BANCORP

Date: May 13, 2011	By:	/s/ Larry D. Barbour
		Larry D. Barbour
		President and Chief Executive Officer

Date: May 13, 2011	By:	/s/ Kirk A. Whorf
		Kirk A. Whorf
		Executive Vice President and Chief Financial Officer

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